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

All right. Good morning, everybody. My name is Luke Sergott. I cover Life Sciences Tools and Diagnostics here at Barclays. With me today, it's my pleasure to have James Foster, CEO of Charles River, also known Jim Foster, whatever preference is.

So a lot to dig in here. So a lot of interesting topics to cover, but can we start off first talking about the [ SAP ] exposure and then the impacts that you're seeing from the customer base? Have you guys broken that out by the revs, I think you had something in your deck on it, but just anything that you're seeing there?

Not seeing anything adverse. I don't just kind of [indiscernible] from clients. We see saying all is good. So we don't expect that's going to have an impact on us.

Okay. That's fair. And then on -- can we just talk about the nonhuman primates [ distribute ] we were just talking -- I don't have the official coverage yet, but been aggressive what's going on. Can you just walk us through there, the dynamics of the supply chain issues and ultimately, how would you think it will be rectified?

No. So a complex and fluid situation, for sure. Sort of initiated by a DOJ investigation of a supplier in Cambodia that we don't use. So I don't know a lot about that supplier except the country that they ran in. And I know others use them with an allegation that they would bring in animals that weren't purpose [ spread ] in other words, [ bread ] for this purpose, so the wildcard. And that's a problem. And so we think that the -- and so we're sort of peripheral to this whole thing, actually, although it's having an impact. So we think that the situation is essentially without merit. There's been on allegations with regard to some people that we supply [ us ], but sort of an implication that they may be looking into whether our supplier is doing something similar. We don't believe they are. We just audited that [ term ] in January, I would say that we have the best [ primate docs ] in the world went over there and look at the facility. We provide a lot of good put on how they run that space as well. So the -- there's multiple [ touch ] lines here. So until this is resolved, we're not either bringing any Cambodian animals in or utilizing them. We have multiple sources of supply and always have. But the majority of NHP used to come from China. China sort of woke up 1 day as we had anticipated they would and said, this will be a competitive advantage to China if we keep those monkeys in country. So they suddenly cut off the supply. It went to Cambodia with analysts the same genetic background and essentially the same type of analysts, but that pivoted very quickly. So the Cambodian thing is significant because it's about 60% of the animals come in from there now. The frustration for us is that we have unrelenting demand, the greatest demand we've ever had way out into 2024. We have plenty of capacity. We have headcount in a good place and we've contracted for and actually have sufficient number of NHPs into the work. We just can't use them. The fix is you have scientific tests showing parentage. So they can prove that this offspring, that's the mother and the [ other was the spread ]. The offspring was purpose spread by that mother and that father. And so we're working on motor of multiple technologies to get there as quickly as possible. I'm quite confident that we will fix this sooner than later. We [indiscernible] than the double negative, [indiscernible] to not fix it. So the way bigger issued in Charles River. So I already had a whole morning of [ monkeys ] but if for some reason, Cambodia was closed to us and others, you and the work with China, you literally would have hundreds or thousands of drugs, which is paralyzed and would not move through the IND process. So it cannot get fixed. We're going to have to take a leadership and get it fixed. I'm trying to be somewhat optimistic about even though it's just been incredibly annoying that -- and the final analysis will elevate the graft and scientifically will improve forever the offspring are as indicated. And we're happy to do that for our competitors, for our clients or whomever for the government to show that this has done well. And so we're just going to have to take a leadership position. So as you would imagine, we are spending in order to [ have time] on this. And it does seem like we're peripheral to it, but it is what it is. As I said, we have multiple supply sources. So we're working really well through this whole thing. We're quite busy. Clients have been fabulous and make sure that the holders understand where we are.

Yes. I mean, so any reason why you wouldn't start your own internal breeding program because of your experience with the rest of the model business. Just Calling.

There's lots of reasons. We did that once. Actually, the project was destroyed by a hurricane. We're putting that aside, when we did it last time, it was going to be cash flow negative in 12 years. Nightmare. So it's incredibly expensive to set it up, incredibly time consuming, so it doesn't ameliorate or solve anything for years. It's unnecessarily expensive and inappropriate because you've got these monkey's running wild all over Asia -- and Africa. And all you need to do is take these feral animals and have multiple generations of the breeding so you get purpose [ bread ] animals and so they're quite plentiful. If companies like us, obviously the science and the genetics and the quality, that's just better. So we still talk about it incessantly. It just doesn't work. It's not even the money. I mean, it would be expensive we could afford to do it, but it would just -- it would take too long. I just think it would be a hideous drag on the P&L.

Yes, makes sense. On the -- so if I get -- if I understand it right, so you guys are offering to offer that test for the genetics and that could be -- you'd be the solution provider to the government saying, okay, we can start allowing these back end. So that could be possibly a tailwind and -- positive for you guys out of this.

I mean, I think it will ultimately be positive that the sort of conversation about wildcard animals versus the purpose rental cease, and we'll be able to prove with certainty that they are what they are. And by the way, genetic testing is a very trivial science. I mean, it's not complicated. It's more about the scale. So it's got a lot of animals [indiscernible] in a very short period of time because we want to get ahead of this proposition. So it's worth of scale and the science. You'll have several folks working on this as client for us with some pretty sophisticated [indiscernible] not only would we be able to prove it with a certainty, but that the speed with which we do would be accelerated. So we're comfortable with the sort of guidance range that we gave, which is the kind of best case, we get to 6 by, I don't know, end of the third quarter. We're off and running in the fourth quarter kind of worst case, it takes us.

Got it. And that's the 200 to 400 basis points.

Yes, exactly.

Okay. So on the -- we've heard from [indiscernible] here from some early-stage customers that have managed to supply enough of their NHPs from U.S. spread sources. Where would those be coming from? I mean there's not a lot of breeding programs, I guess, in the U.S. So I mean, are you guys -- where would the -- I guess, where would the help from.

So there are no U.S. breeding sources. There are a couple of companies that sort of brokers that get animals from wherever. We have used those folks to some extent historically. I'm trying to be careful picking my words here. We prefer not to use them. Reputationally, I just don't think they're the best possible people to use. And I don't actually think they care where the animals come from or what the background is and they've been kind of inappropriate with pricing. So there are probably -- people say there are, I assume they're telling the truth. There are probably animals in country brought in from the outside, including it could be from Cambodia. It could be from the source that DOJ is looking at. I don't know that. We're just not using them, number one. Number two, I don't think it's large numbers of the [ animals ]. Number three, I don't know how sustainable that is.

Okay. And then lastly, here on the DOJ , [indiscernible] what are they -- you said that they're investigating, not you guys, but your -- the partner that you guys use for your supply. Give us some time and time frame here, what they're really looking for.

Yes. I mean it's -- so when I think broke, which I guess is November, September, November, I don't remember. They issued entitlements against 1 of the greatest in Cambodia and they arrested 1 of the government officials and there was [ unindicted ] focus. I think they call them which allegedly are a company that you talked about in the U.S. maybe, maybe some people that we compete. It was unclear. Because nobody was named if we want -- so we're not a target of anything. They don't give us a lot of information except to say that they may look into whether the folks that we get animals from are also doing providing wildcard animals. And they want to look for our paperwork. So meanwhile, nothing is proven. So that's why I say we're sort of on the periphery. Meanwhile, I just want to repeat, we don't think it has any merit. And as far as we're concerned, without going through all of their records, but we did spend -- just spent a couple of weeks there. We think our supplier is extremely high quality. And quite, as I said, we're quite confident that will resolve any sort of uncertainty with scientific data, which is not available. And I think that's what's missing.

Yes. Okay. So it's more of just getting the actual data there to support it. And then lastly, on pricing within the industry, is it still, I guess, skyrocketing would be the modest term.

The pricing is nuts, right? We used to pay $1,000 per monkey, it's $30,000, $40,000, $50,000 now. There's probably no limit to what the suppliers can charge and no limit to what the clients will pay just given the criticality of these animals. So you don't do work in large molecule drug development without nonhuman primates. End of sentence, full stop. So that's why I keep saying it's not a debatable proposition. So we'll pass the prices along which we have been. It doesn't really matter whether the clients like it or not. We're not doing it to gouge anybody. We're not making a lot of money on that. We're simply passing it through. And so they understand that. The clients have been very good about this whole situation.

I mean, they want the project, right? Yes. Okay. All right. So I guess for the remainder of the time, we could talk non-monkeys.

That'll be okay with me.

Sure. So can you talk about within RMS view, I want to spend some time with that CRADL that you guys made the recent announcement. Can you talk about the strategy here and seeing some time of early success?

So this CRADL business is a fabulous business, probably if it's such -- been totally recession proof. So we're providing really workspace for our clients where we built animal rooms and associated lab space for them. And they either go in and do their work. Most of them do we just take care of the animals or we do some of the work or we could do all the work. And we -- so we set up our own business a few years ago, starting Cambridge, MA and then San Francisco and then Shanghai and then Cambridge, England and on and on. And it's -- and that was a big competitor of ours, the company that we bought. So we kind of doubled our capacity. It's a nicely sized business now. I don't think we give the exact numbers, but it's a big business growing nicely. It's great operating margins. We have about 400,000 square feet now and opening new space all the time. So it's a twofer. So it generates revenue on [indiscernible] with high growth rates and high margins that it's also a feeder into other parts of the business, particularly discovery. So they're doing pure R&D with us and then it's a discover compound or a molecule that is promising we go into discovery and then hopefully, safety. So we like this business a lot. The integration of the Explorer Labs, which we bought, I don't remember last April if something is going really, really well. It's been seamless. I just visited recently. We have a lot of stuff in California, so I went to a few of their sites, very well run, beautiful facilities. The interesting thing about the business is we thought all the clients will be small biotech and they're not. We have a lot of big pharma who runs out of space, doesn't want to build this space, need spill over space. We got big biotech, we have medium-sized bio tech. So client base is quite interesting and space fills almost immediately upon building it. So I just looked at the space last week. It isn't yet from a construction point of view, it's already spoken for. It's got really good [indiscernible] this business, and I think it can be larger.

And so I mean the RMS business is always one of the -- the slower of the 3 segments. Is this kind of revitalizing it. Is this -- should we think of this rebasing the underlying growth of it [indiscernible] actually?

I think the research model business is fundamentally different today than it was over the last 10 years. So you've got high growth in China, high growth again in North America, which was not predictable at all, pricing always. High growth in the CRADL business and other services businesses, particularly genetically altered animal business, which we're creating animal models through genetic alteration. We have the cell supply business, which is new. So I would say that the RMS business is moving towards very high single digit, maybe potentially low double, but certainly very high single digit with escalating operating margins. So it's gone from the sort of laggard which was growing off a lot of free cash and funding lots of other things we did to being a nice high-growth business on its own.

Yes. I mean that was always the short picture on you guys is that you had your highest margin, slowest growing business from a mix shift and how you could maintain the margins with the new -- with CRADL coming through, I'm assuming the higher margin, all these new drivers are accretive to the overall corporate margin.

They should be definitely accretive to the top line and some accretive to the margins as well.

Okay. Let's talk about a little bit about the DSA. The strength here continues to be strong. You talk about not being impacted by the biotech side. And as the models progress into outside of discovery and then also into the preclinical toxicology testing. Talk about what you're seeing there and what the legs that you see for the drug.

Yes. So 1 of the things that makes the whole NHP thing even more frustrating is that the demand curve for the toxicology business continues to be extraordinary. We booked -- we've looked at a lot of studies for 2023 and 2024. And 2022, unprecedented enormous amount of pricing power and share gains and really strong capacity utilization. So it's a very, very robust business. I think last year's growth rate was a bit unprecedented. So I think the growth rate will probably normal double digits. I think there's an opportunity to grow margin in that business going forward and to continue to take share. So we like it a lot. We've -- just our scale is so much more significant. Discovery business is obviously small. Tenants ebb and flow. So it's a little bit difficult to read the implications of any sort of capital markets. Now if we don't have much is sort of very strong into the fourth quarter. Right now, it kind of feels a little less strong. And it's tough to read because the studies are very short in duration. So they come in really quickly and then you finish them and so there's less predictability. So there might be a modest impact. Having said that, I do think we have a great franchise in Discovery. We just did an acquisition, a small acquisition last week or the week before with very high science, high throughput screening company. We have a lot of these small technology deals that we become acquisitions in the discovery space. So I would say DSA will put in the NHP thing aside, even with the NHP thing, not tracking well pretty good growth metrics to have okay margins. As we get this fixed, the growth rates will accelerate the margins will improve as well. So I think that has long-term sustained growth metric. Probably in the low double digits.

All right. So the guide for the low to mid-singles, yes, low to mid-singles. How much of that is pricing versus the volumes right now? How do you think about it?

It's hard to say. I mean, the NHP things just confuse us so much of it. I'd say if you put that aside is hard to do. What we run those pro formas both ways. And then we're getting a lot of price, and we're still getting a lot of share. So we're getting both. And maybe the price is more sustainable with the sort of NHP headwind.

Okay. On the -- you talked about the CDMO business that you guys just recently acquired selling gene therapy, I think, to talk about the -- have a couple, I guess, a hiccup there, and now the progress now you guys need to fully integrate and driving growth and profitability back in that business.

So CDMO business, we did 7 acquisitions over the last 2 years. A bunch of them during COVID, which is not for the faint of hire. So I would say that, that makes 2 divisions a little more complicated. But anyway, new area, a very complicated science. Somewhat unsophisticated regulatory environment, some unsophisticated clients and even competitors. So huge learning curve for us. No excuse, just facts. Unpleasant headwind for all of 2022. Without the growth -- top line growth we anticipated and [ hiatus ] margins. We have totally transformed that business. I was just in Memphis last week. That's the biggest part. That's a cell therapy manufacturing facility. You wouldn't recognize the facility. The management team is totally new. Client base is fabulous, $100 million of new business that we've booked over the last 12 months. We have several clients that are on the brink of hopefully gone commercial. It's all clinical trials. But we have several clients that we're talking to very seriously about commercialization. We've been inspected by the EMA, which is the European version of the FDA at some point the FDA comes in as well. So I feel really good about the whole CDMO business right now. It will have good growth rates this year. The first quarter will be [indiscernible] key because we had a bunch of milestones in the first quarter of last year, a 99% [indiscernible] we had in our last conference call. But for [indiscernible] pretty much at the rates we had anticipated a touch about when we bought those businesses, and we have improved margins and that should be a tailwind as opposed to a headwind. I think it has enormous potential. I think we have the potential to be the leading player in Elite cell therapy manufacturing. We also have a plasma DNA business in the viral vector business, 1 in the U.K. and 1 in the space, which also we've read in facilities and the staff and the management of them as well. Are there lessons in there from the M&A point of view? Yes, for sure. I'm not really sure what they -- I mean, some of it has to do with just the amount of deals we did at the same time. And the -- I want to say, dangers with the complexity of moving into an [ invacency ], particularly with new science. Having said that, I'd buy the same access again. And we're a year or 2 off of our valuation model. I still think these businesses will have the same return on investment that we originally [ anticipated ] So I'm still [ selling ] very good, particularly it just was there last week about the leadership, the client base, several of the clients ideally I handle personally, some of the ones that are about to transition, hopefully to commercialization [indiscernible]. So I have a real good sense of what the needs are with the demand will be in capacity. If you think about going from clinical manufacturing. And by the way, it's not a good business, but manufacturing commercial quantities, so being higher quantities, I don't know if it's weekly or monthly over and over. So you're production methodology gets much more sophisticated and you can charge higher prices that they're finally selling something as opposed to just costs going out. So I think the whole structure of that business is in transition right now for us.

And when you talk about going double digits and some of these other drugs going commercial, is that baked into that guide? Or would that be upside if those come in.

I would say that none of that's baked into '23 guide because we can't -- there's no predictability.

Yes. You mentioned.

Maybe something gets approved this year, maybe it's next year, I don't know. I just know what they tell us. I know to tell the shareholders, because we read that so. And I know what the dialogue was with the FDA because we're involved. But as you all know, there's 0 predictive whether targets approved. So we'll see. I would say that most of these drugs are very, very tough diseases for which there is the unmet medical needs for which there are no alternative drugs. So it's highly likely they will get approved. Because they're no alternatives, right, and they are working very well in the clinic, but I'm not really qualified to make that [ determination ].

That's fair. That's fair. And then lastly, you're talking about this business. It sounds like you continue to lean into it as the technologies develop and the indications continue to progress. So talk about some additional M&A targets that you would look for [indiscernible] from a technology perspective.

Yes. So our balance sheet is in great shape, and our leverage continues to be lower all the time because we just keep paying off debt. We've done some small deals. We haven't done anything significant. So as we -- as the CDMO business strengthen as we move past this NHP situation, which is taken on under amount of our time, there's a bunch of things we're looking at. So when we feel that we've hit C-level with CDMO, which I think we're moving towards, we definitely have some targets there. Somewhat geographic, by the way. So that's -- if we just need to do [indiscernible], as you would imagine, the cells are living. So the time frame is a problem or a challenge. So shipping sales from the U.S. to Europe and do what you'd rather [ ship ] them from France to France. So I think we'll do some more there. I think we'll do some more from the scale point of view. There are some aspects of the CDMO business that using third parties that we want to buy. We definitely will do more in Discovery. Definitely in large molecule antibodies, in particular, and we'll do some more in the laboratory testing around that. Interestingly, we have a couple of deals in RMS, which will be high growth and high margin. And we have a couple of deals in Biologics. So I don't think there's any need for us to move beyond our current sort of portfolio. We have kind of a $20-plus billion market that we're participating and we're kind of a $4 billion company. So there's lots of runway for us. And we have a lot of targets right now. Every seller is a private equity fund. So everything is the sale. I'm anticipating valuations will be better. We don't know that yet. [indiscernible] gets anything away, but I do think we have to be thinking about what they need to charge for these businesses because I think you need to monetize some things. So we tend to have multiple conversations going on for several years. And so I know with the next 5 deals are we want to do, whether we actually get to do or not is unclear. But we probably -- look, the sales you get to in our franchises that we've done all this coming -- and we have a unique portfolio that the competition doesn't have and what the clients need. So we want to continue to strengthen that. We do these small technology deals in Discovery. We have 20 of them right now, probably 1/3 of those companies we buy a very cutting-edge heavy-duty IP like this company that we just bought last week. So we'll do lots of those. Those are small deals, but have the potential to get large [ pay ] rapidly.

Awesome. That's all the time we have. Thank you.

Thank you.