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

Hi, everybody. My name is Casey Woodring from the Life Science Tools and Diagnostics team. My pleasure to introduce Charles River Labs, CEO, Jim Foster, take it away.

Thanks for the introduction. It's a safe harbor, Reg G and quiet period statement. So we've been working with clients from early discovery all the way through drugs getting to the clinic. And we've been innovating with our research model business, trying to accelerate time to the clinic for our clients in our Discovery and Safety Assessment business. And we have a growing manufacturing capability which we now have a cell and gene therapy capability that we're quite excited with. A lot of stats. Last 12 months, we did a little over $4 billion in revenue. We're sort of primarily North American, is about 60%, and the balance is outside of North America. I think those percentages will be maintained given the fact that most of -- a lot of biotechers is in North America. Pharma and biotech principally and then other CROs as a client base. A couple of thousand clients, and we have 150 locations now. What's important and beneficial about the locations is all things being equal, clients love proximity. So we are proximate to most of our clients, pretty much everywhere. Our employee base is now over 20,000. We have about 2,600 people with advanced scientific degrees, which is critical. We're all about science. The #1 share position in most of our businesses and are aspiring to have #1 share position in the balance of them. We worked on over 80% of all the drugs were approved by the FDA last year -- and for the last 5 years actually. And probably a similar number of drugs that weren't approved, we get paid either way. And we have a large aggregate marketplace, about $25 billion. So kind of staying in our lane and investing in our businesses gives us a really nice growth opportunity. So if you look at the last 5 years, revenue is a 12% CAGR. We're really pleased with that growth rate. Operating margins are around 21%. Operating cash flow -- CAGR of a little over 11% and same with non-GAAP EPS. So we've had a very nice growth for the last 5 years, actually for the last 10. Here we go. So that's the slide I just talked about. Can we do it again? Okay. So lots of things that we focus on from a corporate citizenship point of view. As I said, we're proud of the fact that we worked on almost all the drugs were approved, and we're aspiring to work on 100%. We're about 36% of our Board is our women and minorities. So we're working hard to have a diverse Board, and we're proud of that as well. A lot of work with the employee resource groups in the company. We have about 3,000 people participating in those, and that's allowing people with all different groups within the company to have cadre of people to share things with and to sort of bring their best selves to work every day. And like most companies, we're focusing very much on sustainability and protecting this planet that we've done such a poor job protecting historically. Scope 1 and 2 greenhouse gas emissions decreased 23% from '18 to '22. We're obviously pleased and proud of that. So the distinguishing feature of Charles River is and has been and will continue to be the uniqueness of our portfolio. When we did our leverage buyout at the end of 1999, we principally were a research model company, and we've done 65-or-so acquisitions since then. And we have a broad platform that really goes from discovery to market approval where we do really everything except run clinical trials. And so the research model business sort of sets the basis for the company. And we're able -- as the drug moves on, we do a bunch of discovery work and GLP tox and we test the drugs before they go into the clinic. And now we're manufacturing at least cell therapy drugs. So we're really working on the whole drug development pipeline and really pleased with that. Just looking at the 3 segments that we report publicly, research model business, which is the core business we started about 75 years ago. It's about 20% of the company. So year-to-date growth is 8% and operating margins are in the low 20s. Our DSA business is now more than half of the company. It's 64% and growing, and that's Discovery and Safety Assessment. Year-to-date, growth rate has been 13% in that business with operating margins almost to 30%. And our manufacturing business has been -- has some headwinds from our cell and gene therapy business, which we think will ameliorate going into next year, only 2% growth and operating margins around 20%. So we should see meaningful growth rate really in all of those segments. So just looking at research models, we have a 40% market share by far, the world's leader 1 out of every 2 research models used anywhere in research comes from us. And we have a footprint in the U.S., Europe and China. Growth in China has been faster than other parts of the world as we build in facilities, we're able to grow nicely there. It's kind of like the U.S. and European markets were 30 years ago. Interestingly, we have a large and growing service business. It's probably 20 years old. We're both doing genetically -- producing genetically engineered models. So those have research models where the -- you've either knocked in or knocked out some genes to express a certain disease state. And one of our most interesting businesses where we did an acquisition last year, it's called our CRADL business, where we have facilities around the world that our clients can use to do basic research. So basically, in animal room, which we staff, and we have those in all of the major pharmaceutical biohubs. To that point, we have about 30 locations in the CRADL business now with about 400,000 square feet. We've been adding new facilities consistently throughout the years. And the genetically engineered models are really important discovery tools. So you've got an animal model that actually expresses a disease similar to a human. And we also have animal models now which are immunocompromised, they have no immune system, we're able to insert -- sort of humanize them. And so those are really powerful models as predictors of human disease. Demand has been this year's reasonably slow as sort of a result of the current economic condition. Even China has been a bit slower. I think as the stock market opens up and things begin to change that we'll see a change in that slope. DSA segment is the largest business. As I said earlier, we have about a 30% share. LabCorp's Covance is the next biggest competitor. They have about a 12% share. They were a much larger company than we were years ago and principally through M&A and continuing to take market share, we've been able to grow this business nicely. On the discovery side, we've actually discovered 100 targets for our clients that they were unable to discover on their own, a bunch of those are in the clinic. So we're really pleased with this. And then one of the interesting facts is that, if you're looking at the way money is spent by our client base, most of the money is spent in the clinic and the preclinical work is 5 to 10x less expensive than the clinical work. So what we do is obviously very important. It's less of a financial commitment and is essential to get drugs into the clinic. Our Discovery business has grown nicely all through acquisition. We have a medicinal chemistry business. We have a large oncology franchise and CNS franchise as well. And we have a growing number of integrated programs where we're able to provide a whole suite of services for our clients. And so we like that business a lot. It's also a feeder into our toxicology business, obviously, drugs that continue to look promising rather than the client finding another provider of toxicology services, they can stay with us. Everything is about speed, so their ability to do that is really quite critical. We're the world's leader in Safety Assessment. Again, that business was the aggregation of about a dozen acquisitions over the last 15 years or so. We do basic general toxicology, but we're the world's leader in specialty talks. And those are things like genetic toxicology, reproductive toxicology, immunotoxicology, ocular toxicology, bone tox and things like that. So particularly in the specialty areas, we have very few competitors, if any. And with the big pharma companies that are increasingly outsourcing their work to us, most of the specialty work wasn't even done inside of the large companies. So not to overstate our importance, but we play a central role with many, many companies, basically all the pharma companies and most of the biotech companies are moving their drugs forward. And most of the biotech companies sort of created these days are virtual, so they have no internal capacity to do anything. So everything is outsourced. So we're proud of the central role that we have. We did all the work on all the COVID vaccines and therapeutics for instance. We continue to add to principally the discovery space through technology partnerships, which I'll talk a little bit about later. And through M&A, we have been, as I said earlier, quite acquisitive. The Discovery business is only about 30% outsourced by our clients. We think that will get to 50%, maybe 60%. Toxicology business is about 60% outsourced. We think that will get to at least 80%, could be higher. We've made a significant investment in digitizing our company so that the clients can work with us without ever talking to anybody if that's what they prefer. So they can get a slot, get a price, initiate a study, get the data, check their data all online. And if they want to talk to one of our scientists because the data is equivocal, they have concerns or they're very pleased with it, they can do that. But this is able to -- we're able to speed up the process as a result of this. We've made a promise to ourselves and our clients that we will take a year out of the drug development process. Digitization is one of the ways we'll do that. We're also looking at the white space. By that, we mean space that's taken up by some things that actually aren't adding value, reports that are too long, waiting for things that they don't actually need. And so we're trying very much to accelerate it. Someday, I hope we can help our clients get more drugs to market faster. But until we can do that, we want to help them get the same amount of drugs faster. So we've had a sort of a slower period in the DSA business. Our backlog's elongated to 18 to 24 months. They're down to about a year. We're fine with that. What we want is to be able to slot a new study and if a current study that book slips or slides, which happens all the time, we have -- client base has been cautious in fiscal '23, given concerns about access to capital. I think a lot of that is psychological rather than real. And I do think that when the capital markets open up, some of this is going to snap back relatively quickly. A lot of conversation about access to nonhuman primates, which are critical for large molecule testing required by law. So we've done a lot of work in expanding our capability and access and enhancing our supply chain and really preparing to enhance our disclosure to you folks. So just a few things that we've done. We're spending more time auditing our suppliers and preparing to provide genetic testing to ensure parentage of these models, and we're going to do that along with appropriate regulatory agencies and the providers. So we feel really good about that. We've bought a couple of the providers. We just finished the acquisition of 90% of one of our suppliers in the island of Mauritius, which has extremely high quality and HP is just because that's an island. And so just the pristine nature of them has been important to our clients, particularly overseas. We also own a facility in China. And in situations where we don't own the facilities, we have joint ventures with some of them and long-term contracts with all of them. And where we have committed to our shareholder base that we'll begin to disclose country of origin and where we're getting the supply sources from a going-forward basis. And so we have a multiplicity of supply sources with similar genetic background and are quite confident that, particularly as we go into next year that we'll be really in great shape. We have spent a lot of time making sure that we have physical capacity principally in the U.S. to keep the NHPs so they can go on study quickly. We test them before they leave the country of origin, we test them when they get here and make sure they're in a pristine nature and I feel good about that. There's been a lot of conversation about access to Cambodian NHPs, and we still have access to those animals and have used our worldwide infrastructure in a really robust way to service our clients. So we had no missteps in terms of supply and access and don't anticipate any in the future. Also spending a lot of time appropriately looking at reducing NHP usage if and as possible, and we're doing things like having virtual control groups instead of having animals that are of control, this is done virtually. We're looking at some in vitro alternatives, which is, I think, a ways off, but there's some interesting technology. We've invested about $200 million over the last few years and looking at alternative technologies, things like AI, next-generation sequencing, 3D modeling organs in a dish, organoids and on and on. And I think some of these technologies will get traction, particularly in the discovery space. Manufacturing segment. We're producing a lot of old biologics, things like monoclonals, cell and gene therapy is new for us. We did several acquisitions during COVID, interestingly enough. And so we've got 3 businesses in this space. We have a microbial testing business, which is looking for a level of contamination when injectable drugs or medical devices are manufactured that's required by law, required by the FDA. It's been historically a very high growth, high-margin business. We also have a biologic testing business, which is testing biologics to make sure they're free of human viruses, for instance, before the drugs going to the clinic and after they've been approved for commercial sale. And then we have the cell and gene therapy business where we produce viral vectors, plasma DNAs. We're actually producing drugs, mostly in the clinic, but we have some commercial drugs as well. So the cell and gene therapy business has been really quite interesting for us. We have a broader portfolio than all of our competitors. And so clients want to stay with us through the life cycle of the drug, so they can discover a drug, we can do the tox for them, we can do the test again. And actually, we went back into the CDMO space because clients were saying, you do all of this testing around that drug, we really would like you to manufacture for us. So we're actually manufacturing gene-modified cell therapy drugs that are going directly into patients from our site. We're really pleased and proud that Vertex just had an announcement, I think, last week or the week before that they have a sickle cell anemia drug that we'll be manufacturing for them in the U.S. So we're proud of that, but it's also a validation of the strength and readiness of our Memphis facility where we do this manufacturing. So we've had multiple audits by multiple regulatory agencies. So that business, we believe, can grow at double-digit rates. We believe that both the growth rate and the margins will continue to improve. We believe that so much of the clinical candidates that we have now will become commercial ones in the not-too-distant future, we hope. So cell and gene has been interesting. There's only 20 drugs that have been approved. I think that has a lot to do with FDA's concern about safety profile. And so you are messing around with people's genome and what's the long-term effect of that. So there's been a fair amount of pauses and concerns. Having said that, the 3,000 drugs in development. And what you see with all of these technologies is that, there's often a second and sometimes a third generation of technology. So we're only in the first generation now. We're quite sure there'll be a second generation. We'll be right in the midst of this and all these drugs have to go through safety testing as well. But some of the breakthroughs in terms of treatments using cell and gene, particularly in the cancer field, have been quite stunning. Tumors shrinking down to nothing in people that had Stage IV cancer and really bleak prospects are leading productive lives. Our ability to continue to build out the portfolio, as I said earlier, has been really important to us. And so we've done a lot of M&A. As I said earlier, over 65 deals. We've done 25 since 2012, spent about -- almost $5 billion doing that. We're very disciplined in our approach and the returns that we look for. I think that our integration capabilities have been enhanced and improved dramatically. We have a full-time team of about 10 people that does due diligence and the integration. I'm spending some time at this meeting, talking to perspective companies that would be very good fits in our portfolio. We're not interested in just getting larger for the sake of getting large, we are interested in being able to support our clients in a more robust way and having them not needing to go outside and validating other providers. So what you see is our clients are using a smaller number of research partners and it's all about speed. We have 20 technology partnerships. We call them where we've provided some equity financing or some debt financing, a small amount, usually. And then where the marketing and sales conduits. So we're providing this technology to our clients and getting feedback from the clients as to whether the technology really works, whether the company that we invested in is responsive and all of these technologies are cutting edge. So they all have very deep IP. Most of them will end up in our discovery portfolio, if and when we buy them, we have a right of first refusal to buy all of these companies and a predetermined takeout formula for several of them. So we've already bought a company in the antibody discovery space. We've made some investments in AI in 3D modeling. We have won a digital pathology space. So really exciting deal. So we'll continue to do that. And then we have very deep relationships with our venture partners. We have maybe 7 or 8 companies -- venture firms where we're LPs. We have another 7 or 8, which we work with strategically were not LPs and another 7 or 8, which we work with, not strategically, but they do a lot of work with us. About 10% of our revenue is with portfolio companies from the venture folks. And as I think I said earlier, most of these companies that are created by the venture capital firms are virtual. So they have 4 or 5 people. They have an idea, they have a molecule, they have a delivery capability and everything is going to be outsourced to get them to market or order failure. And so these relationships with the venture folks are really important. Here's 3 examples of these technology deals that we do. So we have a deal with Valo, which is an AI company. Their goal is to develop a drug totally using AI, no animals, no people. So we'll see how that works. And a portion of that deal we're working with our technology and theirs collectively to help our clients get to a lead compound much faster. So that's also part of our process of taking time out of the discovery process. Deciphex is a digital pathology platform. So the punch line in all of our toxicology studies is what the pathologist sees under the microscope. Sort of lesions show up and are those a result of the drug or is that sort of natural. And so now pathology, it can be digitized and much faster process and you can peer review it. So someone back at one of our clients can look at the same image on his or her computer and talk to our folks about that because some of the results are often equivocal. So is a toxic or not. So we're excited about that. And then another company called PathoQuest, which is next-generation sequencing actually has -- is now inside of one of our facilities. We have a deal with this company. We could also buy it sometime in the future, but that's going to replace some of the animal work that we do in our biologics business. So these are 3 really good examples. So AI, digital pathology and next-generation sequencing of technology that is moving quickly that we have to have, I think, to stay quasi cutting edge, to stay ahead of our competition and to provide services that our clients very much need. So speed is everything, and a client the other day had said to me that they are hoping to take 2 years out of the drug development process and I told them that we would do everything we could to help them with that. And we're committed to speeding up the process and also continuing to improve our operating margins. And so we have guidance out there that by 2026, we'll have 150 bps improvement in our operating margin, while we accelerate time lines. And as I said earlier, this whole digital capability that we have, which we're rolling out across all of our businesses is definitely an accelerant. It drives greater efficiency and drives improvement in our operating margins for sure. So -- we continue to work on strengthening the portfolio. We continue to work all the time in driving efficiency and improving our operating margins. That's something that we're never done with. We're very committed to speeding up the process. We're very committed to evaluating and acquiring cutting-edge technology to the extent that we think it will enhance our ability to provide these services. And we want to continue to have an environment where people want to come and stay, I think our career opportunities are exceptional, and we're recruiting actually a lot of people in from big pharma and biotech and academia. So I think we're poised for a beneficial 2024. And I think I'll stop now and take questions.

All right. Great. Thank you for that overview, Jim. Maybe we'll jump right into it here. So at your Analyst Day in September, you noted that 2024 organic revenue growth will come in below the 24 to 26 top line growth range of 6% to 8% before returning to high singles in '25 and '26. Can you just walk through where the softness is expected in 2024 relative to that high single-digit growth rate in '25 and beyond? How much of that discrepancy will come from lower DSA expectations versus manufacturing versus RMS? Just maybe walk through the different business segments for next year?

I think I'm going to stop short of doing that. Sorry. We haven't -- we're in a quiet period. We haven't finished the year, I haven't seen the Q4 results yet or January results. And so it's critical how the year ends. It's critical how the year starts just in terms of making any assessment about what the growth rate will be in a particular segment. And so I think we'll wait for February. Sorry.

Okay. Fair enough. I wanted to touch on NHP pricing. That's been a key debate. On the 3Q call, you highlighted that NHP pricing had increased $20,000 per model since 2020. Curious how you're thinking about NHP pricing in 2024? Do you think those will come down materially, just given the current market environment? And as a follow-up, you've talked a lot about how NHPs are largely pass-throughs, but can you just maybe walk through the margin impact from potentially substantial drop in NHP prices this year?

So the prices probably will come down somewhat for the industry. We didn't raise our prices as much as many of our competitors. So it's not a foregone conclusion that they'll come down further with regard to Charles River. So I think that we'll be able to maintain our prices. As I said, we have -- going forward, I think we have exceptional supply capabilities. Definitely, there's some margin benefit to the pricing. I think it's less than some people thought. We have very good margins in the non-NHP toxicology work that we do as well. It's an important species and important for large molecule testing. So I think it's going to be a sort of a logical sequence of appropriate pricing and margin contribution.

Maybe longer term, what gives you confidence in that return to high single-digit growth in '25 and beyond? The headwinds in manufacturing seem a bit more transitory, but there remain question marks around the long-term impacts of biotech funding and the IRA and what that impact will look like on the funnel from discovery into safety and it's shown up in RMS here as of 3Q too. So just maybe talk about the headwinds rolling off over the course of '24 to get back to that high single-digit growth rate in '25 and beyond?

I mean our confidence is premised on the fact that we have a very strong competitive position. We continue to enhance the portfolio primarily through M&A, but also through significant organic investment. As I said earlier, there's a whole bunch of new companies somewhere between 500 and 700 created every year by venture capitalists that only outsource and are kind of remaining 10 large pharmaceutical companies are increasingly accelerating their outsourcing needs. We continue to feel that we'll be paid well for our services and the work that we do is essential and complex. And so the result of that sort of building it up segment by segment and to some extent, client by client and understand the competitive dynamic gives us confidence in that longer-term guidance we have out there of high-single digit.

Got it. In DSA, gross book-to-bill has come in above 1 for the second straight quarter after 3Q. Curious there, if there's an expected improvement again in 4Q on that gross bookings number? And then just visibility into next year, I think backlog coverage was at 12 months at the end of 3Q?

I think I want to stay away from that as well. I mean just to repeat what I said earlier, our backlog's elongated to -- we were enjoying it, but they elongated to the point where we really found that we had clients that were booking slots without necessarily having studies associated with that. So as we've gone from maybe 18 to 24 months back down to maybe a dozen months, gives us a really strong backlog to be able to fill in the gaps if studies slip and also have a much clearer understanding of how our capacity, both human staffing capacity and physical capacity will be utilized. So we've been experiencing a normalization of capacity utilization and backlog. And we had years where the backlog was kind of 6 to 9 months that worked really well. We had enough knowledge and enough predictability about how much space we needed and how much staff we had to continue to add. So we're moving back into that domain.

Got it. That's helpful. I'll pause here if anybody has any questions from the audience? I think we have 1 in front.

I just wanted to ask about the NHP pricing, mainly with supported some of the overall trends, both structure [indiscernible] driving this price increases [indiscernible] down side?