Q3 2019 Earnings Call
It's being recorded I'd now like turn the conference over to corporate Vice President of Investor Relations Mr. Totten Spencer. Please go ahead.
Thank you good morning, and welcome to Charles River Laboratories third quarter 2019 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 third quarter of 2019.
Following the presentation. They will respond to questions. There's a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our web site at IR Si River Dotcom, a replay will be a of this call will be available beginning at noon today and can be accessed by calling 804 756 701.
The international access number is three to 0365384 for the access code. Neither cases for seven to 865. The replay will be available through November Twentyth. You May also access an archived version of the webcast on our Investor Relations website.
I'd like to remind you of our safe Harbor any 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 vary materially from those indicated by any forward looking statements.
During the call we will primarily primarily discuss results from continuing operations in non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results in future prospects. 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 through the financial information link I will now I'll turn the call over to Jim Foster.
Good morning.
I'm pleased with our overall third quarter results, which were highlighted by high single digit organic revenue growth consistent with our long term target and operating margin expansion.
That represented a positive step towards achieving our 20% target in 2021.
Market demand for our leading early stage portfolio has remained strong throughout the year.
Hi Tech funding levels and the number of molecules approved by the FDA may end up slightly below peak levels industry fundamentals and scientific innovation maintenance as robust as we've ever seen.
And outsourcing is key to our clients success.
This is promising to be another solid EPS for the biopharmaceutical industry as clients discover solutions for previously unmet medical needs using new technologies like cell and gene therapy, and Immunotherapies and rely on Sierra like Charles.
To support the research programs.
We have no indication that the relationships with our clients or this spending levels have been affected by the geopolitical rhetoric involving the trade war and pricing and we firmly believe that our clients will continue to partner with Charles River in order to bring new drugs to market faster and more efficiently whether patients that need them.
Let me give you the highlights of our third quarter performance as you know we issued preliminary third quarter results on October 21st in conjunction with that successful issuance of $500 million of senior notes about which David will provide more detail shortly.
Our actual third quarter results were at the higher end of the preliminary ranges that we provide we recorded revenue of 600.
For the high single digit organic growth rate, which is consistent with our long term target.
I will provide more details on each of the business driver shortly.
Operating margin was 19.4% 60 basis point increase year over year and above our prior outlook.
This improvement was driven by the manufacturing support and RMS segment and more than offset headwinds from the cytotoxic lab acquisition, the biologics capacity expansion and the large insourcing solutions contract.
We believe this the third quarter margin expansion demonstrates our ability to leverage the investments that we have made in staff capacity and infrastructure to accommodate the robust growth in a more scalable and efficient manner and provides a line of sight to our two year goal of 20%.
With the significant investments largely behind us coupled with our continued focus on driving greater efficiency. We expect the operating margin in the second half of the year will be higher than the first half, resulting in a full year operating margin that is approaching last years level of 18.8%.
Earnings per share $1.69 in the third quarter increase of 16.6% from $1.45 in the third quarter of 18. The increase was due primarily to higher revenue and operating margin improvement.
From a guidance perspective, we now expect organic revenue growth for 2019 to be in a range from eight in the quarter at 83 quarters percent.
This has been moderated from our prior outlook, but still well within the high single digit range you again at growth outlooks for each of the business segments are being narrowed felt remained within the previous ranges for the year, we do not believe the narrow narrowing of our organic.
Growth range demonstrates any dimunition and market conditions.
As we believe both market demand in our fundamental business trends remain robust.
We continue to be well positioned for organic revenue growth in 2019 to be near the 8.7% reported last year, the highest level in a decade and consistent with our long term growth target in the high single digits.
As a result of the third quarter operating performance non-GAAP earnings per share guidance for the years being narrowed to the upper end of the prior range to 650 to 60 60. This represents 12% to 14% growth from 580 last year.
I'd now like to provide you with details on the third quarter segment performance beginning with the DSMB segment. The DSE revenue third quarter was $420.1 million, a 7.9% increase on an organic basis.
Both the discovery services and safety assessment businesses contributing.
We believe that high single digit organic growth in Dsos segment will continue to be driven by demand for our outsourced services.
Global biopharmaceutical clients choose to partner with Charles River, rather than build are maintained capacity in house.
Biotech clients leverage our expertise because they have limited or no internal capabilities to meet our clients' needs. We are focused our business on an unmatched scientific expertise rapid turnaround times flexible creative solutions and the ability to accommodate increasing complexity of our clients research programs.
Our business model has made us an attractive partner for large pharma biotech academic institutions governmental agencies and Ngls, but it's clear that we have become the principal partner of choice for biotech clients of all sizes.
Biotechs are demanding clientele, focusing on exquisite science and speed.
Our unique portfolio and client focused business approach have made Charles River, an indispensable research partner tailor made for this expanding client segment.
The discovery business had an excellent quarter as we continue to distinguish ourselves through the breadth of our portfolio and the synergies between our discovery and safety assessment businesses.
Third quarter performance was driven by broad based growth across oncology early discovery and CNS services, our clients programs often began with the target identification capabilities of our early discovery business and encompass multiple via say sites and services as the programs advance we are successfully.
The demonstrating the clients that working with us through a broader portion of the early stage drug research process enhances the value we provide them both from a scientific and cost effectiveness perspective.
Our efforts to strengthen our discovery tool kit and expand our footprint continue to resonate with clients, both large and small we continue to evaluate new opportunities to add innovative discovery capabilities to our portfolio as we believe creating a comprehensive solution at the earliest stage of drug research will enhance climb.
Retention as their programs progress through the pipeline. Our recent partnership with distributed bio is progressing nicely distribute Bios large molecule discovery capabilities are generating considerable client interest and we believe this relationship and our broader partnership strategy will create additional.
Opportunities to work with clients are there integrated programs client utilization of our expanded South San Francisco Discovery site also continues to increase site office, a wide range of capabilities from CNS to DMT, K and bio analytical services, because a fast growing west coast buyer.
Client base, we expect to expand the services offered there.
Whether by internal investment partnership or acquisition, we intend to continue to build out discovery portfolio to reinforce our position as the premier single source provider for a comprehensive range of discovery services.
Revenue growth for safety assessment was consistent with both our full year and long term expectations for the overall Dsos segment.
The business continued to perform well driven by robust demand from biotech clients increased pricing.
Bookings and backlog improved year over year supporting our safety assessment outlook for the remainder of the and into 2020.
As you know safety assessment growth is not linear and will modestly fluctuate from quarter to quarter, because the balance between price volume mix and the timing of study sites is not always uniform.
The integration of Cytoxan remains on track and its financial performance is in line with the acquisition plan as anticipated. It is a complex integration across multiple sites in multiple countries, but the collaborative efforts and hard work of Sitos labs talented staff and that Charles River colleagues have result.
And in the successful first six months together.
Side talks lab to date and Npis well before hand, we have done an excellent job when the integrations, achieving our goals of adding and retaining hundreds of new clients enhancing the work experience for our employees expanding our capabilities, both geographically and scientifically and driving operational synergies and greater effect.
Yeah.
The DSL your operating margin declined 50 basis points to 22.1%.
Third quarter due entirely to an 80 basis point headwind from the Cytoxan lab acquisition.
As we said at the time of the acquisition Sitos Lab has a lower operating margin than the legacy safety assessment business, though we believe it will reach the 20% level.
Proximately two years of the transaction driven by acquisition synergies and continued growth.
We have built a global DSA footprint with unparalleled breadth and depth by adding capabilities capacity in staff through acquisitions and internal investments and as a result have become the partner of choice for broad range of clients. We have invested significantly in the last few years to achieve appropriate staffing levels.
So that we could accommodate growing client demand in safety assessment business and believe we have achieved this call.
With the appropriate head count going forward continued modest capacity additions and a focus on operational excellence DSD segment as well position to achieve a mid 20% operating margin over the next two years.
RMS segment revenue was $132.5 million, an increase of 5.8% on an organic basis over the third quarter last year, Our research model business in China delivered another excellent performance and Insourcing solutions also continued to perform very well.
As we mentioned at Investor day, there are abundant opportunities to expand into new regions in China to support the substantial growth in this rapidly emerging biomedical research market. In addition to our current footprint in the major R&D have so Beijing and Shanghai, we have plans to open a new site in central China in 2000.
20.
Expanding our presence supports our goals that market leadership and achieving a market share in China's similar to that in western markets.
Because the research model markets outside of China mature.
Hi, and growth continues to be limited in western markets. We expect a continuation of the research model trends that have been largely present for many years declining demand from large biopharma, increasing demand from biotechs and consistent price increases.
From a services perspective, insourcing solutions or I guess continues to perform very well as clients increasingly adopt flexible models to enhance the operational efficiency of the of ovarian management and research efforts. The NIH de contract contributed approximately 350 basis points.
Two RMS revenue growth in the third quarter, we anniversary this contract in mid September so the year over year contribution to revenue growth and the corresponding operating margin headwind will not.
Just beginning in the fourth quarter as a result, we expect beyond this growth rate to moderate to a low single digit rate in the fourth quarter.
The highest business continues to be a flex option for academic and government institutions, which have historically did I asked his primary client base.
Insourcing solutions is also gaining traction with new biopharma clients, particularly through the success of our cradle initiatives Cradle or Charles River accelerator and development last provides both small and large biopharmaceutical clients with turnkey research capacity in the Boston, Cambridge Bio hub.
And beginning early next year in the South San Francisco Bio hub.
Through both unique models like cradle and more traditional in source staffing arrangements.
Business has become an important partner for clients, who need this type of support for the research programs.
In the third quarter of the RMS operating margin increased by 60 basis points to 26.5% due primarily to the research models business as well as our ongoing efficiency initiatives improvement was partially offset by the lower margin in a I'd contract, which reduced the RMS operating margin by approximately.
50 basis points in the quarter.
Our goal is to maintain the RMS operating margin above 25% to our continuing efforts to enhance operating efficiency.
Revenue for the manufacturing support segment was $115.3 million and 10.6% increase on an organic basis over the third quarter last year. The increase was driven by strong demand across spoke biologics testing solutions and the microbial solutions businesses.
The microbial solutions had a good quarter with broad based growth across all three of its major testing platform and to save endotoxin testing Celsis, Bioburden and sterility testing and Actogenix microbial identification services. The primary driver third quarter revenue growth was demand for our.
And to save rapid test systems and cartridges.
We saw significantly more in the safe instruments over the prior year, which in turn will drive greater demand for cartridges and to save improves the efficiency of our clients manufacturing in lottery leads testing processes and because there's no competitive alternative to our rapid testing systems, we are continuing to convert the marketplace to.
More efficient and reliable testing platform.
The continued expansion of the installed base of instruments drives demand for the consumable cartridges, which provides a healthy recurring revenue stream. In addition investments and process improvements that we discussed last quarter are already beginning to result in improved operating leverage.
We're very pleased to see that as expected biologics revenue growth rebounded well above the 10% level in the third quarter.
We are adding global we are adding capacity globally to accommodate the robust growth in a number of biologics.
In the pipeline.
And on the market and the demand for our services the largest global expansion is taking place in Pennsylvania, Our new site in Wayne, Pennsylvania, which we have been transitioning into for the past year will provide the required scale use to support growth in the next three to five years decided registered with the FDA.
We are working with clients on the validation activities into new site, which are expected to be substantially complete by the end of year. In addition to building scale. We also continue to enhance our biologics testing capabilities to accommodate more of our clients process development in quality control needs.
Cell and gene therapies continued to be the fastest growing area for our biologics business and we are developing new assays to provide a more comprehensive portfolio of these services.
The manufacturing segment third quarter operating margin was 36.4% a 300 basis points improvement year over year. The increase was due primarily to enhance operating efficiency and their microbial solutions business and operating leverage from robust revenue growth in biologics testing solutions business we.
We're very pleased with manufacturing segments operating margin rebounded to the mid 30% level in the third quarter, which is consistent with our two year target for this business.
And our recent Investor day, we highlighted the manner in which we have executed our strategy and continue to do so to become the early stage CRL partner of choice for our clients drug research development and manufacturing support efforts to build our extensive scientific expertise, which we believe is unique and unparalleled in the early stage.
See our universe and to invest in our people technology and infrastructure to created eat and more efficient and responsive organization. They provide flexible customized solutions to our clients.
As we look to the future. It's imperative that we continue to expand our portfolio of essential products and services to enhance our ability to comprehensively support our clients drug research efforts, we intend to do so through strategic acquisitions, which is always our prefer to use of capital.
Our pipeline of M&A candidates remains robust and we continue to evaluate a number of opportunities ranging from unique research tools to discovery capabilities to manufacturing support activities.
We also must stay current with new technologies and modalities, such a cell and gene therapies to do so we are increasingly utilizing a partnership strategy such as our relationship with distributed bio to add innovative capabilities and cutting edge technologies with limited upfront risk.
Partnering activities extend beyond the discovery business as we have signed several of these relationships to date encompassing most of our businesses and intend to sign more.
These partnerships allow us to assess breakthrough technologies typically with a small upfront investment and has the potential to result in longer term collaboration agreements or can be a precursor to acquiring the company.
We look to at least a billion dollars in annual revenue through acquisitions and partnerships over the next five years and the transactions with which we choose to move forward will not only fit our strategic rationale, but also meet our disciplined investment criteria in order to generate greater shareholder returns.
We have spent the past several years investing internally and capacity and staffing to levels that are commensurate with growing demand, while striving to enhance the scalability the business.
While we will need to continue to invest we believe that we have achieved an appropriate balance. We now have an enhanced ability to leverage topline growth and drive greater efficiency, which will enable us to achieve the two year financial targets that we provided at investor day, including an aggressive but realistic 20% operating margin.
And in 2021.
As we also mentioned at Investor day, as we work towards our business and financial goals. We are maintaining an intense focus on sustainability, we are committed to environmental social and corporate governance initiatives and believe that this commitment will enable us to minimize our impact on the environment as we implement sustainable.
Practices enhance our corporate citizenship by focusing on improving the quality of People's lives, including patients clients employees, and our communities and operate our business with integrity and accountability as we've always done.
We were pleased to welcome General Wilson to our board last month GNS diverse experienced across multiple industries will enhance the financial acumen of Chaucer his board and its ability to oversee our broader strategy and focus on driving profitable growth Jana brings highly valuable knowledge and experience in managing the finance organization to go.
Growing businesses.
Strategically allocating capital and driving operating efficiency, which will complement the combined skills and experience of our current directors. We will continue to evaluate adding new members to our board to further enhance diversity of skills experience and perspectives.
We're pleased with the performance of the collective portfolio in the third quarter and over the longer term, we expect to deliver high single digit organic revenue growth earnings per share growth at least in the low double digits and strong free cash flow.
In conclusion, I'd like to thank our clients and shareholders for the support and our employees for their exceptional work and commitment.
Yes, David to give you additional details on a third quarter results updated 2019 guidance.
Thank you Jim and good morning, before I begin may I remind you that I'll be speaking primarily to non results from continuing operations, which exclude amortization and other acquisition related charges cost related primarily to our global efficiency initiatives and discrete tax benefit related to our international financing structure and system.
When it comes.
Many of my comments will also referred to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation.
We're pleased with our result, this quarter, which included high single digit organic revenue growth mid teens earnings per share growth and both sequential and year over year improvement in the operating margin.
The third quarter results demonstrate progress towards achieving the two year financial targets that we provided at our Investor Day in September which included high single digit organic revenue growth at least low double digit non-GAAP earnings per share growth and a non-GAAP operating margin of 20% 2021.
I will now provide more detail on two recent accomplishments the third quarter operating margin expansion and the enhancements to our capital structure.
As you are aware operating margin improvement is a priority for the company.
We're very pleased with the collective efforts that have enabled us to leverage revenue growth and drive great operating efficiency.
Operating margin of 19.4% for the third quarter represented a 60 basis point year over year increase and a 90 basis point sequential increase.
This was well above our prior expectation, which was that the operating margin would be similar to the second quarter level. The outperformance was driven largely by the fact that we are benefiting from the scalable investments that we have made it staff capacity and infrastructure as well as our continuing focus on operational excellence and cost management.
The margin improvement was driven by the manufacturing and the army's segments as well as leverage of unallocated corporate costs.
We also and if those right the euro headwind from the compensation structure adjustments at the beginning of the third quarter.
Unallocated corporate cost for the third quarter $40.2 million or 6% of total revenue of 40 basis point decline from 6.4% last year.
At 6% year to date, we continue to expect unallocated corporate costs to be at or slightly below 6% of total revenue for the year.
We're particularly pleased with the margin performance because we continued to be impacted by headwinds from the large government contract in the RMS segment.
Biologics capacity expansion in the manufacturing segment and the acquisition of sign talks like limited say segment as you may recall Sandro flap had a mid teens operating margin when we acquired it which is well below that of the legacy safety assessment business.
So I took club operating module will improve over time through the attainment of deals energy.
We believe that the third quarter operating margin performance reflects our ability to leverage the investments that we have made and our focus on increasing efficiency to drive profitable growth.
For the full year, we continue to expand the operating margin to be approaching the 2018 level of 18.8%.
The other important accomplishment was the issuance of $500 million of senior notes due in 2028 at a 4.25% coupon rate.
We believe that this fixed rate debt enhances our capital structure by locking in a favorable interest rate and staggering the maturity of our long term debt.
We also upsized, our revolver by $500 million, which will provide additional long term borrowing capacity to support our M&A strategy.
During the quarter, we reduced our outstanding debt by $158 million to $1.9 billion at the end of quarter compared to $2.1 billion at the end of the second quarter.
Gross leverage ratio.
At the end of the third quarter was 2.96 times and our net leverage ratio was 2.7 times.
Through on capital management strategy, we were able to reduce our leverage to less than three times within six months of the sign talks Love acquisition, which was ahead of our initial outlook of 12 month. The sub three times leverage ratio generate interest savings on our variable rate debt, reducing the rate by 25 basis points to.
LIBOR plus 125 basis points.
We continuously evaluate our capital priorities and intend to deploying capital to the areas that we believe will generate the greatest returns strategic acquisitions remain our top priority for capital allocation followed by debt repayment.
We are comfortable with a gross leverage ratio includes three times and absent any acquisitions, we continue to repay debt year to date, we have not we posted repurchased any shares and do not intend to in the fourth quarter.
Ladies and gentlemen, please standby whose line has disconnected please continue to hold.
Once again, please continue to hold the host line has disconnected.