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

All right. We'll go ahead and get started. Good morning. Thank you for your attendance here at Jefferies London Healthcare Conference for 2022. I'm Dave Windley. I work in the U.S. healthcare research group, cover CROs and CDMOs, among some other sectors. Very glad to -- pleased to have Charles River Laboratories here with us again. Appreciate your consistent attendance at this London Healthcare Conference. And Flavia Pease is the company's Chief Financial Officer -- Executive VP and Chief Financial Officer, having joined the company just 6 months ago.

That's right.

And has been doing her deep dive into the company. So that really segues into my first question, which is about Flavia, your initial impressions and experience at Charles River, you've been there, had an opportunity to travel around and see a number of the facilities. So maybe give us a sense of what you've learned about the company since you joined and maybe start with what you've seen internally. And then I'll ask you the follow-up about what you're seeing in the end markets as well.

Sure. Good morning, everyone. And David, it's great to be here. Thanks for hosting us. And I'm delighted to have joined Charles River about 6 months ago. I was with Johnson & Johnson for almost 23 years. And I think part of the excitement to join Charles River is the opportunity to remain in a company with a very big focus on a purpose in serving healthcare, and making a difference in human health. Charles River worked on about 85% of all the novel therapies that were approved by the FDA in 2021. So what we do really matters. And that to me is where everything starts. I think secondarily, I was excited that I was joining another leader. Johnson & Johnson is the largest healthcare company in the world, and Charles River is the leading global nonclinical drug development partner for the pharmaceutical and biotech industry. And so clearly, we're in a position to partner with our clients from early discovery, known clinical development, all the way through the safe manufacture of their life-saving therapies. So those things really resonated with me and made me excited to be joining this company. In the last 6 months, to your point, I've been really trying to spend time learning about our businesses, visiting our sites. I have had a chance to actually now be in a site of -- at least in one site of every single businesses that we have. So visit Safety Assessment sites in Canada, our Biologics team in Pennsylvania, our Microbial site in South Carolina, actually just took advantage of being here in the U.K. and visited another site in Edinburgh. And that speaks also to the global nature of our footprint in our ability to support clients geographically diverse. I think what is a constant, as I visit those sites and that I've been very impressed with, is the deep scientific knowledge that we have. Our ability to really differentiate the services that we provide and partner with clients in very complex ways whether it is in designing, safety, toxicology studies or now getting into the CDMO novel -- modality of cell and gene therapy, it really -- we are differentiated in the depth of knowledge that we bring to the table. And then I think the other part that our clients really appreciate is the client or customer intimacy and flexibility and agility to which we work with them. I think that sets us apart in the industry. So it's been a great first 6 months, and I look forward to many more.

It sounds great. Thank you. So in turn -- so that's a good rundown of how -- what you've seen internally as you talk to those internal folks and then also looking at your own tracking of sales funnel, how would you describe the end markets that those various businesses are selling into? What's the persistency of demand? How does that look?

I think actually, the end markets are very robust in all of our businesses. We -- there's still a tremendous amount of headroom I would say, for growth. Our addressable market is probably north of $20 billion. And we enjoy #1 and #2 positions, leadership positions in most of the markets in which we compete, which is a good place to be when you were that thought leader, thought partner to your clients. If I break it down by our segments, if you think about the DSA space, in safety, about 60% of the market is outsourced. So there's still headroom for additional growth. And we have about a 35-plus market share. And so while that's double our nearest competitor, there's still headroom, again, to continue gaining share in that market. So if you think about that, it offers longevity of growth prospects in that end market. In our RMS segment, we are really pleased with what Jim, our CEO, has been calling the renaissance of RMS. That was a slower growth end market that tended to be more in the sort of low single-digit growth space. And we're clearly seeing it now accelerate to high single digit. And it actually has been driven by different components of RMS business. Whether you talk about the services side with our CRADL and Explora turnkey vivarium rental model, which is really growing nicely, strong double-digit, all the way to the more legacy part of the business with models, where we're seeing not only continued double-digit growth in Asia, specifically in China, but also nice share in price in -- especially in North America. And then you round that up with differentiated services like GEMS, our genetically engineered models. It really is broadly based and very robust. And then in manufacturing, we also continue to see strong performance in the end markets for both Biologics and Microbial. And we are very excited with our decision over the last couple of years to enter into the CDMO space with a focus on cell and gene therapy. There's -- it's a new modality. There's over 3,000 drugs being developed. So plenty of work in the clinic. But also, we expect that some of these will progress eventually to commercial, while only a dozen products have been approved so far. As we engage with clients, they do look to partner with CDMOs that have the ability to not just take them through the clinic, but also scale up with them as they get into a commercial viability. So it's a bit of a sticky business. And I think the recent EMA audit that we had in our Memphis site bodes us well to demonstrate the commercial capabilities that we also have. So I think as I sort of go around all of our businesses, there's a lot to be optimistic about. Now I know there's a lot of chatter. And since the beginning of this year, there's anxiety on biotech funding. So I'm sure you would want to explore that. Obviously, the funding this year has slowed down versus 2020 and 2021. But you know better than I, it's still one of the greatest years in funding compared to history. So I think while it has, relative to the last couple of years during the pandemic, been down. Relative to historic norms, it's still very robust. And I think folks tend to perhaps over-index on the causality or correlation of biotech funding, the direct impact into the work that we do. We have seen a bit of a slowdown or elongation of decision-making in our Discovery business, but -- which is the smaller portion of our DSA segment. But when you think about safety, we haven't seen any impact. In fact, we have the longest and healthiest backlog than we probably ever had. And I think it speaks to -- reaching IND is a critical step, a critical pivot for companies to continue their ability to raise funds. And so moving their compounds through safety and toxicology is essential for them to be able to get into the clinic. And I think what we've seen is actually some of the secondary -- successful secondaries have been attached to clinical or preclinical milestones being met. And so I think it continues to bode well for our safety business. We talked about -- our backlog has not only grown year-over-year, but continues to grow sequentially. So overall, I think we continue to be cautiously optimistic on the prospects and outlooks -- and outlook of our businesses.

It's provocative. The ones that entices me to dig in there. Around the -- I guess what is curious to me when I think about the progression of the pipeline, Discovery, preclinical Phase I/II/III, that when companies think about, when companies that we talk to, VCs that we talk to, talk about the areas where in times of scarce funding, they will focus their funding are like Phase II and Phase III. So like the dividing line between what are we probably going to slow, tap the brakes, put on the shelf, whatever versus what are we really going to press hard and try to get to the milestone is somewhere in clinical as opposed to between Discovery and SA. Maybe you could talk about -- a little bit more detail about what interactions you have with that set of clients in SA?

Yes. So a couple of things. First, to get to Phase II, you need to, first, finish your toxicology work and have the ability to get into Phase I and Phase II. So I think the stage gate nature of clinical development, forces clients to continue having that earlier stage before they can advance their compounds. Now if the markets remain close for 5 years, 7 years, eventually it would catch up. But I think despite the fact that there is a lot of uncertainty and volatility in the macroeconomic environment, I think life sciences and healthcare has proven to be a very resilient industry, right? It has tended to be more recession-proof than many other industries. And there is still a lot of unmet medical needs, new modalities to address those needs. And so I think drugs that have a promising future will continue being funded. They'll be funded through M&A and partnerships in large pharmaceutical companies. They will be funded through VC. You talked about VC. Actually, funds continue to being raised at record levels, and they're chasing investment opportunities. I think we all have seen a slowdown in the IPO market, which is one component of biotech funding. But there's several other sources of funding that I think continue to be available. Also, with a bit of the recalibration of multiples, I think assets are also becoming more rational and affordable. And so I continue to be optimistic on the prospects. And as I said, you don't get to Phase II unless you've done your tox work. I think to your point, some clients are becoming a bit more discerning perhaps in the early Discovery side, if they had 5, 6 compounds that they wanted to consider and evaluate. They might do 3 and see how those go. When we talk to clients, they don't specifically talk to us about funding being a driver of that, but you sort of put 2 and 2 together. And if they are taking longer, if they're being more discerning, it's because they're being more careful with their funds.

Right. So maybe I'll ask one more and leave this topic. But as you think about 2023, you as many others did, and I think justifiably so, plan to guide in early '23 as opposed to early as many did during the pandemic. Are you sensitive to -- or taking into account the possibility that, that cautiousness in Discovery leaks forward into Safety Assessment as you think about how you're going to set your guidance for '23?

Yes. So on -- on one hand, as I said, we have had the best visibility we've ever had into our backlog, especially in the safety space. And so studies are booked way into over a year. And so we have a significant portion of the work for 2023 already booked, already scheduled. And so in a counterintuitive way, we actually are in a better position than we have been, historically. Having said that, I think what is very different is there's still a lot of uncertainty in the world. Interest rates are as high as probably many of us have ever seen in our lives. The dollar is the strongest in the last 20 years, energy costs with the war, especially here in Europe. So there's a lot of volatility and uncertainty in the macroeconomic environment that it really doesn't serve us well to try to anticipate or accelerate providing guidance into next year. Our usual cadence has always been to guide in February. And so I think we'll wait to see how the year ends, how things continue to evolve with inflation, with interest, with FX, and then go back to our normal pace of providing guidance in February.

I agree with that, by the way. So many moving parts to stick a flag in the ground in October or November seems premature. Let's talk then about RMS. I want to move through the other parts of the business before we run out of time. You mentioned, as Jim has referenced kind of this renaissance in RMS. It seems like a couple of things have happened there. One that you've -- the company has expanded the breadth of the RMS business, you are adding Solero, HemaCare to -- on the CGT front. So kind of a faster growing mix of business and then some of the individual businesses, as you described, have accelerated themselves. Could you talk about kind of the relative importance of CGT to the RMS business?

Yes. I think CGT holistically is about 15% of all of Charles River. And interestingly enough, we have components of CGT across our portfolio. In RMS, as you talked about with HemaCare and Solero, and ourself -- supply business. In Safety and Discovery, obviously, we're partnering with clients in the CGT space to develop new drugs. And then in manufacturing, we're testing them and now we entered into the CDMO space. And so that was a little bit of the rationale for our recent acquisitions over the last couple of years. Once we took a step back and realize and recognize the importance of CGT, this new modality that already represented such a significant portion of our business. But actually, I think in RMS specifically going back to it, it is much bigger than cell and gene therapy. As you talked about, all the parts of and components of the business are doing well. And to your point, we have made a concerted effort to start getting exposure to higher growth segments within that market. I think the CRADL and Explora turnkey vivarium offerings that we have a great example of that. And it's also synergistic with our legacy models business, right? Because not only we offer the space, the capabilities, the infrastructure, but we can actually offer the models that are being used in that space. And clients actually large and small are -- it's resonating with them. I think when we first started in that business, we expected it to be more focused in small emerging biotechs that didn't have any infrastructure. But surprisingly enough, we also have very established biotech companies and large pharmaceutical companies that are actually using our CRADL facilities and they're recognizing the benefit of investing their R&D dollars in research rather than infrastructure. So it really is broad. So we're very pleased with the performance of RMS, and the growth acceleration that we're seeing there.

So to clarify on -- because this is something that I wanted to try to understand better in CRADL and Explora, in the case of a small client, intuitively, I would think these are folks that don't have a lot of facility at all, and they're turning to you for that. In the case of the larger, more established client, it's an extension of existing lab footprint. Is that the way to think about it?

I think it's -- it might be similar to what happened with safety back in the days, right? When they're having to make a decision on whether they are going to create more infrastructure themselves or whether they can leverage an outsourced model, especially in biotech hubs like Cambridge. I think they're realizing that they can have a partner that offers amazing quality infrastructure and services at effective rates. And instead of having to build themselves, they come to work with us and focus their R&D dollars on the research itself.

Got it. And the type of work that they are doing in these labs is mostly Discovery?

Yes. I would say it tends to be early Discovery. And it's obviously all in vivo. And as things progress, I think that's the other benefit of starting the engagement with the clients early on. We can then expose them to the broader Charles River offerings, right? In South San Francisco, actually, our CRADL locations -- our CRADL facilities co-located with our Discovery site. So it naturally offers an opportunity for them to then be exposed to other services that we offer. And then as things continue to progress, if they get into Safety, again, we can pull through. And there's that synergistic impact with the breadth of our offerings.

And the CRADL facility -- so the Discovery activities, you mentioned already, that gives you an opportunity to supply animals into studies that they might be doing more Discovery in vivo type work. What other pull-through opportunities are there from a -- out of the client that you capture in CRADL, then what else can you do?

Yes. So I think it's an opportunity to start partnering with a client in the very first stages as they are doing their discovery, early science work, all the way to potentially the safe manufacture of their products, right, kind of, from birth to grave, if you will, that's probably not a good analogy because I don't want them to die. But really in the CRADL facilities, not only are we providing the turnkey space, but as I said, we provide the models. As they moved and need more sophisticated Discovery services, we have those capabilities. Then as they move into preclinical toxicology development, we can support them there all the way to -- if the product moves to the clinic, we can do the biologics testing for them. So it is truly a -- and I think that's our differentiation, right? We are a drug development partner of choice because of the breadth and depth of the capabilities that we offer.

Yes. Yes. Let's -- in the time we have remaining, let's touch on manufacturing support, quickly. The CDMO acquisitions in '21 got the company into that area, focused on cell and gene therapy, and I think specifically cell therapy and gene modified cell. Those were businesses that you kind of adjusted earnings for in 2022. My sense was that you've kind of eliminated any kind of revenue go-get from the guidance, and base that out pretty significantly. Is that -- do you still feel comfortable with that? And kind of similar question to earlier, as you think about '23, is that business something that can resume its growth?

Yes. So first, we still remain very excited that we acquired those assets. We believe that the modalities are going to really make a difference in treating and curing diseases. And so the strategic rationale for those transactions remain intact. The market is still very robust. There's 3,000 compounds being developed. And honestly, some of the challenges that we faced were more executional integration rather than something more broadly that would give us pause in the marketplace. So we remain very optimistic about those prospects. We now have -- continued to move expeditiously on the integration, refocusing the sites in centers of excellence for plasmids, viral vectors and cell therapy to your point. We also have supplemented and augmented our BD and sales capabilities. We've beefed up the facilities from a regulatory perspective. And I think the last EMA inspection that we successively had in our Memphis site, epitomizes our readiness to not only support our clients from a clinical development perspective, but also allow them to scale up into commercial manufacturing.

Got it. Very good. We've borrowed a minute here, so we'll thank you for your interest and attendance, and thank you, Flavia, for being here.

Thank you very much, Dave.

Everybody, enjoy the rest of the conference. Thank you.