Men in the Black

After five years of red ink, Commonwealth Biotechnologies is generating a profit. The VCU professors who founded the R&D outsourcing company now see a blue-sky future.

A new federal law has created a juicy market for laboratory companies that do DNA profiling: $1 billion in contracts over five years to clear up the backlog of DNA crime scene samples and convicted offenders.

Commonwealth Biotechnologies Inc. (CBI), based in Chesterfield County, is one of only eight labs in the country accredited by the National Institute of Justice to do the work. Soon, CBI will be one of only seven accredited labs – because it’s buying the assets of one of the others, Fairfax Identity Labs (FIL), in Northern Virginia.

The acquisition was a neat trick for the three VCU scientists-turned-businessmen--Richard Freer, Robert Harris and Thomas Reynolds--who nurtured and nudged CBI to profitability and $5.5 million in annualized sales over 12 long, sometimes painful years. In one gulp, CBI will swallow about $1.8 million in new revenues. Even better, CBI can accommodate virtually all of FIL’s business in its own labs, allowing it to achieve “considerable” cost savings by shutting down the Fairfax facility. Freer expects the acquisition to have a positive impact on the bottom line beginning early 2005.

Best of all, CBI now is positioned to compete for business from the Combined DNA Index System (CODIS) that enables federal, state and local crime labs to swap DNA profiles electronically. Two key scientists and three marketing specialists from FIL have agreed to join CBI and help pursue the federal business. Says Freer: “We’re pretty pumped about it.”

CBI, which provides a wide range of high-end laboratory services, represents one of the first home-grown biotech success stories in the Greater Richmond region since community leaders targeted the life sciences as a priority for economic development. Virginia Commonwealth University generates roughly $200 million a year in research, most of it in the life sciences, and the Virginia Biotechnology Research Park has attracted a cluster of government, not-for-profit and private-sector clients. What Greater Richmond has still to demonstrate is the capacity to launch successful start-up enterprises.

Commonwealth Biotechnologies is one company that has made it. The R&D firm stands as proof that Greater Richmond has the resources to incubate and grow high value-added life science start-ups, says Gene Winter, senior vice president of the Greater Richmond Partnership, the region’s economic development group. The CBI story also demonstrates, he adds, that “a company can compete for federal government business by parlaying Richmond’s lower cost of doing business and proximity to federal customers in metro Washington.”

CBI has reached a “watershed,” Freer says. After struggling for years--first experiencing the problems typical of a start-up venture, then the loss of pharmaceutical business during the Hillary-care scare of the 1990s, and more recently the collapse of the high-tech bubble and ensuing recession--the company is generating $5 million a year in revenue and has established profitability for three quarters running.

In the life sciences, where companies blink in and out of existence like Christmas lights, profitability confers legitimacy in the eyes of potential customers and partners-–the federal government especially. Says Freer: “You’ve got to be able to convince customers that you’re going to be around in four or five years.”

Positive earnings also change the company’s self image. After years of pinching pennies and growing organically at a respectable but hardly world-beating 10-15 percent per year, management is thinking more audaciously about the future. “We’ve turned the corner,” Freer says. “It’s no longer a question of survival. It’s a question of growth.”

In the space of two months this fall, CBI has closed a series of transactions that suddenly make it a company to watch. First, in September, CBI teamed with Fisher Scientific, the world’s largest lab-supply company, to provide outsourced lab services to Fisher clients. In mid-November, the company refinanced its Industrial Revenue Bond debt, raising cash and eliminating covenants that hindered borrowing. Then, a week later, CBI inked the deal to acquire Fairfax Identity Labs.

It’s been a long, hard slog since four Virginia Commonwealth University professors founded CBI in 1992 as a venture to work on in their spare time. Their idea was to set up a lab, buy specialized equipment and lease it to VCU, other universities and commercial clients who couldn't afford to purchase their own. In 1993, Commonwealth Biotechnologies became the first entity to rent space in the newly formed Biotech Research Park, located very near the medical campus in downtown Richmond. “Over the next two to three years,” says Freer, “we worked nights and weekends.”

Eventually, it became obvious to Freer and his partners that they couldn’t juggle two jobs indefinitely. The good news was that, with backing from Virginia ’s Center for Innovative Technology, the business was growing, bringing on new clients and developing new research-related services. The bad news was that the partners were stretched too thin. “It became obvious to all of us that we’d have to finance it appropriately or bag it.”

One of the four original partners chose to remain with VCU. Freer and two others made the leap into the private sector. Harris took the role of president and CEO, taking charge of company financials and protein technologies. Thomas Reynolds assumed the title of Executive Vice President overseeing DNA-related services and research. And Freer became chairman, picking up, as he says, “whatever was left over” – business development, IT, regulatory compliance and communications.

With the help of a local brokerage firm, Anderson & Strudwick, Commonwealth Biotechnologies raised $3 million in June 1997 through a private placement, and then, that October, another $6 million in an initial public offering. Technology offerings are a rarity in Richmond, but Mack Downs, the Anderson & Strudwick financier who led the project was impressed by the management team. “A group of MCV (Medical College of Virginia) professors took a chance and left their very secure, tenured positions to pursue a dream. When you have a group of highly educated people like that … you really need to take a look at them.”

Also, Downs notes, CBI wasn’t a stereotypical biotech company. It’s not as if the company were spending millions in a long-shot bet that it could develop a drug and take it to market. It was a contract laboratory--a service company, really—with a history until then of profitability. “We felt we’d be missing a real opportunity if we didn’t invest in them.”

Flush with cash, CBI moved to consolidate its growing operations, which by then were scattered across three buildings downtown. Issuing industrial revenue bonds, the company built a state-of-the-art laboratory in Chesterfield County. Designing the 32,000-square-foot facility from the ground up with physical security and bio-safety in mind, CBI obtained crucial certifications that allowed it to vie for coveted government contracts.

The Center for Disease Control registration, for instance, requires the building to be locked down 24/7 with controls over who enters the building and even who is permitted into certain labs. Employees are registered with the CDC, the USDA and the FBI. As an added layer of protection, cameras and listening devices monitor activity throughout the building, while a central computer records every movement. If a vial of "sensitive material" shows up missing, there won’t be a lot of guessing who had access to it. Says Freer: “We have a complete understanding of who’s going where in the building.”

CBI also abides by Food and Drug Administration “good laboratory practices” and it’s upgrading to “good manufacturing practices” involving the testing of bio-products for sterility and bacterial contamination. The purpose is to prevent the kind of problem that occurred at Chiron, the British flu vaccine manufacturer, when accidental contamination rendered much of its product unusable. Compliance entails bookkeeping and red tape, Freer says, but it opens up a lot of business with government and the pharmaceutical industry--clients with zero tolerance for error.

Another competitive advantage, says Freer, is CBI’s project management capability. “We assign a senior scientist to every project. They're a single point of contact. The client has only one phone call to make to get their information.” The 40 employees of the firm include 10 with Ph.Ds and 13 with M.S. degrees. Everyone else holds a B.S. degree. Says Freer: “They know their stuff.”

Freer estimates the market for out-sourced biotech R&D services to be in the “billions” of dollars. Outsourcing saves government agencies, pharmaceutical companies and other clients the expense of buying equipment, maintaining the facilities and hiring staff. CBI turns over the data, assigns any intellectual property to the client and signs confidentiality agreements. “We’re rent-a-chemist,” he quips. “We’re just like the plumber. We install your toilet--but don’t claim to own it.”

For years sales grew through word of mouth and bidding on government contracts, but CBI has developed strategic partnerships that should pick up the pace. One partner, DynPort Vaccine Company, of Frederick, Md., develops vaccines to protect the U.S. military and homeland against bio-warfare agents. Drawing on CBI to conduct much of its lab work, the company studies the biology of killers from well-known scourges like the bubonic plague, botulism and anthrax to such arcane organisms as the debilitating Venezuelan equine encephalitis.

Dishing off work to subcontractors like CBI helps DynPort work through backlogs in critical work, says Robert House, vice president of science. “We pick the best contractors with expertise in various areas. It eliminates bottlenecks.”

Commonwealth Biotechnologies, says House, has a breadth of experience in microbiology and molecular biology. The company offers high quality testing programs, and it’s willing to abide by highly restrictive federal safety and security regulations. “They are exceptionally responsive and anxious to do this type of work.”

For the past few years, bio-terror and other government contracts accounted for 50 percent to 60 percent of the CBI’s business. Freer would like diversify revenue streams. That’s why the partnership with Fisher Scientific is so important—it will help make inroads in the commercial marketplace. Under the agreement, the Pittsburgh-based Fisher, a global provider of equipment, supplies and services to scientific laboratories, will re-sell CBI’s contract R&D services.

“We’ve given the Fisher people a mantra,” Freer says. “If their customers come with us, they’ll get quality work, delivered on time and on budget.” It will take a while for the partnership to generate much business, he concedes. Fisher’s sales people will require considerable training about CBI’s capabilities before they can begin selling. But that’s OK, he adds. He’s counting on sales to ramp up slowly so the CBI organization can keep pace with new orders.

Then, of course, there’s DNA sequencing. Commonwealth Biotechnologies got into the business early on, back when the company could pick up $60 a pop for running sequencing reactions, typically for paternity tests. DNA sequencing has become a commodity, however, and the price has tumbled to under $20 per test. The acquisition of Fairfax Identity Labs should move the company into a larger and higher-margin market for DNA testing—crime forensics. That acquisition is doubly significant, Freer says, because it gives CBI its first dedicated sales force. While selling DNA testing, the three-person team also can pitch other research services.

Since going public, CBI has burned through $14 million as it struggled against the bust of the technology bubble and the recession that followed. It was difficult building a big enough base of business to support the overhead of the company’s expensive, state-of-the-art facility. The next round of expansion should be more profitable—CBI can handle significant additional business with existing capacity. “It took us longer than anticipated,” Freer says, “but we made it.”

CBI’s location in Greater Richmond is the result of serendipity: The original four partners just happened to be VCU professors. There is no intrinsic reason why the company has to be located where it is.

But Freer credits state and regional authorities for helping the company along the way. Finding lab space at the Virginia Biotechnology Research Park helped the company get off the ground. Virginia’s Center for Innovative Technology provided early seed capital. Chesterfield County supported low-interest IDA bonds to finance construction of CBI’s state-of-the-art facility. The company has drawn extensively upon local universities—VCU primarily, but also Virginia Tech and James Madison University --to hire employees trained in biotech disciplines. And, despite the conventional wisdom that technology companies can’t raise local equity investment, CBI has managed to raise a total of $12 million in three separate equity offerings sold mainly to Richmond-area investors.

Furthermore, says Freer, it turns out that Richmond is a great place to do business with the federal government. Richmond is close enough to Washington, D.C., that it’s convenient for meeting with clients face-to-face. Yet the cost of doing business in Greater Richmond is considerably lower. “It’s not expensive to live here. It’s a good place for families. My wife and I have lived here 30 years and sent three kids to public schools.”

Might CBI have fared better if located in a larger biotech cluster like suburban Maryland or the Research Triangle? Probably not, says Freer. Business costs would have been considerably higher there. Based out of Richmond, he can visit the people he needs to see. And CBI’s deliverable is data—bound up in a research report. “As long as we have e-mail and Fed-Ex,” he says, “it doesn’t matter where our customers are.”

-- December 6, 2004