Q3 2020 Charles River Laboratories International Inc Earnings Call
[music].
Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories third quarter earnings Conference call.
At this time all participants are in a listen only mode. After the speaker presentations and will be a key.
Question and answer session to.
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I would now like to hand, the conference over to your Speaker today, Hi, Spencer corporate Vice President of Investor Relations. Please go ahead Sir.
Thank you good morning, and welcome to Charles River Laboratories' third quarter 2020 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 2020. Following the presentation there will be.
Respond to questions. There was a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our web site at <unk> Dot few river dotcom. It web web cast replay of this call will be available beginning two hours. After the call today and can also be accessed on our Investor Relations web site. The replay will be available.
All through next quarter's conference call I'd like to remind you of our safe Harbor, our 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 the 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 are prepared with accordance in accordance with GAAP income.
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-19 impact on the company certain methodologies and assumptions 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.
The global pandemic is continuing to adversely affect our world yet.
Through these challenging times the biopharmaceutical industry is distinguishing itself by Lee.
Leading the way scientific innovation that will be vital to finding a cure of the code at 19.
Charles River, we have never been so essential to our diverse and growing client base and we remain fully operational and continued to enable biopharmaceutical clients to move their programs forward across a wide range of therapeutic areas, including COVID-19.
Our resilience to the pandemic has served to enhance our position as the partner of choice for our clients early stage research needs as we continue to differentiate ourselves through our broad portfolio scientific expertise and that superb client service.
In the second quarter, we were encouraged that our research models clients were returning to their facilities and re commencing this scientific research more quickly than anticipated.
This favorable trend continued in the third quarter with a V shaped RMS recovery as clients across North America, Europe, and Asia, Brazil, more normalized research activities.
Celebrated RMS recovery was a key component of our robots third quarter financial results, which exceeded our expectations.
COVID-19 head of very limited impact on our other businesses in the third quarter aside for microbial solutions.
Which continue to work with backlog of delayed instrument installations.
In fact, we continue to generate new business opportunities through share gains, particularly with academic clients.
In addition, we are winning incremental work as clients increasingly choose to outsource in order to utilize more.
More flexible and efficient drug development solutions, which is benefiting our biologics discovery safety assessment and gems businesses. These.
These factors contributed to our robust third quarter performance, which included record revenue non-GAAP earnings per share and free cash flow.
I will now provide additional details on our third quarter results.
We recorded.
$743.3 million in the third quarter.
11.3% increase over last year.
Ganic revenue growth of 7.8% was driven primarily by the strong performance of our DSC and manufacturing support segment.
Both of which improved their organic growth rates compared to the second quarter levels and were consistent.
With our long term targets for these businesses in the high single and low double digits respectively.
Our events also contributed to organic revenue growth returning to growth just one quarter after reporting an 18% organic decline at the height of COVID-19 related clients disruptions and academic site closures.
The operating margin was 22.7%.
Increase of 330 basis points year over year.
This reflects meaningful operating margin improvement across all three business segments.
Primarily as a result of leverage from a strong topline performance continued focus on operating efficiency and cost controls associated with COVID-19.
We were extremely pleased with the strong operating margin performance, which reflected the underlying margin potential across our businesses.
He also benefited from lower discretionary cost due to COVID-19 related restrictions which included travel.
Earnings per share were $2.33 in the third quarter, an increase of 37.9% from $1.69 last year, which exceeded our prior expectation of high single digit improvement.
The record EPS was driven by exceptionally strong operating performance as we emerge from the second quarter, which we believe will be the worst of the Coca 19 financial impact.
The lower tax rate also contributed.
Based on the third quarter performance, we are increasing our revenue growth and non-GAAP earnings per share guidance for 20.
And is approaching the historical trend for that.
As expected China recovered earlier than other geographies.
Clients resumed more normalize research activity.
Returning to the sites in the middle of the second quarter.
Despite a slight lag in western markets demand for research models in North America, and Europe also improved significantly on a sequential basis as clients resume more normalized search activity during the third quarter, particularly in Europe, where we also benefited from some stock up orders as clients returning to the sites.
In the third quarter client ordering trends for research models in western markets move closer to pre coveted level.
And we're only moderately below prior year levels.
As we exit the year, we expect ordering trends in North America to fully recover as well.
We are pleased with the V shape recovery in RMS business today and see other favorable trends that are also quite encouraging we.
We believe that we will continue to benefit from market share gains, including from academic clients as we gain business from new academic principal investigators.
Or p. eyes, when we when we reopened their site.
Academia has been a strategic focus to drive enhance RMS growth with tailored initiatives targeted for the unique needs of the client base.
We have always contended that our global scale superior client support and bio security initiatives have differentiated our research models business in the marketplace, leading clients to choose shelves over for the early stage research needs.
We believe our resilience and ability to remain operational during the pandemic underscores these attributes and has led to new business opportunities and market share gains due in part to competitive dislocation.
The research model services businesses, specifically gems and Insourcing solutions also continued to benefit from the long term trend of clients externalizing more of their work.
This trend has been reinforced during the COVID-19 pandemic as clients increasingly seek the flexibility and efficiently of utilizing our sites and staff instead of their own.
The gems business had another strong quarter as it benefited from incremental outsourcing opportunities with gems clients, who previously manage them I will call is in house.
Opted to outsource work to recover 19 restrictions at their own sites saw the benefit of outsourcing and we expect that many will have us retain this work.
Came a care also rebounded nicely in the third quarter as we mentioned.
In August Haemek has donor clinic reopened in may and demand from its cell therapy clients improve meaningfully at the end of the second quarter couple.
Coupled with the acquisition so were all which was completed in August cell therapy revenue increased more than 20% in the third quarter re accelerating towards our 30% five year targets for these businesses. So they're all has enhanced our access to high quality human derived cellular products.
From healthy donors and patient populations and expanded our geographic reach with donor sites in both eastern and Western United States.
We firmly believe that our ability to supply cell therapy developers and manufacturers with these critical biomaterials will lead them to remain with us through the discovery early stage development and the manufacturing support processes.
We continue to view the cell and gene therapy space as a high growth market.
Which we need to continue to strengthen our capabilities in order to meet clients' increasing needs and further enhance our growth profile.
The RMS operating margin meaningfully improved by 120 basis points to 27.7% in Q3.
The year over year increase was principally driven by the benefit from operating efficiency initiatives.
Prudent cost controls.
Commented in response to the COVID-19 pandemic.
CFA revenue was $461.2 million in the third quarter, and 8.6% increase on an organic basis over the third quarter of 19.
We are pleased that the DSE performance was in line with the long term high single digit growth targets of the segment as a discovery and safety assessment businesses experienced a negligible impact from COVID-19 in the third quarter.
The asset growth was driven by both biotechnology and global biopharmaceutical clients.
Although biotech clients were the primary driver broad based clients spending across the entire biopharmaceutical industry is reflective of the global focus on scientific innovation and the need for our clients to utilize more flexible and efficient early stage outsourcing solution. The.
The discovery services business had another exceptional quarter with broad based growth across early discovery CNS and oncology services, we are winning incremental business as clients outsource programs that they have historically kept in house as well as some COVID-19 related projects, we believe our integrated discovery.
Portfolio scientific expertise and flexible work arrangements, Kevin encourage more clients to partner with us to counteract the challenges of Carbonite team.
We believe our continued success in our clients' willingness to outsource more of the discovery programs will be predicated on our ability to continue to add innovative discovery capabilities to meet our clients' critical research needs, which we are actively accomplishing through our strategic partnerships as well as our ability to forge collaborative.
Relationships that enable our clients to work with us in a flexible noon.
As a result of one of these relationships we received a milestone payment from an integrated drug discovery retired during the third quarter.
Which contributed to the topline growth and operating margin performance.
A milestone based client relationships represent only a small portion of our discovery business.
We believe that our ability to structure working arrangements to meet our clients' needs and deliver the targets of molecules. They seek to develop will lead to more discovery outsourcing opportunities in the future.
We are pleased to have discovered more than 80 novel molecules for clients since its inception of our early discovery.
Safety assessment business continued to perform well with sustained growth in study volume bookings and backlog activity remain robust with strengthened specialty toxicology and GLP bio analysis as well as cell and gene therapies. Each of these areas differentiates Charles River from Us.
Dollar competitors.
We're also seeing increased demand for infectious disease programs, including COVID-19.
Not seeing any corresponding spending reductions in other therapeutic areas.
We believe this demonstrates both the strength of the early stage funding environment in clients, increasing use of outsourcing to ensure the continuity of the research.
The DSE operating margin improved by 310 basis points year over year in the third quarter to 25.2% with meaningful contribution contributions from both the discovery and safety assessment businesses. Several factors drove the improvement, including operating leverage and strong topline growth continue.
Focus on operating efficiencies and cost controls associated with the COVID-19 pandemic. The discovery milestone payment contributed approximately 50 basis points to the margin improvement right.
Revenue for the manufacturing support segment was $130.2 million and 11.5% increase on an organic basis over the third quarter of last year and also in line with our long term growth target for this segment. The biologics testing solutions business had another excellent quarter and the revenue growth rate in the microbiome.
Solutions business improved from the second quarter level as we anticipated.
Last quarter, we commented that microbial solutions was.
Was affected by the delayed instrument installations at certain client sites were inaccessible due to COVID-19 as expected the backlog of instrument installations was gradually reduced in the third quarter. We gained access to additional client sites and conducted some installations virtually but others.
It's remain inaccessible as certain clients maintain the cobot related visitor restriction.
We believe microbial revenue growth will continue to gradually improve as we complete additional instrument installations.
The rate of improvement contingent upon our ability to access client sites.
<unk> biologics business reported another exceptional quarter of strong double digit revenue growth, principally driven by two factors robust market trends and increasing utilization of our new capacity last year, we opened interest transition into our new biologic site in Pennsylvania, which more than doubled our capacity in the region.
We have been selling this new capacity in 2020 due in part to a robust client demand for testing cell and gene therapies and COVID-19 therapeutic.
We believe cell and gene therapy on a core biologics testing work will continue to be significant coast growth drivers for years to come.
And that we will benefit from these trends and take market share because clients see the value and our extensive portfolio of services to support the safe manufacturer of their biologics program and because we have available capacity to accommodate client demand.
The robust biologics growth and higher utilization of the new Pennsylvania site as well as the elimination of duplicate costs from last year's transition to the new site were the primary drivers of the 270 basis point increase in the manufacturing segment third quarter operating margin to 39.1%.
The avian business also contributed and we continue to be pleased with the benefits from enhance operating efficiency and the microbial solutions business as a result of process improvements.
Our third quarter performance is indicative of several important factors.
That our leading portfolio of early stage and manufacturing support solutions continues to resonate with clients, even more today than ever before.
That early stage market trends are strong.
Our client appetite for outsourcing has become increasingly robust and that we have the vision and experience to manage through a challenging period.
We believe that clients outsource more work to us this year, because they trusted the resilience of our business model and our ability to remain fully operational.
And also our ability to partner with them to advance their programs when they face significant co good related disruptions.
As clients, we assume more normalized research activities. We believe they are actively reevaluating their longer term outsourcing strategies. The COVID-19 pandemic has proven the ease and flexibility of partnering with a large stable CRL like Charles River as well as enhance reliability as clients seek greater.
Research efficiency and continuity. Therefore, we believe biopharma clients are already committing to outsource more than they did prior to the panda.
Biotech funding levels were particularly strong in the third quarter, surpassing $100 billion year to date biotech IPO activity accelerating and year to date timing through September has already exceeded last year's total we believe that biotech funding is particularly significant for our clients because many of them are emerging.
Smaller biotechs programs in the discovery of preclinical development stages that said, we see evidence from our clients, including global Biopharma is that their emphasizing greater investment in a preclinical pipelines.
A favorable market environment AIDS us in driving our topline growth.
But it's only one of the factors that we believe will continue to drive our strong financial performance.
Operating margin expansion is also a key component of our strategy. We believe the exceptional third quarter margin improvement of 330 basis points and.
And our ability to expand operating margins in three of the last four quarters demonstrate the underlying operating leverage in our business and our continued focus on driving efficiency, we expect to be near our 20% target. This year essentially one year ahead of expectation.
In order to continue to enhance our value to clients and our growth potential. It is imperative that we continue to expand our unique portfolio of essential products and services to more comprehensively support our clients research needs.
Strategic acquisitions have always been our preferred use of capital and we are continuing to evaluate new opportunities. After a pause in the second quarter that continues to be an abundance of M&A candidates available and we will also increasingly employ our strategic partnership strategy to stay current with new technologies and modalities.
And Ed innovative capabilities and cutting edge technologies with limited upfront risk.
Before I conclude I'd like to announce two recent appointments first earlier this month, we appointed George Lotto to our board of Directors. George is currently senior Vice President and Chief Information Officer at Lexicon Pharmaceuticals, as the serving 25 years of birth.
George is unique view from a client perspective and is technological expertise will be invaluable. He is a dynamic thought leader in the technology field and we look forward to leveraging his insights as we continue to invest in our information technology platform and digital enterprise.
I am pleased to welcome George the challenges Board.
I'd also like to congratulate Vicki creamer to her promotion to executive Vice President and Chief people Officer, Vicki joined US last year to leave the human resources function as a senior Vice president during her time with Charles River. She has developed and executed a strategic HR plan that includes identifying and implementing we.
World Class HR processes.
Developing and rewarding talent and optimizing the organizational design. Most recently Vicki has been instrumental in the company's COVID-19 strategy, ensuring our people are receiving the support and resources necessary to navigate this challenging time congratulations Vicki.
We believe that the strength and resilience of our business model.
Differentiate differentiated portfolio and earn our wavering focus on the client experience have enabled us to enhance our position as the leading early stage zero through the COVID-19 crisis, our success would not be cost level without the collective efforts of the dedicated Charles or staff.
I'd like to again express my sincere appreciation to them for their hard work and our unwavering commitment that allows us to continue to fulfill our mission every day.
I'd also like to thank our clients and shareholders for their continued support now.
Ill ask David to give you additional details on our third quarter results and updated 2020 that.
Thank you Jim and good morning before.
Before I begin Mary mind, you, but I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition related charges costs related primarily to our global efficiency initiatives venture capital and a strategic investment performance and so that's why actions many.
Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation.
We are very pleased with our strong third quarter results, including high single digit organic revenue growth and meaningful operating margin improvement the higher revenue and 330 basis points year over year launch an increased contribution to earnings per share growth.
38% as did a lower tax rate.
These results reflected improved organic revenue growth across all three business segments for the second quarter level and operating margin expansion, both on a sequential and year over year basis.
I would like to start by discussing our operating margin performance at 22.7% in the third quarter. It was one of the highest level in the company's history, we believe that the underlying operating leverage in our business.
It's the primary driver of the improvement benefiting from greater operating efficiencies and cost controls.
Cost controls associated because 19, including restrictions on travel and other discretionary costs.
Attribute it to the first quarter operating launch in performance.
Reflected in our operating margin guidance is a benefit of approximately $14 million from COVID-19 related cost reduction initiatives and cost controls, which is unchanged from our prior estimate.
As we discussed last year, we expected to benefit from the scale of investments that we made in stats capacity and infrastructure as well as our recent acquisitions as the synergies gained traction and the profitability of the acquired businesses in crude.
We believe that these initiatives and our continuing focus on operational excellence and cost management are the primary drivers of the operating margin expansion.
For full year 2020.
We expect to be near out to your operating target of 20% effectively a year ahead of schedule.
In addition to higher revenue efficiency and cost control the operating margin improvement in the fourth quarter was also driven by leveraging of corporate costs.
Unallocated corporate costs for the third quarter were $40.7 million or 5.5% of total revenue a 50 basis point decline from 6% last year.
5.7% year to date, we continue to expect unallocated corporate costs to be approximately 5.5% of total revenue for the year.
Total adjusted net interest expense for the quarter was $18.7 million, an increase of $1.3 million year over year, reflecting higher debt balances and the higher interest rates and try to touch it for the year. We expect adjusted net interest expense to be $1 million lower than our prior guidance in a range of 75.
$77 million.
During the quarter, we repaid approximately $245 million of debt, reducing our total debt balance to $2 billion. This resulted in the reduction of our gross leverage ratio to 2.6 times at the end of the third quarter and our net leverage ratio was 2.3 times.
As a result of sub three times leverage ratio, we will benefit from interest savings on a variable rate debt, reducing the rate by 25 basis points to LIBOR, plus 125 basis points.
We are pleased that we were able to quickly repay debt to bring our leverage to our targeted level below three times after borrowing for the senior care acquisition earlier in yet.
Strategic acquisitions to support our long term growth strategy will remain our top priority for capital allocation absent any acquisitions in the near term, we intend to repay debt.
The third quarter non-GAAP tax rate was 21.9%, representing a 170 basis point decrease from 23.6% in the third quarter of last year the.
The lower tax rate was due primarily to two factors discrete tax benefits associated with foreign tax credits and the higher than expected excess tax benefit associated with stock based compensation, which occurred because higher stock price in the quarter generating more equity exercise activity.
Based on the favorable third quarter tax rate and an expectation of additional discrete tax benefit in the fourth quarter, we are reducing our full year non-GAAP tax rate outlook by 225 basis points at midpoint to a range of 19% to 19.5% compared to our prior outlook of 21% to 22%.
Oh Twentytwenty tax rate outlook includes substantial benefits related to stock compensation and other discrete tax items that are expected to lower the shares rate. However over the longer term. We continue to expect our tax rate will be in the range of our low to mid 22% target as we previously communicated at last year's Investor.
Today.
Free cash flow was $151.1 million in the third quarter, a substantial increase from $120.7 million in the same period last year.
Increase reflected the strong underlying operating performance of our businesses and working capital improvements as a result, we've increased our free cash outlook for the year took approximately $415 million from a profit guidance of $350 million to $365 million.
Capex was $26.2 million in the third quarter, a decrease of $9 million from the prior year.
Our expectation for Capex remains at approximately $130 million for the full year.
With respect to our full year and Twentytwenty guidance as Jim mentioned, we are increasing our revenue growth outlook to a range of 5% to 6% on an organic basis, and 9.5% to 10.5% on a reported basis, reflecting the first quarter performance.
We also expect to achieve meaningful margin improvement.
Which combined with a lower tax rate is driving our higher full year non-GAAP earnings per share outlook to a range of $7 to 75 cents to $7.85.
Our full year outlook for segment revenue growth was also more favorable particularly for the RMS segment given the recovery we are seeing in the business. So the RMS segment. We now expect a mid single digit revenue decline on an organic basis and a mid single digit revenue growth on a reported basis.
It is a segment we continue to expect high single digit organic and low double digit reported revenue growth for.
For the manufacturing segment, we expect high single digit revenue goes on both reported and organic basis.
The detailed somebody about financial guidance can be found on slide 42.
With one quarter remaining India, our fourth quarter outlook is embedded in our guidance for the full year on a year over year basis, we expect organic growth in the mid to high single digit range and reported revenue growth in the high single digit range non-GAAP earnings per share.
Thank you to increase at a low to mid single digit rate in the fourth quarter.
We are extremely pleased with the operating margin expansion that we have generated through the first three quarters of Twentytwenty, particularly I missed the COVID-19 crisis.
The fourth quarter as represented the highest quarterly margin over the last two years, but this year, we have tempered our expectations, primarily because the COVID-19 revenue impact will not be behind us until we exit the year and the cobot related cost control benefits will also further moderate for the third quarter, we believe.
We are well positioned to finish the year strong, including with the achievement of a full year operating margin year, our 20% target and are excited for the prospects as we look ahead into 2021 and beyond thank you.
That concludes our comments, we will now take your questions.
Ladies and gentlemen, as a reminder, you would like to ask a question. Please press star followed by the number one on your telephone to Lipsky a question press the pound key.
Please stand by Bobby capacity Chemo nave assay and also please limit yourselves to one question again its timeline.
And your first question is from the line of David Windley with Jefferies.
Hi, Thanks, good morning.
I wanted to focus on Jim your comments about.
Clients moving toward outsourcing more committing to outsourcing more you mentioned that at several points in your prepared remarks, and I know that early on in 2020 with the Covisint pandemic.
Beginning to impact you.
We're certainly talking about.
Charles River, keeping its facilities open and operating and not providing some.
Some benefit and some motivation to use Charles River more I'm wondering if you could flush out the conversations that you're now having about.
About that kind of temporary situation moving to a more permanent situation in terms of outsourcing and should we expect that this would manifest in.
Bigger kind of headline type deals or will it just show up in the revenue growth rate on a on a kind of on a gradual organic basis.
Yes, thanks, Thanks, Dave.
We will we've been able to demonstrate.
In large measure because of the inflection point that the.
Viruses given provided unfortunately it exists but.
So really magnified the power of our portfolio and magnified the criticality of outsourcing.
Clients, who maybe didn't fully appreciate.
And so.
At a time when clients had.
Difficulty running their own operations opening them getting getting them.
Moving having facilities closed knocking out will depend on themselves. We remained open in providing these services for them across pretty much across the whole portfolio.
And so I think people that were I was skeptical or have some kind of historical preference to do things internally.
Now where.
Had been enjoying the benefits of not having their study slowed down because because they couldn't do their own work.
Hopefully were doing it as quickly and I think in a lot of cases more quickly than them our price points I'm sure better and a lot of cases assigned as science is actually deeper and so we think actually the more prolonged.
This goes on in the more sort of hesitancy in concern they have about their own in infrastructure.
The more pronounced.
Strength to our capability. So we're definitely seeing it as we called out in my prepared remarks, we're definitely seeing it in gems, we're definitely seeing in biologics are definitely seeing it in safety and discovery. Some most of our service businesses, we're seeing it.
And.
There is no reason to not believe Dennis is based upon client input.
That never want we will retain a meaningful amount to the work that has been outsourced to us and our ongoing basis.
Science has historically preferred at or will.
We'll give some input from from some of them, they're rethinking that strategy that is discussing.
The cost of their infrastructures and that there were a part.
Part of the conversation.
I wouldn't I don't know this for a fact I wouldn't want to mislead you to take we're going to have some huge amount. So in some major pop although we could have a client that has now so it's natural that could do that I think thats less likely and more likely that it will continue to be a gradual but persistent across clients that have historically.
We use us for outsourcing and some that have used us less.
And I.
I guess the last thing I would say as we continued to enhance the portfolio, which we surely will through these complex strategic deals that we're doing and through M&A that will make us even a more attractive a resource for the clients to satisfy needs, which they thought for whatever reason and secular only satisfy internal.
Excellent I'll stick to my one thank you. Thanks.
Thanks, Dan.
Your next question is from the line of John Kreger with William Blair.
Hi, Thanks, very much Jim question for you about the research models business as the as the third wave plays out do you think there is a risk that we could you could see a fall off and model order flow somewhere to what you saw in Q2 were pretty thin client attitudes will have changed this time around thanks.
Yeah, So kind of a question does your John.
We.
When one does know for sure of course and.
This virus is as predicted right.
Second wave already in the fall and winter as it gets colder with increase infections and.
Et cetera.
So we think two things the principal impacts our Rms business.
Although other aspects were impacted but the principal impact was academic.
Major academic medical centers across the world, particularly the us in Europe closing abruptly really two or three weeks.
And so we know that number one there.
Sorry that that happened in retrospect that that was that wasn't a thoughtful response on their part of course, we didnt understand this virus very well and now that they do and now they see the impact of that.
We're quite confident that the academic medical centers have made arrangements profit.
They're very structure or how that works, how the PPD staggered shifts how they utilize fluids et cetera that they'll be able to withstand this this apparent than already increase in.
And the answer that's on Texas. So we don't think there were going to have a major dislocation again the tale tell all take a deep deep breath, we don't know what I'm about to say, we see no, but I would be very surprised.
Again, given the education and everybody has about the importance of mass and social distancing Andy.
Careful for you.
Hang out without sort of.
Hang around without sort of work.
Staying home in your SEC all of these things I would be surprised if.
Biotech small biotech companies and large pharma companies shot portions of their sites for any meaningful period of time if at all.
So.
I don't overstated, I mean, I've thought right now and of course, we're in the mix of the second way.
Good.
The second way with the first wave and a new second while the shore. We still think we're going to exit the year pretty much either at a at a historical run rates for research models, both products and services that China will be strong and services will be strong in the us in Europe, which would be beleaguered by Kogut will not.
The.
We think it's highly unlikely that tell us that there will be a major sort of.
I mean, unless there is a major shut down across the sites, which we can't imagine what the rationale would be given the learning curve that we all have in all these institutions have has had so highly unlikely John.
Very helpful. Thank you.
Your next question is from the line of Eric Coldwell with Baird.
Thanks very much.
He mentioned the academic share gains said, particularly strong there I'm curious if you could talk about whats driving share gains within that client base versus competition number one number two you you highlighted that there were some stock up so I think specifically in Europe as institutions came back online.
Hoping you can talk a little bit about how those startups impacted the quarter and what's the knock on effect of that how does that lead to future growth future comps.
How does that really play out in the academic marketplace. Thanks very much.
Sure so so.
Starting up is or as a result of clients being sold out of business and now working for some period of time and getting back to work.
Good wine too we populate colonies begin their internal work as quickly as possible.
Number one the challenging to do and number one that's not something that should continuously do so I don't think thats, a continual process I think that they stock up to get back to some steady state.
Of of operations that they were in prior to October So we're happy to have it we geared up for that.
By the way Eric So we purposely prepared for that because we anticipated that said be this kind of pent up demand and it would have been very frustrating for our clients. If we said was we we reduced our animal colonies during the during the second quarter because business was slow we just simply can't provide those animals too so.
It was as anticipated.
So.
Certainly use of their space and pretty risky because I don't think we have the biosecurity environment to breed animals and keep them pristine.
And if they have some sort of internal outbreak. They can really hurt themselves. So again, they had that they actually outsource those colleagues to us and we have them.
And on the GM side, they outsource, though breeding work and micro biology work to us and we have it.
I can't tell you that nobody will we'll bring it back in house, because there's a fair amount of parochialism, but I can tell you that.
We're getting just with the work is we're retaining the work we're getting into that to work and we're getting a lot of.
Feedback from clients, saying, we're so appreciative that you're aware that you're up and running we didn't realize how seamless this would be.
For you to do the work at Eurosite and provide the animals to us at our site and we actually don't feel like we've given up control.
As we probably discussed with you and everyone else on this line up so many times.
The principal thing that gets in the way of outsourcing for academic or pharma biotech clients is perceived loss of control over or whatever.
Mostly time this notion of stuff has to be down the hall or across the hall and I think we've demonstrated now for years now that that's that's that's kind of a anachronistic view of the world and and isn't necessary and isn't a smart way to work so.
We're quite confident that our academic share opera.
Communities, which we've been actually working for years.
Is and will continue to accelerate because we've demonstrated this.
Pretty unique value that we can provide them.
And we would anticipate that that should continue to grow Jim.
Jim that's a really excellent detailed discussion and I don't mean to overly parse the semantics, but this your discussion sounded more like <unk> penetration into existing accounts as opposed to.
Perhaps taking share from other providers servicing those accounts and maybe it's a combination of both but.
To me that sounds more like a penetration opportunity selling new things.
We're done in house to existing clients.
There are also moving on it where you're taking share from other providers.
I think that I think it's both Eric I think what we heard from our clients or the system just.
My perception is that.
Particularly when co that hit they were disappointed in some of our competitors ability to.
Yeah, the animals to them to priced to provide services to provide services to them or indeed, even be open.
And and as yet as I know you know because you know us well some of our competitors, while well good competitors have a limited geographic footprint. So we asked about competitors with.
A couple of sites, where we have a dozen or more sites and so if one of those sites was closed for a short period of time and that was one of those more proximate to the clients that would be a disruption in service and so for sure. We again, we exemplified what we said three years, which is that you know we have just begun.
Actual infrastructure you can count on that even during tough times, like kogut or hurricane or tornado or whatever so yes, we definitely got to demonstrate that and we heard back from clients with regard to specific competitors that who.
Who weren't able to support them in some cases competitors, who had the lion's share of the work that.
They kind of call. The sheepishly instead I know, we don't do work with you but were stuff can you help us and then of course the legacy of that is that we get some or all of the work going forward.
I think it's both I think it's probably actually more share penetration a work that was done in house at the clients, which is actually in some ways more exciting because.
That wasn't available to anyone that was justice as I said before this kind of internal historic.
He knows where they said man, we just got to do the work ourselves.
And this has been a disruptor to that thought process.
Jim Thanks, very much an impressive result, some good luck with the future. Thanks, Sir.
Your next question comes from the line of Tyco Peterson with JP Morgan.
Hey, Good morning, Jim question on DS say, well actually kill you know you flagged the milestone.
You received I am just curious if your discussions on mix shifting more towards embedded milestones and future work and then it looks like coal that you know another infectious diseases are helping drive safety assessment and then I'm wondering if you could just talk about the percentage of bookings and you know clearly tailwind and how you think about the burn of network. The cobot related work for defense.
Thanks.
So.
I don't think we said it in the prepared remarks. This time, maybe we did so we want to be careful to say that we are.
Really pleased and proud to be doing so much covered work for so many clients.
I think that.
Some drugs and vaccines hopefully they get to market, we will probably have work on so we're proud of that it's it's definitely some incremental revenue across multiple business streams, including including safety, maybe particularly safety. So pleased to have it it's just not a meaningfully large number.
So we just want it we just want to be clear about that and I think that's actually a pretty good thing that that business is strong so strong across so many different therapeutic areas and.
Third Utica modalities.
With a slight enhancement from Covance and by the way we try to give cobot that clients are priority when we do the work.
The idea say staffing, particularly about discovery milestone.
Work done and particularly the milestone that actually paid out again.
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We try to be very flexible in and listening and be open to the notion that a client wants to work with us in a milestone basis.
I wouldn't say, we like it or don't like it we don't necessarily pursue.
Pursue those types of deals.
If a client wants it and we think its a.
That's a.
We think we think the molecule that has promise.
Because we you know we have deep scientific kids goes when we can usually analyze these things well that we're open to taking a smaller amount of money upfront and a larger amount of money going forward.
For some clients that just and then set necessary way that they want to work and if we don't work with them they'll go to the competition, sometimes we let them do that depending on who the client is and what the what the molecule is.
We are open to we have a small number of those deals. So we don't overstate that we're happy with them, obviously, we help them out on payout.
Some wells somewhere around this one did and that's obviously a really positive thing.
Well that client come back and want to do another deal with us with a milestone probably that's worked out really well for both of US doesn't mean, we'll do the milestone deal. If you don't like from particular structure, So I'm not sure it necessarily set necessarily portends.
More of that work to come.
But we are open to it but I want to be clear that because I I know that some people.
Find the milestones are concerned with regard to our.
Oh PNM on our business structure, and so I think that's.
Hey.
The majority of our work is you pay us really well with our services upfront, we do the work and you passed with.
With a small number of them sort of you pay you pay us as we both go together and it's that both go together portion of its most critical because.
We definitely in there ourselves to our clients, who think of US as you know having some skin in the game and what are we being a partner with them and.
For those clients, where that's important were likely to be more open to it.
Okay, and then on manufacturing Biologics, obviously, you doubled your capacity I know, it's filling up quickly are you able to just give us an update on where you are in terms of that capacity being filled and how you think about that that that for next year.
Yeah, I'm still very very big side Psycho and so.
It will be a few years I hope faster, but we have a few years before that shows up in the business is growing very quickly. So thats a good thing you know, there's a causal relationship between the growth rate of that business and available capacity and while we had a good year in biologic last year was not as bad because we were capacity constrained in.
Turning to that Big Pennsylvania site, which is kind of the principal driver of growth.
We did add incremental space at several other sites that we had in Europe, particularly Ireland, and Germany, and we would continue to probably add space.
Suddenly in those two sites kind of continuously and be very thoughtful and prepared to make sure that well in advance of when we think we will Max out.
In Pennsylvania to add a substantial amount of incremental space because so we can stay ahead of it it's a pretty good sites on a by biotech clients support point of view.
We have a big big Yeah, Yeah scientific infrastructure, so I sort of expanding around that would be a smart thing to do then totally new sites.
Elsewhere, we also have a small biologics component in Massachusetts, which obviously is close to.
Cambridge based and Boston based biotech company so.
[noise] capacity is in very good shape, right now and certainly will be for 2021.
Great and then just lastly, quite how about you and I'm wondering if you're willing to comment on 21 at all I know you don't normally at this time, but a lot of your share up here as you've at least talk qualitatively. The streets got you're going just under 10% ex you're able to talk at all about how you're thinking about the set up her for next year.
I think all I would say about 21, because it is premature for us we usually do it turned.
During our February call, which is when we will do it again.
And give you greater clarity I think what I would say now just kind of Directionally is.
We don't see any indications that the current demand curves.
Pretty much across the entire portfolio will be any different [noise].
Lets say funding Hum.
Has been extremely robust for the biotech industry as strong a stronger than ever.
And numbers of Ipos has been dramatically the amount of M&A has been really good for that.
For those companies.
Well a lot of farmer work not just been covered but outside of code red cell and gene therapy being a big driver of growth. This outsourcing thing that I was just talking about earlier with one of your colleagues I think that that will hold us in good stead, because we'll see more outsource work.
Obviously, we have a good comp with this I hope with the second quarter of RMS.
So I think I think that that should be beneficial for us.
Hopefully.
We see the ability to to install them or are you more units with microbial that would which had been held up because our inability to get clients, but the overall demand for.
Our services across the portfolio should be should be consistent so that should give you a good sense of at least where we think the topline.
Directionally moving.
Okay. Thank you.
Sure.
Your next question comes from the line of Robert Jones with Goldman Sachs.
Oh, great. Thanks for the question, Yes, Jim clearly you know RMS is probably the one segment. This year that you know with little volatile because it covered I think you know manufacturing support India say held its own fared pretty well.
Certainly this quarter seems like things are getting back to normal across all three segments. Yeah. If I, if I think about the margin opportunity from here for those businesses you know assuming things hopefully stay relatively normal as we as we look forward you know manufacturing support RMS specifically, you know performing very well already above the long term.
Right and you know from a margin standpoint could you just maybe help us think through where the margin opportunity could be on the forward across the businesses, but I guess in particular as it relates to manufacturing support in Rms.
Sure David Lynch take that.
Yeah, So well done Jim's already mentioned that we don't want to get into too much detail about 2020, one because that's not our normal cadence.
What we would say about the margin is that we are still of course, focusing on achieving that 20% and this year, we expect to be very near it.
We still believe there is potential to go beyond the 20% that is something that we've made public before we still stand by that statement.
But at this stage I think it would be too premature to get into detail, but I would say that the two key drivers that we had outlined back in September last year to year at our Investor Conference.
One of which was.
The D. it day.
And we've seen in Q4, a 240 basis point increase Q1 over Q1 was three Fortyg Q2 over Q2 210, and this quarter. We've seen another 310 basis point increase so we are now getting into the ZIP code of that sort of mid twentys with Dsos. So we're obviously very pleased with that we had called out that the way.
We got that was through integrating our acquisitions generating synergies from those acquisitions, eliminating redundancies and just leveraging on the staff capacity that we have.
The second driver that we called out is leveraging our unallocated corporate costs and over the last several years, we've been bringing that down about 50 basis points as a percentage of revenue and continuing to do that into two this year as well getting the leverage from the sort of way we built our back office units. So.
Yeah, I guess, we'll say more in February in terms of specifics as to where we think we would be going next.
Okay, Great I appreciate that thanks, David.
Your next question comes from Atlanta, and Wright with Credit Suisse.
Changed in terms of your view on the acquisition and partnership opportunities and they said that the thing and then can you did you say the pipeline is larger or on started the year EBITDA or what are you seeing out there from the deal pipeline standpoint. Thanks.
So were really enthused about the street strategic card to ship a strategy that we have and we have nine deals across.
Whole host of cutting edge technologies from artificial intelligence to next generation sequencing.
And on and on and.
There there are wonderful relationships to actually do living due diligence on these on these on these companies.
Some of which we for sure will buy it and we will have a really in depth knowledge of how the businesses operate how responsive added clients how robust the technology is.
And we expect that to buy some of them. We expect that they will give us a competitive advantage because most of these technologies are unique and highly proprietary so there's a lot of those so we had nine signed we probably have an equal number and the conversation you know.
Pretty far along some of their life stage. Some some in early discussions. So yeah, we probably will have a universe kind of on a consistent ongoing basis of.
20, or so these all kinds and some of them are selling.
Some of them will fail some of them will continue is as joint marketing relationships and some of them will be will the acquisitions. So that's that's a really strong so I would say that the pipeline to straight up M&A is is quite remains quite good.
I would say most of the sellers of private equity firms, which means that all of the companies are for sale at some point here to try to get in sync from a timing point of view.
I can make generalizations about what our expectations are with regard to margins because it depends on the asset and the competition for that asset.
But we.
We feel that we have refined methodology the value of these businesses and we have set a strong balance sheet right now with reducing leverage her love just come down I think to the mid twos.
We have a bunch of conversations going on now as we always do.
Across several different products and services.
Across different parts of our portfolio.
I would say.
Even though you didn't specifically asked as that none of the things were looking at a very large I'd say a couple are of modest size and some are small.
But they all would very much improve and enhance the quality and competitive strength of our portfolio.
We have no artificial goals to buy a certain number of companies that add a certain amount of revenue, but we do have a very strong strategic goals to continue to run the portfolio and we think that you know we we don't just like we know that our portfolio breadth of in particular has become a principal distinct competitive advantage. So we want to keep.
Penny or two to enhance that advantage.
Okay. Thank you.
Sure.
Your next question comes from Atlanta to Elizabeth Anderson with Evercore ISI.
[noise] manufacturing operations are helpful and in talking to they get all the station revenue, Pennsylvania, managing the flag is there any other puts and takes that we should think about or in terms of using that three key number sort of like a.
Like run rate number to go forward with at this point.
Uh huh.
Probably would be careful views of the Q3 numbers since it was it.
Finally strong.
Quarter, but yeah. That's this is the markets its probably low double digit growth.
We have two parts of the business and you know the buyback I think go talk to these.
Both of these businesses have the capability to continue to grow at low double digit rates.
We don't we don't sort of we don't sort of break them out.
I think the market dynamics are really strong for both of them I think kogut enhances it more for both of them I think cell and gene therapy enhances it even more than that.
I think Iraq, passing biologics absolutely has meaningfully increased.
Our prominence in that space I.
I think our expanded manufacturing capabilities the M&A that we've done in the new.
A new pieces of equipment software enhancements.
Enhancements that we've added to our microbial businesses has has made US you know a a leader in bacterial contamination.
And detection and so.
Yeah. The I I don't know if you want to.
Lock onto any particular quarterly run rate because as we have almost every quarter.
We don't have a linear business, we'd like we'd like you all to look at our business on an annual basis, I think our ability to call. It on an annual basis has been quite accurate for last few years.
But but we think that we have a strong market demand and the right infrastructure to continue to take advantage of a mark.
Market demand and to take share across both of those markets. So we would expect manufacturing, which obviously has an exhilarating lehigh operating margin at very high growth.
The topline third quarter to continue to be a really strong business for us for a long time.
Perfect that's very helpful.
Your next question comes from the line of one Evan Dan <unk> with Bank of America.
Follow up on the M&A pipeline I'm actually looking through that pipeline are you focusing on service oriented efforts or what is your point of view on the numerous technology oriented assets that are out there are trying to descriptor cracked discovery and preclinical development space I mean, given you.
The addition of George Good Board prior experience in information technology should we expect Charles River could become more involved are under technology side of things.
I think you should expect Charles River to continue to utilize data and more impactful ways both to operate our business more efficiently connect with clients more efficiently to design better studies with hopefully better outcomes for our clients and to hopefully use all of that data too.
Accelerate the work that we do for our clients. So yes.
HM.
Yeah, we have both products and service businesses that we're looking at you know I think we have a preference for one even though our businesses.
You know we are.
Our lineages product and our current portfolio is pretty.
Principally services it must be 75, or 82 cents services right now correct.
Yes, he mccann soleris product businesses extremely high growth and good operating margins.
The analog business does that.
Microbial business has the avian business and so what we're good at product, we're good at driving efficiency in manufacturing and delivery.
Of those products, but also we have obviously, a larger and significant service component.
Component, where I also think we've done a very good job in driving efficiency and better connectivity with our clients. So.
We're looking at both.
We were sort of thought one out over the other.
There are definitely some product businesses or would like to add it hopefully well and there there's probably more opportunity on the service side just to just to put a punctuation.
Thank you Jim Congrats on the quarter.
Thanks.
Your next question comes from the line of Dan Brennan with you yes.
No microbial solutions part I know that business has been a little more impacted due to coded as you talk about any could you could you maybe give us a little more color on the extent of any impact how much been hampering growth.
Any color about kind of the rate of improvement that we could potentially see as we go forward.
Yeah. So you know if it's a tough one to call out some extremely.
A well run business with really terrific demand. It's it's been as the business has been strong as we've seen it.
Yeah, we have these three product product lines.
All of which I think this is a meaningful demand for as I said, a moment ago cell and gene therapy, and kogut have definitely enhance the demand.
You know we sell these systems that have reagents.
Or cartridges are associated with them. So it's got this razor razor razor razor blade capability.
Or structure and I think that that aspect of it continues unabated.
For systems that are out there and so your people continuously need to use these reagents as they do testing to see whether the drugs are being contaminated what's the source of contamination is.
So its a steady business highly profitable business with with I think good growth metrics.
We have a fair number of systems, mostly large systems that are very complicated who usually go in and do an installed people go in our people going to the client.
And the client has to work with us for some period of time to understand that understand the software understand how to qualify the system put on regulatory costs.
And so we are we have we have two issues. One now one is that sites are closed and such it just closed or sites are close to outside people.
And so.
We as we just reported in the third quarter, we had some other sites were closed so can.
We were able to work out virtual installs with some clients with some of the less complex systems, particularly for clients are understood them.
But yeah, you hit a little bit of a wall there I do think that out of necessity.
My analogy would be that the FDA is auditing Charles or so these ustaĊĦas auditing the Charles River facilities clients are auditing exercise virtually which is something they've never done before and they probably don't like it but that's the way we have to do business or R&D development grinds to a halt.
So I do think that in the I'm not going to say like you are unlikely event that I don't know I'm, assuming that the sites that we hope will open don't or.
It is so good so red hot that they just don't allow outsiders and and the clients really need out here.
To make sure that what they manufactured is is a safe enough to be sold to the clinical trials or to end use market.
Then I'm confident that both we and then concert will figure out a way crushingly to virtually do that it will be it will be less elegant and more awkward and probably take longer.
But it's possible so we're working on that real time.
To provide a simple solution.
And I think that clients need it more hopefully we'll figure out a way I don't want to give a prognosis on what I think will be passed that 'cause it's impossible and as soon as the only remaining legacy I mean.
Manageable, one I might add but.
The only remaining legacy kind of headwind legacy from Kogut, which we're delighted with that.
We're moving through well, but it still exists.
Okay. Thanks, Jim sure.
Sure.
Your next question comes from the line of Patrick Donnelly with Citi.
You know, it's been one of the big beneficiaries and some of the co. Good work can you just talk about how you're prioritizing some of that work versus whats in the portfolio and then also just kind of thinking about that over the next few quarters. You are you generally just can see some of the early work in that phase as you get more towards.
The vaccine commercial process I'm, just trying to think about the durability of some of those tailwinds.
I mean, I, let the summaries and I have a delay first few words of everybody's question. So what gives you from what was that there was all the questions I was going to say the safety side I'm just around some of the Cobrand work. The durability. Just given you guys tend to be a little on the earlier side in terms of seeing some of the runs just wondering as we go through the next few quarters how that trends.
Yeah, So I I just want to emphasize the fact that.
It's a subtle relatively minor amount of revenue I think it's more about the pride.
Financial impact.
Yes, these drugs and vaccines that get into the clinic, we'll have to have been safety tested for us.
They don't have to do with us, but lots of them are.
So we're seeing the benefit of that there's a pretty pretty healthy number of drugs and vaccines in development.
Many of which aren't in the clinic, yet so so without getting too specific.
You know, we still are enjoying some of the benefits of that and will continue to to I think it's so minor and so subtle that as these drugs hopefully moves through the clinic and get approval and to the market.
And I you know I think it will only be room for a certain number of them. I mean, you know assuming there are effective kogut.
Therapeutics I don't know, how many one needs right or effective vaccines I don't know how many so I.
So unless it's a less effective drugs or vaccines are elusive none of these things work and they just keep make new ones and have a new shots on goal I think we sort of move whatever.
Minor.
Positive impact we are getting we sort of moved beyond that I don't think you'll be discernible I think our business is so big now this is a pretty modest and kind of what we do and even in even in safety, which of course is our biggest business. So.
As we said before happy to have the work or is it you know it yet or what have you do the work as long as it's available.
We probably will go through that through that at some period of time.
Okay. Thanks, Jim.
Sure.
Your next question comes from the line of Jack Meehan with me.
He from research.
Good morning, Hi.
Hey, Jim Theres been some discussion around some supply chain constraints when it comes to non human primates, just being shipped around I was curious have you seen any of that and how you manage through it.
Okay.
So and important part of research and a whole host of areas, particularly for large molecules and then have to model it's been important for years.
Supply sources are.
Pretty much external coming from places like China, and malicious or [noise].
Cambodia Vietnam.
And so we work really hard to have multiple supply sources.
From multiple geographies and multiple suppliers within those geographies.
Close working relationships with them to ensure you know exceptional veterinary oversight.
And supply numbers.
On a consistent and profitably and hopefully always well in advance of when we need these.
These animals because it's so.
Importantly source and so.
We we have always worked really hard and ensuring that supply. So supply overall supply I have the numbers have picked up over the last few years, so more suppliers I necessary, we feel really good about our supply situation.
Situation, although I would like to have certainly sufficient number of animals for the balance of this year and well into next year.
And it's it's a continual dialogue with the suppliers.
Try to match the supply with what we anticipate he will be based on what we hear from our clients but.
I think we're doing very well resourcing and HP.
Thanks, Jim.
Sure.
Our final question comes from the line of George Hill with Deutsche Bank.
Yeah. Good morning, guys and thanks for taking the question I'll keep this brief as it relates to kind of the cost reductions the margin improvement as a result of covered some of that I'm sure has to be temporary have you guys kind of quantified how much of the cost basis comes back as we're kind of resumes to normal versus how much you think is a permanent improvement.
And then maybe I guess kind of a Jim I don't I know you're not talking about 2021, what should the next margin target look like.
[laughter] well that they would take that question.
Yes, so I'll cover both the revenue and the temporary cost reduction so.
When we spoke to you in May we thought that we could have a revenue impact as high it turned and 15 million in a sort of downside case. When we spoke in August we felt good about what we saw in Q2 that we reduced that down to 100 million and now with the strong Q3 results, we got that down to 17 million head.
And.
And of course as you know that's mainly in research models, a little bit to do with microbial and the inability to get the instruments installed.
So.
When we look at that time, the temporary cost reductions. That's also come down when we last spoke we said 40 million and we're still holding to that 14 million a majority of those cost savings came in Q2, and what what I, what I can check.
Is that the amount in Q4 is going to be about half that of what we saw in Q3.
So that's beginning to tail off now in terms of the temporary cost reductions.
Of course, as we bleed into Twentytwenty, one may still see some benefits in terms of less travel than we used to do but by and large much. If there is some cost reduction initiatives and are now behind us.
So in terms of your question in terms of headwinds as we go in clearly clearly there's a little headwind still legacy from Q2, well most of those savings took place, but broadly speaking, we're exiting with them with the exception of travel much of it now behind us.
Thank you.
Great. Thank you for joining us today on this mornings conference call. We look forward to speak with you at several upcoming Investor Conference.
This concludes the conference call. Thanks.
Thank you ladies and gentlemen, you may now disconnect your line.
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