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

Thank you all for joining us. I'm John Kreger, the analyst at Blair that covers Charles River. By way of disclosures, please see williamblair.com for any and all conflicts that we have. Logistically, as we've done all week, we're going to do a 30-minute presentation here in the room. And then anyone that wants to take part in Q&A, that will be in Richardson upstairs on the second floor. Presenting will be Jim Foster, the CEO. Thank you, Jim, for coming. And then we also have Flavia Pease, the brand-new CFO, sitting here in the front row; and also Todd Spencer, running IR. They'll both be available for Q&A upstairs. So with that, Jim, I'll turn it over to you.

Thank you, John. Always a pleasure to be at this conference. Safe harbor and Reg G statements. So we've got some great stats. We worked on 85% of the drugs approved in the last 3 to 5 years. You see doubled the size of the company since 2016. We have the #1 share position in most of the businesses that we're in. We have about a $20 billion market that we're in if you aggregate all the markets from all of our businesses, which gives us a really long runway of both organic growth and probably some more M&A. We have guidance out there that says we'll grow this company low double digits certainly through 2024 with improving operating margins. We have one of our businesses that actually finds the targets. So we've actually discovered 90 novel targets for our clients, large pharma and biotech, who couldn't do it on their own. Some of those targets -- or some of those drugs are in the clinic. And we spent about $4.5 billion on 25 acquisitions in the last decade with really attractive returns. So probably half of our growth is connected to our M&A. We did a leverage buyout at the end of '99. And we've done roughly 60 acquisitions since then, which takes us from sort of market -- from early discovery all the way through market approval. It'd be really interesting if I could read these slides. Our revenue for the last 12 months is about $3.5 billion. So we're pleased with that. And we're very pleased with the breadth of our portfolio and the competitive strength of it. We have pretty low customer concentration, no more than 4% of our revenue. Client base -- employee base is about 20,000. And the client base has shifted and changed over the last decade or so. So we used to be all pharma -- that was pharma with my Boston accent, all pharma with a little bit of academic. And biotech eclipsed pharmaceutical industry probably 6 or 7 years ago, so we actually have more revenue from biotech companies, and the rest from large global companies and then some medical device companies and other CROs. And the geographic reach is not surprising. Biotech is still -- this sounds parochial, but it's true. Biotech is still a U.S. phenomenon and I think will always be. So it's actually even a Cambridge, Mass and South San Francisco phenomenon. So our revenue will probably be nuanced the way it is here, sort of 60-plus percent in North America and the rest, rest of world. So this shows the portfolio really stretching all the way from discovering a drug through commercialization of the drug. We actually don't run human clinical trials. But we do all the testing of the drugs before they go into the clinic. And we've now moved into the CDMO business, which is the contract manufacturing business of cell therapy drugs who are actually making the drug that will go into the clinic. So it's a unique portfolio, as I said earlier, which puts us in a really strong competitive position. So several businesses. So our research model business is a business that we start with -- we have almost a 40% share. The market is about $1.7 billion. And this is a research model business, sort of one out of every two research models used in biomedical research everywhere in the world, anywhere in the world comes from us. We have a large growing Chinese business with a largest market share in China and really growing dramatically as we build new spaces. We also provide genetically engineered mice, so you have genes knocked in or knocked out to express disease state that's like the human. So you're looking for translational information, stuff that you see in the animal, which you'll see in people. We have a small -- we have a large business called Insourcing Solutions, where we manage other people's animal facilities. We just made an acquisition of a business where we have incubator space, mostly in California, which added to our own incubator business. We have multiple facilities around the world, where actually very small and very large companies are using our capacity to do their research, often with our employees, sometimes on their own, going to be a very large, high-growth business for us. And we bought a cell supply -- two cell supply companies a couple of years ago to provide the cells for cell therapy. So I think you all know that cell and gene therapy is kind of the hot, new modality, a very powerful way to both treat and cure diseases both at the cellular level and the genetic level. So the research model business, which is where the company started, is about 19 -- let's say, 20% of our revenue with comparable operating margins. Margins are in the high 20s. And interestingly, our own business, our toxicology business, is the largest client. So we're vertically integrated. That's what happened over a period of years. That definitely gives us a huge competitive advantage that we provide our own animals. We have facilities all over the world to do that, close to our toxicology facilities. We're working really hard across our whole portfolio to digitize our data and our information, so the clients can interface with us on a digital basis that will both reduce costs and accelerate the velocity of them getting the drugs to market. About, I don't know, 10 or 12 years ago, we moved into the discovery space. We bought a bunch of companies that, where you saw on my first slide, that can do everything from actually find the targets, improve the drug, particularly small molecule drugs, pills, but do all of the development work after the discovery. So I met a lot of clients who were like, "Fine, we do the discovery ourselves." We get that. But all the sort of institutionalized, repetitive but also highly complex work, we're now doing for a lot of companies. And we have a really interesting portfolio of services. So we have in vitro screens, so what you would do in animals, you're doing in vitro, not in animals. You're looking for absorption and metabolism and other things of the drug. We have a big chemistry business. We actually design the drug. We have high-throughput screening libraries. So you take a new drug and you put it through your library to see whether it has any hits with existing molecules. We have a pretty big oncology business, where we're just doing pharmacology in oncology, very early work. We have a CNS business, that's central nervous system. So we're doing work in MS and ALS and Alzheimer's. So high-growth business, this is all the result of acquisitions over the last dozen years. It will be a source of additional M&A for us for sure. This is a market that's probably $5 billion or $6 billion. It's 25% outsourced right now. We think it will get to at least 50% outsourced in the not-too-distant future. Safety Assessment business is our biggest business. That's another word for toxicology. So you're looking to see whether the drug is toxic. In other words, can you tolerate it? And drug companies using our services will moderate the dosage to find the dosage that you can tolerate. Even if a drug is effective and going to cure or treat your disease, if it's toxic, you're not going to be able to take it. So this is a really big business. This is half of our revenue. We have a dozen sites. It's probably close to a dozen acquisitions. And we do non-GLP. So that's testing before the work goes to the FDA, then we do mostly GLP testing. So all of that data is going to the FDA or other regulatory agencies around the world. We do very straightforward general toxicology and then very complex stuff, like looking at the impact of the drug on your immune system or your genes or unborn fetus or on your eyes or on your bones. And we have a phototoxicology business that is looking at the effects of sun causing cancer and drugs that -- to treat that cancer. So a really interesting business. We have a big laboratory services business that goes with the toxicology. And we have the largest number of veterinary pathologists in the world. There's -- I don't know, there's 400 or 500 of them and we have the 150 or 160 that work for us. So that's the kind of punchline of toxicology work. We bought most of the second tier of our competition over the last -- from 2016 to 2019, we bought these three companies that are listed here that really catapulted us into a very, very strong leadership position. You can see that we have a 36% share in a company called Covance, which is owned by LabCorp, which you probably all know who LabCorp is. Besides all the COVID testing that when you go to your doctor and give blood or urine, that's where it goes, to LabCorp or Quest. So they bought our biggest competitor and have managed to shrink it over time. So we have sort of double the market share that they do. It's a pretty big market. It's a $5 billion market. It's about 60% outsourced. We think the outsourcing penetration will get to 80%, maybe 90% over time, really, really important business. By the way, we did all the safety testing work for all the COVID vaccines and all the COVID drugs, all of it. So I just went to a celebration for Stéphane Bancel, who's the CEO of Moderna. And he said publicly during that, that but for Charles River, he would never have gotten that vaccine to market. So we're really proud of our role in the drug development ecosystem. This DSA segment, Discovery and Safety Assessment, is 60% of our revenue, about 53% of our operating margin. The biggest opportunity to improve margin for the whole company is here. And we're doing that a lot through our digitization initiative, which I just talked about. So you want clients to be able to get online, book a study, get a price, get their data virtually every day if they want without calling us. So really, really excited about that. As I said earlier, we have a dozen safety sites. We have 30 discovery and safety sites. So all things being equal, clients prefer proximity. So California clients would like to do stuff in California and French clients would like to do stuff in Paris and not in Boston, although they sometimes do that. So our global infrastructure is really important. We have this really interesting business called Microbial Solutions. And the FDA requires that all medical devices and injectable drugs have to be tested after they've been manufactured to make sure they didn't become contaminated. It used to be done using rabbits, used to inject the drug into a rabbit. And if it got a fever, you had a contamination. It's now done in vitro. We have this very sophisticated testing system, both large and small. The small one is sort of a razor-and-razorblade device. And we -- this is the only business where we do pure R&D and actually have really deep IP. We're way ahead of our competition. You can see here, we have 50% of the volume that's out there. This is about a $3 billion market, very high growth. This business has grown at least 10% annually for the last 25 years. It's a really big business, very profitable and high growth. And that testing is required by law forever. A business that's been -- our Biologics Testing business has -- you can see it's in -- the top 5 companies, including us, have a 50% share. This is the business where we have the best and largest competitors, but we're all doing really well. This is driven by the proliferation of large molecule drugs. So that means things like monoclonal antibodies, which you hear a lot about in connection with COVID, all the cell and gene therapy drugs, large molecules, which are driving this as well. So a very high-growth business for us, improving operating margins, continued investment in facilities throughout the world and highly connected to our cell and gene therapy assets, which I'm going to talk about in a moment. So we test the drugs before they go into the clinic. We test the drugs after -- before they go into the market, assuming that they've been approved. So we bought 7 cell and gene therapy companies over the last 2 years. It's a pretty big business. You can see the breakdown. So we have a cell therapy manufacturing business, which means we actually make the drug. So you take cells out of your body and you infuse them with some drug, put them back into your body and it treats the disease. This is being widely used in blood-borne cancers at the moment, successfully, by the way. And then we have two smaller businesses providing plasma DNA and viral vectors, which is the way you deliver the gene therapy or gene-modified cell therapy. This whole field is really nascent but a lot of money going into it, a couple of -- $2.5 billion market growing at least at 25% a year. We -- if you aggregate all of these businesses with our historical -- our legacy businesses that are providing products or services in cell therapy -- cell and gene therapy, it's about 15% of our revenues. So it's a very big business for us. We have a bigger portfolio than most of our competitors. So in this Manufacturing Solutions, we have the three businesses that I just talked about. Operating margins have historically been in the mid-30s. This is an incredibly profitable segment of the business. And I think there's opportunities for the margins over time to improve as the cell and gene therapy business -- as some of the cell therapy drugs that we're making go from the clinic to getting commercially approved. So you can see here that through M&A, we've developed these capabilities both in large molecule, small molecule and cell and gene therapy to help our clients discover these drugs and move them through the drug development process. And there's really nobody else that can do that. So what we saw historically -- so this is the 15% of our portfolio that I was talking about. But in pretty much everything we do, we do things that are required for cell and gene therapy. So we have immunodeficient mice, which means they have no immune system. We have combination safety studies between our Discovery and Safety Assessment business and a certain number of bioanalytical assays that we have to do to test the drug to make sure it's safe. We do a bunch of testing both in our microbial and biologics business. And so we see this as a source of high growth. And there's a couple of thousand drugs that have been developed by a whole bunch of clients, large and small, that have to be developed either through failure or proof of concept, will have some meaningful role in a meaningful number of these drugs. Just sort of an interesting slide about what our sales look like over the last -- where does this start, 2010. So 2009 and '10 weren't a fun time for us after the economy blew up. So we've sort of had flat sales. You can see low single-digit growth in '12 and '13, what's this say, 5% to 8%, in the next 3 years, 6% to 9%. And last year, we grew at 15% organically. You can see all those names in the bottom are companies that we bought along the way. So our strategy is to buy companies and invigorate and expand our portfolio with already successful, functioning companies with decent margins, high growth and a good scientific reputation. I think that's held us in good stead. So just sort of quickly to go through our strategic imperatives. We're looking constantly to strengthen the portfolio. As I said, we've done a bunch of acquisitions. We also are beginning to do a lot of strategic partnerships, finding cutting-edge technologies, providing some debt or equity financing, being the marketing partner for these companies and perhaps buying them either with a predetermined formula or at least having a right-of-first refusal. So I don't know whether we have to be cutting edge, but we have to be close to cutting edge. And I think that will continue to distinguish us. So this is maybe the most important slide in the whole deck. So let me just spend a minute on this. So this is sort of the -- a lot of where our growth is coming from. So as I said earlier, we've done about 60 acquisitions. We've done 25 in the last 10 years. The returns are terrific. And they fundamentally changed who we are. So we've gone from a company providing mice to a company doing virtually everything to develop a drug, except run the human clinical trials. So we're not perfect. I do think that we do an increasingly better job at M&A. We have a full-time integration team that does the due diligence and puts together an integration plan. And I think we've done a good job understanding the cultures and the ethos of the companies that we buy and bringing them into the parent ecosystem. Then we have the strategic partnerships that I was starting to talk about. We have 18 of them right now. They're relatively small investment. Through all '18, it's only $70 million investment. It's really cutting-edge stuff, like large molecule discovery or AI or next-generation sequencing or digital pathology or bioinformatics, so very cutting-edge stuff. It may or may not work, may or may not pan out. A lot of these companies come out of academia, most of them are pre revenue. The ones that do have revenues are growing. They're really small, so they're growing at crazy high clips, maybe 100% a year. So we have 18 of them. I think we'll have -- let's say, we have a couple of dozen. We probably write off 1/3 of them because they don't actually pan out scientifically. But that's kind of our way of doing R&D. Maybe another 1/3, we work with them to be their marketing partner and the other 1/3, we buy. So I think a lot of these companies we'll buy and put them in our discovery business. And of course, you're doing real life due diligence because you're the marketing and sales conduit with the client for this technology. We have these amazing relationships with the venture firms. I don't know why our competition hasn't followed suit here. So these fall into three categories. Category 1 is that we're LPs with a bunch of VCs. You might say, "Well, that's not your business. Why are you doing that?" And the answer is to have really close relationships with them, which provides two things. One is access to the portfolio companies. But most importantly, with these -- there are huge brain trusts in these venture capital firms of really smart people that -- I don't know whether they can literally see the future, but they make huge investments in future technology. So we have these great strategic relationships with us. And we have a significant amount of revenue with them. And we get the returns from the venture funds, which have done really well. Then we have -- and that's about 1/3 of the venture partners -- venture clients. Then we have another 1/3 that don't need or want our money but will use our services strategically. Then we have another 1/3 that don't need or want our money, don't use it strategically but use us a lot. So you can see that we have a 30% actual annual return on the VC relationships. And it's now 10% of our revenue. So a really important part of what we're doing both scientifically and financially. I think I've spent enough time on this. We have promised the clients that we'll take a year out of the drug development process. So I don't think we can necessarily -- I hope we can, but I don't think we can necessarily help our clients get more drugs to market. I think we can help our clients get more drugs to market faster. So if we can help them get $1 billion drug to market a year earlier, that's $1 billion of revenue that they wouldn't have had. So we're spending a lot of time on optimizing our processes, on digitizing what we do, taking the white space out of our business model. This is the last bullet, talks about the speed, trying to be more responsive than big pharma companies are to themselves internally and certainly more responsive than our clients -- sorry, than our competitors are. And increasingly, as we get larger, I keep saying to the folks who work with me, we have no right to buy businesses and get larger unless we're faster as a result of that. So we're all about speed. All of our clients are only interested in speed to market. They're all in a race to get things to -- drugs to market. And they're often working on the same target. So 4 companies work on the same target, the first one that gets the drug to market gets 80% share, the second one gets 20% share and the other 2 go bankrupt. So spending a lot of time, as I said, on digitization and e-commerce. I think the company has been way too manual historically in what we do. AI is going to play an important role in this -- in what we do. Logically, it should. So if we've done thousands and thousands of safety studies for thousands of clients, we should be able to use that data to help new clients design better trials with better outcomes. And we should be able to link that with companies that are doing the clinical trials so that your biomarkers are all along the way. So we have several relationships with some prominent AI companies to sort of prove this theory and see whether we can get some practical applications of AI. But it's coming for sure. I don't know, every company should start with this. We have 20,000 people, on our way to 21,000. We hired 5,000 people last year. We have thousands of people who have been with the company over 20 years. So I do think that kind of our secret sauce is the longevity of our employees and the culture that we have. I think there are amazing career opportunities, spending a lot of time on having an inclusive environment. And I think we're actually doing a really good job in a tough labor market these days recruiting new folks. We had an 8-K yesterday. This is sort of a summary of it. So we always give an outlook for the next quarter. So when we did our Q1 call, we had the outlook for the second quarter. And you can see the prior outlook and the current one. So reported revenue has now moved down from low double digits to high single. Organic growth rate, it really has stayed the same. And EPS, there's been a slight change. And the result -- this was a direct result of unfavorable FX movement. And one of the acquisitions that we made had a preexisting contract to make COVID vaccines, which is not the reason we bought the company. We bought the company to make plasma DNA. And that contract kind of rolled off more quickly than we had anticipated. And we're spending a lot of time sort of retooling that space to go back to making plasma DNA. That's going to cause a little bit of performance disruption in the second quarter. Having said that, our RMS and DSA businesses are performing really well and will perform better than they did in the first quarter. And we also said that we expect our organic growth -- revenue growth and EPS will remain within our guidance for the year. And sort of a concluding slide, you can see 17% CAGR in our revenue over -- from '17. You can see we are a big free cash flow-generating company, more free cash flow than anybody in our space. And you can see the growth rates there and the actual dollars. We're maniacally focused on improving our operating margins. We improved our operating margin 100 bps last year. We've said that we hope to improve them slightly this year. And you can see the earnings per share growth as well. So we've had a very high-growth business. If you think about the client base, you have new biotech companies created all the time and have no internal capability to do anything except discover the drugs. So they don't have to use us, but they have to use someone externally to develop their drug, particularly to do all the safety testing. And you see the big pharmaceutical companies increasingly outsource more of the work that they used to only do internally. They were only vertically integrated. And we do a lot of the work for many, if not most, of the pharmaceutical companies. So it's a unique portfolio that we've added to aggressively through M&A. We will continue to do that. We've taken a little bit of a pause to absorb the companies that we just bought. But we have a strong balance sheet. Leverage is pretty low. And there's a lot of targets out there that I think will continue to invigorate the portfolio. We continue to distinguish ourselves from the competition. Demand is really quite strong. We're actually booking safety studies well into 2023, which is unheard of. We've never booked studies that far in advance. So really pleased with our business model. And John, I have no idea what to have -- oh, 60 seconds. So thank you all.

Thank you, Jim. That was great.