Charles River Laboratories International, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Charles Weaver Laboratories International Fourth Quarter Earnings Conference Call and 2021 Guidance Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question, you will need to press star 1 on your telephone. Please be advised, today's conference is being recorded. If you require any further assistance, please press star zero. I'd like to hand the conference over to your speaker today, Mr. Todd Spencer, Corporate Vice President of Investor Relations with Charles River. Please go ahead.

Thank you, Mary. Good morning and welcome to Charles River Laboratories' fourth quarter 2020 earnings and 2021 guidance conference call and webcast. This morning, Jim Foster, Chairman, President, and Chief Executive Officer And David Smith, Executive Vice President and Chief Financial Officer, will comment on our results for the fourth quarter and full year 2020 and our guidance for 2021, as well as our planned acquisition of Cognate Bioservices. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which will be posted on the investor relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately two hours after today's call and can also be accessed on our investor relations website. The replay will be available through next quarter's conference call. I'd like to remind you of our safe harbor. All remarks that we make about future expectations, plans, and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated. During this call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results from operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the investor relations section of our website. In addition, today's remarks will also include estimates of the COVID impact on the company. Certain methodologies and assumptions related to how we develop these estimates can be found on slide three. I will now turn the call over to Jim Foster.

Thanks, Todd. Good morning. I'm very pleased to speak with you today about the conclusion of another extraordinary year for Charles River, our expectations for 2021. and the expansion of our early-stage research and manufacturing support portfolio into a complementary high-growth sector. 2020 was an unprecedented year. The COVID-19 pandemic challenged us in many ways, but to date we've navigated it successfully and reinforced our position as the leading non-clinical CRO. Our success in 2020 was due to the resilience of our business model our comprehensive business continuity plans that enabled us to keep our worldwide operating sites open and adequately staffed, our broad scientific capabilities and flexible outsourcing solutions that supported clients' needs, and our employees around the world who met client needs through their commitment and dedication. As a result, we have now become even more integral to our valued clients and more differentiated from the competition. Despite the short-term impact of COVID-related client disruptions, we benefited from robust underlying client demands across most of our businesses. This was largely driven by clients' intensified use of strategic outsourcing to overcome challenges at their own sites as they partnered with us to move their early-stage research programs forward during the pandemic. In addition, the record biotech funding environment, which eclipsed $130 billion last year, is allowing our clients to place greater emphasis on R&D investments particularly in the early stage pipelines. We believe these factors drove our exceptional financial results in the fourth quarter and for the full year. We are extremely pleased to report organic revenue growth above 10% in the fourth quarter and 7% for the year. Both metrics are in line with or above our high single-digit organic growth target, despite the short-term challenges associated with COVID-19 last year. We also achieved our two-year operating margin target of 20% for the full year, one year ahead of schedule. We are continuing to closely monitor COVID-19, but believe our strong performance in 2020 and a continuation of robust demand trends, including record booking and proposal activity in the safety assessment business, position us well to get off to a strong start in 2021. COVID-19 pandemic has also enhanced the global focus on scientific innovation, which is generating biomedical breakthroughs across multiple therapeutic areas, including for COVID-19 vaccines. This innovation has fueled continued investment in, and the proliferation of, more complex research techniques involving advanced drug modalities, such as cell and gene therapies. The complexity of these new modalities is increasing our clients' reliance on a high science outsourcing partner like Shell's River. To enhance our ability to meet our clients' needs in these emerging areas of scientific innovation and to take advantage of the significant growth opportunity that these advanced drug modalities present, we are expanding our portfolio and scientific expertise through a combination of acquisitions, strategic partnerships, and internal investments. This morning, we announced our intent to acquire Cognate Bioservices, a premier CDMO partner for clients' comprehensive cell and gene therapy development and manufacturing needs. We believe Cognate, which will become part of our manufacturing segment, is an excellent opportunity to enter the CDMO market because it will allow us to participate in a niche value-added sector with a high growth profile that adds to our existing non-clinical development and manufacturing support capabilities. Let me start by highlighting three key aspects of the strategic rationale. Cognate has solutions across the major CDMO platforms for cell and gene therapies. Integrating manufacturing and required analytical testing is critical to drive efficiency, and the cell and gene therapy sector offers exceptional growth potential. Cognate's scientific expertise expertise makes this a particularly attractive transaction. It provides CDMO services across both cell and gene therapies with its primary area of expertise in the CGMP cell therapy manufacturing. Cognate also has capabilities in the production of plasma DNA, which is a foundational tool for the development of gene-modified cell therapies and gene therapies, as well as other inputs in the CDMO value chain. Cell and gene therapies are emerging drug modalities, and as such, the science will continue to evolve. However, Cognate's broad capabilities should enable it to better adapt to shifts in the marketplace. Cognate has a track record of producing various cell types and technologies, use in cellular immunotherapy and immuno-oncology, regenerative medicine, and advanced cell therapy. The synergistic fit is the second pillar of the rationale. Cognate will be highly complementary to our existing non-clinical capabilities, establishing a premier scientific partner for cell and gene therapy development, testing, and manufacturing, and providing clients with an integrated solution from basic research through GMP production. Biopharmaceutical clients are seeking to drive greater efficiency and leverage scientific benefits by working with fewer trusted partners who have broad integrated capabilities. As we are already a provider of extensive non-clinical services for cell and gene therapies, the acquisition of Cognate will enable us to produce drugs in these advanced modalities. We believe the strategic expansion of our portfolio is particularly synergistic with our biologics testing solutions business. It will be ideal for clients to be able to seamlessly conduct analytical testing, process development, and manufacturing for advanced modalities with the same scientific partners. enabling them to achieve their goal of driving greater efficiency. Our biologics business is a premier provider of quality control testing for cell and gene therapies, including assay development, analytical testing, and cell banking, which are all critical steps in the manufacturing scale-up and commercial production processes. Clients will also have access to our cellular products as the starting point for the cell therapy programs. and we'll be able to work with Charles River through every step of the research and early stage development process before moving into CGMP production with Cognate, accelerating our clients' speed to market for advanced drug modalities. With Charles River and Cognate combined, we expect to effectively double the revenue base of our comprehensive cell and gene therapy capabilities to approximately 10% of our total revenue. We believe Cognate will also immediately enhance our growth potential by expanding our capabilities and scale into this complementary high-growth cell and gene therapy sector. The addressable market for Cognate CDMO services, principally cell therapy and plasmid production, is currently estimated at approximately $1.5 billion and expected to grow at least 25% annually over the next five years. Growth is being fueled by the robust biotech funding environment Approximately $20 billion was invested in cell and gene therapy companies in 2020, fueling the rapid rise of cell and gene therapies in the R&D pipeline, which now total over 2,000 programs. We believe the demand for cognate services will intensify as more of these programs progress into late-stage development and commercialization. The companies that are successful in the market will be able to provide the science, the space, and the integrated solutions to broadly support clients' cell and gene therapy programs. We intend to be one of these successful companies. The purchase price for Cognate is expected to be approximately $875 million in cash, and the valuation will be consistent with comparable high growth, high science transactions in the cell and gene therapy CDMO sector. Cognate is expected to generate annual revenue of approximately $140 million in 2021, which we project to grow at or above the estimated market rate of at least 25% annually over the next five years. Because of the market growth potential and the emerging role of cell and gene therapies as treatments for oncology and rare diseases in particular, we believe Cognate will meaningfully enhance our revenue and earnings growth potential, and the transaction will achieve our hurdle rates for investment returns. David will provide additional financial details on the transaction, including the estimated 2021 financial impact. We look forward to welcoming Cognate's dedicated employees to the Charles River family. Now let me give you the highlights of our fourth quarter and full year performance. We reported revenue of $791 million in the fourth quarter of 2020, an increase of 14.4% on a reported basis. Robust client demand across all three business segments drove organic revenue growth of 10.3%, The DSA and manufacturing segments reported low double-digit organic growth. The RMS segments' organic growth rate rebounded to a mid-single-digit rate, recovering from COVID-related client disruptions principally in the second quarter. For 2020, revenue was $2.92 billion, with a reported growth rate of 11.5% and an organic growth rate of 7%. We're very pleased with this high single-digit organic growth rate, particularly in light of the revenue headwind from COVID-19. The operating margin was 20.8% in the fourth quarter, a decrease of 60 basis points year-over-year. Margin improvement in both R&S and manufacturing segments was offset by DSA operating margin decline. For the full year, the operating margin increased by 100 basis points to 20%, achieving our target one year ahead of schedule. This was an exceptional performance, resulting primarily from the inherent operating leverage in our business, our continued efforts to drive operating efficiency and build a more scalable infrastructure, and the benefits from the temporary cost reduction initiatives related to COVID-19. Despite achieving our 20% target, we believe we are well positioned to achieve modest operating margin improvement in 2021. Earnings per share were $2.39 in the fourth quarter, an increase of 18.9% from $2.01 in the fourth quarter of 2019. For the full year, earnings per share were $8.13, a 20.8% increase over the prior year. We exceeded our prior guidance range of $7.75 to $7.85 due primarily to robust low double-digit organic revenue growth and favorable below-the-line items for the fourth quarter, including a lower tax rate. We are very enthusiastic about the outlook for 2021. We believe our exceptional market position, the strategic expansion of our unique portfolio, and our focus on operational excellence, combined with continuing robust client demand, position us extremely well for the year ahead. Excluding Cognate, we expect organic revenue growth of 9% to 11%, and non-GAAP earnings per share in a range of $9 to $9.25, or an increase of 11% to 14% year-over-year. The acquisition of cognates expected to be neutral to non-GAAP earnings per share in 2021 and add approximately 400 basis points to the reported revenue growth rate, which equates to a reported revenue growth outlook of 16% to 18% in 2021. I'd like to provide you with additional details on our fourth quarter segment performance and our expectations for 2021, beginning with the DSA segment's results. DSA revenue in the fourth quarter was $495 million, an 11.3% increase on an organic basis, driven by robust demand from global biopharmaceutical and biotechnology clients in both discovery and safety assessments. For the full year, DSA organic revenue growth was 9.4%. We expect organic revenue growth will be approaching 10% in the DSA segment in 2021 because clients, both large and small, are increasingly choosing to partner with a large, reliable CRO like Charles River. Clients know that utilizing our science, our broad early-stage portfolio, and our flexible outsourcing solutions will propel their research efforts faster and more efficiently than they could do it alone. This was amply demonstrated during the pandemic when they faced challenges at their own sites. Robust biotech funding also continues to fuel a healthy demand environment. Our safety assessment business continued to perform extremely well, driven by higher study volume and price increases in the fourth quarter. Bookings and proposal volume reached record levels in the fourth quarter across all regions and major service areas, which we believe positions the safety assessment business favorably for a strong first half of 2021. We're pleased with the extensive depth and breadth of our safety assessment portfolio and remain intently focused on continuing to enhance the value we provide to our clients. We're also seeing greater opportunities to conduct safety and efficacy testing on cell and gene therapies. We believe there is meaningful growth potential inherent in the more than 2,000 programs currently in the cell and gene therapy pipeline, approximately two-thirds of which are in the preclinical phase. The testing requirements for cell and gene therapies vary by molecule, from complex combination pharmacology safety studies to certain cell therapies to safety programs that are similar to a traditional large molecule for gene therapies. We've already built one of the largest early-stage testing platforms to support this emerging high-growth sector and intend to continue to adapt and enhance our capabilities to meet the specific needs of these emerging drug modalities. We are continuing to add new capabilities across many of our businesses, including through strategic partnerships. Our partnership strategy has proven to be very successful to stay current with cutting-edge technologies and add innovative capabilities with limited upfront risk. In the last several months, we've added new partnerships and expanded existing ones across several businesses, including with Cypray, for 3D tumor modeling and screening immuno-oncological compounds in our discovery business, and with PathoQuest and Jade Biomedical in our biologics business. In addition, last month, we announced the acquisition of Distributed Bio, formerly a strategic partner, through which we established our integrated large molecule discovery platform. This platform filled a gap in our portfolio and expanded our early discovery expertise in the complex drug modality that few CROs can successfully offer. We believe our clients' willingness to outsource more of their discovery programs will be predicated on our ability to continue to add innovative capabilities to meet their critical research needs. We believe the combination of the strategic outsourcing trend, deep scientific expertise, and our willingness to forge flexible relationships with clients led to the tremendous performance of the discovery business, which had another exceptional quarter and year Broad-based demand for our suite of early discovery oncology and CNS services drove the fourth quarter performance. To achieve our goals in 2021 and beyond, we will continue to strengthen our portfolio by expanding our scale, our science, and our innovative technologies. By doing so, we are enabling our clients to remain with one scientific partner from target identification through IND filing and solidifying our position as the leading early-stage CRO. The DSA operating margin was 23.2% in the fourth quarter, a decrease of 240 basis points for the fourth quarter of 2019. The decrease was driven by increased costs due in part to performance-based bonuses and a slightly less favorable study mix in the safety assessment business. For 2020, the DSA operating margin improved by 140 basis points to 23.4%. We are pleased with the full-year margin expansion in the DSA segment. and believe there will be incremental opportunities for improvement. RMS revenue in the fourth quarter was $156.7 million, an increase of 5.2% on an organic basis. For the year, RMS organic revenue declined by 3.3%, reflecting an impact of approximately 7% from COVID-19, principally in the second quarter. Our outlook for RMS organic revenue growth will be in the high teens for 2021 as a result of the recovery from last year's COVID-19 headwinds and the incremental benefit from adding the high-growth self-supply businesses to the organic revenue base following the respective anniversaries of the Hemacare and Solero acquisitions. As anticipated, global demand for research models improved in the fourth quarter, both on a year-over-year and sequential basis as clients returned to normalize order activity in all geographic regions following COVID-related disruptions earlier in the year. Demand accelerated nicely in the fourth quarter, particularly in China. We believe that we benefited from market share gains in 2020, especially with academic clients. As research sites reopened and not all suppliers could meet the client's needs, we will continue to monitor the evolving COVID-19 situation globally, but at this point, It appears that most academic and biopharmaceutical clients have adapted their protocols to continue working during the pandemic. Research model services also continue to perform well. GEMS is benefiting from renewed outsourcing demand due in part to COVID-19 challenges at our client sites earlier in the year, as well as scientists' use of more complex research models. We're the natural partner for our GEMS clients since we have extensive animal husbandry expertise which enables us to manage their proprietary models safely and efficiently. We're also continuing to generate client interest for insourcing solutions through both our cradle initiative, where we provide turnkey research capacity to our clients, as well as through more traditional insourced staffing arrangements. Revenue for our self-supplied businesses, Hemacare and Solero, increased in the fourth quarter on a comparative basis, but remained at a growth rate below the targeted 30% level. We anticipate that this growth rate will accelerate as COVID-19 constraints ease, and we expect to achieve our growth rate for these businesses in 2021. We continue to work diligently to expand our donor base in the U.S. and add more comprehensive capabilities at all our sites to accommodate the robust demand in the cell therapy market. The acquisition of Cognate also positions Charles River as a trusted partner that can move cell therapy programs forward using the same cellular products through each step of the research and early stage development phases and into CGMP production at Cognate. The RMS operating margin was 25.1% in the fourth quarter, an increase of 50 basis points from the fourth quarter of 19. The increase was driven by operating leverage from higher sales volumes in the research model business, as well as the benefit from operating efficiency initiatives. For 2020, the RMS operating margin declined by 420 basis points to 22%, due almost entirely to the impact of COVID-19. With the financial impact of COVID-19 believed to be largely behind us, we expect the RMS operating margin will rebound well above the 25% level in 2021. Manufacturing revenue was $139.3 million For the fourth quarter, a growth rate of 12.4% on an organic basis, driven primarily by the biologics businesses. The microbial solutions and avian vaccines businesses were also meaningful contributors to the fourth quarter revenue growth. Organic revenue growth for the year was 10.4%. Microbial solutions revenue growth rate improved again in the fourth quarter, due in part to year-end ordering trends for EndoSafe testing cartridges. We continue to have delayed instrument installations resulting from COVID-19 restrictions at certain client sites. We expect this will constrain the microbial solutions revenue growth rate well into 2021, primarily because the incremental revenue stream associated with corresponding sale of consumables, including cartridges, reagents, and actigenics microbial identification services that generally follow the installation of our high throughput systems will be delayed. This is the primary factor that is expected to cause the segment's organic growth rate to be slightly below 10% in 2021. Beyond the COVID-19-related impact, we continue to firmly believe that our ability to provide clients with a comprehensive, rapid, and efficient microbial testing solution, as well as a high-quality and accurate testing platform, are key differentiators from the competition and will lead clients to continue to choose Charles River for the critical quality control testing requirements. The biologics business reported an exceptional quarter in a year with strong double-digit revenue growth. We believe that robust market demand will continue to support biologics revenue growth in 2021 due largely to demand for testing of cell and gene therapies. We've developed a comprehensive suite of new assays required to support the unique needs of cell and gene therapies and will continue to add assays in 2021 to accommodate the robust demand. The acquisition of Cognate is also expected to be highly synergistic to our biologics business. Its clients will now be able to outsource GMP cell and gene therapy production and the required analytical testing to one scientific partner, reducing the bottlenecks and inefficiencies of utilizing multiple outsource providers. We also expect to derive a benefit from COVID-19 testing. We believe our biologic business will be providing required production testing as many of the vaccines move into the commercial production phase and some of the early stage testing activities subside. Given the strength of the demand environment, we are continuing to build upon our extensive portfolio of services to support the safe manufacture of biologics and ensure we have available capacity to accommodate client demand. As part of this strategy, we were pleased to recently announce that we have expanded our partnership with PathQuest to build a next-generation sequencing lab at our Pennsylvania site and partnered with Jade Biomedical to enhance our biologic testing capabilities and geographic reach in China. Due to the leverage from strong revenue growth, the manufacturing support segment's operating margin was 37.3% in the fourth quarter, an increase of 10 basis points. For the year, the operating margin was 37.4% above our mid-30% target and consistent with our expectations for 2021, excluding cognate. As I mentioned earlier, we believe that the COVID-19 pandemic has demonstrated that we are even more integral to our clients now. We have been intently focused on accommodating their evolving needs during these challenging times, and many clients have told us that they couldn't move They couldn't move their research forward without us. Clients have outsourced incremental work to us across multiple therapeutic areas because of our deep scientific expertise and the ease and flexibility of working with an integrated early-stage CRO like Charles Ferber. As a result, we generated approximately $60 million in revenue last year from our work on COVID-19 vaccines and related therapeutics. We're proud to have worked on all of the COVID-19 vaccines that have been approved for emergency use by the FDA and and in the UK to date, including the AstraZeneca and Moderna vaccines. AstraZeneca and Moderna are two leading biopharmaceutical companies that we have worked closely with under our respective strategic relationships for many years, as they have embraced the benefits of outsourcing and driving efficiency through their R&D organizations. Our relationships with Moderna and AstraZeneca demonstrate how we can work together towards a common mission, to bring breakthrough treatments to market to save lives, which has been particularly critical now as we strive to find a solution to the pandemic. As 2020 has demonstrated, we are operating in a robust business environment with excellent growth potential. To continue to successfully execute our strategy to maintain and enhance Charles River's position as a leading early-stage CRO, to expand our manufacturing support to CDMO capabilities, We will continue to make investments in our scientific capabilities through M&A, strategic partnerships, and internal development, expand capacity and staff to accommodate demand, and exploit our digital enterprise to provide critical data for internal use and to enhance connectivity with our clients. We will continue to evaluate acquisition opportunities across our businesses and across a number of drug modalities and scientific capabilities. We will invest in a disciplined manner, strengthening our portfolio and focusing on speed and responsiveness as we meet our clients' individual needs and promote a more efficient drug development model. Our goal is to enhance our position as a trusted scientific partner for pharmaceutical and biotechnology companies, academic institutions, and government and non-governmental organizations worldwide. By providing exceptional value to our clients, we believe we will continue to deliver greater value to our shareholders. Conclusion, I want to thank our employees for their exceptional work and commitment, especially during the COVID-19 pandemic, and our shareholders for their support. Now, I'd like David Smith to give you additional details on our financial performance and 2021 guidance, as well as additional details on the acquisition of Cognate.