Charles River Laboratories International, Inc.

Today, thank you for standing by and welcome to the Charles River Laboratories International Q2 2021 Earnings 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 during the session, you need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, press star 0. I would now like to hand the call over to your host, Todd Spencer, Corporate Vice President of Investor Relations. Please go ahead.

Thank you. Good morning and welcome to Charles River Laboratory's second quarter 2021 earnings 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 second quarter of 2021. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is 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 the call today and can 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 of 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. I will now turn the call over to Jim Foster.

Thanks, Todd. Good morning. The strength of our leading non-clinical portfolio was clearly demonstrated in our second quarter financial performance. Robust Industry fundamentals are leading to unprecedented client demand across most of our businesses, and we're extremely well positioned to succeed in this environment. Second quarter organic growth, revenue growth, was in the mid-teens, even after normalizing for last year's COVID-19 impact, and exceeded the long-term low double-digit target that we recently provided at our investor day in May. Clients are increasingly choosing to partner with us for our flexible and efficient outsourcing solutions, the scientific depth and breadth of our portfolio, and our unwavering focus on flawlessly serving the diverse needs. Utilizing our capabilities enables them to drive greater efficiency and accelerate the speed of their research, non-clinical development, and manufacturing programs. We believe that the efforts we have made and continue to make to differentiate ourselves from the competition are critical as clients choose to work with a smaller number of CROs who offer broader scientific capabilities. Due to the sustained demand, we are keenly focused on the execution of our strategy. We are strengthening our portfolio, as we did through the acquisition of Gene Therapy CDMO by Gene Biosciences in late June, strategically adding staff and capacity to accommodate the robust demand and support our clients, and enhancing our digital enterprise capabilities to provide greater connectivity and exceptional service to them. We believe we will make these investments and remain well positioned to achieve our operating margin target of 22.5% in 2024. We believe the success of our strategy is reflected in our second quarter performance. So let me provide some of the highlights. Quarterly revenue surpassed $900 million for the first time. and at $914.6 million in the second quarter of 2021, represented a 34% increase over last year. Organic revenue growth of 24.1% was increased by approximately 8% when compared to last year's COVID-19 impact in the second quarter of 2020, with the greatest impact in the research models and services segment. Even after normalizing for the COVID impact, we reported mid-teens organic growth, with double-digit increases across all three business segments. The operating margin was 20.8%, an increase of 350 basis points year-over-year. The improvement was principally driven by the RMS segment, reflecting operating leverage from significantly higher sales volume for research models, due in part to the comparison to last year's COVID-19 impact. Notwithstanding this favorable year-over-year comparison, We were pleased with the margin progression in the first half of the year and are on track to achieve a full year operating margin of approximately 21% or 100 basis points higher than last year. Earnings per share were $2.61 in the second quarter, an increase of 65.2% from $1.58 in the second quarter of last year. This result widely exceeded our prior outlook of more than 50% earnings growth for the quarter and primarily as a result of the exceptional demand environment. Based on the second quarter performance and our expectation for sustained demand through the remainder of the year, we are increasing our revenue growth and non-GAAP earnings per share guidance for 2021. We now expect organic revenue growth in a range of 13 to 15 percent, 100 basis point increase from our prior range. Non-GAAP earnings per share are expected to be in a range from $10.10 to $10.35, which represents 24% to 27% year-over-year growth, and an increase of $0.35 at midpoint from our prior outlook. We attribute this exceptional performance and outlook to the success of our ongoing efforts to enhance our position as the leading non-clinical contract research and manufacturing organization, as well as the pace of scientific innovation that's fueling a significant increase in biotech funding and FDA approvals, both of which are tracking to near record levels through the first half of the year. I'd like to provide you with details on the second quarter segment performance beginning with the DSA segment. Revenue is $540.1 million in the second quarter, an 18.1% increase on an organic basis over the second quarter of 2020, driven by broad-based demand for both discovery and safety assessment services. COVID only had a small impact on the DSA segment last year, so it wasn't a meaningful driver of the year-over-year growth. Safety assessment business continued to perform exceptionally well, reflecting robust demand from both biotech and global biopharma clients and price increases. Bookings and proposal volume continued to achieve record highs in the second quarter, with strength across all regions and major service areas. The strength of biotech funding is enabling clients to meaningfully invest in early-stage programs, and due to the unprecedented demand, we are now booking work into next year. As I mentioned last quarter, clients are expanding their preclinical pipelines and intensifying their focus on complex biologics to ensure that They do not delay their research. We believe clients are securing space with us further in advance, which in turn provides us with greater visibility. To support our clients, we are continuing to add staff, capacity, and the resources necessary to effectively manage the current demand environment and provide our clients with a timely, efficient, and high-quality service that they have come to expect from Charles River. We believe these investments position safety assessment business well and will support low double-digit organic revenue growth in the DSA segment this year. We believe the combination of the robust funding environment as well as our deep scientific expertise and willingness to forge flexible relationships with our clients led to another exceptional quarter for the discovery business. Our comprehensive portfolio of oncology, CNS, early discovery, and antibody discovery capabilities which we recently enhanced through the distributed bio and retrogenics acquisitions, is resonating with clients, and clients are increasingly choosing to outsource to integrated discovery partners like Charles River. Despite the robust funding, biotech clients continue to maintain limited or no internal infrastructure, opting instead to invest in their pipelines and utilize our services to move their programs forward. To support the robust demand from biotech and global biopharmaceutical clients, we will continue to strengthen our portfolio by expanding our scale, our science, and our innovative technologies through a combination of internal investment, M&A, and our strategic partnership strategy. By doing so, we are enabling our clients to remain with one scientific partner from target ID through IND filing and beyond and solidifying our position as the leading non-clinical CRO. The DSA operating margin increased by 30 basis points to 23.5% in the second quarter. Leverage from the robust DSA revenue growth was the primary driver of the margin improvement. Foreign exchange reduced the DSA operating margin by 150 basis points in the quarter as revenue and costs are not naturally hedged at certain DSA sites, including our safety assessment operations in Canada. We continue to expect the DSA margin will be in the mid-20% range for the year. RMS revenue was $176.7 million, an increase of 44.5% on an organic basis over the second quarter of 20. Approximately 33.4% of this growth was attributable to the comparison to last year's COVID-related revenue impact from client-side closures and disruptions, which reduced research model order activity. Adjusted for the COVID impact, the RMS growth rate was above 10%, as strong research activity across biopharmaceutical, academic, and government clients led most RMS businesses to grow above their targeted growth rates. Robust demand for research models in China continued to be the primary driver of RMS revenue growth. There has been a resurgence of research activity this year, and model volumes far exceed pre-COVID levels. Similar to Western markets, the client base in China has transitioned from one dominated by academic and government accounts to a vibrant mid-tier biotech and CRO client base, which now represents the majority of our clients in China. We believe the expansion of our client base is fueling increased demand, and to accommodate the growth, we are continuing to expand our model and services offering and our geographic footprint in Western and Southern China, We are currently experiencing strong double-digit revenue growth in China. Demand for research models outside of China was also quite strong. We believe this correlates with the increased level of non-clinical research that's being conducted by biopharmaceutical and academic clients in Western markets. Research investments have led to biomedical breakthroughs and new drug modalities, and we believe a global focus on scientific innovation is sustainable. We also continue to win new academic clients in the second quarter, resulting from the COVID-19-related client shutdowns last year, and more recently from digital engagements targeting the academic client base. Research model services also perform very well. GEMS is benefiting from strong outsourcing demand as our clients seek the greater flexibility and efficiency they gain when we manage their proprietary model colonies. The greater complexity of scientific research and the proprietary models that our clients are creating further reinforce the value proposition for the GEMS business. Clients' need for greater flexibility and efficiency is also driving demand for our insourcing solutions or IS business, particularly for our cradle initiative, which provides both small and large biopharmaceutical clients with turnkey research capacity at Charles River sites. In addition to expanding our existing cradle presence and adding clients in the Boston, Cambridge, and South San Francisco biohubs, we're also looking to expand into other regions to provide a flexible capacity solution for our clients in emerging biohubs. Utilizing cradle also provides clients with collaborative opportunities to seamlessly access other Charles River services, which further enhances the speed and efficiency of their research programs. The revenue growth rate for our self-supply businesses, Hemacare and Solero, improved in the second quarter but remained below the targeted level due to continued limitations on donor access. We believe self-supply revenue will increase during the second half of the year as donor availability and capacity improve. We have expanded capabilities including donor capacity at our self-supply sites in Massachusetts and Washington State which we believe will enable us to further expand our donor base in the U.S. and accommodate the robust demand in the broader cell therapy market. We expect Hemacare and Celero will provide the critical tools for our new cell and gene therapy CDMO business, Cognate and BiGene. We believe this will be highly synergistic for both Charles River and our clients because it will enable us to move client cell therapy programs forward using the same cellular products from research to CGMP production. The RMS operating margin increased to 27.4% from 9.1% in the second quarter of last year. This significant improvement was primarily due to the comparison to last year's depressed margin associated with COVID-related client disruptions and the corresponding reduction in research model order activity. Revenue for the manufacturing segment was $197.8 million, a 26.6% increase on an organic basis over the second quarter of last year. The increase was driven by strong double-digit revenue growth in both the biologics testing solutions and microbial solutions businesses. COVID-19 did not have a meaningful impact on the segment's revenue last year, but testing on COVID-19 vaccines has helped accelerate biologics revenue growth rate this year. Consistent with the first quarter, microbial solutions growth rate in the second quarter was well above the 10% level, reflecting strong demand for our endosafe endotoxin-testing systems, cartridges, and core reagents in all geographic regions, as well as Acugenics microbial identification services. With COVID-related client access restrictions effectively behind us, we were pleased with the strength of the underlying demand for our endotoxin testing platform, which reforms FDA-mandated law-release testing for our clients' critical quality control testing needs. The advantages of our comprehensive portfolio continue to resonate with clients, and we believe that our ability to provide a total microbial testing solution will enable microbial solutions to deliver at least low double-digit organic revenue growth this year and beyond, which is consistent with the historical trend pre-COVID. The biologics testing business reported another exceptional quarter of strong revenue growth that was well above the 20% growth target for this business. Robust demand for cell and gene therapy testing services continued to be the primary growth driver. There has been a rapid increase in the number of cell and gene therapy programs in development, to approximately 3,000 programs now in the pipeline, with approximately two-thirds in the preclinical phase, which is expected to continue to fuel the strong growth. COVID-19 vaccine work was also a meaningful driver of biologics' second quarter growth, but the underlying biologics growth trends remained above the 20% level, even without the incremental COVID-19 testing revenue. We believe cell and gene therapies will continue to be significant growth drivers over the long term and demand for COVID-19 vaccine testing is showing no signs of abating. We believe the commercial production of COVID vaccines will continue for many years to come, supporting the demand for our services. These factors are contributing to the strength of the demand environment, and we continue to build our extensive portfolio of manufacturing services to ensure we have available capacity to accommodate client demand. The manufacturing segment second quarter operating margin declined by 420 basis points to 33.2%. The primary driver of the decline was the addition of Cognate's CDMO business, as well as higher production costs in the microbial business. Cognate is a profitable business with a solid operating margin, but its margin is below the manufacturing segment. Coupled with the addition of Vigin in the third quarter, we expect a full-year manufacturing margin slightly below the mid-30% range. However, beyond 2021, we expect this headwind to gradually dissipate as we drive efficiency and as the significant growth we anticipate generates greater economies of scale and optimizes throughout our CDMO sites. Early in the second quarter, Cognate Bioservices officially joined Charles River, followed by Vigene Biosciences in late June, We were very pleased to welcome both teams to the company. Along with Hemacare and Solera, these businesses form the core of our cell and gene therapy offering, and we believe they will be highly complementary to our biologics business and our portfolio as a whole. We are pleased with the initial progress on the integrations and the addition of the cell and gene therapy CDMO services to our comprehensive portfolio, which is resonating with clients. Our clients are beginning to explore opportunities to streamline their biologics development workflows by using Cognates and ViGene services, and their legacy clients are already looking to utilize other products and services within the Charles River portfolio to drive greater efficiency in their development and manufacturing activities. We believe the acquisition of ViGene Biosciences with its viral vector-based gene delivery solutions fulfills our objective to create a comprehensive cell and gene therapy portfolio, which spans each of the major CDMO platforms, gene-modified cell therapy, viral vector, and plasmid DNA production. In combination with Cognate's Memphis-based operations, we have established an end-to-end gene-modified cell therapy solution in the U.S., which we believe is critical to support our clients more seamlessly. Our goal is to enable clients to conduct analytical testing, process development, and manufacturing for these advanced modalities with the same scientific partner, enabling them to achieve their goal of driving greater efficiency and accelerating their speed to market. As a result of the successful execution of our strategy to date, we believe that our portfolio is the strongest it has ever been. Our efforts to enhance our scientific capabilities include deliver flexible outsourcing solutions, and provide greater value to our clients have made Shells River an important partner for our clients. With the biopharmaceutical industry benefiting from record funding levels, we are experiencing robust demand for our essential products and services. To support this demand and to continue to enhance the value we provide to clients, we will continue to move our growth strategy forward. Acquisitions and strategic partnerships remain vital components of our strategy as we endeavor to expand the scientific expertise, global reach, and innovative technologies that we can offer clients across all three of our business segments. Investing in our scientific capabilities as well as internally on the necessary staff, resources, and our digital enterprise will help us ensure that we can meet the needs of our clients. The successful execution of our strategy will not only enable us to enhance our position as our client's partner of choice from concept to non-clinical development to the safe manufacture of their life-saving therapeutics, it will also allow us to achieve our longer-term financial targets of low double-digit organic revenue growth and an average of approximately 50 basis points of operating margin improvement beyond 2021. In conclusion, I'd like to thank our clients and shareholders for their support and our employees for their exceptional work and commitment. And now I'll ask David to give you additional details on our second quarter results and updated 2021 guidance. Thank you, Jim, and good morning.