All right. Good morning, everybody. My name's Luke Sergott. I cover Life Sciences, Tools, and Diagnostics here at Barclays. With me today, it's my pleasure. I have James Foster, CEO of Charles River, also known as Jim Foster, whoever you prefer to, so a lot to dig in here, so a lot of interesting topics to cover, but can we start off first talking about the SVB exposure and then the impacts that you're seeing from the customer base? Have you guys broken that out by the revs? I think you had something in your deck on it, but just anything that you're seeing there.
Not seeing anything adverse. Just kind of emails from clients and VCs saying all is good. So we don't expect that's going to have an impact on us.
Okay. That's fair. And then on, can we just talk about the non-human primate issue? We were just talking. I don't have the official coverage yet, but I've been impressed with what's going on. Can you just walk us through the dynamics of the supply chain issue and how you think it will be rectified?
Yeah, so a complex and fluid situation for sure, so initiated by a DOJ investigation of a supplier in Cambodia that we don't use, so I don't know a lot about that supplier except the country that they're in, and I know others use them with an allegation that they were bringing animals that weren't purpose-bred, in other words, bred for this purpose, so they're wild-caught, and that's a problem, and so we think that, and so we're sort of peripheral to this whole thing, actually, although it's having an impact, so we think that the situation is essentially without merit. There's been no allegations with regard to us or suppliers that supply us, but sort of an implication that they may be looking into whether our supplier is doing something similar. We don't believe they are. We just audited that firm in January.
I would say that we have the best primate stocks in the world. We went over there and looked at this facility. We provided a lot of input on how they run that space as well. So there's multiple pain points here. So until this is resolved, we're not either bringing any Cambodian animals in or utilizing them. We have multiple sources of supply and always have. But the majority of NHPs used to come from China. China sort of woke up one day, as we had anticipated they would, and said, "This would be a competitive advantage to China if we keep those monkeys in country." And so they suddenly cut off the supply. They went to Cambodia with animals of sort of the same genetic background and essentially the same type of animals. But that pivoted very quickly.
The Cambodian thing is significant because about 60% of the animals come in from there. The frustration for us is that we have sort of unrelenting demand, the greatest demand we've ever had way out into 2024. We have plenty of capacity. We have headcount that's in a good place. And we've contracted for and actually have sufficient number of NHPs to do the work. We just can't use them. The fix is to have scientific tests showing parentage so they can prove that this offspring—that's the mother of the offspring—and the mother was a purpose-bred. That the offspring was purpose-bred by that mother and that father so we're working on sort of multiple technologies to get there as quickly as possible. I'm quite confident that we will fix this sooner than later. We tied in a double negative, but we can't not fix it.
So this is a way bigger issue than Charles River. So I already had a whole morning of monkeys. But if for some reason Cambodia was closed to us and others, and the work went to China, you literally would have hundreds or thousands of drugs that would just paralyze that would not move through the IND process. So it can't not get fixed. We're going to have to take a leadership and get it fixed. I'm trying to be somewhat optimistic about this, even though it's just been incredibly annoying that in the final analysis, we'll elevate the craft. And scientifically, we'll prove forever that the offspring are as indicated. And we're happy to do that for our competitors, for our clients, for whomever, for the government to show that this is done well. And so we're just going to have to take a leadership position.
So as you would imagine, we're spending an inordinate amount of time on this. And it does seem like we're peripheral to it, but it is what it is. As I said, we have multiple supply sources. So we're working really well through this whole thing. We're quite busy. Clients have been fabulous. I think shareholders understand where we are.
Yeah. I mean, so any reason why you wouldn't start your own internal breeding program? Because of your experience with the rest of the model business other than just cost?
Yeah, and there's lots of reasons. We did that once. Actually, the project was destroyed by a hurricane, but putting that aside, when we did it last time, it was going to be cash flow negative for 12 years. It's a nightmare. So it's incredibly expensive to set it up, incredibly time-consuming. So it doesn't ameliorate or solve anything for years. It's unnecessarily expensive and inappropriate because you've got these monkeys running wild all over Asia and Africa. And all you need to do is take these feral animals and have multiple generations of them breeding so you get purpose-bred animals instead of quite plentiful. And if companies like us oversee the science and the genetics and the quality, then that's just better. So we still talk about it incessantly. It just doesn't work. It's not even the money. I mean, it would be expensive.
We could afford to do it, but it would just take too long, and I just think it would be a hideous drag on the P&L.
Yeah. Makes sense. So if I understand it right, so you guys are offering to offer that test for the genetics, and that could be you'd be the solution provider to the government saying, "Okay, we can start allowing these back in." So that could be possibly a tail-ended positive for you guys out of this.
I mean, I think it'll ultimately be positive that this sort of conversation about wild-caught animals versus the purpose-bred will cease. And we'll be able to prove with certainty that they are what they are. And by the way, genetic testing is a very trivial science. I mean, it's not complicated. It's more about the scale. It's a lot of animals to test in a very short period of time because we want to get ahead of this proposition. So it's more the scale than the science. But we do have several folks working on the science for us with some pretty sophisticated stuff, which not only would we be able to prove it with a certainty, but the speed with which we do it would be accelerated.
So, we're comfortable with the sort of guidance range that we gave, which said the kind of best case we get this fixed by, I don't know, into the third quarter. We're often running in the fourth quarter. Kind of worst case, it takes us.
Got it. That's the 200-400 basis points.
Yes. Exactly.
Okay. So we've heard from some channel checks here from some early-stage customers that have managed to supply enough of their NHPs from U.S.-bred sources. Where would those be coming from? I mean, there's not a lot of breeding programs, I guess, in the U.S.. So I mean, are you guys, where would that, I guess, yeah, where would that come from?
So there are no U.S.-bred sources. There are a couple of companies that are sort of brokers that get animals from wherever. We have used those folks. To some extent, historically, I'm trying to be careful picking my words here. We prefer not to use them. Reputationally, I just don't think they're the best possible people to use. And I don't actually think they care where the animals come from or what their background is. And they've been kind of inappropriately priced. So there are probably. People say there are. I assume they're telling the truth. There are probably animals in country brought in from the outside, including could be from Cambodia, could be from the source that the DOJ is looking at. I don't know that. We're just not using them. Number one. Number two, I don't think it's large numbers of animals.
Number three, I don't know how sustainable that is.
Okay. And then lastly here on the DOJ investigation, what are they? You said that they're just investigating not you guys, but the partner that you guys use for your supply. Give us some time and timeframe here what they're really looking for.
Yeah. I mean, so when the thing broke, which I guess is November, September, November, I don't remember, they issued indictments against one of the breeders in Cambodia, and they arrested one of the government officials, and there was an unindicted co-conspirator, I think they called them, which allegedly are a company that you've talked about in the U.S., maybe. Maybe some people that we compete with. It was unclear because nobody was named except we weren't, so we're not a target of anything. They don't give us a lot of information except to say that they may look into whether the folks that we get animals from are also providing wild-caught animals, and they want to look more at our paperwork, but meanwhile, nothing is progressing, so that's why I say we're sort of on the periphery.
Meanwhile, I just want to repeat, we don't think it has any merit, and as I said, we're quite confident that we'll resolve any sort of uncertainty with scientific data, which is not debatable, and I think that's what's missing here.
Yeah. Okay, so it's more of just getting the actual data there to support it, and then lastly, on pricing within the industry, it's still, I guess, skyrocketing would be the modest term.
The pricing's nuts, right? So we used to pay $1,000 for monkey. It's $30,000-$50,000 now. There's probably no limit to what the suppliers can charge and no limit to what the clients will pay, just given the criticality of these animals. So you don't do work in large molecule drug development without non-human primates. End of sentence. Full stop. So that's why I keep saying it's not a debatable proposition. So we'll pass the prices along, which we have been. It doesn't really matter whether the clients like it or not. We're not doing it to gouge anybody. We're not making a lot of money on that. We're simply passing it through. And so they understand that. The clients have been very good about this whole situation.
Yeah. I mean, they want the project to get done, right?
Yeah. Exactly.
Okay. All right. So I guess for the remainder of the time, we can talk non-monkeys?
That'll be okay with me.
Sure. So, can you talk about within RMS, if you want to spend some time with that CRADL that you guys made the recent announcement? Can you talk about the strategy here and seeing some signs of early success?
So this CRADL business is a fabulous business, probably if there's such a thing, totally recession-proof. So we're providing really workspace for our clients where we build animal rooms and associated lab space for them. And they either go in and do their work, which most of them do, and we just take care of the animals, or we do some of the work, or we could do all the work. And so we set up our own business a few years ago, starting Cambridge, Massachusetts, and then South San Francisco, and then Shanghai, and then Cambridge, England, and on and on and on. And that was a big competitor of ours, the company that we bought. So we kind of doubled our capacity. It's a nicely sized business now. I don't think we give the exact numbers, but it's a big business growing nicely. It's great operating margins.
We have about 400,000 sq ft now and opening new space all the time. So it's a twofer. So it generates revenue on its own with high growth rates and high margins, as I said. It's also a feeder into other parts of the business, particularly Discovery. So they're doing pure R&D with us. And then if they discover a compound or a molecule that looks promising, we go into Discovery and then hopefully Safety. So we like this business a lot. The integration of the Explora BioLabs, which we bought, I don't remember, last April or something, is going really, really well. It's been seamless. I just visited it recently. They have a lot of stuff in California, so I went to a few of their sites. Very well-run, beautiful facilities.
The interesting thing about the business is we thought all the clients would be small biotech, and they're not. So we have a lot of big pharma who either runs out of space, doesn't want to build new space, needs spillover space. We got big biotech. We have medium-sized biotech. So client base is quite interesting, and space fills almost immediately upon building it. So I just looked at some space last week. It isn't finished yet from a construction point of view. It's already spoken for. It's got really good legs, this business. And I think it can be quite large.
And so, I mean, the RMS business is always one of the slower of the three segments. Is this kind of revitalizing it? Or should we think of this rebasing the underlying growth of it, potentially?
I think the research model business is fundamentally different today than it was over the last 10 years. So you've got high growth in China, high growth again in North America, which was not predictable at all. Pricing always. High growth in the CRADL business and in other services businesses, particularly our genetically altered animals business, which we're creating animal models through genetic alteration. We have a cell supply business, which is new. So I would say that the RMS business is moving towards very high single- digit, maybe potentially low double, but certainly very high single- digit with escalating operating margins. So it's gone from this sort of laggard, which was throwing off a lot of free cash and funding lots of other things we did, to being a nice high-growth business on its own.
Yeah. I mean, that was always the short pitch on you guys is that you had your highest margins, slowest growing business from a mix shift and how you could maintain the margins. With the new CRADL coming in, that coming through, I'm assuming at a higher margin, all these new drivers are accretive to the overall corporate margin?
They should be. Yeah. They should be definitely accretive to the top line and some accretive to the margins as well.
Okay. Let's talk a little bit about DSA. The strength here continues to be strong. Talk about not being impacted by the biotech side. And as the models progress into outside of Discovery and then also into the preclinical toxicology testing, talk about what you're seeing there and the legs that you see for the drive.
Yeah. So one of the things that makes the whole NHP thing even more frustrating is that the demand curve for the toxicology business continues to be extraordinary. We booked a lot of studies for 2023 and 2024 and 2022, unprecedented. Enormous amount of pricing power and share gains and really strong capacity utilization. So it's a very, very robust business. I think last year's growth rate was a bit unprecedented. So I think the growth rate will probably normalize, I don't know, low double- digits. I think there's an opportunity to grow margin in that business going forward and to continue to take share. So we like it a lot. Just our scale is so much more significant. Discovery business is obviously smaller. Tends to ebb and flow. So it's a little bit difficult to read the implications of any sort of capital market stuff. We don't hear much.
It's sort of very strong into the fourth quarter. Right now, it kind of feels a little less strong, and it's tough to read because the studies are very short in duration, so they come in really quickly, and then you finish them, and so there's less predictability, so there might be a modest impact. Having said that, I do think we have a great franchise in Discovery. We just did an acquisition, a small acquisition last week or the week before, a very high-science, high-throughput screening company, so we have a lot of these small technology deals that will become acquisitions in the Discovery space, so I would say DSA will, putting the NHP thing aside, even with the NHP thing not tracking well, pretty good growth metrics, should have okay margins. As we get this fixed, the growth rates will accelerate. The margins will improve as well.
So I think that has long-term sustained growth metrics, probably in the low double- digits.
All right. So the guide for the low to mid singles? Yeah, low to mid singles. How much of that is pricing versus the volumes right now? How do you think about it?
It's hard to say because the NHP thing just confuses so much of it. I'd say if you put that aside, which is hard to do, but we run those pro formas both ways. I mean, we're getting a lot of price, and we're still getting a lot of share. So we're getting both. And maybe the price is more sustainable with the sort of NHP headwind.
Okay. We can talk about the CDMO business that you guys just recently acquired, cell and gene therapy, I think. So talk about the-I have a couple, I guess, a hiccup there and now the progress that you guys need to fully integrate and driving growth and profitability back in that business.
So, CDMO business, we did seven acquisitions over the last two years, a bunch of them during COVID, which is not for the faint of heart. So I would say that makes due diligence a little more complicated. But anyway, new area, very complicated science, somewhat unsophisticated regulatory environment, some unsophisticated clients and even competitors. So huge learning curve for us. No excuses, just facts. Unpleasant headwind for all of 2022. Without the growth, top-line growth we anticipated and with hideous margins. We have totally transformed that business. I was just at Memphis last week. That's the biggest part. That's a cell therapy manufacturing facility. You wouldn't recognize the facility. The management team is totally new. Client base is fabulous. The $100 million of new business that we've booked over the last 12 months. We have several clients that are on the brink of hopefully going commercial.
It's all clinical trials. But we have several clients that we're talking to very seriously about commercialization. We've been inspected by the EMA, which is the European version of the FDA. At some point, the FDA comes in as well. So I feel really good about the whole CDMO business right now. It will have good growth rates this year. The first quarter will be funky because we had a bunch of milestones in the first quarter of last year. I'm 99% sure we said that in our last conference call. But for the year, it will grow pretty much at the rates we had anticipated, talked about when we bought those businesses. It will have improved margins, and it should be a tailwind as opposed to a headwind. I think it has enormous potential.
And I think we have the potential to be the leading player in elite cell therapy manufacturing. We also have a plasmid DNA business and a viral vector business, one in the U.K. and one in the States, which also we've redone the facilities and the staff and the management of them as well. Are there lessons in there from the M&A point of view? Yeah, for sure. I'm not really sure what they, I mean, some of it has to do with just the amount of deals we did at the same time. I don't want to say dangerous, but the complexity of moving into an adjacency, particularly with new science. Having said that, I'd buy the same assets again. And we're a year or two off of our valuation model. I still think these businesses will have the same return on investment that we originally anticipated.
So I'm feeling very good, particularly since I just was there last week about the leadership, the client base. Several of the clients I deal with, I handle personally, some of the ones that are about to transition, hopefully, to commercialization dealing with me alone. And so I have a real good sense of what the needs are, what the demand will be, and capacity. If you think about going from clinical manufacturing, and by the way, it's not a good business, but manufacturing commercial quantities, so you're doing higher quantities. I don't know if it's weekly or monthly, over and over. So your production methodology gets much more sophisticated, and you can charge higher prices because they're finally selling something as opposed to just costs going up. So I think the whole structure of that business is in transition right now for us.
When you talk about the growing double- digits and some of these other drugs going commercial, is that baked into that guide, or would that be upside if there's some proof?
I would say that none of that's baked into 2023 guidance because there's no predictability. Maybe something gets approved this year. Maybe it's next year. I don't know. I just know what they tell us. I know what they tell their shareholders because we read that stuff, and I know what the dialogue was with the FDA because we're involved, but as you all know, there's zero predictability on whether a drug gets approved, so we'll see. I would say that most of these drugs are very, very tough diseases for which there are unmet medical needs for which there are no alternative drugs, so it's highly likely they will get approved because there are no alternatives, right, and they're working very well in the clinic, but I'm not really qualified to make that determination.
That's fair. That's fair. And then lastly, you're talking about this business. It sounds like you continue to lean into it as the technology is developed and the indications continue to progress. So talk about some additional M&A targets that you would look for from a technology perspective.
Yeah. So our balance sheet is in great shape, and our leverage continues to be lower all the time because we just keep paying off debt. We've done some small deals. We haven't done anything significant. So as the CDMO business strengthens, as we move past this NHP situation, which is taking an undue amount of our time, there's a bunch of things we're looking at. So when we feel that we've hit C- level with CDMO, which I think we're moving towards, we definitely have some targets there. Some are geographic, by the way. Some of that stuff, we just need to do in other locales. As you would imagine, the cells are living. So the time frame is a problem or a challenge. So shipping cells from the U.S. to Europe is doable, but you'd rather ship them from France to France.
So I think we'll do some more there. I think we'll do some more from a scale point of view. There are some aspects of the CDMO business that we use in third parties that we want to buy. We definitely will do more in Discovery, definitely in large molecule antibodies in particular. We'll do some more in laboratory testing around that. Interestingly, we have a couple of deals in RMS, which would be high growth and high margin. And we have a couple of deals in biologics. So I don't think there's any need for us to move beyond our current sort of portfolio. We have kind of a $20-plus billion market that we're participating in. We're kind of a $4 billion company. So it's lots of runway for us. And we have a lot of targets right now.
Every seller is a private equity firm, so everything's for sale. I'm anticipating valuations will be better. I don't know that yet. I don't think PE ever gives anything away, but I do think they have to be thinking about what they need to charge for these businesses because I think they need to monetize some things. So we tend to have multiple conversations going on for several years, and so I know what the next five deals are we want to do, whether we actually get to do them or not, is unclear, but we probably look, the distinguishing feature in our franchise is that we've done all this M&A, and we have a unique portfolio that the competition doesn't have and that the clients need. So we want to continue to strengthen that. We do these small technology deals in Discovery. We have 20 of them right now.
Probably a third of those companies we buy is very cutting-edge, heavy-duty IP, like this company that we just bought last week. So we'll do lots of those. Those are small deals, but have the potential to get large pretty rapidly.
Awesome. That's all the time we have. Thank you.
Thank you.