Biotechnology Business Focused on Charles

Biotechnology Business Focused on Charles River Laboratories

The biotechnology industry is relatively new, but is has been responsible for some of the most important scientific discoveries that have benefited humanity to date. A concomitant to these contributions by the biotechnology community, though, has been the increased use of animals that are bred specifically for this purpose, a practice that has been roundly criticized by animal rights activists and the general public alike in recent years. Despite these criticisms, though, the use of animals in scientific experimentation is a highly regulated practice, but even these safeguards fall far short of providing any ultimate protections for laboratory animals and calls for an end to the practice continue today. Nevertheless, laboratory animals are big business and the industry continues to expand in response to increased demand from the scientific community. One company that has enjoyed a successful run by providing these products is Charles River Laboratories, a Massachusetts-based company that was founded in 1947 and now competes on a global basis. This paper provides an overview of Charles River Laboratories and the industry in which it competes; current science challenges facing the company; economic and industry concerns; financial, marketing and ethical considerations; relevant regulatory issues involved the use of laboratory animals; and, legal and strategic planning issues. A recap of the company's current management and leadership cadre is followed by a discussion of challenges in its consulting and staffing services. A summary of the research and salient findings are presented in the conclusion.

Review and Analysis

Company Overview.

The Market Guide profile for Charles River Laboratories International, Inc. reports that, together with its subsidiaries, the company provides solutions that advance the drug discovery and development process, including research models and associated services, and outsourced preclinical services worldwide. Charles River Laboratories, Inc. (hereinafter alternatively "the company" or "Charles River"), operates in two segments as shown in Table 1 below:

Table 1.

Charles River Laboratories' current business segments.

Segment

Description

Research Models and Services (RMS)

This segment involves in the production and sale of research models, principally genetically and virally defined purpose-bred rats, mice, and other rodents for use by researchers to pharmaceutical and biotechnology companies, government agencies, and hospitals and academic institutions. This business segment also offers research model services, including transgenic, laboratory, consulting and staffing, and preconditioning services. In addition, RMS offers vaccine support and in vitro technology products for testing of medical devices and injectable drugs. The RMS segment accounted for almost half (48.7%) of the company's net sales in 2006, which includes sales of research models, transgenic services, laboratory services, preconditioning services, consulting and staffing services, vaccine support and in vitro technology (primarily endotoxin testing). Net sales for this segment increased 2.4% compared to 2005, due to increased research model production and in vitro sales, partially offset by lower large model and transgenic sales as well as reduced spending by certain of our large pharmaceutical customers. Unfavorable foreign currency translation decreased the net sales gain by 0.4%. The company experienced declines in both the RMS gross margin and operating margin, (to 41.6% from 42.8%, and to 28.7% from 31.8%, respectively), due primarily to the impact of stock option expense and the impact of lower large model and transgenic sales.

Preclinical Services (PCS)

This business segment engages in the discovery and development of new drugs, devices, and therapies. It offers toxicology studies; pathology services; bioanalysis, pharmacokinetics, and drug metabolism services; discovery support; biopharmaceuticals services; and clinical services, including Phase I trials in healthy normal and special populations.

Source:

Charles River Laboratories, 2007 & Form 10-K, 2007.

Charles River Laboratories was established in 1947 and is currently headquartered in Wilmington, Massachusetts (Charles River Laboratories, 2007).

According to the company's most recent (February 27, 2007) annual report, Charles River Laboratories is a leading global provider of solutions that advance the drug discovery and development process, including research models and associated services and outsourced preclinical services, which include Phase I clinical services. Further, the company partners with global pharmaceutical companies, a wide range of biotechnology companies, as well as government agencies, leading hospitals and academic institutions throughout the world in order to bring drugs to market faster and more efficiently (Form 10-K, 2007).

The annual report also notes that Charles River offers a:

wide array of tools and services enables our customers to reduce costs, increase speed and enhance their productivity and effectiveness in drug discovery and development. We currently operate over 80 facilities in 15 countries worldwide. We have been in business for 60 years. We have built upon our core competency of laboratory animal medicine and science (research model technologies) to develop a diverse and growing portfolio of services which address drug discovery and development in the preclinical arena, including Phase I clinical studies (Form 10-K, 2007, p. 2).

Science Challenges.

In spite of its fairly recent origins, there have been a number of important and valuable discoveries made in the field of biotechnology in recent years that have fueled demand for the company's products (Demaine & Fellmeth, 2002). Indeed, an analysis of the peer-reviewed literature for "Charles River Laboratories" showed dozens and dozens of scientific studies that use the company's products for their experimentation (pers. obs.). By any measure, scientific experimentation in any setting is a veritable crapshoot, and the product line being marketed by the company does not stand much of a chance of surviving the rigors of their intended use whatever it might be. Therefore, because of the nature of the industry in which it competes, Charles River is on some shaky ethical ground when it comes to justifying how its animals are bred and for what scientific purposes they are intended. In this regard, Donnelly (1990) emphasizes that, "Several ethical dilemmas arising from the very nature and limitations of science are inescapable. For example, it has been forcibly argued that animal experimentation leads to important theoretical and practical results, benefiting both humans and animals. But it is also undeniable that many experiments lead nowhere, despite the animal suffering and loss of life" (emphasis added) (p. 8). Therefore, in the final analysis, Charles River Laboratories competes in a legitimate industry that makes substantive contributions to the scientific community in a process that has been shown time and again to have proven benefits for humanity. Until and unless viable alternatives to the practice are identified in the future, perhaps through further innovations in computer modeling applications that can mimic or even replace animals in scientific experimentation, it is reasonable to assume that the ethical considerations involved notwithstanding, the company will continue to enjoy the same success that it has enjoyed to date.

Economic and Industry Concerns.

According to Davies, Hobday and Prencipe (2003), "Biotechnology is a new industry compared with the PC industry. It may never have as wide a spectrum of specialist enterprises. Nevertheless, the biotech industry of Massachusetts has a number of features of an open-systems geographical cluster" (p. 215). These attributes of the company's current headquarters are described further in Table 2 below.

Table 2.

Attributes of Charles River Laboratories' current geographic location.

Attribute

Description

Massachusetts companies are represented in all of the diverse collection of interrelated product-application segments that make up the biotech industry

These include medical therapeutics, human diagnostics, genomics, medical devices, agribusiness, scientific equipment supplies, scientific services, and others; many of these firms predate the revolution in science that established modern biotech.

Massachusetts is home to previously existing specialist companies that have redefined their mission to capture opportunities from biotechnology

Many of the companies that are members of the Massachusetts Biotechnology Council were established long before the biotechnology industry appeared (2000); examples include: Advanced Instruments (1955), Corning (1904), Honeywell (1904), Harvard Apparatus (1904), Instrumentation Laboratory (1959), Micro Video Instruments (1964), Orion Research (1964), Osmonics (1969), VWR Scientific Products (1854), Abt Associates (1965), and Charles River Laboratories (1946).

The region in which the company is situated is characterized by a rapid turnover of firms, both entering and exiting.

This trend has facilitated the conversion of new technologies into viable product applications.

Massachusetts has a unique collection of specialist 'tools' companies.

Many of the tools revolutionizing the pharmaceutical discovery and development process -- genomics, bioinformatics, and combinatorial chemistry -- have been invented and continue to flourish in this region"; further, "It is no wonder that a number of the world's major pharmaceutical companies have chosen to locate research and development facilities in the Boston area" (p. 215).

Source: Davies et al., 2003, p. 215.

Financial Considerations.

The company continues to enjoy healthy returns on investment and is outperforming or maintaining pace with its major competitors today. A recapitulation of salient financial metrics and performance indicators is provided in Table 3 and Figure 1 below.

Table 3.

Direct Competitor Comparison.

Category

CRL

DGEN.PK

PRXL

Pvt1

Industry

Market Cap:

3.19B

14.44M

1.10B

Employees:

Qtrly Rev Growth (yoy):

5.20%

24.90%

10.90%

Revenue (ttm):

1.06B

2.40B1

10.91M

Gross Margin (ttm):

39.07%

27.53%

97.21%

EBITDA (ttm):

87.56M

16.62M

Oper Margins (ttm):

17.78%

6.09%

Net Income (ttm):

35.28M

600.00K1

18.59M

EPS (ttm):

P/E (ttm):

PEG (5 yr expected):

P/S (ttm):

DGEN.PK = Deltagen Inc.

PRXL = Parexel International Corp.

Pvt1 = Quintiles Transnational Corp. (privately held)

Industry = Biotechnology

As of 2005

Source: Yahoo! Finance, April 29, 2007.

Figure 1. Financial Performance: Charles River Laboratories vs. Deltagen Inc. And Parexel International Corp. - January 2002 to date.

Source: Yahoo! Finance, April 29, 2007.

Operating income for 2006 was reported by the company to be $188.2 million compared to $184.7 million for 2005 and its operating margin for 2006 was 17.8% compared to 18.6% for 2005 (Form 10-K, 2007). The company's 2006 operating margin rate was adversely affected by a $11.7 million (1.1%) charge due to the additional costs associated with expensing stock options; however, the negative impact was partially offset by improved margins in the company's PCS business segment (Form 10-K, 2007). Finally, the company's net income from continuing operations in 2006 was $125.2 million compared with $145.8 million in 2005; the company's diluted earnings per share from continuing operations for 2006 were $1.79 compared to $2.02 in 2005 (Form 10-K, 2007).

Marketing Considerations.

The company keeps a close eye on what its customers want and how best to deliver on that need through various initiatives intended to streamline its supply chain management function and to improve the marketability of its products. For example, throughout 2006, the company's sales growth was fueled by spending by major pharmaceuticals, biotechnology companies and academic institutions on Charles River' global line of products and services, which supported the company's development and marketing of new drugs and products (Form 10-K, 2007). The company's marketing initiatives have been heavily influenced by careful attention to what their customers are using their products for, and what steps the company can take to facilitate their production and delivery. In this regard, Charles River' latest annual report emphasizes that, "This growth in revenues was partially offset by customer focus on cost-savings. Future dRiver for our business as a whole are primarily expected to emerge from our customers' continued growing demand for drug discovery and development services, including increased strategic focus on outsourcing which should drive future sales of services" (Form 10-K, 2007, p. 4).

Likewise, in 2006, the company began construction to expand the capacity of its Northern California production facility to meet the increasing demand of its West Coast customers for models, preconditioning services and value-added model characterization services for their drug discovery and development efforts. To this end, the company's latest annual report notes that, "We expect to begin production in approximately one-half of this addition in the second quarter of 2007. Preconditioning services presents a significant opportunity for future growth, therefore, we intend to dedicate space at our major breeding facilities over the next few years to support our customers' expected increased use of outsourced preconditioning services" (Form 10-K, 2007, p. 5).

Ethical Considerations.

Many people become uneasy or even violent in their reactions to the use of animals in research, and the ethical considerations involved in these settings frequently become lost amid heated and emotional rhetoric that fails to take into account all of the salient factors involved. For example, in her essay, "Policy Issues in the Use of Animals in Research, Testing and Education," Orlans (1990) reports that, "Public policy about the use of animals in research in the United States acknowledges that animal experimentation is a needed part of science and that it must be conducted in accord with certain humane standards. National policies require registration and inspection of facilities, compliance with specified husbandry standards, and efforts to minimize animal pain, among other provisions" (p. 25). This author suggests that insufficient attention has been given to the ethical justification of research protocols involving animals, including standards to distinguish between acceptable and unacceptable animal experiments: "The degree of public concern over questionable or unjustified experiments suggests that public policy should more thoroughly address attention to justification standards" (Orlans, 1990, p. 25).

These ethical justification standards would likely relate to the purpose for which the research was being conducted. According to this author, biomedical research is used primarily for two fundamental purposes: (a) to add to scientific understanding of basic biological functions, processes, and behavior (basic research), or (b) to improve human or animal health by studying the natural history of disease, its pathophysiology and prevention, and by developing diagnostic and therapeutic methods (applied research) (Orlans, 1990). "These are important and worthy goals," Orlans adds, and suggests that, "Public attitudes are such that, compared with other uses of animals, the use of animals for research (both basic and applied) would be granted the greatest sanction. Presumably, the public would tolerate a greater degree of animal pain for the purpose of research than for either testing or for education" (emphasis added) (Orlans, 1990, p. 26).

This point is also made by Donnelley (1990), who suggests that, "At the heart of the wide-ranging and seemingly unending controversy over the use of animals in biomedical science, whether in basic or applied research, toxicity testing, drug production, or education, is one burning question: Are we humans ethically justified in such a use of animals, in general and in particular cases?" (p. 8). In this regard, Donnelly suggests that the bottom-line ethical issue involved in the company's industry is, "How we individually or collectively answer this question no doubt finally depends on our moral worldview, including the judgment of the relative moral status of human beings and animals" (p. 8).

In reality, though, even the most ardent critics of the use of animals in laboratory testing protocols have undoubtedly benefited from the practice at some point in their lives through inoculations and vaccines that would not have been possible without the use of animals for experimentation purposes, and the ethical issues involved become even muddier when the relative importance of humanity compared to that of the animals used for such testing are weighed. It is also likely that this relative weight would tend to shift according to how closely affected the critics are by the diseases that continue to plague mankind; for example, critics of the use of animals in laboratory testing for a specific disease might well reconsider their position in they themselves or their children were afflicted by the disease. As noted above, unless and until viable alternatives are identified, the ethical considerations involved in the use of animals for scientific experimentation will likely be far outweighed by their continuing contribution to the body of scientific knowledge that stands to benefit humans and animals alike in the long-term. From a broader perspective, though, Demaine and Fellmeth (2002) suggest that that long-term implications for the industry in which the company competes will be dictated by how the U.S. government decides legal questions concerning the patentability of preexisting genes and other biochemical products. According to these authors:

The ownership of preexisting genes and other biochemicals raises important questions about the scope and purpose of the patent law -- what it is designed to accomplish and how biotechnology fits within that design. More fundamentally, whether patent law is properly applied to products not independently created by a patent applicant implicates questions about the limits of intellectual property ownership, policy decisions about whether natural substances and processes should reside in the public or private sphere, choices about the value placed upon publicly available knowledge, and the microeconomic effects of limiting patents to some kinds of biotechnological innovations while excluding patents on others. (Demaine and Fellmeth, 2002, p. 303)

Therefore, to the extent that continues interest in the use of laboratory animals is fueled by the availability of patents for the end results of the scientific experiments in which they are used will be the extent to which there will continue to be increasing demand for Charles River Laboratories' products in the future.

Regulatory Issues.

As noted above, Charles River Laboratories is a leading global provider of live laboratory animals that focuses on the commercial breeding of guinea pigs and other rodents for scientific research (Wallace & Washburn, 1999; Carbone, 2004). Therefore, and not surprisingly, the company is subject to a wide range of U.S. federal regulatory guidance that stipulates how they must care for the animals in their charge and what steps must be followed during the breeding, maintenance and delivery processes. As a result, the company stresses the importance of its delivery methods, and regularly measures their corporate performance through customer satisfaction surveys. As Gil Slater, the company's vice president of customer relations function states:

Since live product is being transported, delivery is very important to our clients, but we discovered that in our business the method of delivery is actually more important than the date of delivery. We had traditionally used a combination of company-owned trucks supplemented by outside air freight. Customers expressed their very strong preference for delivery in our own vehicles. They were apparently concerned about the possible stress which test animals might go through at high altitudes where they thought lower temperatures could reduce resistance to disease. We responded by extending truck routes into new areas. Concurrently, our sales force promoted this as a specific benefit to current and potential customers...one which would assure quality control. It not only improved our satisfaction scores among customers, it attracted new ones and generated an increase in business. By continuing the survey process annually, we can determine the hierarchical listing of features and benefits. So we really know what is important to our customers and can focus on selling and providing what they really want, not what we think they want (emphasis added). (quoted in Wallace & Washburn, 1999 at p. 162)

Notwithstanding this bit of corporate (and misguided) hyperbole, though, the company has also come under increasing attack from animal rights advocates that loudly complain about the company's use of animals in its product testing regimens. In this regard, one such prominent advocacy organization today, the Animal Liberation Front (ALF), became the focus of worldwide attention when it attacked Charles River Laboratories' facilities in 1972: "In 1972, Ronald Lee and Clifford Goodman started a group known as the Band of Mercy, which began direct attacks on hunters in England. The new name, Animal Liberation Front, emerged in 1976 with the first attack on the Charles River Laboratories where vehicles were damaged" (Guither, 1998, p. 153). Since that time, the ALF has claimed credit for approximately 60% of the total incidents documented by the U.S. Department of Justice (Guither, 1998). The company also complies with the Animal Welfare Act, but has sought changes favorable to its operations in terms of cage sizes required and what types of enclosures are most appropriate (Carbone, 2004). According to Carbone (2004), "The Animal Welfare Act is imposed upon scientific research from the outside, a congressional law heavily influenced by lobbying of animal protectionists (and by resistance of research advocates, to be sure)" (p. 13).

As noted above, because of the nature of the industry in which it competes, Charles River is subject to numerous national and international regulatory agencies, including the U.S. Department of Agriculture (USDA), the Occupational Safety & Hazards Administration (OSHA) that publishes a guide for the care and use of lab animals, the American Association for Laboratory Animal Science (AALAS), the Association for Assessment and Accreditation of Laboratory Animal Care International (AAALAC), the U.S. Food & Drug Administration (FDA), the Animal Welfare Act, and the Public Health Service that provide specific guidance concerning how animals are to be treated, with some exceptions and some overlap in coverage. For example, the U.S. Animal Welfare Act, enacted in 1966, has been amended several times since (Nussbaum & Sunstein, 2004). These authorities report that, "The Animal Welfare Act is a comprehensive federal protection of animals in captivity. On the cost side, the practical impediments to defining and enforcing animal rights require particular emphasis" (Nussbaum & Sunstein, 2004, p. 71).

According Orlans, "The Animal Welfare Act requires registration and federal inspection of facilities where non-human primates, dogs, cats, guinea pigs, hamsters, rabbits, and other warm-blooded animals except rats and mice are used for experimentation" (p. 25). The exclusion of rats and mice, though, means that approximately 90% of laboratory animals are not covered by the provisions of the Animal Welfare Act in contrast to Public Health Service (PHS) policy; the Act applies to a number of research institutions, both academic and commercial, but a few are exempt because they use only excluded species (Orlans, 1990). Furthermore, the exclusion of rats and mice effectively exempts most testing and many educational facilities (Orlans, 1990).

Legal Issues.

According to Charles River' latest annual report, "We are a worldwide business and operate in various tax jurisdictions where tax laws and tax rates are subject to change given the political and economic climate in these countries" (Form 10-K, 2007, p. 5). In addition, the company reported a pension liability of $49.6 million as of December 30, 2006. The company's latest annual report notes that, "The actuarial computations require the use of assumptions to estimate the total benefits ultimately payable to employees and allocate this cost to the service periods. The key assumptions include the discount rate, the expected return on plan assets and expected future rate of salary increases. In addition, these actuaries determine the expense or liability of the plan using other assumptions for future experiences such as withdrawal and mortality rate" (p. 5). The primary assumptions that were used to calculate the above pension costs were determined and reviewed by management each year following collaboration with outside investment consultants and actuaries; the assumed discount rate is intended to be the actual rate at which benefits could effectively be settled and is adjusted based on the change in the long-term bond yield as of the measurement date (Form 10-K, 2007). The annual report concludes that as of December 30, 2006 the weighted average discount rate for the company's pension plans was 4.95% (Form 10-K, 2007).

Strategic Planning Issues.

The company's latest annual report also features a number of references to how the company's is prosecuting is strategic planning function. For example, the company reports that it is continuing its capacity expansion program to position Charles River to take advantage of these long-term opportunities. "In 2006 we began major construction at our preclinical sites in Massachusetts and Nevada, which are planned to open in early and mid-2007, respectively. Other significant projects include expanding our California RMS capabilities, building of a facility in Maryland which will support the National Cancer Institute (NCI) contract we were awarded in late 2006 as well as additional RMS capacity, and additional Preclinical capacity in Ohio and Scotland" (p. 4).

The company's capital expenditures of over $180 million in 2006, and its planned capital expenditures in the range of $200 million to $225 million in 2007, reflect its ongoing commitment to this strategy (Form 10-K, 2007). Furthermore, beyond its internally generated organic growth, the company's business strategic initiatives today include various "bolt-on" acquisitions that complement their current business and increase the rate of its growth, as reflected in their acquisition in late 2006 of Northwest Kinetics, a Phase I clinical services business, to augment its existing European Phase I clinic in Edinburgh, Scotland (Form 10-K, 2007, p. 4). This initiative follows the company's 2004 acquisition of a former Scottish competitor, the drug testing group Inveresk, for more than pounds 800 million (Animal test firm in buyout, 2004).