Operator:

Ladies and gentlemen, thank you for standing by, and welcome to Charles River Laboratories Second Quarter 2024 Earnings Conference Call. Just a reminder, this call is being recorded. At this time, all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Mr. Todd Spencer, Vice President, Investor Relations. Mr. Spencer, please go ahead, sir.

Jim Foster:

Good morning. I will begin by providing highlights of our second quarter performance and revised guidance. We reported revenue of $1.03 billion in the second quarter of 2024, a 3.2% decline on both the reported and organic basis over last year. The top line performance was in line with our outlook as organic revenue growth in the Manufacturing segment was more than offset by DSA and RMS revenue declines. By client segment, we continued to experience lower revenue from small and midsized biotech clients in the second quarter, while revenue from global biopharmaceutical clients increased modestly. I'll provide more details on the evolving trends within these 2 client segments shortly. The operating margin was 21.3%, an increase of 90 basis points year-over-year. The increase was principally driven by lower performance-based bonus compensation accruals in the quarter reflecting the reduction in our financial outlook for the second half of the year. On a segment basis, a higher operating margin in the manufacturing segment and lower corporate costs were largely offset by lower margins in RMS and the DSA segments. These lower accruals were the largest contributor to the earnings outperformance in the second quarter. Earnings per share of $2.80 increased 4.1% year-over-year and exceeded the implied outlook in our prior guidance by approximately $0.40. We are significantly reducing our financial guidance for the year because forward-looking DSA trend data suggests that demand will not improve during the second half of the year as we had previously anticipated, and, in fact, will decline for global biopharmaceutical clients. As a result, we are reducing our revenue outlook to a 3% to 5% decline on an organic basis this year, and non-GAAP earnings per share is now expected to be in a range of $9.90 to $10.20. We intend to partially offset the headwinds through aggressive actions to streamline our cost structure, optimize our global footprint and drive greater operating efficiency, which will enable us to limit the bottom line impact going forward. We believe taking these actions will also enable us to emerge from this period of softer demand as a stronger and leaner organization and better positioned to capture new business opportunities. Before I discuss the second quarter business segment performance, I will provide more details on these end market demand trends as well as the actions we are taking to manage through the current environment. Our financial performance to date, including a low single-digit organic revenue decline in the first half, has been largely in line with our initial outlook. However, the lack of a recovery in demand for our biotechnology clients as well as recently emerging and softening demand trends in our global biopharmaceutical client base have caused us to take a much more negative view of our growth prospects for the second half of the year. Because of this, the second half revenue growth that we previously anticipated will not materialize. And in fact, demand is expected to continue to soften for global biopharmaceutical clients in the near term. These trends for our broader biopharmaceutical client base are expected to lead to a low to mid-single-digit organic revenue decline in the second half of the year on a consolidated basis. As you are aware, most global biopharmaceutical companies have announced major restructuring programs likely precipitated by the IRA or pending patent expirations or both. And this has undoubtedly led to tighter budgets and additional pipeline reprioritization activities this year. Revenue for this client base continued to increase in the second quarter. However, proposal activity and bookings began to notably decline and diverge from biotech clients during the second quarter. We now expect demand for global biopharmaceutical clients to further deteriorate over the remainder of the year. We anticipate these trends are also likely to impact the DSA growth rate into 2025, so we are working now to reset our cost base to both withstand the pressures on our bottom line and to better position the company to when demand cycles back. Large biopharmaceutical companies are currently focused on resetting their budgets to create leaner cost structures. We expect these actions and the resulting softening of our demand KPIs will continue to cause a period of slower spending by large pharma on their early-stage drug development activities, particularly because they are more focused on their clinical pipelines at this time. We believe that these clients continue to view strategic outsourcing as a compelling solution to improve their cost efficiency and speed to market, presenting a longer-term opportunity for us once they inevitably refocus on their preclinical pipelines. In contrast to large pharma, demand KPIs for small and midsized biotech clients have stabilized and trended somewhat more favorably through the first half, reflecting the solid funding environment and favorable sentiment around interest rates. Biotech companies are our largest client base at approximately 40% of total revenue, and more than half of DSA revenue. And DSA proposals and net bookings have improved to this client base this year. We experienced an improvement in biotech booking activity in the second quarter as the higher proposal levels that we commented on last quarter have begun to translate into new business wins. While we are cautiously optimistic that these trends will lead to a future demand recovery in our biotech client base, they're also not sufficient to support the DSA revenue improvement in the second half of the year than we previously anticipated, and therefore, we do not expect revenue to biotech clients to improve from first half levels. We are laser-focused on initiatives to generate more revenue, contain costs and protect shareholder value. As I discussed earlier this year, we have already begun to enhance our commercial efforts. We are focused on optimizing our sales force to accelerate revenue growth by adjusting go-to-market strategies and being a flexible partner for our clients, focusing on selling across the entire portfolio and leveraging technology to enhance sales insights and identify selling opportunities earlier. Our digital strategy is also helping us to better connect with our clients including through our Apollo cloud-based platform to provide real-time access to scientific data and self-service tools for clients. To drive additional savings and preserve the bottom line, we will continue to aggressively manage our cost structure to ensure that capacity and head count are aligned with the current softer demand environment. We have already consolidated several smaller sites and reduced staffing levels. These recent actions and additional actions that will be implemented by the end of the third quarter are expected to generate over $150 million of annualized cost savings, which will be fully realized in 2025. We are also finalizing our EA strategy, focusing on further optimizing our global footprint, driving greater operating efficiency and leveraging our digital platform and global business services to further streamline processes. We expect to implement the initial phases of this plan before the end of this year, and we'll provide a more comprehensive update in November, including the incremental savings that these initiatives will deliver. As referenced in this morning's earnings release, we will also reinstate a stock repurchase program, and our Board recently approved a new stock repurchase authorization totaling $1 billion. We intend to reinstate stock repurchase activity before the end of the third quarter. Flavia will provide more details on this topic as well as an update on our capital priorities. I'd now like to provide you with additional details on our second quarter segment performance, beginning with the DSA segment's results. DSA revenue in the second quarter was $627.4 million, a decrease of 5% on an organic basis, driven by lower revenue in both the Discovery Services and Safety Assessment businesses. In the safety assessment business, lower steady volume was partially offset by a small benefit from price increases. The overall business trends were relatively consistent with those that we have discussed in recent quarters with the exception of diverging demand trends between our global biopharmaceutical client base and small and mid-tier biotechs. As mentioned earlier, we are beginning to see improvements in proposals and booking activity for biotech clients, but is meaningfully slowing for global biopharma clients. The combined effect has resulted in a net book-to-bill ratio that was similar to the last 5 quarters, but below 1 times in the second quarter. Gross bookings also remained above 1 times in the second quarter. And the cancellation rate was consistent with first quarter levels, which was below its peak, but still not back to targeted levels. As a result of these trends, the DSA backlog decreased on a sequential basis to $2.16 billion at the end of the second quarter from $2.35 billion at the end of the first quarter. Since we do not expect these trends to improve during the second half of the year, as previously anticipated, and because we will likely be impacted by incremental spending pressures from our global biopharmaceutical client base, we have reduced our DSA revenue outlook to a high single-digit organic decline for the full year. In the near term, we will ensure that our capacity both space and staffing are aligned with this lower expected level of demand. Looking beyond that, we will continue to speak with our clients and closely monitor for indications that clients are beginning to return their focus to their IND-enabling programs versus their recent focus on post-IND studies and for demand trends to stabilize or begin to improve across both the global and mid-tier client bases. The DSA operating margin was 27.1% in the second quarter, a 50 basis point decrease from the second quarter of 2023. The year-over-year decline reflected the impact of lower sales volume and moderated pricing, particularly in the Discovery Services business. The operating margin improved from the first quarter level, which was commensurate with sales volume, lower bonus accruals and additional cost savings generated by our restructuring efforts. RMS revenue was $206.4 million, a decrease of 3.9% on an organic basis over the second quarter of 2023. The RMS revenue decline was primarily driven by lower NHP revenue. As we mentioned last quarter, we expected the timing of NHP shipments to be a meaningful headwind to the second quarter RMS growth rate. Excluding the NHP impact, RMS revenue was essentially flat year-over-year as higher sales of small research models were offset by slightly lower revenue for research model services. For the full year, we believe the market environment will remain stable overall. So we are reaffirming our RMS organic revenue growth outlook of flat to low single-digit growth. Revenue for small models continued to increase in all geographies, particularly in China and Europe. The resilience of the research models business reflects the fact that small models are essential low-cost tools for research, which also enhances our ability to continue to realize price increases globally. Our China business has been resilient despite the macroeconomic pressures in the country as the growth rate for small research models have strengthened driven primarily by share gains associated with our geographic expansions within China. Research model services experienced a slight revenue decline in the second quarter in both GEMS and Insourcing Solutions. These trends largely reflect the overall biopharma demand environment. However, the benefits generated by clients that utilize our GEMS and IS solutions can help them overcome their budgetary pressures by driving efficiency. CRADL business model, while not unaffected by the demand environment, continues to resonate with clients who are looking for cost-effective solutions for their vivarium space requirements. There are pockets of softer demand, particularly in South San Francisco that have led to the consolidation of our CRADL capacity there. However, other biohubs continue to perform well. In the second quarter, the RMS operating margin decreased by 330 basis points to 23.1%. The decline was primarily a result of the lower NHP revenue. The timing of NHP shipments from both Noveprim and in China can lead to quarterly revenue fluctuations. And since the sales of these large models are quite profitable, the timing of shipments can have a meaningful impact on the RMS margins on a quarterly basis. However, our view for the year hasn't changed and both the RMS and manufacturing segments are expected to deliver operating margin expansion in 2024. Revenue for the Manufacturing Solutions segment was $192.3 million, an increase of 3.7% on an organic basis compared to the second quarter of last year. Each of the segment's businesses contributed to the revenue growth. As anticipated, the manufacturing growth rate was lower than the first quarter level because of a more challenging prior year comparison for the CDMO business. You may recall that we anniversaried the recovery of the CDMO business in the second quarter of last year. We expect the CDMO growth rate to reaccelerate in the second half of the year based on the current pipeline of new projects, particularly for cell therapy. As a result, we expect manufacturing organic revenue growth will be in the mid- to high single-digit range, a slight increase from our prior outlook. The competitive landscape is also undergoing a transition in certain manufacturing market sectors due to M&A or proposed geopolitical regulation, both of which should offer new opportunities to demonstrate the synergies of our comprehensive testing portfolio and win new business. The CDMO business continues to perform well and client interest remains strong. The third client who utilizes our viral vector center of excellence in Maryland received commercial approval last month, and we are also regularly adding new projects across the various phases of clinical development. Booking activity continues to improve, and the CDMO business remains on track to deliver solid double-digit growth this year. Revenue in our manufacturing quality control testing business, Biologics Testing and Microbial Solutions also continued to grow, rebounding from the more challenging market environment last year. Biologics Testing's performance was driven by its core testing activities, including cell banking and viral clearance. For Microbial Solutions, the primary driver of revenue growth was demand for our Endosafe testing cartridges. Clients have resumed their purchases of reagents and consumables as destocking activity have subsided. The manufacturing segment second quarter operating margin was 26.6%, demonstrated continued improvement with increases of 370 basis points year-over-year to 130 basis points sequentially. The improvement is largely a result of leverage from higher sales volume across each of the segment's businesses. We expect this trend will continue as the segment rebounds from 2023 and also due to the ongoing increase in the scale of our CDMO business. To conclude, it is clear that our clients are in the midst of reassessing their budgets, reprioritizing their pipelines and managing their cost structures. However, our clients will continue to seek life-saving treatments for rare diseases and other unmet medical needs. In order to do so, they will, by necessity, reinvigorate investment in their early-stage R&D programs over time. To emerge as an even stronger partner for our clients, we are working to actively manage our costs, initiate new and innovative ways to transform our business, protect shareholder value and enhance our clients commercial experience to gain additional share. To conclude, I'd like to thank our employees for their exceptional work and commitment and our clients and shareholders for their continued support. Now Flavia will provide additional details on our second quarter financial performance and 2024 guidance.

Todd Spencer:

That concludes our comments. We will now take your questions.

Matt Sykes:

Maybe just on a higher level, just thinking about your commentary about global biopharma it seems that demand really took a bit of a hit post the -- in Q2 and post that. And as you think about that client base and you think about sort of the cost cuts that have been going on, they've been going on for some time now, what kind of rationale can you give for the increased deceleration of that demand? And just given the size and scope of these organizations, do you think it's going to take lot longer for that to come back, just given that it's going to be difficult for them to pivot so quickly?

Matt Sykes:

And then just on DSA and given -- and noting the comments you made on the commercial restructuring and shift in go-to-market, is there a market share issue going on here? Or would you still chuck this up to overall macro pressures?

Operator:

We'll go next now to Eric Coldwell at Baird.

Flavia Pease:

It's Flavia, I'll take that one. It was approximately $20 million in the second quarter or about $0.30. And the second quarter was a true-up for the first half of the year.

Flavia Pease:

You can expect also additional favorability that would come through the second half as we updated guidance for the full year. So we will probably have additional favorability following through.

Flavia Pease:

You're correct. It's mostly DSA and at the corporate level. The other 2 segments, as you pointed out, are performing well and in line with the plan. So the majority of the impact is at corporate and DSA.

Flavia Pease:

Yes. I we're not going to get to that level of specificity. I think, as I said, there will be additional favorability in the second half just because the true-up that we did so far was only for the first half.

Jim Foster:

We feel like we're holding our own, certainly, from a competitive point of view, I would say, across the entire portfolio. Certainly in RMS, both from a product and services point of view. And like for a relatively long time, we've had modest volume declines with meaningful pricing declines across the world. So that will persist. China is quite strong, notwithstanding some of the political issues there. Europe is quite strong. And services have been strong now for -- I don't know how long, Eric, maybe a decade. The GEMS business is a little softer than we would like just because of the slowdown in both client bases, pharma and biotech. But we think that's a critical element in doing basic research. And our CRADL initiative is definitely in times of economic stress, which I think a lot of our clients are in, that's a really good solution for them. So we have a little bit of facility overlap, maybe a little bit too much capacity in some locales, opportunities to have more capacity in other locales. So that business should hold up well. Manufacturing business definitely should hold up well. Definitely, principal amount of pressure is in DSA. But if you just look at the SA portion of that, a lot of drugs were parked or have been parked or will be parked by our clients before INDs were filed. So they have a drug that they like, they have a certain amount of cash to spend and they prioritize, they will get back to those next. And so we're seeing a lot of emphasis on post-IND work that will shift to classic IND work. And then at some point, when they feel that the coffers are stable, will get back to more significant spending in core discovery. But of course, as we all know, there is no future. There is no preclinical. There is no clinical without discovery, so that business should improve as well. Time frame, obviously, is a little bit difficult to call. And we think that will be the last thing. that recovers.

Elizabeth Anderson:

If we think about how you're flowing this through, particularly in DSA, and sort of a mid-single-digit organic revenue decline in the third quarter, what have you seen in sort of the July time frame? Is that sort of stable to how you saw 2Q generally? Would you say things are still getting a little bit worse? I'm just trying to understand how you thought about the sort of flow-through relative to how the quarter progressed?

Elizabeth Anderson:

And Flavia, maybe one clarification question just for you. I know you talked about potentially doing some share repurchase agreement. Is there any share repo built into the new guidance range? Or we should consider that to be separate?

Jim Foster:

So it's not in the numbers.

Operator:

Thank you. We'll go next now to Dave Windley at Jefferies.

Jim Foster:

Let me take a shot at that and then Flavia can jump in as well. As you said, biotech funding has been strong. It was particularly strong in the first quarter. Second quarter was okay. July wasn't great. So I don't think any of us know, Dave, but you may be right that it's cooling off a bit. Having said that, we've had a proliferation of proposals and some improvement in bookings as well. So much of it is psychology, though. So I think our client base is nervous about the consistency of the availability of cash. Obviously, they're going to continue to be conservative. And I think pharma has a lot of work to do in terms of trying to get their infrastructure where they want it to be, given the impending patent cliff. So look, all we can say -- and even though it's a long time, this isn't always, always for us and I think we do this well. We have to get our capacity. And by that, I mean, human capacity and physical capacity, in line with our expectations for growth and demand. We always have to call it, I don't know, 12 to 24 months in advance. So our CapEx investments in growth in a bunch of areas, obviously, will slow down dramatically, has slowed down dramatically and will continue to. Half of our costs -- at least half of our cost is staff. So we've already made some cutbacks and we'll look to do more starting at the end of this year through next year. And we've had some small facility consolidations, and we'll look at perhaps larger ones to see whether those are appropriate. We've done a really good job over the last decade of having capacity really well utilized across all of our businesses. And indeed, as you know, been able to add space without impairing our operating margins. So we, I think, are in the midst of and will continue to scale back both of them commensurate with what the demand is. '25, a little bit tough to call, but as I said a few moments ago, it's hard to believe that the pharma pullbacks won't continue and persist to some portion of next year. If you are right that we're beginning to see a cooling off of biotech, which we try to be careful with calling trends, Dave, because it was actually a pretty good first half of the year. So I don't know what the election will do. I don't know what the wars will do. I don't know what any of those things will do. But assuming that it's stable and doesn't get worse, I do think that biotech work and volume could continue to improve for us just because there's still hundreds of new companies minted every year that don't have any internal capacity and we work with a lot of the VCs and a lot of those portfolio companies. So we need to watch it very carefully. Obviously, we need to call it today. We've called a lot of the savings, $150 million, $100 million of which will hit in this year. We've already called that and have implemented a bunch of it and we'll continue to. And then we will, for sure, do more next year.

Dave Windley:

So then my follow-up around pricing, I believe your commentary is talking about modest positive price impact in 2Q, but expect that to flip negatively. I know Eric kind of got at this -- but I'm wondering -- we've certainly heard and you and I have talked about some fairly aggressive price discounting by your peers. And I'm wondering kind of the balance as you think about where you feel like you have to chase that down versus maybe some of your softness in bookings is just refusing to chase that down. And maybe you could help us to understand the balance there and how you think that plays out and to what extent you've included price pressure in your margin assumptions for DSA in the back half of the year.

Jim Foster:

There's no question, Dave, that our competitors principally use price as the lever. And so we don't like to chase it. We try not to. As we said sort of in the first half of the year, we reduced price pretty sparingly to certainly preserve share and to gain share. I just think it feels like it's going to be more pronounced in the back half of the year given the sort of pretty sudden pullback by big pharma and maybe some concern by our biotech clients about access to capital. So price, which for years became less of an issue and maybe for the last year or so, it's become more of an issue. As Flavia said, should become more pronounced in the back half of the year. We're anticipating that, that's embedded in our guidance.

Patrick Donnelly:

Jim, I guess maybe one for you. Just as you think about some of these headwinds, it sounds like you're suggesting a few of them will linger into '25. I know you kind of said pharma pullbacks, it would be hard to believe that those don't linger into '25. So I guess, when you kind of think high level, which of these headwinds persist for several quarters and where you have visibility into things may be improving, I guess, just when you look at the backlog, cancellation rates, what are the areas of real concern as we head into '25 that you don't expect to improve at least at the start of the year? And where are you feeling maybe okay to start next year?

Patrick Donnelly:

And maybe following up on a few of your points there. I mean, in terms of the softness on the pharma side, are you seeing it -- it sounds like it's more broad-based versus concentrated on just a few customers. And then also in your conversations with customers, are you seeing it more on where you play in the discovery preclinical? Or in your view, is it this broad-based softening kind of across pharma spend?

Operator:

We go next now to Tejas Savant at Morgan Stanley.

Jim Foster:

I mean this is unusual activity for our pharma clients who obviously we've been servicing forever, and that was our principal source of revenue and there's obviously a meaningful source of revenue right now. I think your comments on IRA are accurate except we're surprised that we're hearing more about it lately. So I don't know what sort of restarted that. But almost all the clients have mentioned that. They're mentioning the patent lifts even more. So the notion that they would double down on our R&D to try to offset that, which actually at least on the -- or an early depart makes a lot of sense. Strategically and structurally and organizationally, we just don't see them doing it right now. It's just, as you know, it takes longer to get drugs into the clinic. It takes longer for them to get to market and it costs a lot more. So they just have to work on a smaller number of drugs to offset the impending impact from so many of them, some many of the patents coming off. So feels like unusual activity. It also feels unusually profound and sudden. And as we said, we used the word unexpected because we're really close to these folks and we deal with them every day and we're their service provider, and in many ways, an extension of their own internal facilities. And yet it's not like they said to watch a year ago. I just want to tell you we're going to be -- we're going to emphasize clinical work to the detriment of preclinical so you need to prepare for that, we'll be doing less work with you. So we didn't get that sort of warning or dialogue. I think we're increasingly closer to our clients. We feel that we're sitting on the same side of the table with them. I think a lot of these decisions have been taken relatively recently and probably more to come and haven't been taken yet.

Jim Foster:

I think it's hard to believe that the BIOSECURE ACT won't have a positive benefit to the demand curve for us across lots of what we do, right, biologics, CDMO for sure, some safety, some discovery. I mean it's pretty profound, and there's a lot of Chinese competitors in that space who compete with us principally on price, but have very good scale and our clients have been quite happy with them. And while it's quite clear to us that, that should have a positive benefit, as we said, I think, on our last call or some of the interim conversations we've had at the investor conferences, there's been a very small amount of both conversation and interest and a tiny amount of work that has come with us. So we don't -- we want to be careful not to overstate the potential, although we think there is a potential over time. So we just have to watch and see how it rolls out, see what the ultimate language is, see what the severity is and see whether clients follow. We did say, I think it was on our last call, that we had meetings with a couple of very big venture capital firms with whom we work who said they had, "Instructed their portfolio of companies not to do work in China." And we thought that was an unusually strong inter -- sort of interference with what these portfolio companies do. They didn't say we would prefer you don't use China. They said, we don't want you to. So that gave us an indication that, that might be something that expands. These are VCs that are creating new companies from scratch and the fact that they don't even want to start with China, quite interesting. So it feels like it should have a greater head of steam, doesn't seem to have much right now. A lot of talk about it. So obviously, it's not built into anything that we're saying for this year, and we'll see whether there's any changes post-election on this. And I'll let Flavia take the interest expense question.

Operator:

We'll go next now to Casey Woodring at JPMorgan.

Flavia Pease:

I can take that one, Casey. So -- and I'll separate it a little bit because I'm assuming that your question is more focused on NHP pricing in the DSA business, but I'll also provide some commentary on NHP pricing when we sell it to third parties, which is reflected in the RMS business. So for DSA, NHP pricing was still slightly positive in the second quarter as we, I think, indicated. And it's off from the peak levels of last year, but still positive. It will probably follow the same pattern as overall pricing for the DSA business, so probably modulate to slightly decline in the tail end of this year. Shifting now to the NHP pricing within RMS. Obviously, we have 2 parts of that business, I think, as we have commented since we acquired Noveprim. We have the NHP sales in China for China. And then we have now NHP sales through the Noveprim acquisition. So in China, prices have come down and they have been reflected in our results so far this year, and we'll continue to expect them to be at the levels that we're experiencing them today. And then in the case of Noveprim, prices are stable. They -- these agreements are long-term relationships and we haven't experienced price pressure there this year and do not expect it to happen in the second half of the year.

Flavia Pease:

No problem. I'll take that one as well, Jim. And you're correct, Casey, the cancellations for sort of biotech, small and mid-tier companies, actually was a slight sequential improvement from Q1. So less cancellations. And global has actually picked up between Q1 and Q2. So sequentially, it was a deterioration, more cancellations for global in Q2 and an improvement for mid-tiers as you had guessed.

Luke Sergott:

So I just wanted to talk about the -- I know you guys are taking out costs and aligning the costs with the demand. But as the as that demand starts coming back in DSA, how quickly can you spin up those resources again? And just trying to think about the timing, is it like a quarter ahead given the visibility that you guys have? Or is it kind of it will happen -- have to happen in real time?

Luke Sergott:

And then this goes on, I guess, on tail end of Matt Sykes was asking about the prioritization. I mean, this market has been kind of -- this part of the business has been soft for a while with pharma continuing to rationalize this discovery work and keep those budgets tight. Like how long do you think that they can maintain this tight budgetary environment or continue to cut there without it starting to impact the later-phase work?

Operator:

We'll go next now to Michael Ryskin at Bank of America.

Jim Foster:

I think we're probably already seeing a little bit of a bleed-through, just to use your language, in North America, which has been a bit slower, and of course, that's where all most of biotech resides. Conversely, Europe, which has less biotech and ironically lots of pharma, has been solid. China is still growing really nicely. That's a function of capital going into life sciences. Just the scale of the country and the scale of our operation because we built some new facilities. So we feel pretty good -- we feel pretty good about our guidance there. We've always gotten price in RMS forever. None of our clients produce their own animals and the competition is relatively small. And while the service parts of RMS are a bit slow at the moment, it's still quite substantial. They've got good operating margins. And they are part of the solution for the clients watching the cost structure. So we would imagine that, that work will stabilize as well. So I think as we said, RMS will continue to do its thing. Our guidance is only 0 to low single digits. So we certainly feel quite confident about our ability to deliver that for the 3 or 4 reasons I just gave you.

Max Smock:

I'll keep it to one question as well. I just wanted to follow up on some of the prior questions around market share, given your commentary is a bit out of line with what we heard from one of your competitors last week. I was just hoping you could give some detail around how your win rate in DSA has trended so far in 2024 and whether you've seen that hold up for new proposals more recently or if there's any sort of drop off to call out here?

Flavia Pease:

And Max, if I can just add, I think you alluded to one of our competitors that reported last week, if I saw it correctly, and it's a smaller piece of their business, but the piece that we compete more directly, I think their performance in the quarter was worse than ours. And so I think to Jim's point, we believe this is more of a market dynamic as opposed to a competitive dynamic driving the more negative outlook that we are forecasting.

Operator:

Thank you, Mr. Spencer. Ladies and gentlemen, again, that does conclude today's Charles River Laboratories Second Quarter 2024 Earnings Call. Again, thanks for your participation. You may now disconnect.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories First Quarter 2024 Earnings Conference Call. This call is being recorded. [Operator Instructions]

Todd Spencer:

Good morning, and welcome to Charles River Laboratories First Quarter 2024 Earnings Conference Call and Webcast. This morning, I am joined by Jim Foster, Chair, President and Chief Executive Officer; and Flavia Pease, Executive Vice President and Chief Financial Officer. They will provide comments on our first quarter 2024.

James Foster:

Good morning. I'd like to begin by providing an update on the overall market trends. There has been an increasing focus on market sentiment through the first 4 months of this year from clients, investors and other stakeholders. We still believe that the end market trends for our biopharmaceutical clients remain stable with signs that demand will begin to improve later this year, which is consistent with the outlook that we gave in February. One of these signs is an improvement in biotech funding after 2 years of tempered activity.

Flavia Pease:

Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition-related adjustments, costs related primarily to restructuring actions, gains or losses from certain venture capital and other strategic investments and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, divestitures and foreign currency translation.

Operator:

[Operator Instructions] We'll take our first question from Michael Ryskin with Bank of America Securities.

James Foster:

What was the beginning of the question?

James Foster:

I mean our confidence in the back half of the year ramp is premised on a multiplicity of things. Inflows to the VCs, wonderful funding in the capital markets, fourth best in the history of biotech last quarter, the increase in proposal volume, modest reduction in cancellations and just the general dialogue with our clients, a; b, the comps of last year; and c, the fact that we can see pent-up demand on the part of our clients.

Operator:

And we'll take our next question from Max Smock with William Blair.

James Foster:

So the principal way our competitors compete with Charles River is with regard to price. So competition has prices pretty much across the board, a bit slower than ours. I certainly don't think the workers is good or the science is a substantive or the infrastructure is as significant. But it's a fact. And so in challenging financial times and people are sort of worried about access to capital, I think pricing is more important.

James Foster:

I mean that's one of our volume. I wouldn't say we've been dramatically cutting prices. I would say that we've been cutting prices very modestly, to be more competitive, to have clients that are on the edge, to say that Charles River's science is better. I want to work with that. But I need better price and are concerned about access to capital. So as I said, we feel that we're doing it responsive, responsibly and thoughtfully.

Operator:

We'll take our next question from Dave Windley with Jefferies.

Flavia Pease:

Yes, Dave, what I would say is price is definitely not going to be as much of a tailwind as it had been in the past few years. And I think we are, as Jim said, appropriately, pricing given the market conditions and the domain environment. In our guidance for the year, we still contemplate positive pricing. And at the top end of our guidance, we are also contemplating some flat to slightly up volume. And so I think what will be critical in the margin impact is seeing that rebound in volume as Jim said, the strength in biotech funding starts translating into not only proposals for bookings and then revenue, which we fully expect will happen. I think as we said, it's not a matter of this but when. And that will be the key contributor to the margin accelerating throughout the year.

James Foster:

So a significant amount of revenue we can't see, we see not all of it. But as I said, proposal volume has been increasing nicely, and we anticipate that bookings will follow. There's usually a lag. So we're going to need a couple of quarters to see this, but we're confident given the dialogue with the clients that we will. BIOSECURE Act is an interesting one. Not legislation yet, but dialogue opportunity seems positive. So no, there's nothing built into our guidance that assumes anything about the BIOSECURE Act because it would be premature to do that.

David Windley:

Got it. If I could just sneak one last one in on the price relative to inflation comments. So Flavia, you talked about inflation that impacting margin. I guess, my assumption would have been that inflation would have been moderating along with price. Maybe you could put those in relation as to what is kind of still propping up the inflation cost side of the equation there, in terms of price to cost.

Operator:

We'll take our next question from Elizabeth Anderson with Evercore ISI.

James Foster:

So general proposition is that we try to utilize our space as fully and efficiently as possible. So we don't have huge amounts of empty space in any of our businesses. And as you know, depending on the demand, we're always adding to our capacity. Having said that, we have some incremental capacity in some of our businesses across the board. So we do have the ability to accommodate increased work in the back half of the year across multiple businesses and particularly in Safety Assessment.

Elizabeth Anderson:

Got it. That's very helpful. And then if we just think about like the incrementals in terms of DSA margins as we move through the year. What -- so the key focus is volumes and then the cost savings, any other like potential positives and then potential -- like any other major like pluses or minuses to call out as we think about that progression specifically in DSA?

Operator:

We'll take our next question from Dan Leonard with UBS.

Flavia Pease:

Yes. We're -- I don't think we're going to quantify the dollar proposal activity increase. I think we talked about it being sequentially up both year-over-year at being up both sequentially and year-over-year. And I think you also saw us talk about the impact -- the net impact into the backlog of bookings and cancellations. Cancellations also went improved sequentially in the first quarter. And so our adjustment to the backlog, the decrease was smaller than the decrease on Q4 versus Q3. but I don't think it will talk specifics in terms of what percentage of the increase we saw in proposals.

Daniel Leonard:

Understood. And Jim, you talked a lot about the leading indicators in biotech. Can you speak to what leading indicators you're seeing on the large pharma front as well?

Casey Woodring:

I guess a two-parter here. First is, did you give how many months of backlog you have? I think at the end of 4Q, you had 12 months, and you talked about your normalized ranges kind of 6 to 9 months time frame. So can you walk us through that? And then you talked a lot about safety in the prepared when talking about DSA, but can you just elaborate on how Discovery fared in the quarter relative to your expectations?

James Foster:

So Discovery is an interesting one. So no question that's been the hardest hit of all of our businesses by overall economy. And there's a lot of dialogue around as funding continues to improve, how quickly will that come back? And it certainly will come back. Studies, to some extent, shorter. But unlikely to come back first. A lot of our pharma clients still do that work internally. And as I said earlier, what we think will come back first are pre-IND work for drugs that have already been developed but haven't been filed yet as opposed to post-IND work.

Casey Woodring:

That's helpful. And maybe just if I can sneak one more in, just because we haven't touched on it, is on the manufacturing rebound in the quarter. It looks like each business there is seeing nice growth, and the segment came in above Street expectations. Curious if you think there was upside to the guide in manufacturing this year just in terms of how quickly that business has began to turn to start the year?

Operator:

And we'll take our next question from Tejas Savant with Morgan Stanley.

James Foster:

We would say that that's still the view. Competition had prices significantly higher than we. So they had to come. They've had to bring their prices down. I think it gives us a little bit of pricing power actually. So we're also really pleased with our sourcing of NHPs, particularly given the acquisition that we recently made.

Tejas Savant:

Got it. That's helpful. And then a couple of unrelated follow-ups. One on the CDMO piece, Jim, where is capacity utilization today? And what's embedded in the guide in terms of where you finish the year just in light of the ramping backlog of work are? And then on your comments on China. Are you seeing any sort of widening in that price disparity versus the Chinese CROs, particularly outside of China as we look to defense share at all? And any early sort of green shoots from the stimulus that just went -- I mean, that was put out there in March, in terms of how that could benefit local demand in China into your end or perhaps '25?

Operator:

We'll take our next question from Patrick Donnelly with Citi.

James Foster:

Yes. So everything that happened in April is embedded in our guidance. So I don't want to cut it month-by-month. We're pleased with what's been happening, the moderation and decline of cancellations. By the way, as you know, we always have cancellations. I mean all we can say is what we said, which is that we have to see a reduction in cancellations for some sustained period of time to have confidence that it's meaningful and will continue. We believe that, that's the trajectory that we're on, but we have to. We have to experience that for that to be beneficial and in terms of our backlog.

James Foster:

We work really hard, and I think we've done this quite successfully -- I don't know, for at least, 1.5 decades. The marry capacity with anticipated demand. It's not just current demand because we have to build space a year or 2 in advance. And we've lived through a period -- a long time ago, but it was painful where we and everybody else in the industry just built too much space. And that has a deleterious impact on your margins, and it's tough to manage that when you're swimming in space. So we never want to get back to that. We have worked really hard, and I think successfully and not having an adequate amount of space. That's the risk, of course. You get the [indiscernible] work and you don't have capacity. So we never want to get there.

Operator:

We'll take our next question from Josh Waldman with Cleveland Research.

James Foster:

Not sure what normal is. But I'd say it's reasonably normal. As I said before, except maybe for some periods where the demand was overwhelming, there is a lag between proposals and bookings. And particularly in this period where people are trying to ensure that they have confidence in accessibility of capital. So the conversions are pretty much as we would have expected. And hopefully, that will improve, but there's going to be kind of 2 or 3 quarters necessary to get this to be more robust. We're heartened to see the proposal volume as is. People feel -- seem to be coming out of their shells, acknowledging access to capital, obviously, desirous of developing the rest of their portfolios. And that's underlying our anticipation at the back half of the year will be much stronger. So I think it's pretty much as anticipated.

Flavia Pease:

Maybe I'll take that. I think as we said in our prepared remarks, I think what was different and drove the beat in the first quarter and is also impacting how we guided the second quarter is, obviously, RMS. There was a timing shift with NHP shipments that accelerated into the first quarter. So that was a tailwind in the first quarter and will be a headwind in the second. And then we talked about the strength of manufacturing in the first quarter, which was encouraging. I think we were silent in DSA in the sense that it performed according to our expectations, both in the first quarter and the impact of that is contemplated on the guidance for the second quarter. So I think we spoke about what was different than our expectations of the other 2 businesses.

Jack Wallace:

Just quickly on the CapEx commentary. It looks like you reiterated the guide, there's the moderating of capacity expansions. You comment in the deck and just reiterate a couple questions ago. Can you just help us kind of bridge the rate or guide against those comments? And should we think about that as being more CapEx in the back half of the year? Or is the dollars being spent differently than capacity expansions?

Jack Wallace:

Got it. And then in your prepared remarks, I think you mentioned some timing element in the first quarter for manufacturing as well as RMS. Was there any kind of snapback demand that was [indiscernible] surprising that might not continue in the second quarter? Or did I misinterpret that comment?

Jack Wallace:

Got it. So there's no -- so basically, the reason why we wouldn't necessarily want to raise the guidance here based on the stronger demand in the first quarter just has to deal with the tougher comps, not because that there's an expectation that the level of the strength in the first quarter wouldn't necessarily repeat in the upcoming quarters. Is that right?

Operator:

Thank you. We have no further questions in queue. I will turn the conference back to Todd Spencer for closing remarks.

Operator:

Thank you. That does conclude today's Charles River Laboratories First Quarter 2024 Earnings Call. Thank you for your participation, and you may now disconnect.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories’ Fourth Quarter and Full-Year 2023 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speaker’s presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

James Foster:

Good morning. The stability and resilience of Charles River’s business model were very clear in 2023. Although demand trends moderated in the broader life sciences sector, we delivered organic revenue growth at 6.5% and earnings per share of $10.67, both of which were in the upper half of the original guidance ranges that we provided last February. We accomplished this despite the pipeline, reprioritization activities and more conscious spending by many of our biopharmaceutical clients, and also by successfully mitigating the impact of the NHP supplied disruption in the United States. We are anticipating that constrained client spending will persist into 2024, but that demand will stabilize during the year. At the top end of our financial guidance range, we expect that demand trends will begin to modestly improve later this year. These trends are expected to result in organic revenue that is flat to 3% growth in 2024. Since providing a high level outlook at our Investor Day in September, we have further de-risked our 2024 financial plan and believe our current outlook is appropriately balanced as cancellations remained elevated and backlog continued to moderately decline in our safety assessment business during the fourth quarter of last year. Our belief that the macroeconomic environment will stabilize this year is supported by early external indicators that improvement will come, including several successful biotech IPOs in January, providing early signs that the capital markets should reopen and biotech funding will improve. Our internal indicators also suggest that demand trends may be beginning to stabilize in certain businesses, including signs of the client destocking activity in microbial solutions is easing, and increased proposal activity and biologics testing business in the fourth quarter. We believe the market environment is transitory. The long-term industry fundamentals for drug development remain firmly intact because the overwhelming need to find lifesaving treatments for rare diseases and many other unmet medical needs is unchanged. Biotech will again move into favor in the capital markets and will lead the way, using advanced modalities and new technologies to drive innovation, and Large Pharma has consistently adapted to scientific advancements, the regulatory environment, and a drive to be more efficient. Therefore, we anticipate little change with regard to the industry’s healthy, long-term growth prospects and continued investments in R&D. In today’s market environment, we will not wait for client spending patterns to improve. We are proactively and continuously engaged in actions to streamline our organization to drive productivity, enhance our speed and responsiveness, and become an even stronger scientific partner to our clients. We are doing this by continuing to focus our initiatives to win additional market share and new outsourcing opportunities across all three business segments. This includes enhanced commercial efforts through optimizing on Salesforce to accelerate revenue growth by adjusting go-to-market strategies, focusing on selling across our entire portfolio and leveraging technology to enhance sales insights, and identify earlier selling opportunities. Our digital strategy is helping us to better connect with our clients, including through our Apollo Cloud-based platform to provide real time access to scientific data and self-service tools for clients. We also have a culture [Technical difficulty (07:26) to (07:30)] continuous improvement at Charles River that enables us to drive operational efficiencies and cost saving actions to proactively manage our cost structure and to become an even more compelling partner for our clients for the longer term. Flavia will outline the cost savings from our restructuring initiative shortly. Overall, our successful execution in these areas will enable us to capitalize on new business opportunities as they emerge while delivering operating margin improvement in 2024 and beyond. Before I provide more details on our 2024 outlook, let me give you the highlights of our fourth quarter performance. We reported revenue of $1.01 billion in the fourth quarter of 2023, a 3.5% decline on an organic basis. Over the previous year, the decrease was driven primarily by a mid-single digit decrease in the DSA segment. As we have regularly mentioned the year-over-year DSA growth rate was affected by a challenging comparison to the 26.5% growth rate reported in the fourth quarter of 2022. As has been the trend throughout 2023, sales to the global biopharmaceutical client segment outperformed small and midsize biotechs again in the fourth quarter. For 2023, we were pleased to report revenue of $4.13 billion with an organic revenue increase of 6.5%. The top-line performance was driven by another solid year in our safety assessment business, as well as healthy growth in the RMS segment. The operating margin decreased 130 basis points year-over-year to 19.1% in the fourth quarter, principally driven by higher and allocated corporate costs due in part to a meaningful increase in health related expenses. And the DSA operating margin also contributed with a small year-over-year decline driven by lower sales volume in the discovery business. For the full-year, the operating margin declined by 70 basis points to 20.3%. The decrease was primarily driven by the manufacturing and RMS segments as well as higher unallocated corporate costs. Earnings per share were $2.46 in the fourth quarter a decrease of 17.4% from $2.98 in the fourth quarter of 2022. In addition to the lower revenue and operating margin, a higher tax rate, as well as the 53rd week in 2022 and the divestiture of the avian vaccine business in the fourth quarter of 2022 were earnings headwinds. For 2023 earnings per share declined by 4% to $10.67 due primarily to the non-operating headwinds, including significantly higher interest expense, in total interest expense tax and the avian divestiture reduced 2023 earnings per share by over a dollar. With respect to 2024, we believe our outlook is appropriately balanced. Demand from many of our large biopharmaceutical clients is expected to be stable while small and mid-sized biotechnology clients may continue to spend cautiously as they endeavor to extend their cash runways until clear indications of an improving funding environment emerge. At the same time, we expect both of these client segments to continue to increasingly utilize strategic outsourcing to gain efficiencies and cost effectiveness in their drug development programs. As I mentioned earlier, organic revenue in 2024 is expected to be in a range from flat to 3% growth. Non-GAAP earnings per share are expected to be in a range from $10.90 to $11.40 including at least $0.30 of earnings accretion from the November increase in our ownership stake in Noveprim, our NHP supplier in Mauritius. The range represents earnings per share growth for approximately two to 7% with earnings growth expected to exceed revenue growth due primarily to operating margin expansion of at least 50 basis points this year. I would like to provide you with additional details on our fourth quarter segment performance, and our expectations for 2024. Beginning with the DSA segment. DSA revenue in the fourth quarter was $625.8 million, a decrease at 6% on an organic basis. The quarterly decline reflected the difficult comparison to the 26.5% growth rate last year, as well as a meaningful decline in the discovery services revenue in the fourth quarter, safety assessment revenue also decreased by the lower rate. And the safety assessment business. The elevated cancellations throughout 2023 and slippage had a greater impact on the fourth quarter with work being canceled or stock dates moved out of the fourth quarter and into 2024. For the year, DSA revenue increased 7.9% on an organic basis, which met our segment outlook due to another solid year in the safety assessment business. As anticipated, the backlog coverage enabled us to achieve our DSA financial outlook of high single digit organic revenue growth in 2023. The year-end DSA backlog modestly declined to $2.45 billion from $2.6 billion at the end of the third quarter. Cancellation rate increased from third quarter levels, resulting in a net book-to-bill that remained relatively stable to below one times. However, the net book-to-bill has moved within a similar range throughout each quarter of 2023, with gross bookings remaining about one times at the end of the fourth quarter. We expect demand KPIs to improve modestly once the cancellation rate subsides, which is one of the assumptions behind our DSA outlook. We expect flat to low single digit organic revenue growth in the DSA segment in 2024. The first quarter will exhibit trends similar to the fourth quarter of 2023. Doing part to the normal seasonal lag of study starts at the beginning of the year. We expect study volume to improve thereafter, but the first half growth rate will be lower before the easier year-over-year growth comparison and improving demand KPIs benefit the second half DSA growth rate. Another assumption is that DSA revenue growth will be principally driven by modest price increases in 2024. This includes a $15 million to $35 million impact from NHP pricing, which reflects a significantly lower price increase than in recent years. One of the reasons that we are able to navigate a volatile NHP pricing environment is our longstanding high quality NHP supply relationships, which give us an important competitive advantage in the preclinical sector. The November acquisition of an additional 41% stake in Noveprim for approximately $145 to a 90% controlling interest firmly supports our stated NHP supply strategy of enhancing s safeguards and diversifying RNHP supply to increased ownership and operational control. Noveprim is reported as part of our DSA segment for NHPs vertically integrated into our safety assessment supply chain and the RMS segment for NHP sold to third party clients. Flavia will provide more details on the financial impact of Noveprim, which is now consolidated in our financial results. As we often comment, we are also deeply committed to initiatives to modify and reduce animal use, which are embedded in our four RMS comparatives of replacement, reduction, refinement and responsibility. We intend to remain the leader in regulatory required preclinical development services through both enhanced efforts to secure and safeguard our supply chain and also by championing methodologies to reduce animal use, including alternative technologies. Over the last four years, we have invested approximately $200 million in these technologies, principally through our strategic partnership activities to add capabilities from AI to next-generation sequencing as well as through investments in our digital enterprise and our animal free Endosafe Trillium testing platform. Discovery services had a challenging year and saw a meaningful revenue decline in the fourth quarter across all client segments. Discovery proposal volume remained low throughout the year, and clients’ decision making timelines for new projects remained extended. Despite these near-term challenges, Discovery services remain a critical component of our end-to-end early stage portfolio as we are able to partner with clients and often establish a relationship with them earlier in their life cycles. Whether for a single project or an integrated program, we are able to work flexibly by providing clients with cutting edge capabilities to discover their novel therapeutics. As we turn the page to 2024, we are cautiously optimistic that budget replenishment in the New Year will lead to healthier demand trends, but have forecast the business to be essentially flat in 2024. The DSA operating margin was 26% in the fourth quarter, the 30 basis point decrease from the fourth quarter of 2022 due to the revenue decline in the discovery services business. For the year, DSA operating margin increased by 220 basis points to 27.5% as a result of operating leverage associated with higher revenue and favorable mix in the safety assessment business. RMS revenue in the fourth quarter was $195.8 million, a decrease of 0.4% on an organic basis. For the year, RMS organic revenue growth was 5.9%. Demand for small research models across all client segments slowed conservatively in the fourth quarter, particularly in North America and Europe. Sales of small models were the principle headwind to fourth quarter growth as well as continued softness in the cell solutions business. These headwinds were largely offset by healthy revenue growth in China for both small models and NHPs in the fourth quarter despite the numerous reports of a difficult demand environment for the life science sectors within the country. To 2024, we expect RMS organic revenue will be flat to low single digit growth. The current demand environment will likely limit unit volume growth this year in the research model business in North America and Europe. So we expect to drive most of the growth from modest price increase. In China, we expect continued healthy demand for small models and associated services, albeit tempered from the robust historical double digit growth rates in the region. We expect NHP revenue in China to decline in 2024 due primarily to lower pricing in the region. Research model services are positioned to be a notable contributor to revenue growth in 2024. We are expanding our gems capacity in certain regions to accommodate our clients’ increasing requirements for our support of their complex research and maintenance of the genetically modified model colonies. In addition, CRADL, one of the largest growth drivers for RMS in recent years is expected to deliver a solid top-line performance in 2024 with growth accelerating in the second half of the year due in prior to the ramp up of several new CRADL sites. Clients are continuing to adopt this flexible model to access variant space without having to invest in internal infrastructure, which provides a powerful value proposition to biotech clients in particular who are trying to conserve capital. The RMS operating margin increased by 40 basis points year-over-year to 23.1% in the fourth quarter, but decreased by 220 basis points to 23 points, 23% in 2023.The one month contribution from Noveprim, as well as increased shipments of NHP within China with the principle contributors to the fourth quarter margin improvement, partially offset by lower sales volume in the small models business. As I mentioned, Noveprim sale of NHP to third-party external clients has been included in the RMS segment, which is expected to drive meaningful margin improvement in the RMS segment in 2024. Manufacturing solutions revenue was $191.9 million for the fourth quarter, a growth rate of 2.3% on an organic basis and the full-year organic growth rate was 2%. The CDMO business drove a segment growth rate with solid double digit growth in both the fourth quarter and for the full-year. Initiatives that we implemented to improve the performance of our CDMO business have proven successful in 2023. We believe the business is now well positioned competitively with its centers of excellence for cell therapies, viral vectors and plasmids and that investments made over the past two years have enhanced the commercial readiness of our operations. The enhancements to the business have been well received and are positive feedback from clients. We are generating additional client interest that has undoubtedly been initiated by our announcement in December that our method site received U.S. and EU approval to manufacture casgevy by Vertex, the first gene edited cell therapy targeting severe sickle cell disease. We are very pleased with our relationship with Vertex and believe commercial relationships like this will continue to drive new client inquiries going forward. Our biologics testing solutions and microbial solutions businesses both reported modest revenue declines in the fourth quarter. Microbial solutions did experience a modest increase in the year end client order activity as normally occurs, but not to the extent that occurred in the fourth quarter of 2022 when there was a significant budget flush. We are now seeing positive signs that client destocking activity is starting to wind down at both large biopharmaceutical and CDMO clients as a number of large clients recently resumed their order activity for reagents and consumables. In addition, we are now seeing confirmed ship dates for instruments including the Endo Safe Nexus 200 automated system that were delayed in 2023. As we previously mentioned, the biologics testing business had a difficult year due to tighter client spending in its end markets. However, we saw an increase in client proposal activity in the fourth quarter, which was the first quarterly increase in 2023. First quarter sample volumes for the biologics testing business are always seasonally soft coming out of the holidays, but we believe both biologics testing and microbial solutions will see improving trends over the course of the year in our position to generate modest revenue growth in 2024. In total, we expect low to mid single-digit organic revenue growth in the manufacturing segment this year. The manufacturing segments operating margin increased slightly to 25.4% in the fourth quarter that declined by 700 basis points for the year to 21.8%, while the operating margin decline in each of the Manufacturing segment’s business units in 2023, the CDMO business was the most meaningful headwind throughout the year. However, as project volumes continue to improve and enhance the business’ margin profile, we expect significant improvement this year, contributing to meaningful segment operating margin improvement in 2024. As we mentioned at Investor Day in September, we expect the manufacturing segment will drive the improvement towards the company’s margin expansion targets over the next 3 years, and the CDMO business is a key component of that goal. Before I conclude, I would like to congratulate Bill Barbo on a remarkable 42-year career at Charles River. As we announced previously, Bill will retire as Executive Vice President and Chief Commercial Officer; at the end of 2024. Bill’s career began with a lot of science, working as an animal care intern before joining the company as a full-time research scientist. We continue to assume positions of increasing responsibility eventually moving into our commercial organization. During his time at Charles River we have built led numerous initiatives, which contributed to our market-leading position and his comprehensive knowledge of our portfolio has made him an indispensable leader of our commercial organization. Bill has dedicated his career to ensuring we deliver on our purpose and has truly embraced our values. I greatly appreciated builds contributions and partnerships over the last 42 years and wish him all the best in his next chapter. For many years, Bill has been working with Kristen Eisenhauer, a Senior Vice President responsible for all client services and sales. Kristen has now assumed the Chief Commercial Officer role, so we are fortunate to have a successor in place and anticipate a seamless transition. Thanks again, Bill, and congratulations to Kristen. In addition to Bill’s retirement, Senior Vice President, Chris evolve, has now assumed responsibility for the Microbial Solutions business and will now be responsible for our entire Manufacturing Solutions segment. This aligns the operational leadership for our CGMP certified businesses under Kirsten, as she has effectively led our biologics testing and CDMO operations for a number of years. To close, we were pleased with our solid performance in 2023. Our long-term prospects for revenue growth and margin expansion remain unchanged from the targets we provided at Investor Day including averaging 6% to 8% organic revenue growth and approximately 150 basis points of cumulative operating margin improvement through 2026. Charles River is positioned exquisitely to meet the evolving needs of our clients and will capitalize on the opportunities that emerge in today’s business environment as the demand trends stabilize and eventually improve. We are taking action to gain additional market share to enhance commercial initiatives and by strengthening our leading nonclinical portfolio by focusing on innovation, including adding cutting-edge technologies from AI to next-generation sequencing. We are also committed to driving efficiency and appropriately managing our cost structure without sacrificing the flexibility to respond to a changing industry and client requirements, and we have stabilized and continue to secure our supply chain, including through the acquisition of Noveprim. We will continue to lead and to proactively manage the business through this dynamic market environment as well as to deliver value to our shareholders. To conclude, I would like to thank our employees for their exceptional work and commitment and for our clients and shareholders for their support. Now I would like Flavia to give you additional details on our financial performance and 2024 guidance.

Todd Spencer:

That concludes our comments. We will now take questions.

Derik De Bruin:

Jim, so I’m a little bit surprised to sort of see the significant ramp you are embedding in the second half. I mean your book-to-bill is hovering around, what, 0.75, 0.8. Your cancellations are up and you are assuming some NHP pricing, which I think is contrary to what some of the market surveys are showing. Can you sort of like break these down like and how you are sort of like getting the confidence you are doing with that. I think particularly on the pricing standpoint, I mean, is it something with no prime acquisition is allowing you to sort of get this incremental pricing?

Derik De Bruin:

If I can do just one follow-up, which is any sign that the Chinese are going to reintroduce NHPs or start exploring again?

Operator:

I will take our next question from Patrick Donnelly with Citi.

James Foster:

Yes. We have been trying to not over-read it. We were very pleased to see the cancellation rates, which have gotten higher than historically - they have been historically starting to come down, and we said that that is fabulous. But one quarter is not just positive of anything. And they were up again in the fourth quarter. So we do think that they will come down. We do think that we need to see it come down for a couple of quarters. it is somewhat related or very much related to the elongation of the backlog. And I think as you’ll recall from the last quarter’s conference call. We talked a lot about how the backlogs have gotten to be 18-plus months. And while that felt good, to some extent, the problem with that was we definitely had some clients that were just booking slots. I want to have a slot. I’m not actually sure I don’t want to do with that slot, but by the time I get there, 18 months from now, I’m sure I will have some work. And what’s happened with a lot of the clients if they get to 16-months out and they say, "Gee, sorry, we actually don’t have a study. So we will give up that slot. So the elongation of the backlog, I think from that standpoint is probably too long and not all that helpful. So it is back down to about 12-months, that seems more rational, and it appears from the nature of the conversations we are having with the clients with real specificity about what they are up to, that they actually have actual studies of the sliding in whatever it is within that 12-month period, which would stabilize the cancellation rate and help to recede. I think as you know, there is always been sort of a healthy amount of slippage, and that is when the drug isn’t quite ready on time. And some percentage of the stuff just cancels because the clients or to reprioritize things so the drug is formulating properly or run out of cash or blah, blah, blah - there is a bunch of reasons for it. So we are guardedly optimistic that the cancellation levels are normalizing and will continue to normalize throughout the year, the cancellation that sort we are fine with it in a dozen months. We have had years where it was kind of six to nine-months if it drops even further. I think that is fine. You want some healthy backlog. So when things do cancel or postpone that the clients have - that we have something else to slot back in to that. So probably somewhat of a normal ebb and flow of the bookings, and we are happy to see it normalizing.

Flavia Pease:

Sure. Patrick, as you pointed out, there are a few factors that are putting pressure on the Q1 margin and then throughout the year that those factors are going to ameliorate and the margin will ramp. Mainly the tax rate that I talked about in Q1 will be in the mid-20s versus our guidance for the year of 23% to 24%. I also talked about the seasonal ramp of our business, which Jim just alluded to, with those normal seasonal trends, we will see the margin improving throughout the year. And then in addition to the normal seasonal trends, you are going to have a tailwind of Noveprim that tends to be higher in the later part of the year that aligns with sort of gestational periods for their Colony as well as CRADL that Jim talked about that will ramp in the second half. And then finally, corporate is also a little bit higher in the first quarter vis-a-vis our guidance for the year. So between corporate and tax alone, that is about $0.25 in Q1. Then you have the normal seasonality and the $60 million to $70 million that I talked about in terms of benefit from some of our restructuring actions, that will pick up as the year progresses as well. So we have good line of sight on that margin accelerating throughout the year and confidence that we will be able to achieve that.

Elizabeth Anderson:

I was hoping you could talk a little bit about - I know you talked about the biotech demand environment and sort of versus midsize. Could you maybe specifically talk about some of the pharma demand? I think one question people have some of the restructurings that are going on, which seems to be maybe disproportionately impacting preclinical that seems to be a sort of question. And then secondarily, can you talk about any sort of share gain opportunities during the year? Obviously, there have been some bills in Congress that might potentially impact some of your competitors or willing of some sponsors to work with those competitors. So any comments there would be broadly helpful as well.

Elizabeth Anderson:

Got it. And one1 additional follow-up question. The 29,000 of average NHP pricing that you cited at your Investor Day, is that still the right way to think about sort of the pricing level for 2023 as a whole?

Operator:

And we will take our next question from Dave Windley with Jefferies.

Flavia Pease:

Yes, I will take that. So just to reiterate, we expect Noveprim to add between $40 million and $50 million of top-line revenue, which will obviously impact reported revenue but not organic. We also expect that Noveprim will add about $0.30 of EPS, which, if you do the math, is about 50 basis points of margin expansion. And just to articulate a little bit how the construct will work at this point in time, even though Noveprim is definitely a move that will allow us to have additional oversight control and eventually higher volume of NHPs in support of our safety business. In the short term, the majority of the financial impact will be reflected in the RMS segment, where that external revenue will be reported. And so that $40 million to $50 million of third-party revenue will also increase the RMS margin approximately 200 basis points. If you think about the benefit for the Safety Assessment and DSA segments it is going to be relatively small, especially in 2024 as we obviously already have safety stock of NHPs from Noveprim and other suppliers in the case of Noveprim that were acquired prior to the acquisition. So it is only once we start having models that go into studies that benefit from Noveprim being consolidated into Charles River that will start having an impact in the DSA margin, and that will be impacted by timing. So the majority of the impact in 2024 will be reflected in the RMS segment.

James Foster:

Let me take that one. So Dave, I would say that all of our competitors and the smaller they get, the more this is factor compete with us primarily on price. And so to some extent, that is an -. And we accept that and clients that either can’t afford it or think we are too expensive or running out of cash or whatever or prefer the competition, whether it is East or Western can and will go there. And that is okay. So I mean, that is an -. The Chinese capacity - there are certainly some small, let’s say, U.S. biotech companies that do their work in China. There is a limited amount of capacity in China. So that will happen. They will come and go. And yes, the cost of labor is lower and the cost of everything that is lower there. And I won’t comment on the quality of the work, I mean they will have to make that determination themselves. We try to be rational and appropriate and professional with our pricing, as I said earlier in my comments, we have a lot of long-term contracts with big pharma for some reason, most of them came to fruition in fiscal 2023. So they have all been resigned. The pricing is locked in. So that is a significant amount of what we do. I do think that folks come to us because our portfolio is larger. Our proximity is closer. The depth of our science is better. And our scale is better. And of course, if they know us well, the presumption that were too big and too expensive is really not true. So we will use pricing as well in certain instances. And I would say those just kind of fall into a few categories, which is to protect share in big - just a big clients that we have that is out shopping specifically for price. And so we may have to do something there. We certainly will be price aggressive if we are going after a big sluggish share with a client that we either don’t have at all or have very little. But we often pass when the price point just gets too low because it is going to be at cost or below cost or a trivial operating margin, and it is just not worth it given the complexity of the studies. I guess one other thing I would say is that where - I don’t know the exact numbers these days, but it is probably in the high 30% range what our market share is. While we are pleased and proud of that, I do think our share will be much larger over time. But if we only have a 30 - whatever, 6% share, there is lots of share that they are going elsewhere. So I think it is important that we have decent competition regardless of their price points. And regardless of where they do the work. And I think it is important to engender large clients, particularly Big Pharma clients to outsource that they feel that they can outsource to folks that are capable. But I think from a pricing point of view, we have been and we will continue to hold our own. We will invest in price in safety in fiscal 2024. That is not just in fiscal 2023. I think that is a commentary and lots of things, commentary on the nature of your question, commentary on the overall economy commentary on the cautiousness of our clients as they put a little more emphasis on post-IND work and clinical work, maybe to the detriment of some of the earlier tax work and certainly on the discovery work. But I think most of the time, we feel that we are being paid quite well for our work.

Justin Bowers:

So just a two-parter for me. Can you talk about the sort of like the pros and cons of owning farms and HP suppliers? I know we have done this in the past, and there has been - your strategy is evolving over the last 18 to 24-months. So could you just sort of give us some thoughts there on that? And then part two would just be around competition, just given the demand environment has slowed in general, there had been, I think, some competitors funded over the last few years. Just what are you seeing in the competitive environment competitive environment. Generally, what are you asking about specifically with regard to compensation? Sorry, within like within DSA, for example. Are we seeing exits from competitors or anything? Yes.

Operator:

We will take our next question from Jacob Johnson with Stephens.

James Foster:

So the CDMO business has been a huge headwind for us. For the past couple of years, right? Losing money growing okay. The back half of last year, grew very nicely, but had been slower than we thought it would be. And as you know, we have literally had to recapitulate, redesign, re-staff all three of these businesses, and I’m talking about general management all the way down to the technicians in the study rooms. And I think we have done a really good job as evidenced by the fact that we have had multiple regulatory audits culminating in with Vertex’s new sickle cell drug, which we are going to be producing a large amount of that. So a couple of things with that. That is obviously our key clients. That is obviously sort of wonderful almost marketing to be out there when other clients are thinking about who they are going to use, they are going to call Vertex and they are going to ask them about our relationship. And we have other clients who we are talking to right now who are about to file BLAs or finishing Phase IIIs. And I do think sort of success begets for the business. That business, while it won’t end fiscal 2024, where it should have been given our valuation models will have significantly better margins and significantly higher revenue not growing quite - we don’t have - our operating plan doesn’t have it growing quite at the rate that we thought it would when we bought them. But I still think that is transitory. And I think particularly as we get commercial clients that is going to crank up nicely. So we are liking this business a lot now. It has great connectivity with our biologics business and also with our Safety Assessment business. And so the portfolio effect is alive and well. The other two businesses in the manufacturing segment, first being the Microbial Business had its first year. I think it had one year where it grew at 9% and we have owned it for 28-years. Linear grew at 9%. Every other year, it grew double digit. Last year was the only year it grew slowly. And that is so we have explained that 50 times what happened there with that business. The top-line will expand because the clients have worked through a lot of the backlog because they loaded up on supplies during COVID. And the margins are stunning in that business. So that should continue to bolster the operating mines. And then Biologics, which is a business that in 2022 and 2021 had dynamic top-line growth teams and escalating operating margins had a very slow year last year, all because the economy, less numbers of drugs to test. It had a bunch of their capacity show Covid stuff we are still working through anyway. That business, as we said in the prepared remarks, proposal levels were up in the fourth quarter, which is a good sign that work comes back very, very quickly typically. And so we should see that whole segment, not our largest business, but to be significant not only in fiscal 2024, but if you look at the kind of three-year guidance that we gave, the CDMO business will be instrumental in driving operating margin and revenue growth for sure. It will be accretive to the manufacturing segment that will also be accretive to the business as a whole, and just reorganized that business with new general management and a different and tighter way of selling with single leadership and more commonality across those businesses. Because a couple of them are GMP businesses, which is the same sort of regulatory oversight and that sort of mindset is beneficial across the clients so important segment has some margin opportunity. Last thing just to specifically answer your question, that segment before we got in the CDMO business was around mid-30s operating margin. We had a few years where it was higher, maybe a few years where it was lower. It will continue to grow back towards that. It is a little bit difficult to say if and when it will get higher than mid-30s. But what we did say when we bought the company was that we believe that when we had a substantial bolus of commercial work at higher price points, with greater efficiency and greater predictability and just larger volumes definitely would be accretive to our operating margins. So that is going to take a while since we have only really signed our first one. But there will be more to follow. And as we get more of those and they get locked in for long periods of time. It will definitely benefit the operating margin of that segment. So we feel very optimistic, particularly optimistic about the CDMO business, in particular, but I’m quite optimistic about the home Manufacturing segment in terms of its importance to our client base in terms of the commonality of a lot of the work and in terms of the potential for better financial performance.

Maxwell Smock:

Just a quick one for me here on DSA. Can you just confirm that net bookings were down sequentially in the quarter and then discuss how you are thinking about net bookings moving forward in cancellations obviously elevated again here in the quarter. Can you just give us some detail around how gross bookings trended quarter-over-quarter? I think you called out still above one, but maybe just sequentially, any color there would be helpful.

Maxwell Smock:

Yes, understood. Had to give it a shot there at the gross bookings. Maybe just a quick follow-up for me. Given the back half guide, can you just talk about when you need to see demand trends at the meat segment start to improve in order to hit the midpoint of your guide for this year? You had that comment in the deck about how at the top end of your financial guide. You assume demand trends will begin to modestly improve later this year. But just wanted to clarify your assumptions for when the management start to pick back up at both the low end and the high end of your guide and how that maybe differs by segment.

James Foster:

I mean I think that was fine. I mean we are quite confident that we are going to see a sequential improvement in top of the bottom line throughout the year. Some of that has to do with the comps of last year. Some of it has to do with our assumptions. I went through a bunch of those with the first question I answered business by business. There are some subtle things that are improving. There are definitely some subtle things that are improving in the marketplace, in the M&A space and with the capital markets. Look, the one thing that you should all keep in mind is that there is - there would be and there was enormous demand for our services. The preponderance of our clients have to do the work externally. They have no internal capacity. Their portfolio is quite full and robust given the lesser of modalities that they have to work on. And so our clients are holding back. Our clients have reprioritized. The clients have good drugs sitting on the shelf. So our clients are clearly very frustrated by that. And so I think we think that we get to the point where they are more comfortable spending because they have greater access to capital. The demand should improve nicely. Is it going to improve overnight in one-month, one quarter, I don’t know, but we do think that it will sequentially continue to grow when we have seen this before. We have several of our businesses where the work does come in and go out very, very quickly, particularly Discovery and Biologics, and we have others that we have very close relationships with the clients and the pricing is all fixed. And so the ability get a slot is quite straightforward. I’m so optimistic with our guidance so optimistic that the demand comes back. Yes, it comes back, it is only when. It is a little bit murky to call, but we are calling it as best we can given decades in the business given the fact that we talked to thousands of clients every week. Given the fact we actually we have a very good understanding of the competition and what the strengths and limitations are. So yes, we would be very surprised if anything happens to change the slope of growth. Obviously, there are exogenous things under our control, but the things that we see that are within our control or that are already in sort of calculated in our guidance, it is unlikely those things will change.

Daniel Leonard:

I just wanted to clarify, are you seeing any of these improved external indicators in the biotech market translate into increased inquiry activity or RFPs in DSA - and if you are not, what would you expect any lag to look like if there was a sustained capital markets recovery in biotech?

Operator:

Thank you. I will now turn the conference back over to Todd Spencer for closing remarks.

Operator:

Thank you. That does conclude today’s Charles River Laboratories Fourth Quarter and Full-Year 2023 Earnings Call. Thank you for your participation and you may now disconnect.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories' Third Quarter 2023 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

Jim Foster:

Good morning. We reported third quarter organic revenue growth of 4.1% and earnings per share of $2.72, both of which exceeded our prior outlook. As anticipated, our growth rates declined from first half levels, reflecting the difficult comps from last year and the moderating demand that is affecting our businesses this year. Looking at the biopharmaceutical end market environment, we believe certain demand trends slowed -- showed some early positive signs, but clients also remain cautious with their spending. Biopharmaceutical clients are continuing to reprioritize their pipelines and in some cases, conserve cash or streamline their cost structures. This has led to a meaningful impact on some of our businesses this year, including Discovery Services and our Manufacturing segment and began to have a more discernible impact on the RMS business in the third quarter. We believe the current client spending patterns will persist in the near-term. However, we are also seeing some early encouraging signs starting to emerge, which support our belief that the demand environment will stabilize. In the Safety Assessment business, we were pleased to see sequential improvement in both the study cancellation rate and the net book-to-bill ratio in the third quarter. These favorable trends are supported by external indicators, including a stable biotech funding environment. The third quarter was the second consecutive quarterly increase in biotech funding on a trailing 12-month basis, led by venture capital investments. I will now provide highlights of our third quarter performance. We reported revenue of $1.03 billion in the third quarter of 2023, a 3.8% increase over last year. Organic revenue growth of 4.1% was driven by all three business segments, led by a mid-single-digit increase in the DSA segment. As I mentioned earlier, the third quarter growth rate was affected by a difficult comparison to last year that included organic growth of 15.3% in the third quarter of 2022. By client segment, third quarter revenue growth was driven by solid demand from global biopharma clients and academic institutions. As has been the case throughout the year, the growth rate for small and midsized biotech slowed as these clients are being more selective with their spending. Growth of biotech clients last year also outpaced all other client segments, driving the particularly difficult comparison in the second half of the year. The operating margin was 20.5%, an increase of 10 basis points year-over-year. The slight improvement was driven primarily by the DSA segment as well as lower unallocated corporate costs. These improvements were largely offset by margin pressure in both the RMS and Manufacturing segments. Earnings per share were $2.72 in the third quarter, an increase of 3.4% from the third quarter of last year. This exceeded our prior outlook, due primarily to the top line outperformance. In addition, the year-over-year headwind from interest expense is beginning to dissipate. We have tightened our revenue and non-GAAP earnings per share guidance ranges for 2023 as we move into the final quarter of the year. We are narrowing our organic revenue growth guidance to a range of 5.5% to 6.5%, and our non-GAAP earnings per share guidance to a range of $10.50 to $10.70, which raises the bottom end and trims the top end of our prior range by $0.20 per share, respectively. The guidance update is primarily due to shifts in the gating of our forecast between quarters and the favorable impact of lower third quarter cancellations in the Safety Assessment business being largely offset by a reduced outlook for our Manufacturing Solutions segment in the fourth quarter. I'd like to provide you with additional details on our third quarter segment performance, beginning with the DSA segment's results. DSA revenue in the third quarter was $664 million, an increase of 5.3% on an organic basis. Safety Assessment business continued to drive DSA revenue growth with contributions from base pricing and higher study volume, driven by non-NHP related work and post-IND studies. NHP pricing was a modest benefit to the growth rate. But as I will discuss shortly, NHP study volume declined year-over-year. Discovery Services remained an integral component of our end-to-end early-stage portfolio because it enables us to forge relationships with clients at earlier stages of the R&D process. However, the business continues to be impacted by the overall biopharma demand environment as clients focus on post-IND work and getting their drugs to the clinic to the detriment of discovery spending. As I mentioned earlier, we saw some early signs of more favorable demand trends in the third quarter for our safety assessment business. The cancellation rate improved sequentially and was at the lowest level since the second quarter of 2022. The net book-to-bill ratio also improved sequentially, but remained below one times. As a result, the DSA backlog declined in the third quarter to $2.6 billion from $2.8 billion at the end of the second quarter. However, as the lower cancellation suggests clients appear to be moving further along in their pipeline reprioritization processes, which we believe will lead to a higher quality and more reliable book of business. With the net book-to-bill remaining below one times, we believe the current demand trends will persist in the near term, including in the fourth quarter, which, as a reminder, already faces a difficult comparison to DSA organic growth of 26.5% reported last year. Overall, we believe stabilizing demand trends and significant backlog coverage will enable us to achieve our financial targets, including high single-digit DSA organic revenue growth for 2023, which is above our prior outlook for the segment. The DSA operating margin was 27.2% in the third quarter, a 100-basis-point increase from the third quarter of 2022. The increase continued to be driven by operating leverage associated with higher revenue in the Safety Assessment business. Before moving on to RMS, I'd like to comment on our NHP-related study work. At our Investor Day in September, we provided some information around the benefit from NHP pricing on our DSA revenue growth rates. We believe that additional information would be useful for investors and analysts to gain a better understanding of the impact of NHP pricing and NHP-related safety assessment studies on our business. Over a three-year period, ending in 2023, NHP pricing is expected to benefit DSA revenue growth by a total of just $230 million or approximately 30% of our total DSA revenue growth since 2020. Without the impact of NHP pricing, DSA revenue would still have increased at a high single-digit growth CAGR since 2020. In total, NHP Safety Assessment study revenue, which includes both services and the embedded NHP revenue, is expected to represent approximately 30% of DSA segment revenue in both 2022 and 2023. NHP pricing has rapidly escalated since 2020 due to both NHP supply constraints and the continued increase of biologic drugs in development. Supply constraints began in China around the pandemic and intensified last year due to the Cambodian NHP supply situation in the US. This has caused NHP pricing to increase by approximately $20,000 per model in aggregate since 2020. In 2023, we expect to utilize approximately 11,400 NHPs in safety assessment studies worldwide. This represents a reduction of approximately 25% from over 15,000 in the prior year, principally driven by the current level of biopharmaceutical demand and our clients' focus on their post-IND safety assessment work, which generates higher service revenue per model due to the longer-term nature of these studies, with fewer NHPs are used to generate that service revenue. A long-standing strategic imperative of the company is responsible animal use, which includes modifying or reducing animal usage. Responsible animal use is firmly embedded in our commitment to animal welfare and the 4R principles. And its adoption accelerated this year as a result of the NHP supply constraints. One example of our progress is the introduction of virtual control groups for toxicology studies. Virtual control groups, or VCGs, replaced the animals and control groups with existing randomized data sets and statistical evaluations. It will take some time to adopt, but we are having active discussions with our clients about VCGs. As many of you are aware, we have committed to providing additional disclosure on NHP sourcing, and a comprehensive update on our NHP strategic initiatives in early 2024. The timing of this strategic update will be ideal as we recognize the industry is changing, and these shifts are causing disruptive technologies to emerge and societal needs to evolve. With the industry at an inflection point, we will reinforce our critical role in preclinical drug development and maintain our leadership position. We will do this by leading with science, remaining committed to our essential mission of creating healthier lives and ensuring patient safety and by consistently challenging ourselves to raise the bar. And as we look to the future, we will be focused on ensuring a sustainable supply chain, particularly for NHPs. And we'll also pursue a longer-term strategy to lead the industry in adopting animal alternatives. Our team is diligently working to continue to enhance our processes and key initiatives in these areas. We've already made several investments in non-animal technologies, ranging from our Endosafe Trillium launch this summer for endotoxin detection testing, to our technology partnerships with Valo for Discovery AI, PathoQuest for next-gen sequencing for in vitro viral study safety testing and Cypre for 3D tumor modeling. We look forward to sharing our NHP strategic update in early 2024. RMS revenue was $186.8 million, an increase of 3.2% on an organic basis over the third quarter of 2022. This is below the year-to-date high single-digit revenue growth rate for two primary reasons

Todd Spencer:

That concludes our comments. We will now take your questions

Eric Coldwell:

Thank you very much. Good morning and truly appreciate all the additional details on the NHPs. I'm curious, in 3Q, could you provide commentary on the gross awards in DSA? Were those positive, above one, below one? Just any color on gross bookings in the quarter? And then on the backlog, $2.6 billion. I'm wondering if you have additional thoughts on where and when that backlog may stabilize at what level? What -- how long it might take for the net reductions to come to an end? Thank you.

Eric Coldwell:

Jim, if I could just jump in with one more. You had an Investor Day not so long ago. Some new updates here on the timing of 3Q, 4Q impacts, maybe some additional market change over the last month or two. I'm just curious, does -- anything you're seeing today change your outlook on the LRP that was provided just a while ago, achievability, confidence levels? And then specifically on 2024, I know you plan to give guidance later, but Street's hovering around $11 of earnings. I think this update might provide some controversy about whether that's a realistic target. I'm just comfort with high-level views on your comfort levels with where Street expectations are for next year? Thank you.

Eric Coldwell:

Okay. Thank you very much.

Elizabeth Anderson:

Hi, guys. Thanks so much for the question. Just in terms of DSA bookings, just a follow-up from Eric's question. Do you see any impact from like push-outs or timing issues? I just want to make sure that we're just looking at everything on sort of like an apples-to-apples basis? And secondarily, can you talk about the cash flow in the quarter? It's a little weaker than we had been expecting. So I just wanted to make sure I understand -- understood all of the puts and takes there. Thank you very much.

Flavia Pease:

Good morning, Elizabeth, on free cash flow, the quarter actually was pretty solid. We reported about 100 -- close to $140 million in -- that was up almost $80 million or 130% versus prior year, although last year was a relative slow base. For the year, cash flow is a little pressured. Some movement on working capital, receivables and inventory and timing of that, but I think it's still a very solid performance. We actually have lowered our CapEx for the year a little bit. Our guidance, as you saw to reflect modulation of our investment in capacity, given the current demand environment in Q3, CapEx was a little bit above 6% of sales which is below what we've been -- we told you all at Investor Day that our target would be 7% to 8%. I think we are navigating the current demand environment well, fortifying our performance, and we'll deliver solid free cash flow for the year.

Flavia Pease:

Yes. So I'll parts those two comments out. So we are not seeing any impact or any significant impact with regards to bad debt or any similar metrics of creditworthiness. There's nothing unusual and significant in the receivables side. And then from a capital perspective, we're not coming off of the 7% to 8% that we provided about 1.5 months ago. I'm just saying that relative to that, we were lower in the third quarter.

Operator:

Thank you. We will take our next question from Derik De Bruin with Bank of America. Your line is open.

Flavia Pease:

Derik, it's Flavia. I'll start, and then Jim can comment. I think it's a little bit of an impossible when and if prices will come down. We have -- as I think we provided in our additional disclosures, price has been a benefit, but perhaps not as much of a benefit as people have predicted. We have diversified supply base, which helps mitigate and manage -- help us mitigate and manage through price fluctuations and volatility. As we said in our Investor Day, we have taken into consideration a modulation of pricing of NHP in our outlook. So we already took that into consideration as we provided you all our LRP numbers for the next three years. I speak more than that. I don't know -- I have any additional comments. Jim?

Derik De Bruin:

Great. Okay. And just switching to something different as a follow-up, can you sort of like quantify what the -- how much microbial was down in the business? And how much of that was China versus the rest of the world? And also, what was the impact to RMS from the NHP push-out to China in 3Q? Thanks.

Derik De Bruin:

Microbial.

Flavia Pease:

Derik, just to add specifically on the NHP, it is just a modest headwind to the RMS revenue in the third quarter. We're not going to specify the amount, but it's a modest impact. And to Jim's point, while the Microbial China business is still relatively small, it has been growing nicely for us. So that slowdown does affect the microbial growth rate.

Operator:

Thank you. We will take our next question from Casey Woodring with JPMorgan. Your line is open

Flavia Pease:

So I'll maybe take the question on cancellations and growth in that book-to-bill. So I think we also stated in our remarks, the cancellation level in the third quarter was the lowest that we had seen since the second quarter of 2022. So I think we have been talking about a normalization of the domain environment, people going through their pipeline, reprioritization, and we had speculated that, that would eventually modulate. As Jim said, slippage and cancellation is a normal part of the business, but we had certainly seen a higher level of cancellations as the backlog expanded significantly at its peak to 17 months. And so there was a lot of, I would say, rationalization and people prioritizing their compounds. The gross book-to-bill in the quarter was above 1, as we said. And so the lower cancellations did help improve the net book-to-bill sequentially in the third quarter versus the second quarter. So I hope that answers your question. And can you repeat the part about the NHP pricing?

Flavia Pease:

Yes. Thanks for clarifying that. Yes. And the last NHP usage and still, on a relative basis, higher revenue is driven by the types of studies that we're conducting more so. As clients seem to be prioritized and post-IND work, we are seeing the impact of that into our study mix as well. And we do a significant amount of post-IND work. These studies are longer in nature. And so from a mix perspective, they result in less units, but relatively higher revenue since you -- they last longer, as I said. So it really will depend on what happens with the demand. It's -- we -- if clients are going back to pre-IND work, you see a reverse of higher numbers of units being used. So it's hard for us to predict, at this point, given that we don't know our clients are going to be clients are going to be prioritizing their pipeline if they're focusing on pre or post-IND studies.

Patrick Donnelly:

Hi, guys. Thanks for taking the questions. Flavia, maybe one for you, just on the margin side. Gross margins came in a little light. I mean was that just to do with the lower manufacturing side? And then you guys, obviously, offset that with the SG&A being quite a bit lower. Can you just talk about, I guess, the moving pieces on those two and the right way to think about them going forward?

Patrick Donnelly:

Okay. No, that's helpful. And then maybe just one more quick one on the gross bookings side. Can you just help us think about what the gross book-to-bill was last quarter? Again, just trying to feel out the numbers here without the cancellations on the gross bookings side? I appreciate it.

Patrick Donnelly:

All right. Thank you guys.

Dave Windley:

Hi, good morning. Thanks for taking my question, and thanks for the additional disclosures. I appreciate that very much. I wanted to try to follow up on a couple of prior questions. So, on the kind of Casey's question, I guess, on the revenue per NHP implied. Flavia, I understand your point about -- I think you're talking about like maybe long-term CAR studies or something of that sort that are -- that run longer without needing more animals. Is that the exclusive impact? Or is there also like a reuse that's not in the -- I'm thinking if you have 11,000 unique animals, for example, and then there are also some reuses of those animals, that would also have the effect of lowering that revenue per annum. I just want to make sure I understand the various contributors to these numbers that you've disclosed this morning.

Jim Foster:

So we have a reduction in numbers of NHPs use, with a meaningful amount of revenue associated with those just because of studies are much higher value -- or much longer and are really essential to be getting drugs through the clinic. So a little bit of a shift at least for this year. It's difficult to say help, but we usually have a pretty good balance between IND files and post-IND work, but that's a really good explanation for why the units are down.

Jim Foster:

Well, I'm glad you asked that, Dave. So, Charles River has a responsibility to utilize alternative adjunct technologies to the extent that they actually exist and work, and regulators and clients will embrace that. And they'll give us decent information. And so, as the largest provider of research models, as the largest [indiscernible] company, we have to lead. So we have multiple investments, relatively small, except for one multiple investments and a whole bunch of different technologies, particularly AI, next-generation sequencing, 3D modeling would be once it come to mind immediately. I met with a company yesterday that's in the AI field, so that's probably going to be another one. And it's impossible to tell how much traction we'll get, but I do think that there's a fair amount of work being done right now. And I can see it sooner than later in discovery, and we can see it sooner than later in helping the clients identify a lead compound and moving away from other drugs that we're working on that probably don't show efficacy and being able to do that with non-animal technologies or less animals. And hopefully, that would speed up the whole process of them moving towards the clinic. So we feel really good about that. Dave, I couldn't guess how far away this is, but I think we'll see some of the discovery impact. And I think -- we think that's beneficial for the industry and for us sometime maybe in the next five years. I don't think it will be substantial. But I do think it will be real. To the extent to which those technologies work, those are likely to be companies that we buy or technologies that we license. And never is a long time, so I won't use the word never, but from everybody that we speak to, we think it's highly unlikely that you're going to see any post-sale replacement of animals and classic toxicology just because it's all about safety in a wholly animal model appears to be the best use -- the best way to do that, but -- and so the extent to which the non-animal technologies ever get any traction tax, I think -- we think that's way off. Having said that, we're just going to do a lot of work, Dave, in all of this stuff. Study it, write about it, utilize it, talk to our clients about it, talk with regulators about it and make multiple shots on goal with these potentially valuable technologies to see what really has traction. So we're going to continue to talk about it because we do think it's important. We do think it's possible in some domain, and we do think that if anybody is going to lead it, it really needs to be us.

Jim Foster:

I think that directionally, that's going to be important, not just for regulators, regardless of the country, but for ourselves just to know that and for our clients just to make sure that these animals are purpose spread. So yes, it's going to be sort of slow going to get kind of a sense from government agencies that they like what we're doing. We actually found several places that we could do this on a cost-effective basis and really sort of nail down the fact that those animals are as we desire. We got out really fast working on it. I think the government is going to be a little more slow in their uptake of even having a conversation with us. But I do think that's something that again, Dave, that I think it's essential. I think we have to -- have the leadership position there. I think that, that -- it's not very complicated by the way. As you know, we have this whole -- the whole being able to identify the genetics -- genome -- the specific animals is relatively straightforward science. It's a lot of animals, so it's not trivial from a cost point of view. But I think we can do it cost effectively and whatever it is other going to pass it on. So we still, I would say, in the background, Dave, but we'll get back to it at some point, for sure.

Jim Foster:

Sure.

Justin Bowers:

Hi, good morning, everyone. So with booking -- a two-parter for me. With the bookings stabilized and sort of if I look at the revenue and safety assessment for the first three quarters, does that seem like sort of a good run rate like on the go forward? And I just -- if I look at what the guidance implies for 4Q, for example, and we adjust for the extra week last year, it sort of gets at DSA revenues flat, plus or minus Q-over-Q. So that's the first one. And then just with the improvement in the bookings that you're seeing, and I understand flow of cancellations. Is there any way to parse that out in terms of the nature of those cancellations and how it's sort of improved? Is it like -- is it more less of the empty rooms versus programs that are in flight being canceled? Just any additional color there would be helpful.

Flavia Pease:

And we can maybe follow-up with you later on the DSA revenue for the fourth quarter, just -- to make sure that we get the math correct. When we provided guidance by segment, it's on an organic basis. And so the DSA, at high-single-digits for the year, leads the fourth quarter there, would imply probably a negative growth in the fourth quarter. And again, to remind everybody, we had an extraordinary fourth quarter in 2022 with 26.5% growth for DSA. So there's a bit of comps there that impacts it. So I don't know if it's the impact of the 53rd week when you did your math.

Flavia Pease:

Sequentially, you're right. It should be flattish.

Flavia Pease:

I thought you were talking year-over-year.

Operator:

Thank you. We'll take our next question from Dan Leonard with UBS. Your line is now open.

Jim Foster:

Hardly at all. So I understand why you asked the question. So our strategy and goal is very much that Discovery is a feeder for safety. So that's obviously the essence of your question so. It's a trivial part of the DSA revenue right now. Although we love the business, and we have good science and good parts and pieces, we're in an air pocket right now, but that's going to be transitory. To sort of refresh my answer to your question, if Discovery is rocking that's beneficial to our safety business, particularly if we if we hold on to work. And just generally speaking. But I would say that it's kind of a tale of two cities. Our safety business is actually in this kind of funky economic environment is performing extremely well. We're getting price and share and lots of big studies and our capacity is well utilized when I say capacity, both people and space. So as you think about the future, which I assume you are and if you assume that Discovery sheer pocket continues, and I don't know whether that's true or not. It will matter. It won't really fundamentally affect the size and scope and growth rate and our margin profile for the Safety Assessment business. And if it comes back strong, which, by the way, can on very short notice or no notice, it just would be beneficial and add some incremental revenue to the sector. Also has I guess last also has good margins. So I don't want you to forget that even though it's slower than we would certainly like the Discovery business has gotten nicely profitable had wonderful growth rate last year, the year before and the year before that. And I think we're holding our own very well. But it's just -- it's very simple. You've got clients, big and small, emphasizing post-IND preclinical work and clinical work just because they have to get some drugs to market to generate more revenue. That's -- and that's sort of an always-always. But if they don't spend money on discovery, which, of course, is what they do, what biotech only does, they don't spend money on Discovery, then they'll have nothing whatever, two years, three years, one year from now in the clinic. So it's not our opinion. It's a certainty that the pendulum has to swing back a little bit difficult to call because it's definitely related to funding and the overall economy. And I think it's related to that much less being related to the strength of the scientific modalities, which are going to be quite powerful. We got some really great drugs with these companies we're working on that are better life saving. So we'll watch you. We'll let you know as soon as Discovery begins to come back. And as I said a moment ago, it will come back sort of surprisingly fast. Studies are short. We don't give a lot of notice on them. The turnaround time is pretty good, so is the pricing.

Jim Foster:

Good question. So the CDMO business is all pretty much all clinical. So that's not manufacturing that stuff. So it's a little bit different than the rest. Yeah, I mean, a big piece of microbial is to lot release for commercial products. So yeah, for sure and less stuff goes through the pipeline as less stuff is approved as they're trying to spend money in the clinic and maybe manufacture less of their other products. It slows down a little bit. Similarly, with biologics, that's also -- we have to test those drugs before they go into the clinic. So just so I don't confuse you, yeah, a lot of stuff is focused on the clinic and going into the clinic, but less than they would otherwise like to go into the clinic just because they care. But we talked about the reprioritization of their pipelines. So even big companies, big pharma, who is well financed, has budgets and they're very tight on the budgets, both in terms of headcount and other things. So we've definitely seen just a conservatism on the part of almost our entire client base who has -- they have really good portfolios. They are just not developing and prosecuting their entire portfolios, maybe the way they did in 2021 and 2022. Again, it's all transitory. So as stuff gets through the clinic and into the market, and when the economy feels better for these folks, I'm not an economist, so I have my opinion that kind of -- not useful on this call, I do think we'll start to see a lot more spending in discovery. But to answer your question specifically, you'll see a lot more testing of commercial products to go into the clinic.

Operator:

Thank you. We will take our next question from Tejas Savant with Morgan Stanley. Your line is open.

Flavia Pease:

Hi, Tejas, how are you? So the RMS impact, both on top line as well as margin was a combination, as I said, of the lack of significant shipments of NHPs in China as well as a mix of businesses in our RMS segment. As you pointed out, we had a higher growth of some of the lower -- on a relative basis, lower margin subsegments within RMS. So we expect that to continue into the fourth quarter. We're seeing, from a demand perspective, more resilience on the larger pharmaceutical clients and government contracts. So that plays into the margin. And then in the fourth quarter, though, we will have NHP shipments. So the margin for RMS will pick up in the fourth quarter. I think we had telegraphed data or signal that in Q3, we weren't going to have any meaningful shipments and therefore, the margin was going to come down. So again, this is consistent with what we have been expecting. As far as the government contracts that we expect that we announced in the Investor Day, that are lower margin and that we would be exiting will likely start in the 2024 horizon.

Jim Foster:

I know it would be super helpful, but I have to wait until February to get that clarity, but I appreciate you asking.

Tejas Savant:

All right. Thanks, guys. Appreciate the time

Max Smock:

Hi, all. Thanks for taking our questions. To start, maybe I'll try to get at Derik's question from a lot earlier here, just in a different way. So your disclosures imply about $780 million of NHP-related revenue in 2023. How do the margins associated with this NHP work compared to your DSA operating margins this year? And how have the margins on that NHP were changed over the last few years as a result of the pricing increases on the NHP side? And then in terms of assumptions moving forward, I'd be curious to hear your take on what you actually have baked in for margins on NHP work as part of your midterm guide here, given your comments about pricing normalizing some here as we move forward. Thank you.

Jim Foster:

I think that's all.

Jim Foster:

Don't be concerned. It's not the first time this has happened. When times are good, we see a balanced spending in discovery and development. That benefits our whole portfolio. When client base is concerned about revenues, they tend to nuance the clinic. And with regard to preclinical stuff, the post-IND stuff, and there before. And in terms of the growth in development and solidity and strength of the companies, they have to go back and spend a discovery. So it's just a matter of time, and it's impossible to call it, although we'll obviously have to call for our operating plan for next year. But as I said before, our discovery business, which we're pleased with the scale, pleased with what we put together is still trivial by comparison. So it's really going to have no impact on the growth of our safety assessment business any time soon. As I said before, positive about as we continue to work hard to have a flow-through for successful molecules for discovery safety, it could be a benefit, but I really don't see this being a detriment. I suppose if the business was much larger, and 90% of our clients were moving stuff from discovery to safety, I might give you a different answer, but that's -- maybe we'll be there someday. It's not where we are right now. So I understand that they are connected, but it's actually useful to look at it on a connected basis. So what you see when we report DSA is essentially primarily our safety assessment results.

Operator:

Thank you. We'll take our next question from Charles Rhyee with TD Cowen. Your line is open.

Flavia Pease:

It depends on what you mean by jump-off point from a growth rate, right? Our first -- our fourth quarter, as I indicated in my remarks from an organic revenue, it's mid-single-digit decline, which is not, I think, how you should be thinking about the outlook for 2024. Without putting -- without giving any guidance into 2024, we -- I think the fourth quarter is being impacted by comps, because we had extraordinarily high performance in the fourth quarter of 2022, with close to 19% growth. So if you're talking about growth rates, I have to be careful.

Flavia Pease:

Yes. So I think from a dollar standpoint, I think I commented earlier, it's sort of flattish, I think, to slightly down versus the third quarter. Normally, our fourth quarter tends to be our largest quarter from a dollar perspective. But we do, as you pointed out, we've seen some impacts from the demand environment, and that plays a little bit into the fourth quarter. We really encourage you guys to look at us on an annualized basis. We have fluctuations quarter-to-quarter. There's comps when we compare to last year, first half, second half, as we pointed out. First half was relatively lower, second half was very strong from a growth rate, and then there's other things like the timing of the NHP shipments in China, as I pointed out.

Jim Foster:

Use the entire year as the jumping off point, I think it's what we're saying. So we had -- we've had some complicated comps this year and last year, first half year versus second and vise versa. The sort of assumption that quarters will be at certain growth rate is almost a positive for us to discern. I think we do a very good job at giving you annual guidance. So try to embrace what the full year is growth rate and margin is as some sort of reasonable jumping off point, subject to whatever we do with pricing and whatever volume we can gather for the next year. But if you just assume that whatever the fourth quarter is just going to continue, I think that's going to give you an erroneous result.

Jim Foster:

Yes. No, I mean it's always been there. We had to call it out, because it was sort of unpredictable and the numbers are pretty big. The impact when we get it is quite positive. We don't have a lot of control and we have x number of NHPs available. We have a handful of local clients, Chinese clients who want them. And sometimes that slides, they say they want them in a certain quarter, and they don't take them or they don't take all of them. So it's again, a little bit unpredictable, but we should end up selling all that we had anticipated during the fiscal year. So we have said earlier that numbers of animals available was slightly less than they were a couple of years ago. And so that has an impact as well.

Jim Foster:

Sure.

Jack Wallace:

Hey, thanks for taking my questions. Quick one on NHPs and again, I appreciate all the disclosure. I think you recall that there was expected to be about half or certainly less than the $190 million -- or $160 million impact for the back half of the year due to supply constraints. It looks like there was a solid beat in DSA in the quarter, possibly related to that. Was there any NHP revenue drop there or impact that was you previously called out that we experienced in the third quarter?

Jack Wallace:

That's fantastic. And then quickly over to manufacturing, thinking about the testing business. Just to put the demand for testing in context for vaccines, roughly, where are we today in terms of demand mix versus, say, pre-COVID? Just trying to get an idea if there's -- as inventories have been diminishing, whether there's a snapback here. We're still above -- at an elevated level compared to historical norms. Thank you.

Jack Wallace:

Appreciate it. Thank you.

Operator:

Thank you. We'll take our next question from Josh Waldman with Cleveland Research. Your line is open.

Jim Foster:

We're not. We are significantly larger, deeper science and a much broader footprint than our competitors. And we also have the connectivity on the other parts of our business, particularly discovery aspects of manufacturing -- the manufacturing business. So we're not seeing any fundamental changes. We have smaller competitors. I would say that without exception, they compete with us primarily and essentially on price. I think they can do an okay, general toxicology study for you, but definitely not an okay complex study for you. And some of them have very small footprints and very limited capacity. So I think we're holding and taking share. I think we're getting price when appropriate. I won't tell you that we never have aggressive pricing. We'll get aggressive if somebody's attacking a big client that we have or we're bidding on new de novo business. But generally, we feel that over the last few years, we've got much better paid for the complexity of our work. So I don't think the competitive dynamic is going to change. It's probably a complex, expensive business where you have to have a lot of history for your clients. So appreciate you. So I think folks that know better tend to come to us we're working hard to have sufficient capacity. So we don't turn them away. And when I say capacity, I'm talking about staffing and facilities. And not just facilities in one place, but facilities all over the world. So we feel particularly good about our competitive posture in most of our businesses, but I would say particularly in safety.

Operator:

Thank you. We'll take our next question from Tim Daley with Wells Fargo. Your line is open.

Jim Foster:

So I assume the first part of your question is about NHP disruption that we encountered at the beginning of the year and thought it might be more profound. So all that we can tell you is that we have a large international infrastructure. We have multiple sources of supply, some of which we have an ownership position, some we have JVs, and all of them we have long-term contracts. So we have sufficient numbers of NHPs. I can't guarantee anything about the future, except to tell you that we are operating in very good harmony with local regulatory authorities. We have sufficient numbers of very high-quality healthy animals from multisources. We've had no disruption to and with our clients are really pleased with the way we've been handling it. We will have the same assumption in terms of stability of NHP supply as we move into next year for sure, and unless something case happens in the next couple of months, which we don't anticipate. So your question was a little was looking for some guarantees. We don't anticipate any disruption, and we're doing everything we can to ensure that we don't have disruption and we had disruption at the beginning of the year as we think through no fault of our own, as our set of circumstances. But right now, things are very stable from a client support point of view. I take the second part of that question.

Tim Daley :

All right. Got it. That's really helpful. And Jim, just a follow-up here. On the supply side of things, in the 2Q 10-Q filing, there was a mention of a post quarter end acquisition of the majority stake of a prior JV large animal model supplier in the DSA business. I think kind of grossing it up gets to almost $0.5 billion valuation for that entity. So could you just please provide us some detail on that? Location, plan, strategy, just some help there would be great. Thank you.

Tim Daley:

Got it. Look forward to it. Thanks.

Operator:

Thank you. We have no further questions in queue. I will turn the conference back to Todd Spencer for closing remarks.

Operator:

Thank you. That does conclude today's Charles River Laboratories Third Quarter 2023 Earnings Call. Thank you for your participation. You may now disconnect.

Operator:

Please stand by your program is about to begin. [Operator Instructions] Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories Second Quarter 2023 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

Jim Foster:

Good morning. We were pleased with our second quarter financial performance including organic revenue growth of 11.2%. As expected, the revenue growth rates in the RMS and Manufacturing segments improved from first quarter levels and the DSA segment had another strong quarter with low double digit revenue growth and operating margin improvement. DSA performance reflected the substantial scale and duration of our backlog, which has enabled us to effectively manage the business. For the year, we are narrowing our revenue growth and our non-GAAP earnings per share guidance to the upper ends of the previous ranges. This update largely reflects the successful implementation of our mitigation efforts around NHP supply for which I will provide additional details shortly. However, we continue to expect for second half growth rates to be pressured primarily in the DSA segment as a result of three primary factors. First, the current market conditions are resulting in a continuation of the lower backlog and booking trends. Second, the DSA segment faces a challenging year-over-year comparison after having generated organic revenue growth of 23.6% in the second half of 2022 and finally we still expect a modest impact from NHP supply constraints principally in the third quarter. We are also closely monitoring the near term demand trends of our biopharmaceutical clients as they appear to be reprioritizing their pipelines and tightening their R&D budgets. This is affecting our industry and our company, but we will continue to leverage our significant DSA backlog and intend to appropriately manage the business amidst a more cautious biopharma spending environment. During times of funding or macroeconomic uncertainty, clients are looking for even more efficiency and speed to market and we believe they will continue to choose an industry leader like Charles River in order to derive additional value from our flexible and efficient outsourcing solutions. With regard to NHP supply, we have been effective in our efforts to leverage our global safety assessment infrastructure to alleviate the overall impact of supply constraints caused by the suspension of Cambodian imports into the U.S. and have made significant progress to better utilize our sites outside of the U.S. Based on our progress today, we believe that we have successfully mitigated the logistical challenges posed by the current NHP supply constraints by conducting more studies outside of the U.S. and better leveraging our global infrastructure, which is a competitive advantage for Charles River. We have been able to effectively transfer safety assessment work between sites because much of our capacity was built flexibly to accommodate multiple species of both small and large models. The transition of this work to our international sites this year has required time to implement study scheduling, logistics, quarantine operations and retraining of some staff as well as working with local government agencies. However, we have already made significant progress with these initiatives and do not foresee any meaningful NHP supply constraints affecting the business in the fourth quarter and next year. As a result, we now expect the impact from NHP supply constraints will be less than our initial outlook of a 2% to 4% impact to consolidated revenue growth this year. We have narrowed our DSA organic growth and growth outlook to the mid single digits or the upper end of the prior range to reflect this positive update on NHP supply. But we also expect the favorable impact to be largely offset by the current DSA demand trends. Going forward, we are operating under the assumption that we will conduct meaningfully the last NHP related study work in the U.S. as our international infrastructure will be sufficient to accommodate this work. I will now provide highlights of our second quarter performance. We reported revenue of $1.06 billion in the second quarter of 2023 and 8.9% increase over the last year. Organic revenue growth of 11.2% was driven by strong performance in the RMS and DSA segments as well as an improvement in the manufacturing growth rate led by the CDMO business. By client segment, second quarter revenue growth was broad based across global biopharma, biotechs and academic and government institutions. However, demand from global biopharmaceutical clients modestly outpaced small and mid-sized biotech clients for the second consecutive quarter. This demonstrates the diversity and stability of our overall client base as globals continue to move their critical programs forward at a time when biotechs are being more selective with spending to extend their cash runways. The operating margin was 20.4%, a decrease of 140 basis points year-over-year. The decline was driven by continued margin pressure in the manufacturing segment as well as higher unallocated corporate costs. Earnings per share were $2.69 in the second quarter, a decrease of 2.9% from the second quarter of last year. As anticipated the year-over-year increase in interest expense and the tax rate continued to be meaningful headwinds to earnings growth this year as was the divestiture of the avian vaccine business. As I mentioned earlier, we have narrowed our revenue and non-GAAP earnings per share guidance ranges for the year to the upper ends of the ranges due largely to the successful implementation of our NHP mitigation efforts. We are narrowing our organic revenue growth guidance to a range of 5.5% to 7.5% and our non-GAAP earnings per share guidance to a range of $10.30 to $10.90 for 2023. We have increased the lower end of the ranges by 50 basis points and $0.40 per share respectively. We believe our existing DSA backlog and our in depth assessment of the normalizing demand trends gives us continued confidence in our financial outlook for this year. I'd like to provide you with additional details on a second quarter segment performance beginning with the DSA segments results. DSA revenue in the second quarter was $663.5 million, an increase of 11.7% on an organic basis. The Safety Assessment business continued to drive DSA revenue growth and contributions from base pricing and study volume. NHP pricing was a small benefit to the growth rate, although less of a benefit than in prior quarters. The second quarter performance of the discovery services business which posted lower revenue compared to the prior year was reflective of the current market environment coupled with the shorter term nature of both discovery projects and the businesses backlog. DSA backlog decreased modestly on a sequential basis to $2.8 billion at the end of the second quarter from $3 billion at the end of the first quarter. Net bookings and proposal activity continued to trend lower with net book-to-bill remaining below one times on a quarterly basis. This was primarily driven by the cancellation rate which trended higher and accelerated in the second quarter. We believe the cancellation rate has increased because during the peak demand environment over the last few years clients booked studies further in advance of when the work would be required. Now the clients are rationalizing lower priority projects in their pipeline. They are cancelling the associated studies. We view this trend as largely a reversion to the mean and expect that as clients complete the pipeline rationalization process, cancellation rates will decline and the backlog will be more reliable -- will more reliably reflect the actual study demand. We believe the cancellations will decline because incoming new Business Awards or gross booking activity that is not adjusted for cancellations remain robust resulting in a gross book-to-bill remaining about one times in the second quarter. We now see clients booking closer to when studies are required, which increases the reliability of the backlog. The current level of gross bookings can support healthy revenue growth rates which suggests that solid underlying growth prospects for the Safety Assessment business will return once the rate of cancellation subsides. We believe the stabilization of the demand trends will be supported by encouraging macroeconomic indicators as well as stable to improving biotech funding levels. In the second quarter, biotech funding showed the first quarter over year increases in seven quarters on a trailing twelve month basis. We also have an average of thirteen months of revenue coverage and our safety coverage and our safety assessment backlog. This solid backlog coverage affords us the ability to appropriately manage the business through fluctuations in demand environment, backfill gaps and study schedule and meet our near term financial targets. This and our level of backlog coverage for the remaining quarters in 2023 is well above the historical pre-pandemic averages which gives us additional confidence about the resilience of the business and our ability to achieve our financial goals. The DSA margin was 27.6% in the second quarter at 230 basis point increase from the second quarter of 2022. The increase continued to be driven by operating leverage associated with higher revenue in the Safety Assessment business. In addition, we are closely monitoring capacity utilization for both physical infrastructure and labor, including the pace of capital spending and hiring and are committed to keeping these metrics closely aligned with the current demand environment as the DSA growth rate normalizes. RMS revenue is $209.9 million, an increase of 13.9% on an organic basis over the second quarter of 2022. RMS segment continued to benefit from broad based growth in all geographic regions for small research models and another exceptional performance from our end sourcing solutions business led by our CRADL initiative. In addition, as we referenced last quarter, the timing of large model shipments within China benefited the second quarter growth rate leading to the outperformance compared to our full year RMS outlook of high single digit organic growth. The growth rate for small models in China also benefited from the comparison to last year's modest impact from COVID related restrictions in the Beijing and Shanghai regions. While growth rates cooled a bit in the second quarter we are continuing to see stable demand and pricing for small research models in North America and Europe, which reinforces our growth outlook for the year. As you know, these models are essential tools that enable scientists to move their biomedical research programs forward. The stable demand trends also reflects a large base of wealth and the clients in the RMS segment as more than half of RMS revenue is generated from academic and government institutions and large biopharmaceutical clients. The Services businesses continue to be the primary growth driver for RMS. With in-sourcing solutions or IS leading the way, IS’s CRADL operations are continuing to expand and generate excellent client interest. We recently opened a new site in Seattle and our first location Philadelphia. Including these locations, we now have 32 CRADL sites totaling over 400,000 square feet in five states with growing biohubs as well as in London and China. The Philadelphia side is expected to cater to a large base of cell and gene therapy companies in the region, a sector of the market which we continue to believe will generate abundant growth opportunities across our portfolio. Our CRADL network supports the flexible growth of the entire life sciences ecosystem in each biohub, allowing researchers to utilize our flexible Vivarium rental space instead of building their own infrastructure. In the second quarter of the RMS, operating margin increased by 150 basis points to 26.4%. This improvement was driven primarily by leverage from higher revenue growth in China due to the timing of large model shipments and last year's COVID related impact. Because the timing of large model shipments in China is not linear we are expecting the third quarter RMS revenue growth rate and operating margin will be a bit lighter than the second quarter as a result of fewer shipments. Revenue for the Manufacturing Solutions segment was $186.5 million, an increase of 6.6% on an organic basis compared to the second quarter of last year. The increase was driven by the CDMO and Microbial Solutions businesses, partially offset by continued softer demand for biologics testing. The cell and gene therapy CDMO business had a strong quarter reporting a solid double digit growth rate. We are very pleased that the initiatives the CDMO team implemented over the past eighteen months to improve performance have been successful and are beginning to generate the intended results. The creation of centers of excellence in gene modified cell therapy, viral vectors and plasmids has more optimally aligned the business and investments in the commercial readiness of our operations and efforts to continue to improve the sales funnel for new projects have also contributed to the performance improvement. We are also pleased to be working with a commercial self therapy client in Memphis and have a few other clients who are nearing commercial launches over the next one to two years at both Memphis and our Gene Therapy Center of Excellence in Maryland. Microbial Solutions delivered a solid second quarter performance led by the continued strength of the Accugenix Microbial Identification platform. Last month, we were very pleased to have completed the launch of our Endosafe Trillium recombinant cascade reagent, or rCR for bacterial endotoxin testing. This animal free solution reinforces our commitment to sustainability initiatives and provides a recombinant alternative for indecisive clients who wish to become early adopters of more sustainable testing methods. Trillium utilizes three biological proteins which we believe provides superior accuracy and testing outcomes to competitors, single protein alternatives as well as equivalents to LAL based testing measures. With the launch of reagent kits in July, we plan to have Trillium cartridges available this winter, which clients will be able to utilize in their existing Endosafe systems for a seamless transition from LAL to rCR. We believe that client adoption will be gradual over the next several years as most clients will likely continue to rely on our LAL based Endosafe cartridges which utilizes 95% less LAL than traditional methods. The introduction of the animal free Trillion solution supports our advancement of responsible science and further enhances our industry leading position as the only provider who can offer a comprehensive solution for rapid manufacturing and quality control testing. Testing volume in the biologics testing business improved from the seasonally soft first quarter level. But the year-over-year growth rate continued to be pressured, particularly for viral clearance and cell banking services. We believe the performance is indicative of the current market dynamics of clients reprioritizing projects and becoming more budget focused, particularly for services that could be conducted at various times during the development process. Manufacturing segments operating margin declined by 570 basis points year-over-year to 22.9 % in the second quarter of 2023, but did improve sequentially as anticipated. The year-over-year decline was primarily driven by the biologics testing and CDMO businesses, but we do expect the segment margin to continue to trend higher, particularly as the CDMO performance continues to improve. We were very pleased with the second quarter results which gave us the confidence to narrow a 2023 revenue growth and non-GAAP earnings per share guidance to the upper ends of the previous ranges. Although some demand trends are moderating, we believe that's a fundamental drivers of our business are intact and we are well positioned to manage through any near term fluctuations for several reasons. First, clients are under intense pressure to bring new drugs to market, we believe they will always a large experience scientific partner like Charles River who can provide the greatest value to them through unmatched scientific expertise and flexible and efficient outsourcing solutions. Second, the scale and duration of our DSA backlog provides us the visibility to more effectively manage the business through timing and location using our global network of facilities. And third, we will continue to drive a culture of continuous improvement, speed and efficiency. As a result of our digital transformation, which provides us with better access to data and insights internally to appropriately manage costs and investments and enables our clients to access real time data, e-commerce solutions and other self-service tools. And finally, we believe the power of our unique portfolio differentiates us today more than ever from other companies that provide R&D support services to the bio-pharmaceutical industry. As part of our annual strategic planning process, we recently completed a thorough review of the current market environment, our growth prospects and the strategic imperatives for our company. Through this process, we believe the current and market trends could be characterized as a normalization from the past several years when there was unprecedented focus on investment in biomedical research and scientific innovation. However, we are optimistic that we will be able to capitalize on the many opportunities our markets provide. We intend to share more of our conclusions and update our longer term financial targets at our Virtual Investor Day, which we have planned for Thursday, September 21. To conclude, I'd like to thank our employees for their exceptional work and commitment and our clients and shareholders for their continued support. Now, Flavia will provide additional details on our second quarter financial performance and 2023 guidance.

Todd Spencer:

That concludes our comments. We will now take your questions.

Sandy Draper:

Great. Thanks very much. And I apologize hopefully Jim you didn't cover this. I had to jump on the call a little bit late. But in terms of the demand environment is there a noticeable split between the types of customers large pharma, mid-size pharma, emerging biotech that it's--- is it coming in any particular area any whether by size by therapeutic classes, any way to think about sort of or is it broad based that you're seeing sort of come a little bit more cautious as across all the different therapeutic classes and all the different sizes? Thanks.

Sandy Draper:

Great. Thanks, Chairman. I'll just keep it to one question for now. Thanks.

Operator:

Thank you. And we'll take our next question from Eric Coldwell with Baird. Your line is open.

Jim Foster:

Yes, difficult to say where it settles out. So we had a sickly, frothy market and clients, definitely -- concerned about getting slots? And so they booked way out. So yes, we got as far out as you know seventeen, eighteen months, we talked about that. We got about thirteen months of coverage right now, which, feels good. We will have less slippage, so slippage increased, sorry, we've always had slippages increase just because the sheer volume of work has increased by the same token, I think people were holding slots without necessarily knowing what drug they would put into that slot. That's exacerbated by the fact that everybody's sort of refining their pipelines. And so as things continue to normalize which they are and we think they will continue to, I think the good news is that they'll be booking studies somewhat closer to when they start. So that's a good thing for them and for us. We should see a reduction in slippage for sure, but we should still have a substantial amount of business and backlog where it shakes out is a little bit difficult to call. What we've said is it's normalizing instead of returning to the mean, and I think all of that's true. We've gotten a significant amount of price each year for the past half a decade anyway, increasingly so because the studies are more complex. So as we look to the current and the future, we think the price will continue to be an important part of the equation, as will some substantial volume. So we'll just have to walk through this together as we walk through the quarters. The other thing which we keep saying that I'm not sure people pay a lot of attention to it, is we don't have linearity in our business. So, last year we had a very slow first half and a very strong second half. This year we've had a very strong first half and a less, sort of pointing to a less strong second half. That doesn't necessarily tell you much because our clients look at the spending throughout the whole year and we've -- I think we've been able to call, so the annual cadence really well. But we feel that that business is good, demand is solid, we have a strong competitive situation and that our clients will be focusing on studies to start more rapidly than they have over the last two years.

Eric Coldwell:

And Flavia, if gross bookings were above one, is I think about this 12% revenue growth in the segment, does that mean gross bookings were up 12% plus as well? Am I thinking about that right?

Eric Coldwell:

Okay. Thank you.

Derik De Bruin:

Hi, good morning. Thank you for taking my question. So I've got two. Jim, we continue to get a lot of questions from investors about -- speaking about how NHP pricing is going to roll to the business that normalizes and pricing starts to come down. People are worried about your margins. Can you sort of walk through the impact of what that has done in terms of NHP price on your margins and just sort of how you're sort of thinking about mitigating that? Thanks. And then I've got a follow up.

Derik De Bruin:

Great. And then a follow up on the Manufacturing segment, high single digit growth now versus high single low double digit prior. Just a little bit more color there in terms of some of the headwinds in terms of the testing business and just what you're seeing in the CDMO just basically the questions or goes into this is like when do we expect that business to go back to its potential double digit growth rate? Is that feasible going back and looking at 2024?

Derik De Bruin:

Thank you.

Tejas Savant:

Hi guys, good morning. I want to go back to that earlier question on price, Jim if I may. You know in the past you've always told us that clients are less focused on price and safety assessment, more focused on start times. Now obviously that concern around start times no longer seems to be as acute anymore and will likely keep coming in lower, if you will. So with that sort of backdrop and the macro cross currents that you're seeing, how should we be thinking about pricing into sort of not just the back half of this year, but perhaps into 2024?

Flavia Pease:

The only caveat on -- has that I was include is -- over obviously the last couple of years, inflation has been unusually high and as Jim pointed out, given the complexity of the work that we perform, we are able to pass inflationary pressures to our clients and as that modulates and normalizes that level of past will also adjust. So that's the only thing to keep in mind.

Jim Foster:

Yeah. So you'll have to be patient for another month. We'll give you chapter and verse on where we think we're going, both on the top line and bottom line. Let's wait until we do that on Mass. Q - Tejas Savant All right. Thank you. I appreciate the time.

Dan Leonard:

Thank you. My first question on the NHP situation. It sounds from your remarks that the solution you have in place to utilize your global footprint is permanent. What are the implications of that for margins or otherwise?

Dan Leonard:

But it's possible that it's permanent, right?

Dan Leonard:

Understood. And I have a follow up, Jim, on your CDMO business. You mentioned that you have a few other clients reaching commercialization in the next one to two years. Possibly you could speak to whether any of these are more meaningful indications and could be more needle moving. Thank you.

Dan Leonard:

Yes, more meaningful indications or more needle moving?

Dan Leonard:

Appreciate those thoughts. Thank you.

Elizabeth Anderson:

Hi, guys. Thanks so much for the question. Maybe I have sort of a two-part question, one on the short-term side and one on the longer term side. If we talk about sort of what -- your commentary on, on DSA bookings and cancellations, I'd be curious sort of if you could talk about whether you saw the accelerating cancellations continuing into July? And then on the longer term end of the spectrum like can you help remind us like if we've gone through other sort of biotech funding cycles like if we think back to 2016, 2017 or even back to the financial crisis? Like how do we sort of like thread this sort of improving biotech funding environment that we've been seeing your sort of cancellation commentaries in terms of like when those things sort of the funding sort of might come through to offset that? Thanks.

Elizabeth Anderson:

Got it. That’s helpful. And then just a quick follow up, in terms of the more global NHP work that you talked about before, are you seeing an interest from non-Chinese clients and doing NHP work in China or is that kind of remain like a more dominated by Chinese biopharma companies?

Elizabeth Anderson:

Got it. Thanks so much.

Dave Windley:

Hi, I wanted to clarify quickly. In your answer to Eric, Flavia, did you say gross bookings about one times or above one times, just interested in -- are we talking 1.01 or 1.1 or 1.2, just an order of magnitude if you don't mind?

Dave Windley:

Okay. Jim, on the international or global activity and repositioning your NHP work, can you talk about -- you mentioned, I think conversations with regulators or work with regulators. Can you, can you talk about the work that you've done there to get either Canada or Europe, European organizations comfortable with the supply chain in a way that the Fish and Wildlife Service is not comfortable?

Dave Windley:

Thank you. And just as a quick follow up, you mentioned to Tejas that, I think you're still seeing price or in the current, just thinking short term in the current environment given the changes in demand trend, are you seeing discounting in the market from your competitors at all for safety assessment studies? Thanks. That's all I have.

Flavia Pease:

Different types of work as well, right? The more complex work, there's less competition and a little bit more -- less resiliency.

Operator:

Thank you. We'll take our next question from Max Smock with William Blair. Your line is open.

Jim Foster:

Yes. The RMS business is particularly strong [indiscernible] it was particularly strong in the second quarter in large measure because of NHP sales in China, service, significant service revenue particularly on the CRAFL and small animals in the U.S. and Europe. So, while there may be less animals acquired for discovery, those animals are obviously used widely in pharmacology and in regulated and non-regulated talks. So I think, I think it will be the minimus and you're not going to get drugs in the clinic next year or the year after or five years from now if the discovery work doesn't start up in a significant way again. So these sort of emphasis on one place or another has to be short lived in terms of the development of pipeline. So, we continue to sell our research models literally to everybody in the world. Business fields between -- quite strong right now we've -- we always have and will and do get price. And we have a much broader portfolio and geographic footprint from the competition. So, while it might be a little bit slow on discovery side, it will continue to improve.

James Foster:

That would be nice, and I'm not sure that that's happening, but it's very complex. It's expensive, it's a necessity. Drugs don't get into the clinic unless you can prove that you cleared any sort of human viruses that might be in the mix. We've seen it historically done earlier in the process. And so it's just simply – it's a little bit comparable to safety studies and specialized safety studies that are way more expensive and clients wait until they're in Phase 2 or Phase 3 before they spend the money on that. So it's not that unusual. It's a very smart thing to do and you don't want to expend the money on a drug that's not going to get to the client, which could happen if you do it prematurely. It's difficult to extrapolate as to whether there's any sort of bolus at all. So I wouldn't want to take a guess at that. I think that for sure, people are sort of whittling down their pipeline; it doesn't mean that they're necessarily selling or canceling programs. It just means that they're shelving them. So that could heat up again and that could bolus of all work across multiple work streams.

Operator:

Thank you. We'll take our next question from Patrick Donnelly with Citi. Your line is open.

James Foster:

If it's a right or wrong way. You've got more work in backlog, which necessitate which brings with it more slippage and cancellation. So it's -- to some extent, its math. But as it's elongated, I think it's exacerbated and increased it. So it's not particularly comparable to other things that we've seen historically which is fine. This sort of demand curve and competitive scenario, complexity mortalities continues to morph and change all the time. But we're definitely normalizing the situation, which I think will be normalized the situation, and we still have 13 months of backlog. I think it will be a better paradigm to predict the next quarter and to come up with our operating plan for 2024 when we do that.

Flavia Pease:

Yes. I think as Jim has said, we'll provide additional clarity to 2024 in our longer-term outlook in our Investor Day on September 21. But I think just in terms of the normalization of any impact of NHP supply, as we said, there shouldn't be anything in Q4 for 2024. So from that perspective, it should be [indiscernible].

Todd Spencer:

I think I'll just up that. I think any one quarter, as Jim said before, that our business isn't linear. So any one quarter is remember a good indicator of a longer-term trend necessarily. I mean we really take a lot of pricing guidance on an annual basis, and I think we've been pretty successful with that so far.

Operator:

Thank you. And we'll take our next question from Casey Woodring with JPMorgan. Your line is open.

James Foster:

Discovery work in discovery comes in very rapidly and goes out very rapidly, Sipho [ph]. The demand curve can turn on a dime as our client smaller and some midsized clients get more comfortable with their access to capital. There's lots of tea leaves to reap there, right, it's follow-ons and IPOs and money coming in from big pharma and DCs, et cetera, which appears to be strengthening. At what point the clients are comfortable enough to prosecute a larger cadre of drugs is somewhat unclear, but it seems to be moving in the right direction. So we felt for a long time with the client base. It's been extremely well financed. And I wouldn't say they're poorly financed right now, I'd just say that there has been mounting concern about the weather access to capital would continue or not. So given that the tea leaves look positive, we would think that at some point, they would be more comfortable with that. But right now, there's definitely an enhanced focus on the clinic. That makes a lot of sense. It's not a huge surprise but they have to get back to basic discovery sooner than later.

Flavia Pease:

Yes. So I think between Jim and I, we addressed this in the prepared remarks. There's a few items impacting the second half and in particular, DSA. There is a little bit of NHP supply impact in the third quarter. Just as we finalize the rescheduling of the work across our international footprint. There's also a comp. If you will have the last year, DSA was incredibly strong in the second half. So we have those costs impacting it there. I think as we got it to a mid-single digit in the first half of the SA being about 15%, 17%, you will see a second half deceleration of that growth rate.

Operator:

Thank you. We'll move to our next question from Justin Bowers with Deutsche Bank. Your line is open.

James Foster:

Sure. We've got three centers of excellence in that business now, which is a change from the companies that we bought. So one company doing gene-modified cell therapy manufacturing, another one doing viral vector manufacturing and another one doing plasmids. We've spoken previously, we have enhanced change and we upgraded pretty much staffing across the board from sales for regulatory folks to our general managers. We definitely have improving books of business in all three of those locales subject to the caveat they all have a slightly different time frame to generate new business. As we said a moment ago, we do have a few clients that we're talking to about moving into a commercial domain in the cell therapy manufacturing business. So it takes some time for a world to actually acknowledge and that we're in this business that we do it seriously, what our products and services are and how they can contrast that with others that they could do the work with. So we had a rough year last year, for sure, just kind of retooling these businesses. They feel like they're a much stronger place right now. Clients seem much happier. We've got some regulators in. And so we're confident that we're going to have higher growth rates this year and meaningful improvement over the past year or last year. And we anticipate that, that will continue. We had great hopes for these businesses, both in terms of top line growth, significant top line growth that would be accretive to both manufacturing for sure and the company as a whole and that the margins would improve as the scale improved, which we still believe.

James Foster:

Yes, again, a bit tough to say, but we probably have six to nine month backlog depending on the type of tax work of specialty for general and depending on the client and the locale, they got much longer than that. Historically, never got more than, I would say, nine months. So the kind of pre-COVID was as it was in a good place. And we have more price lately than we used to in those days. So the hope would be that we get back to a reasonably attractive run rate that both allows us to take share and continue to gain our price and continue to be paid for the complexity of our work and utilize our capacity. So I'm pretty comfortable with the capacity situation, both staff and space for us and the industry and for us, particularly since we're the largest player. I think that plays very well to this continuing to be a financially beneficial business with hopefully improving operating margins over time.

Operator:

Thank you. We'll take our next question from John Sourbeer with UBS. Your line is open.

James Foster:

So not going to break down the growth rate on the individual pieces on a quarterly basis. But that business continues to have terrific technology, IP that's quite advanced, a broader portfolio than any of the competitors that's using a classic capabilities and our cartridges and now coming [indiscernible] common version of that cartridge using less and less crude out of the [indiscernible] and continued more automation and the utilization of digitization. So that business, which is extremely profitable, we do think has the propensity to be more profitable and certainly grow at historical rates. So – and also has a sort of increasing connectivity with our Biologics business and our cell and gene therapy business. So it was a little more of a – it's always been an attractive business. It's a little bit of an outlier years ago, and it feels much more central to the portfolio than it has historically. So we remain very positive about the current and future prospects of that business

Operator:

Thank you. We'll take our next question from Jacob Johnson with Stephens. Your line is open.

James Foster:

Yes. The client base has been and continues to be very surprising. So we thought it would be all tiny biotech companies that we're watching that cash or didn't want to commit to large amounts of space in places like Kendall Square and Cambridge or South San Francisco. And we have a bunch of those. We have a surprising number of really midsized companies and big pharma companies, which is a surprise because even they either run out of space or don't want to build new space and have a hot new drug that they want to work on. And so we love that. So we have some very big pharma footprints in many of these geographic locales. So it's a business that is even more attractive than we originally thought. It has very high growth rates, very high margins. You would be very impressed with the client base at each site. Some of the sites get full before we open them. People go through them and they kind of commit to them. As we said previously, I think the huge opportunity here is the preponderance of the work we do now is often supplying the animals and taking care of them while people do basic research. And that's a perfectly good business, by the way. I think over time, we'll supply the animals, take care of them and participate with the client in running the study or do the entire study for them. And whether or not we do that, this is definitely a business that is currently and will continue to feed other parts of our portfolio, particularly discovery and eventually safety if the drug looks promising. So high-growth, high-margin business, if you looked at it on a see-through basis, it's even higher growth and higher margin. I also think -- I don't mean to be a wise guy with his comment that it's relatively recession-proof -- probably the most recession-proof thing that we do because it's companies large and small, totally depending on our proximity and infrastructure to do their basic research. So we love this business. You saw in the prepared remarks, we have a lot of sites now and a significant amount of square footage. The acquisition that we did last year is doing extremely well to a smart thing for us to do and we love the geographic footprint

Operator:

And we'll take our last question from Tim Daley with Wells Fargo. Your line is open. Please ask your question.

James Foster:

So not going to call that time. I mean the large models at every quarter. And the numbers of animals is a little bit difficult to predict as at the price points, but it’s definitely was beneficial to the RMS top line growth rate and margin for the quarter. It continues to be a very attractive market for us. It was adversely impact a little bit over the last couple of years with some of the COVID lockdowns. But we have several new facilities. We're trying to cover the whole country. Competition continues to be local. We're getting a decent price and we like both the growth rates and the margin. We're also beginning to see significant improvement in the service businesses in China as we're seeing in the U.S., in Europe. So it's a marketplace, as we've said many times, it's reminiscent or the U.S. and Europe or maybe 20 or 25 years ago. So we would anticipate additional continued high growth. And we continue to be surprised by the lack of sort of the global players still not getting into China. So we're sort of on our own as a non-Chinese entity.

Operator:

Thank you. We have no further questions in the queue. I will turn the conference back over to Todd Spencer for closing remarks.

Operator:

Thank you. That does conclude today's Charles River Laboratory’s Second Quarter 2023 Earnings Call. Thank you for your participation and you may now disconnect.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories First Quarter 2023 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

Jim Foster:

Good morning. We had a strong start to the year with organic revenue growth of 15.4% and non-GAAP earnings per share of $2.78 both widely exceeding the outlook that we provided in February. The year began with a continuation of the strong demand and pricing environment in our DSA segment that we experienced through the end of last year. This was expected based on the strength of the backlog, which supports more than a year of DSA revenue. Clients continue to choose to partner with Charles River for our industry-leading scientific expertise for the breadth and depth of our portfolio and for the flexible, efficient outsourcing solutions that we are able to provide to them. We are a large, stable scientific partner focused on holistically supporting our clients’ drug discovery, nonclinical development and manufacturing efforts, which we believe is increasingly important in the current market environment. The biopharmaceutical end market seems slightly less robust than last year, which we had anticipated and factored into our initial guidance in February. Clients appear to be more thoughtful about their spending and have prioritized their programs at the beginning of the year. This is not surprising in light of the changing macroeconomic factors that are present today and the unprecedented level of biomedical research activity that occurred over the past several years. However, we still believe that our client base remains adequately funded with one sell-side analyst recently estimating that public biotechs still have about three years of cash on hand. Although, we continue to watch the market closely, and are seeing a normalization of demand trends towards pre-pandemic levels, our clients are continuing to move thousands of their critical programs forward with us. So we believe these trends and current business development activity firmly support our financial guidance for the year. Before I provide more details on our first quarter financial results, I would like to provide a brief update on the nonhuman primate or NHP supply situation. As you know, we suspended shipments of Cambodian NHPs into the U.S. in February. We took this action so that we could develop and implement new testing procedures that would reinforce our confidence that the NHPs we import from Cambodia are purpose-bred. We have made advancements towards identifying a new testing platform and implementing the new testing procedures and are engaged with the relevant government agencies in furtherance of the needed resolution. We have also been working in parallel to accommodate our clients NHP-related study stocks by utilizing our global safety assessment site network. Our global scale is one of the key factors which we believe differentiates us from the competition. We believe that these efforts will mitigate some of the NHP supply impact on our clients’ programs that we expect during the second half of the year and afford us greater confidence in our 2023 financial guidance. Our wider guidance range continues to accommodate a number of scenarios related to the success of our mitigation efforts since our plans have not yet been fully implemented and NHP supply remains a fluid situation. As a reminder, biologic drugs cannot be approved for commercial use without NHPs. And it is critical that we work diligently with industry and government agencies to resolve the NHP situation and restore this important supply chain so that life-saving therapies can continue to move forward. I’ll now provide highlights of our first quarter performance. Reported revenue of $1.03 billion in the first quarter of 2023, a 12.6% increase over last year, organic revenue growth of 15.4% was driven by the robust DSA performance as well as solid RMS growth. The manufacturing growth rate was impacted by a challenging year-over-year comparison as well as lower-than-anticipated Biologics Testing volume to start the year. By client segment, global biopharmaceutical companies, small and midsized biotechs and academic and government accounts all made significant contributions to the growth rate. The operating margin was 21.2%, a decrease of 20 basis points year-over-year. The decline was driven by the Manufacturing and RMS segments. Earnings per share were $2.78 in the first quarter, an increase of 1.1% from the first quarter of last year, strong low double-digit operating income growth was modestly – was mostly offset by increased interest expense and a higher tax rate compared to the prior year as well as the impact of the Avian Vaccine divestiture. Based on the strong first quarter performance and expectations for the remainder of the year, which remain largely consistent with our initial outlook, we are narrowing our organic revenue growth guidance to a range of 5% to 7.5% and our non-GAAP earnings per share guidance to a range of $9.90 to $10.90 for 2023. We’ve increased the lower end of the ranges by 50 basis points and $0.20 per share respectively. As I mentioned, our outlook continues to reflect the anticipated financial impact of the Cambodian NHP supply constraints, which will have a greater impact on the second half results. I’d like to provide you with additional details on our first quarter segment performance beginning with the DSA segment’s results. DSA revenue in the first quarter was $662.4 million, another significant increase of 23.6% on an organic basis. The Safety Assessment business continued to be the principle driver of DSA revenue growth with significant contributions from study volume and base pricing with NHP pass-throughs also adding to the growth rate. Although revenue for Discovery Services increased in the quarter, growth rate continued to modulate, which we believe is reflective of the current market environment coupled with the shorter-term nature of both discovery projects and the businesses backlog. The DSA backlog decreased modestly on a sequential basis to $3 billion at the end of the first quarter from $3.15 billion at year end. As previously mentioned in February, this trend is reflective of the normalization of booking and proposal activity that we experienced at the end of last year and in the first quarter. Clients are not booking work as far out as they did over the past few years, and we believe this is the result of their evaluation of pipeline priorities and scheduling with a nearer-term focus. That said, we believe these trends in the current market environment, coupled with the strength of our current backlog, which still affords us 14 months of revenue coverage in our Safety Assessment business will drive the expected DSA revenue growth this year. Our client base remains stable and resilient. Our biotech clients continued to send us new programs and generated healthy double digit revenue growth in the first quarter. It was also encouraging to see that biotech funding levels increased year-over-year by more than 20% in the first quarter to approximately $15 billion. We believe this higher funding demonstrates that venture capital remains a reliable source of funding to enable biotech clients to spend on their promising molecules and the public markets had a better quarter. Moreover, large biopharmaceutical companies continue to move programs forward with vigor, with first quarter revenue growth outpacing biotechs and demonstrating the strength and balance of our client base. Through the first four months of the year, 14 new drugs were approved by the FDA, which is on pace to exceed last year’s total. Since we have worked on over 80% of the FDA-approved drugs over the last five years, we believe the pipeline of new drugs supports ample future growth opportunities for us. However, after three consecutive quarters with extraordinary revenue growth above the 20% level, the DSA growth rate is expected to moderate over the course of this year due to three primary factors. The normalization of the demand trends has just discussed, more challenging year-over-year comparisons as 2023 progresses and the impact of NHP supply constraints mostly in the second half of the year. We expect less of an impact from NHP supply constraints in the second quarter than originally planned because of our ability to collaborate with our clients, optimize study schedules, leverage our flexible global infrastructure, and also due to our extensive backlog coverage across multiple study types. And as I said earlier, the strong first quarter results and our progress with regard to additional mitigation efforts around the NHP supply constraints over the course of this year have also improved our confidence in our full year financial guidance. We are moving forward with plans to reconfirm NHP study starts that are already scheduled for the second half of the year. Based on communications with our clients, we are confident that we remain the preferred partner for the preclinical development activities because of our global scale, scientific differentiation, exceptional quality and the value that we bring to the research and development efforts. Even in this time of disruption in the NHP supply chain, we do not believe the competition can provide a better value proposition to clients than we can. DSA operating margin was 29% for the first quarter, a 610 basis point increase from the first quarter of 2022. The increase continued to be driven by operating leverage associated with meaningfully higher revenue in the Safety Assessment business as well as price increases. RMS revenue was $199.8 million, an increase of 6.8% on an organic basis over the first quarter of 2022. The RMS segment benefited from broad-based demand for small research models in all geographic regions, for Research Model Services and for the Cell Solutions business. The RMS growth rate was below the high single digit target for the year due primarily to RMS China. While demand for small models remained strong, the timing of NHP shipments to clients in China impacted the first quarter growth rate. Since exports from China were shut down at the beginning of the pandemic, we had been selling a relatively small number of NHPs locally to clients since we were unable to utilize these models in our global Safety Assessment operations. We expect the RMS growth rate to meaningfully improve in the second quarter as the NHPs have shipped in China, and we continue to expect RMS to deliver high single digit organic revenue growth in 2023. Outside of China revenue growth for small research models in North America and Europe remain strong, driven by healthy volume increases in North America and continued pricing gains globally. We believe demand for research models is an excellent indicator of the health and stability of early stage research activity. The demand and pricing trends this year demonstrate their clients are continuing to move their research program forward, which will drive solid RMS revenue growth. From a services perspective, revenue growth was also broad-based with the Insourcing Solutions and GEMS businesses leading the way. Insourcing Solutions or IS growth continued to be primarily driven by our CRADL operations, which offer flexible vivarium rental space at Charles River sites to both small and large biopharmaceutical clients. Having expanded significantly last year through both the acquisition of Explora BioLabs and by adding nine CRADL and Explora sites, we are now focused on ramping up utilization of the new sites as well as continuing to moderately add new sites. This will generate a runway for continued robust revenue growth and margin enhancement opportunities for CRADL. Our traditional IS model, which provides staffing and vivarium management at our client sites still resonates with clients. It has historically had a larger academic and government client base. However, commercial clients are also seeking the benefits of driving cost savings and greater operational efficiency by allowing us to manage their internal vivarium. We were pleased to add a new meaningful commercial biopharmaceutical contract in the first quarter. We also continue to expand our GEMS business in North America to accommodate increasing demand from both biopharmaceutical and academic clients as they partner with us to maintain their proprietary genetically modified model colonies. These models are playing an increasingly critical role as drug research becomes more complex with a shift to oncology, rare disease and cell and gene therapies. In the first quarter, the RMS operating margin decreased by 650 basis points to 23.4%. Most of the decline was driven by the temporary headwind related to timing of NHP shipments within China. Revenue mix was also a factor due in part to the Explora acquisition in April 2022 and the ramp-up of utilization in our CRADL and Explora operations, which were expanded last year. We expect the RMS operating margin to meaningfully improve in the second quarter as these headwinds subside. Revenue for the Manufacturing Solutions segment was $167.3 million, a decrease of 1.8% on an organic basis compared to the first quarter of last year. The decrease was driven by the CDMO and Biologics Testing businesses, partially offset by a solid performance for the Microbial Solutions business. As we mentioned in February, we expected the segment’s year-over-year revenue comparison would be challenging due to commercial readiness milestones in the CDMO business and COVID vaccine testing revenue in the Biologics Testing business. Both of which occurred in the first quarter of last year. We believe these factors will be largely anniversaried beginning in the second quarter. In addition to these factors, the Biologics Testing business experienced a slower start to the year. Testing volume tends to be seasonally softer in the first quarter with lower sample volume reflecting reduced client manufacturing activity over the holidays. This year, we also experienced lower-than-anticipated volumes, particularly for viral clearance and cell banking services. Because clients seem to be prioritizing their programs and more budget focused at the beginning of the year. Microbial Solutions delivered a solid first quarter performance led by the continued strength of the Accugenix microbial identification platform due to both instrument placements and demand for our testing services. Our advantage is as the only provider who can offer a comprehensive solution for rapid manufacturing and quality control testing continues to resonate with our clients. The cell and gene therapy CDMO business continued to make progress towards its targeted growth rate goal. As expected, the growth rate was affected by the comparison to the commercial readiness milestones paid in the first quarter of last year, but the initiatives that we have implemented to improve the performance of our CDMO business continue to gain traction and earn positive feedback from clients. We believe that the success of these actions and an increasing sales funnel will result in a marked improvement in the CDMO growth rate in the second quarter. Now we expect the CDMO business will drive a rebound in the Manufacturing segment organic growth rate over the course of the year. The Manufacturing segment’s first quarter operating margin was 13.7%, and a significant decline from 33.1% in the first quarter of last year. The decline was primarily related to lower operating margins in each of the segment’s business units, particularly CDMO and Biologics Testing. This was driven largely by the prior year headwinds and the slower start in the Biologics Testing business that I discussed as well as an asset impairment in the segment. As anticipated, end market dynamics have moderated somewhat in 2023, but it’s important to reiterate that our client base remains stable and resilient, particularly biotech. These companies have now become the innovation engine for the entire biopharmaceutical industry with a number of biopharma companies with active pipelines doubling over the past 10 years. We believe the early stage research that we conducted is instrumental to our biotech clients achievement of the important milestones that enable them to secure additional funding, and therefore, they will continue to partner with Charles River for our flexible and efficient platform that accelerates their therapeutic innovation. These factors, coupled with the strength and scale of our DSA backlog and the substantial visibility that it provides will enable us to better withstand any near-term fluctuation in the market. We believe the power of our unique portfolio differentiates us today more than ever. From other companies that provide R&D support services to the biopharmaceutical industry. We are continuing to further distinguish ourselves scientifically by adding capabilities in biologics and cell and gene therapies. By investing in technology partnerships to bring cutting-edge tools to our clients and by building greater digital connectivity with our clients, including through the launch of Apollo in March. Apollo will revolutionize client access to real-time study data, planning and cost estimates and other self-service tools. To conclude, I’d like to thank our employees for their exceptional work and commitment and our clients and shareholders for their continued support. Now Flavia will provide additional details on our first quarter financial performance and 2023 guidance.

Todd Spencer:

That concludes our comments. We will now take your questions.

Eric Coldwell:

Thank you. Good morning. I wanted to just clarify. Last quarter, you highlighted the 200 to 400 basis point potential impact from NHPs this year. I may have missed it, but I didn’t see an update on that commentary. It looks like Q1 probably did a little better than the Street expected, 2Q looks better than the Street expected. I’m just curious if your range of potential impact has changed or if it’s just shifted totally out to the third and fourth quarter? That’s the first question. I have another.

Eric Coldwell:

Okay. And just maybe a bigger picture question on this topic. Has any government agency actually blocked importation or exportation or changed any policy? Or are all of your actions to this point, very much proactive and internally driven decisions to just be as safe as possible.

Eric Coldwell:

Okay. I’ll let others jump in. Thank you very much.

Operator:

And we’ll take our next question from Derik De Bruin with Bank of America.

Jim Foster:

Hi, Derik.

Jim Foster:

So we don’t have any indication that the supplies are going to China. Of course, we did not get animals from all of the suppliers there, only one principal one. So we don’t categorically know, but I would doubt that China has lots of NHPs themselves, which is how this whole thing started. We’re doing the best we can to accommodate the demand by doing work in multiple geographies within CRL. We’re as confident as we can show parentage if we – as the discussion continues, and we have clarity and sort of cooperation with the various supply sources so I don’t think this is a situation of getting that supply back from some place that they’ll be gone forever. I think this is a transitory situation sort of an unusual one, frankly. I just want to reiterate for the record that we’re cooperating in an investigation, providing information. I think we’re cooperating really well. We’re not a target of investigation, and we don’t know whether our supplier is, but we can just tell you that we’ve been there, we think the place is well run, pursuant to the sort of CITES oversight that’s required for purpose-bred breeding. We also think that the veterinary oversight and nutritional oversight and transportation oversight and the farm that we utilize has done really well. So given our experience with farms all over the world, including farms that we had ourselves years ago and started on our own we think it’s a good supply. So again, just to go back to my answer to the first question, we’re being very responsive on a timely basis with the folks that are asking us for information but we have very little control over the pace and response and how we move forward. But I would be surprised and disappointed if Cambodia doesn’t continue to be a source of supply. And as you know, really well given your scientific background, not doing a sufficient amount of large molecule work and moving these drugs through the FDA, without using NHPs. So it’s not optional. And since this is the largest supply source, it’s something that needs to be rectified in as timely a basis as possible.

Jim Foster:

Sure. Thanks, Derik.

Sandy Draper:

Thanks very much. I guess maybe just thinking about the quarter, obviously, strong – strong quarter total, that sort of it looks like we as well as the Street sort of mismodeled DSA was much stronger than we expected. RMS, pretty much in line, manufacturing lower. I’m just curious I know you don’t give quarterly guidance by segment, but was this type of result generally in line? It sounds like maybe you’re a little bit surprised by DSA. Just trying to think about how these results compare and so how we should be thinking about your commentary on full year growth rate by segment, are those still appropriate or based on the first quarter results, should we be sort of rethinking stronger DSA but lighter manufacturing and RMS. Thanks.

Flavia Pease:

Yes. And Sandy, I think we always talked about how our business is not linear and it’s not linear in totality and definitely not at a segment level either. And so to Jim’s point, RMS, we reaffirmed our full year guidance of high single digits. We talked a little bit about some timing events in RMS in the first quarter. That will normalize in the second quarter. DSA was very, very strong in the first quarter. As Jim pointed out, continued strength following the second half of 2022, I also commented that the growth will modulate throughout the year, both given the comp as the growth accelerated in 2022 you’d have a comp dynamic that will impact 2023. And we reaffirmed our guidance of low to mid-single digits for the year. And Manufacturing Solutions, as Jim pointed out, had a couple of headwinds in the first quarter with COVID vaccine volumes that are no longer existing as well as the CDMO milestones and we talked a little bit about a slower start in biologic solutions. So we expanded the guidance range a little bit to now include high single digit to low double digit for the year. The previous guidance was low double digits. So we just extended that range.

Sandy Draper:

Great. That’s really helpful. Thanks so much for the comments.

Unidentified Analyst:

Good morning. [Indiscernible] Olivia on for Patrick. So just one more on the NHPs. It sounds like you’re making progress on the test to determine parentage. I guess how long do you anticipate the rollout of that test, what you have, it will take throughout your supply and anything that we can expect there? And I’ll leave it at there. Thank you.

Flavia Pease:

And if I can just add to Jim’s point, we made progress on scientifically identifying how the test can be done. It will take some time to operationalize, given, obviously, the supply logistics and everything. So it is as we continue to work with government authorities, it will take some time to get this off the ground.

Operator:

And we’ll take our next question from Max Smock with William Blair.

Jim Foster:

So we’ll both comment on this. Proposals and bookings continue to be strong, less strong than last year, which was a very unusual year. Enjoyable but unusual. And you have a combination of factors. But I would say the principal factor is you have clients that at a certain level of waiting to start this study, it just becomes problematic for them to plan their business and to get drugs into the clinic and ultimately into the market. So we’re seeing a normalization kind of pre-COVID normalization of that level of demand, still healthy, still a lot of price, still everybody – not everybody but almost everybody comes to Charles River for the really complex work and our geographic footprint. So we think this is in the process of normalizing. We think the demand will – I’m not going to tell you about 2024, but the demand will remain strong this year. If you didn’t have the sort of private overhang, I think we would have a very strong year in the safety business, not to the level of last year. So we’re not concerned by that. We’ve got a very big denominator in this business. It’s a big business now. We’re having nice growth rate, taking share, getting good price. We don’t see any amelioration of that.

Max Smock:

Got it, thank you.

Dave Windley:

I do have a brother name, Steve Windley, so hi, good morning. I actually – my brother is actually Steve Windley. So Jim, I’ll redirect a little bit. I know you already said no more NHP questions. I’m going to try to ask a positive. Yes, in your proxy, you put a kind of a commitment to 2024 broadening out your supply chain diligence and how you work around your sourcing of these animals that are needed for research. I appreciate that. I look forward to the information in that. I guess, I’m thinking in that context, certainly, if we go back to November, when the indictments were first unsealed, certainly kind of a big shock to the industry. How has that influenced your proxy calls at risk-based due diligence and risk-based supplier oversight. How has the environment changed the way you go about evaluating the situation. At SOT, there was a suggestion – I thought I understood that you were not importing Cambodian animals into any part of the business, international or the U.S., and you’re saying U.S. today. So I wanted to understand that. But just kind of the risk management around the situation, how has the changing environment changed your risk management.

Dave Windley:

Appreciate that. If I could – that was a long question and answer, if I could attempt to clarify one thing in the prepared remarks. So you talk about these NHPs and use the term pass-through. The pricing on the NHPs has gone up a lot. I just want to make sure I understand because DSA margin was very, very good, maybe the best of all time and that rising price on NHPs if it is only passed through would be a pretty significant headwind to your margin. And so I was hoping maybe Flavia, if you could clarify that for us. Are the NHPs contributing to margin? Or are they a detriment to margin? Thanks.

Dave Windley:

Okay. Thank you. Thanks for the extra question.

Casey Woodring:

Hi. Thank you for taking my questions. So as a follow-up to the DSA backlog question from earlier, by our math, it looks like bookings were down over 40% on the year in the quarter. So was that step down in line with your booking normalization expectations in DSA? And then just on manufacturing quickly, appreciate the commentary around the tough comes from last year, but curious as to the rationale for widening that growth range for the year. Wondering if there’s any cushion baked in for a more volatile cell and gene therapy demand environment just given some of your peer commentary in the CDMO space from earlier this week? Thanks.

Todd Spencer:

I think we’re ready for the next question.

Tejas Savant:

Hey, guys. Good morning. And Jim, since you’ve told us not to ask about NHPs, that is exactly what I will do. Just one clarification actually to that first question from Eric. Flavia, you mentioned sort of the 200 bps to 400 bps range being the same, but at the same time, you also talked about how some of your ongoing efforts should mitigate some of the impact here. So is it fair to assume that at the midpoint, things have moved a little bit towards the lower end of that 200 bps to 400 bps range? And then Jim one for you in terms of just dealing with the competition here, more tactical rather than structural long-term, because I know you’re very competitive here. But given some of these Chinese CROs and NHPs being an abundance supply there, also some of your U.S. competitors perhaps acquiring NHPs from some local suppliers, which you may or may not have wanted to deal with. How do you think about the near-term sort of tactical competitive landscape in the market at the moment?

Jim Foster:

So on the NHP competitive scenario, I’d say a couple of things. One is, there’s obviously a significant number of NHPs in China to be utilized by Chinese CROs to both support their current industry – I mean, their internal China industry and perhaps some U.S. and European companies. The scale of the industry there is still relatively small. Obviously that’s subject to change over a period of time. Some clients may – some Western clients may have gone there. It’s difficult for us to tell, but not too many. And I think there’s a reluctance for a whole bunch of obvious reasons to be taking your new drug – newly patented drugs and doing the work in China. But having said that, I think they’ll get the work done wherever they can. With regard to our domestic competitors, I’d remind you that number one, they’re smaller – way smaller. Number two, I think they have very limited supply sources. Number three, I think they’re also not bringing animals in from Cambodia. Number four, they may be using suppliers that we might not use. So, we’re constantly trying to take the high road in terms of quality, consistency and volume of supply and we think we’re in a very strong competitive position.

Jim Foster:

Sure.

John Sourbeer:

Good morning and thanks for taking the questions. I guess just looking into the CDMO, could you just talk about some of the backlog building there? I know there’s been some announcements over the last several months and just the maturity of some of these programs and you still see the potential for commercial products this year or into next year. And then just one follow-up too, on unrelated subject. There’s been some press reports on bans of harvesting of horseshoe crabs. Just any comment there on or what the size of that business is for Charles River? Thanks.

John Sourbeer:

Thanks for taking the questions.

Justin Bowers:

Hi. Good morning, everyone. Just sticking with the CDMO and the improvements there. Sequentially, I think in the deck or the prepared remarks too, you talked about returning to those targeted growth rates. Can you just remind us what those are? And then maybe qualitatively is, for 2023 are you thinking that that business is sort of above or below the segment growth rates for the year?

Justin Bowers:

Great. And congrats on the commercial production there in Memphis. And then maybe just a quick follow-up on RMS and NHPs in China. Is that – are the – is the messaging there? Was there a blip in 1Q and then it’s back to normal in 2Q? Or has something changed in the way that you’re sort of going to market there with RMS and NHPs in China?

Flavia Pease:

Yes. It’s purely timing. I would characterize.

Operator:

And we’ll take our next question from Elizabeth Anderson with Evercore.

Flavia Pease:

Yes. So Elizabeth, we’ve been talking about cancellations and slippage throughout last year as we also continue to talk about the size of the backlog, which had expanded to significantly higher than historical levels. And we talked about the elongation of that backlog, which, as one might expect would drive additional cancellations or slippage. So first, cancellations and slippage of a normal part of the business as clients do not have the test articles ready or continue to negotiate design study with the appropriate regulatory agencies that normally happens in the business. As the backlog elongated in time, that certainly becomes more pronounced as it’s harder to predict things that much into the future. So, we had seen that elongate throughout 2022. I think we’re getting back to I would say, maybe more normalized pre-pandemic levels. And so I think those things will work well adjust together. The backlog is not going to be perhaps as well long and the cancellation and slippage will lower accordingly.

Flavia Pease:

So let me comment first on the Manufacturing Solutions margin in the quarter. So as Jim talked about, we had some of those prior year headwinds with the milestones in CDMO and the biologics COVID volume that we no longer have. We also had a lighter start in Biologics Testing this year. And then I think we also talked about we had an asset impairment in that segment in Q1. So all those things contributed to a, I’d say, unusually low Manufacturing Solutions margin in Q1. I think for the overall margin for the company, we were about 20 basis points lower year-over-year. And we continue provided an update on the guidance for the full year of flat to lower versus 2022, given the continued fluidity of the NHP situation that we talked about earlier.

Operator:

We’ll take our next question from Tim Daley with Wells Fargo.

Jim Foster:

I mean, certainly, for this year, we feel good about RMS growing at high single the constituent parts of that business continue to strengthen. We’re actually gaining share in the U.S. and Europe, which we haven’t seen in a lot of time. We always get price in that business. Chinese business is growing nicely both in the small animal side and NHP business. Service businesses, which have great margins are growing very nicely. Obviously, we did an acquisition last year, which is Explora labs with all of these new CRADLs and very important geographies really great receptivity in a tough economy for these sites. And surprisingly, nicely surprisingly, clients are both very large and very small. And we felt they would be only smart clients. And the cell supply business, which was in the prepared remarks, but we haven’t talked about that much albeit a small business really had probably the only business in the portfolio really had a tough time as a result of COVID and had a very nice first quarter. So I’d say, without getting into 2024, obviously, that the outlook for that business continues to be stronger. [Indiscernible] extremely well utilized competition. Well, we always respect scanning whenever I’m about to say, I would say, is continues to be financially less strong and more fragile. And more silos. So I think it’s difficult for them to compete with us. So we’re feeling really good about that. On the DSA side with some moderation from an extremely strong 2022 and assuming vantage fee situation gets resolved permanently as we hope it does. And we think that’s going to be a DSA should be a strong business for us. Our current guidance given the vagaries is what is a low to mid-single digit, but the current long-term guidance out there is what low double, I think. So we’ll give updates on all of those growth rates sometime when we have our – sometimes when we have our investor conference. So things are a little bit fluid, as I said, on the NHP side, but we’ll give guidance, assuming that, that’s clarified or hopefully it will be clarified by the time we have our investor comments. But I think we have pretty much across the board, very good demand for what we do. I think we’re providing an extraordinarily valuable service and products with various out of a position and great connectivity across the various parts of our business that should only be enhanced given the current portfolio and hopefully, as we continue to add to with very small and perhaps the midsized deals.

Flavia Pease:

Yes. I think the only business really that we have a China presence is RMS with obviously our models business there, but also the services business. And so as you can imagine, because – and then we also have microbial, which is part of the Manufacturing Solutions business, be distributed and available in China. So our largest business – excuse me, lot of [ph] segment, which is DSA, has no presence in China. So as a result of that, China is a fairly modest portion of overall Charles River sales.

Tim Daley:

Great. Thank you.

Todd Spencer:

Great. Thank you for joining us on the conference call this morning. We look forward to seeing you at upcoming investor conference in June. That concludes the conference call. Thank you.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories Fourth Quarter and Full Year 2022 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead, sir.

Jim Foster:

Good morning. Before I speak about our strong fourth quarter results, I want to provide an update on the non-human primate or NHP supply situation. As many of you are aware, there has been an ongoing industry-wide investigation into NHP imports from Cambodia. On February 17, we received a subpoena from the U.S. Department of Justice related to an investigation into the Cambodian NHP supply chain. We have been informed this investigation related specifically to shipments of NHPs received by Charles River from our Cambodian supplier. We intend to fully cooperate with the U.S. government. Once the Department of Justice concludes its investigation, we believe it will find that any concerns with respect to Charles River are without merit. As we have stated before, we are committed to ensuring our operations are fully compliant with all U.S. and international laws and regulations. And we maintain risk-based supplier due diligence, audit and management practices to help ensure the quality of our supplier relationships and compliance of applicable laws, including the status of the NHPs we import. Based on ongoing investigations and a heightened focus on the Cambodia NHP supply chain, in recent months, we have voluntarily suspended planned future shipments of Cambodian NHPs until such time that we and the U.S. Fish and Wildlife Service can develop and implement new procedures to reinforce confidence that the NHPs we import from Cambodia are purpose-bred. This will take time to implement and the duration of which is unknown. The investigation in current NHP supply situation will result in study delays in our Safety Assessment business. By way of background, NHPs are the most scientifically relevant large model for the regulatory required safety testing of biologics drugs as mandated by the FDA and other international regulatory agencies. Biologic drugs cannot be approved for commercial use without NHPs. And given the proliferation of biologic drug development activity in recent years, NHPs have been in high demand. As an example, all of the COVID-19 vaccines developed in the United States and Europe utilized NHPs. In recent years, NHPs sourced from Cambodia have been responsible for approximately 60% of the NHPs supplied to the United States and to Charles River for drug research and development. While there is no other near-term global source to replace the supply, we are continuing to actively work to diversify our NHP supply chain. It’s critical that we work diligently to resolve the NHP supply situation and collaborate with all agencies of the U.S. government, including the U.S. Fish and Wildlife Service, to restore this important supply chain because the U.S. pharmaceutical industry and the patients who need new life saving treatments are counting on us. The current Cambodian NHP supply constraints and the corresponding impact to our Safety Assessment business are expected to reduce our consolidated revenue growth forecast by approximately 200 basis points to 400 basis points this year, resulting in organic revenue growth guidance of 4.5% to 7.5% for the total company. The non-GAAP earnings per share are expected to be in a range of $9.70 to $10.90 in 2023 with the wider ranges encompassing a number of scenarios related to the timing of the resumption of Cambodian NHP imports this year. The top end of our guidance ranges anticipate that we will have Cambodian NHPs available for studies in the fourth quarter, whereas the bottom end of our guidance assumes that we will have no Cambodian NHP imports for the remainder of 2023. In either case, we expect to begin to experience a more meaningful impact from NHP supply constraints in the second quarter. In addition to NHP supply, several non-operating items are significantly affecting the year-over-year earnings per share comparison in 2023, including higher interest expense, a higher tax rate and the divestiture of our Avian Vaccine business, which was completed in December. These items will generate a combined earnings per share headwind of $1.20 to $1.40 in 2023, partially offset by up to a $0.25 benefit from foreign exchange. Flavia will discuss these items in more detail shortly. Now I’ll speak with you about an outstanding finish to another strong year for Charles River. We reported robust operating performance in 2022, highlighted by 13.4% organic revenue growth against the backdrop of escalating macroeconomic pressures. 2022 performance demonstrates the continued execution of our strategy, which enables us to enhance our position as the scientific partner of choice to accelerate biomedical research and therapeutic innovation. Let me give you the highlights of our fourth quarter and full year performance. We reported record quarterly revenue of $1.1 billion in the fourth quarter of 2022, exceeding the $1 billion mark for the first time and representing an increase of 21.5% on an organic – on a reported basis. Organic revenue growth of 18.8% was driven by increases from all three business segments with the most significant contribution from the DSA segment due to another robust performance in the Safety Assessment business. In the second half, DSA organic growth rate rose to 23.6% as we exceeded the second half growth acceleration that we had forecast since the beginning of last year. For 2022, revenue was $3.98 billion with a reported growth rate of 12.3% and an organic growth rate of 13.4%. The revenue growth rate exceeded the top end of our guidance range by 140 basis points driven primarily by outperformance in both the Discovery and Safety Assessment businesses. The operating margin was 20.4% in the fourth quarter, a decrease of 50 basis points year-over-year driven primarily by the Manufacturing and RMS segments. For the full year, the operating margin was unchanged at 21%. We are pleased to have held the operating margin steady in a year with substantial cost inflation and the CDMO business generated significant margin pressure. Earnings per share were $2.98 in the fourth quarter, an increase of 19.7% from $2.49 in the fourth quarter of 2021. For the full year, earnings per share were $11.12, a 7.8% increase over the prior year. We exceeded our last guidance range of $10.80 to $10.95 due primarily to the robust fourth quarter revenue growth, particularly in the DSA segment. We believe our 2022 performance thoroughly demonstrated the successful execution of our strategy to position Charles River as the non-clinical drug development partner of choice for our valued clients as well as the sustained pace of demand from these clients despite macroeconomic headwinds. Our exceptional market position, unique early-stage focus and our large diversified client base give us confidence that many of the underlying business trends will remain intact in 2023. I’d like to provide you with additional details on our fourth quarter segment performance and our expectations for 2023 beginning with the DSA segment’s results. DSA revenue in the fourth quarter was $691.7 million or a substantial 26.5% increase on an organic basis. The Safety Assessment business continued to be the principal driver of DSA revenue growth with significant contributions from study volume, pricing and NHP pass-throughs in order of magnitude. As we have often mentioned, our business is not linear. In this case, the record fourth quarter DSA revenue growth was driven by a combination of the current robust demand and pricing environment as well as the comparison to the fourth quarter of 2021 when the business experienced some resource constraints, including staffing. The Discovery Business Services growth rate also improved in the quarter. For the full year, DSA organic revenue growth was also a record 17.5%, exceeding our midterm outlook. As of year-end, the DSA backlog has increased 32% year-over-year to $3.15 billion. The backlog remained robust in 2022 and continues to support a long growth runway and also normalized during the year as expected because the backlog duration stabilized after substantially elongating in prior years. We are continuing to see broad-based and sustained client demand across our Safety Assessment business as we have the staffing and capacity to accommodate this client demand. The current NHP supply situation may restrict the revenue growth rate and margin expansion in 2023, but the underlying strength and resilience of demand environment and pricing should afford us with healthy DSO growth opportunities once the NHP supply situation is resolved and we have an adequate supply of these large models. The Discovery Services business had a good quarter with improvement in the revenue growth rate from the third quarter level. Many of our clients who previously lengthened the timeframes to start new projects move forward with their programs in the fourth quarter. Discovery booking and proposal activity also support a healthy growth profile as we begin 2023. In order to strengthen our position as a single-source partner to support our clients’ early-stage research needs, we continue to expand our discovery capabilities through our technology partnership strategy and through M&A. We achieved both with SAMDI Tech, which we acquired in January. We established an initial partnership with SAMDI Tech in 2018, and we were able to validate their proprietary mass spectrometry technology for label-free, high-throughput screening with our clients. During the partnership, we determined that SAMDI Tech cutting-edge technology was increasingly favored by clients to accelerate their timeline and reduce the costs required to identify a lead drug candidate and make critical go/no-go decisions earlier. As a result of the successful partnership, we mutually agreed to have SAMDI Tech join Charles River. Partnerships and acquisitions like this advance our ongoing efforts to build our scientific expertise for the discovery of novel therapeutics and strengthen our discovery toolkit by adding cutting-edge capabilities to enable clients to work with us for a single project or on an integrated program in a flexible manner tailored to their specific outsourcing needs. The DSA operating margin was 26.3% in the fourth quarter, a 320 basis point increase from the fourth quarter of 2021. For the year, the DSA operating margin increased by 160 basis points to 25.3%. Both increases were driven primarily by operating leverage associated with the meaningfully higher revenue in the Safety Assessment business. RMS revenue in the fourth quarter was $196.1 million, an increase of 10.8% on an organic basis. For the year, RMS organic revenue growth was 9%, squarely in line with our outlook of high single-digit growth in 2022. Accelerating growth for Research Model Services, particularly our CRADL initiative and research models in North America and China, drove the exceptional RMS revenue growth rates for the fourth quarter and full year. We also continue to benefit from meaningful price increases, which were implemented in part to offset inflationary cost pressures. We expect similar trends will drive high single-digit organic growth again in 2023. In the Research Model business, North America continued to generate strong revenue growth. And China, although reporting a double-digit increase, experienced a modest impact from an increase in COVID cases during the fourth quarter. The expansion of the central, southern and western regions of China are progressing well, and each new set is operational with two sites already shipping research models. This will enable us to continue to generate robust double-digit growth in China and gain additional market share. Research Model Services also continued to perform well with broad-based growth across Insourcing Solutions and GEMS in the fourth quarter and for the year. Growth was primarily driven by Insourcing Solutions CRADL operations or Charles River Accelerator and Development Labs, including last year’s Explora acquisition. Clients are increasingly adopting this flexible model to access vivarium space without having to invest in internal infrastructure. Explora continued to perform very well, and the combined CRADL footprint now encompasses 28 vivarium facilities totaling over 380,000 square feet of turnkey rental capacity. CRADL and Explora provide us with a new and unique pathway to connect with clients in earlier stages, enabling these clients to invest in a research and not in infrastructure, preferring to leverage Charles River’s broader capabilities to continue to advance their research. The RMS operating margin declined by 420 basis points year-over-year to 22.7% in the fourth quarter and by 210 basis points to 25.2% in 2022. The declines were primarily attributable to the 53rd week, which has a greater impact on the RMS segment, headwinds from expansions of our CRADL and Explora operations and new RMS sites in China and also a modest COVID impact in China. We anticipate that each of these factors will either be eliminated or generate less of an impact in 2023, resulting in improvement in the RMS operating margin. Manufacturing Solutions revenue was $212.1 million in the fourth quarter, a growth rate of 5.3% on an organic basis. And the full year organic growth rate was also 5.3%, in line with our mid-single-digit outlook for 2022. The segment growth rate in 2022 was compressed by lower revenue in the CDMO business. The initiatives that we have implemented to improve the performance of our CDMO business continue to gain traction and earn positive feedback from clients. Our creation of centers of excellence for cell therapies, viral vectors and plasmids has been well received. And coupled with our focus on CDMO business development efforts and investing in the commercial readiness of our operations, we are generating new client interest. We have won over $100 million of new CDMO projects over the past 12 months and more than two thirds of which are for our world-class cell therapy operations in Memphis. We believe that a stronger sales funnel has helped in a gradual improvement in the CDMO performance during 2023 as the business returns to its targeted growth rates. We expect the CDMO business will drive a rebound in the Manufacturing segment organic growth rate to the low double digits in 2023. The Biologics Testing Solutions and Microbial Solutions businesses both performed very well in the fourth quarter, benefiting from robust client demand as the growth prospects for these legacy manufacturing quality control businesses remain strong. These businesses in the Manufacturing segment in total will continue to be principally driven by demand for biologic drugs, including cell and gene therapies and other complex biologics. Microbial Solutions had a strong quarter and full year, benefiting from broad-based growth across its Endosafe Endotoxin testing and Accugenix microbial identification testing platforms. We are continuing to convert the marketplace to our more efficient and reliable quality control testing platform. The continued expansion of the installed base of instruments drives demand for the consumable cartridges and reagents, which provides a healthy recurring revenue stream. We believe Microbial Solutions’ long-term growth potential continues to be approximately 10%, including in 2023. The Biologics Testing business reported an excellent fourth quarter and full year. Robust demand for cell and gene therapy testing services continue to be the primary growth factor as well as traditional biologics. And the business had an excellent year despite the moderation of COVID vaccine testing revenue during 2022. We have been successful in maintaining – and we have been successfully gaining business because of our extensive portfolio of services to support the safe manufacture of biologics. We believe cell and gene therapies will continue to be significant growth drivers over the longer term. The Manufacturing segment’s operating growth declined meaningfully in both the fourth quarter and full year to 25.3% and 28.8%, respectively. As has been the case all year, the decline was driven almost entirely by the underperformance of the CDMO business. Based on our expectations for the CDMO business, we believe the manufacturing operating margin will improve meaningfully in 2023 to above the 30% level. As you know, there is inherent operating leverage in our businesses. So as project volumes improve in the CDMO business, we expect the margin profile will follow. In 2022, we celebrated our Charles River’s 75th anniversary. We’re delighted to have evolved from a small revolutionary research model company overlooking the Charles River to a leading global drug discovery and development partner, generating nearly $4 billion in annual revenue and helping to lead the biopharmaceutical industry’s essential nonclinical drug development efforts. As we look to 2023, we continue to see a resilient funding environment to continued renaissance in the golden age of scientific innovation, our clients’ increasing use of strategic outsourcing and their need for enhanced efficiency and speed to market. Our core competencies, including our extensive scientific knowledge and our focus on preclinical R&D, are precisely tailored to these trends and make us an even more indispensable partner to advance our clients’ life-saving therapies. I assure you that we will continue to proactively manage the NHP supply and reinforce our firm commitment to conducting ethical regulatory compliant business practices and to the humane treatment of the research model under our care. To conclude, I’d like to thank our employees for their exceptional work and commitment and our clients and shareholders for their support. Now I’d like Flavia to give you additional details on our financial performance and 2023 guidance.

Operator:

[Operator Instructions] And our first question will come from Derik De Bruin with Bank of America. Your line is open.

Jim Foster:

Tough to comment on the competition, Derik. I guess my overarching comment would be, number one, we are a much wider scale. Number two, we have different supply sources and different capabilities. But I would say that with regard to Cambodia, where 60% of the animals come from, we are all at least temporarily foreclosed from bringing new animals in and utilizing them on studies in the United States. So you want to extrapolate this and say this is an industry issue, a relatively profound one because drugs aren’t going to move through preclinical and into the clinic. Biologics are not going to move unless they’re tested on large animals, and it’s has to be NHP. So we are – our focus now is to work with Fish and Wildlife to come up with a collaborative methodology that they’re in agreement with, and we can execute to show parentage, which is sort of the underlying issue here. It’s going to be some sort of laboratory assay that we’re developing, but we have to be able to do that quickly and cross a large population of animals. The – just to reset the table for you, the irony is that demand is really significant for us. I can’t comment on the competition, but I assume similarly. So demand is exceptional. We’re well staffed. Capacity’s in a good place. We actually have enough animal supply in terms of our relationships with the various suppliers that we have where we either own a piece or have a long-term contract. And we’ve hit this unanticipated speed bump with Fish and Wildlife. They’re saying that they’re concerned about parentage. So I don’t – I can’t guarantee anything. I don’t think this is a situation that we’ve been concerned about losing share. It’s a situation of how do we – we, and that’s both Charles River and the competition to some extent, move past this so we can support the clients to get drugs through preclinical and to patients. And that’s – that’ll be pretty much 100% of our focus going forward. We’re optimistic that we will be able – that’s been a request. We’re optimistic that we’ll be able to meet that request. It’s a little bit difficult to determine exactly when it will be resolved and exactly when we will get animals into the U.S. We’ve sized our guide, as we said in the prepared remarks, to either have animals kind of late in the third quarter for utilization in Q4. That would be sort of the best case. Worst case would be that Cambodia doesn’t open up at all for fiscal 2023. And of course, it’s about 60% of the supply source, both for Charles River and the industry at large. So it’s – I don’t know how else to say this. It’s not really optional that we fix it, have to fix it for our clients and for patients and for ourselves. I think the U.S. government authorities understand the criticality of the work that we do and the role that NHPs play. And we’re hoping they’ll work closely with us as we work through the resolution.

Jim Foster:

I mean, the timing is hard only because they’re pretty much consistent that we prove parentage. By the same token, Fish and Wildlife absolutely understand how these animals are used and the critical nature of them. I know that the various government agencies have been in conversation with one another on the outlook of the world through a different lens. But it’s going to be essential to move drug development forward for hundreds of clients and drugs that we have a resolution. So we’re off working on that. We’re off with an open dialogue with Fish and Wildlife about what exactly they need. And we have to explain to them that the reality of it’s going to take some time to get this up and running, but we’re well intentioned that we have deep science on our own. We’ll collaborate with some others to get this up and running. And we’ll provide these tests, which – yes, that’s the basis of this whole situation to prevent wild animals being used in biomedical research.

Jim Foster:

Sure.

Eric Coldwell:

Thanks very much. On the subpoena, are there any additional details you can provide on the timing of the receipt, what DOJ perhaps might think, they have come across that would drive this? And then can you confirm that the incremental margin on the rough $80 million to $160 million revenue headwind is about 50% to 60%? That’s what’s embedded in the guidance. And then third, could you talk about the supply expansion you’ve – to what extent you’ve been able to achieve supply expansion beyond Cambodia? Is there any additional detail you could – would be willing to provide on countries of origin, new suppliers, increases with existing non-Cambodian suppliers? Is there anything you can share to let us know what might be the ultimate outcome if, let’s say, worst-case scenario Cambodia doesn’t reopen?

Flavia Pease:

Thanks, Jim and good morning Eric. Yes, our EPS guidance obviously assumes different scenarios as we mentioned in our prepared remarks. Obviously, the revenue loss drops down at a fairly high rate initially. But I’ll prefer not to comment on the specifics.

Todd Spencer:

Hey Sandy, are you on mute? We can’t hear you.

Jim Foster:

Yes. So on the Fish and Wildlife situation, so there was all sorts of contradictory and probably erroneous information about what Cambodia was doing after this first farm was invited back in November. So the initial ruling was that the Cambodian government just closed down exports, which was we don’t believe was ever true. So Cambodia is – from their end, is open for business. We’d like to shift the animals, we’ll provide the paperwork. The U.S. government is saying, you can’t bring them in yet. And the ones that you have in country, and we have some in country, you can’t use yet until we sort of work out and ensure that they are indeed purpose-bred. So no. So I don’t think it’s – I don’t think we can just do what we want. I mean, there’s always permitting. There are these site permits that one has to get and then they – when they – so canceled, you can go ahead and utilize the animal. So just your prevalence, I guess our hands are tied, but we’re trying to look at that positively that it’s within our control to get them untied. They’re just going to sort of wait for us to make a proposal on how we can prove they’re purpose-bred. So as I said, that’s like 100% of our focus right now in our control. And obviously, the faster we do it, the faster they will allow us to utilize the animals. CDMO business is an interesting one. As we’ve spoken to consistently for a while, now integration has been complicated. The science is quite complicated and new. And we really had to re-staff all three of the companies, the major companies that we bought from kind of top to bottom, senior management, sales, regulatory, et cetera. I think the demand has been great across the Board. The sales cycle is long. So I’m not sure that was totally clear to us or the length wasn’t crystal clear to us when we bought the company and plus some of the clients that we felt we had firm commitments weren’t so firm. So I think we’ve done a great job with the new sales force where people that understand the science can explain it well. And we have in our prepared remarks a commentary $100 million of new business come in last year. Our Memphis facility, which is a gene-modified cell therapy manufacturing operation, this sounds particularly solid right now just in terms of numbers of clients, scale of clients. By that, I mean, there’s a bunch of companies that are cell therapy companies that are kind of small and new that you’ve never heard of, but there’s a bunch of really big companies, including big biotech and big pharma who either don’t have their own space or don’t feel there’s sufficient space in the system. We have several clients that we’re talking to who have either finished Phase 3 or almost – who are talking to us about commercial quantities. And there’s at least one client that we are confident that we will produce commercial quantities for them this fiscal year, which obviously would be fabulous just in terms of, I don’t know, expertise, reputation, capability and really doing it because there’s still a few commercial products actually being manufactured. So the business feels better, stronger, better demand, better client understanding of who we are, better integration amongst and between the cell and gene therapy companies and also between cell and gene therapy and our biologics business, in particular, and I would say safety. Secondarily, we have very good facilities that have been all three of the big – three of the major facilities have been added on to over the past year. So we’ve got new space, incremental space and pretty well staffed. It’s a very attractive area. There’s lots of people that want to work and sell in gene therapy. I think there’s a little bit of a positive buzz around our capability and potential. So we should have nice growth rates in those businesses in fiscal 2023. The margins won’t be anywhere near we want them to be, but they will be distinctly better than the prior year. So CDMO should be accretive for sort of the manufacturing top and bottom line. And similarly, obviously, to a lesser extent given the denominator, but similarly to CRL’s top and bottom line also. So we feel good about those businesses as we’ve entered this fiscal year.

Jim Foster:

Pleasure.

Elizabeth Anderson:

Hi guys, thanks so much for the question. I was wondering if you could comment, it seems like you based on the guidance that you gave for the full year on NHPs that you probably have enough supply domestically to get you to this sort of fourth quarter at least between the Cambodia and non-Cambodian supply. So if that’s something you could comment on. And then secondarily, can you talk about the impact of potentially follow-on work after NHPs? It seems like maybe is that something that you guys have accounted for in the guidance? Or is that something that would maybe impact 2024 more than 2023? Thank you.

Operator:

Thank you. Our next question will come from Jacob Johnson with Stephens. Your line is open.

Jim Foster:

Yes. CRADL for sure. CRADL’s – I don’t want to overstate it. I’d say it’s a relatively recession-proof business and kind of the pure-play outsourcing move for – we thought it was only going to be small companies. It’s a whole range of countries. It’s quite interesting, but for everyone at the moment who might not want to build de novo space, add on to the current space, just hold on to the capital and at least small amounts of space from us, use our people either in large measure or a small measure. I think that business is going really well. Look, our whole thesis – I mean the whole basis of the bargain with Charles River is that we can be your outsourcing partner. You use our people and our space as if they’re your own. We’ll invest in technology and capacity consistently. We’ll help you get your drug into the market or at least tell you that it shouldn’t get into the market because of high levels of toxicity or whatever, lack of efficacy. So I think that so much of what we do, all of the Research Model Services are pure outsourcing. All of our discovery and safety work is pure outsourcing. And so is the biologics work. And so – and everything that we’ve added through M&A over the last decade or even two decades has been about providing a large cohesive portfolio to – so somebody can literally give us a drug and say, please tell me, file my IND and get this thing to market. So obviously, it’s somewhat correlated to the availability of cash. I would say that our biotech clients, in particular, are very judicious and thoughtful about the way they spend money. So they tend not to move forward unless they think they have enough money to at least get their drug minimally into the clinic and actually to proof of concept. And we’re still hearing very little from our clients about concern about access to capital and how that would impair or slowdown both the demands from us and ability to spend. So yes, we think our – and if they have those concerns, and they’re just not articulating it, I think our portfolio is quite helpful for them. And yes, I would agree that CRADL is kind of the top of the list.

Jim Foster:

Sure.

Patrick Donnelly:

Hey guys, thank you for taking the questions. Jim, can you maybe just talk through the timeline of how this all played out? I mean, obviously, you put out the 8-K, I think it was mid to late this November, sorry. And then December, there were mixed reports. Cambodia was shut down, then it wasn’t a few days later. And obviously, you guys got the subpoena just a few days ago. So can you just talk about when you guys started to realize, hey, this might be a real disruption, and this is going to shut down and just trying to get a sense in terms of how quickly you could prepare for this and just how it played out internally would be helpful. Thank you.

Patrick Donnelly:

That’s helpful. Thanks, Jim.

Operator:

Thank you. Our next question will come from Max Smock with William Blair. Your line is open.

Jim Foster:

Sure. The market is strong and has remained strong. There’s a plethora of cell and gene therapy drugs that had then quote discovered and need to be developed either to success or failure. So we’re going to be very, very busy. We’ve, as I said earlier, retooled the sales organization. So we’ve got people with great expertise in both cell and gene therapy to understand both the science and the processes for manufacturing and the time frame. As I said earlier, the time frame is longer than we had anticipated. So we’re really pleased with the way we’ve been signing up clients, large and small, the openness to share their anticipated plans with us to wheel what the market size they think the drugs might have. As I said earlier, we have several clients that are on the verge of commercialization. It doesn’t mean the drugs will get to market, but I’m just saying from a regulatory point of view are on the verge of having finished clinicals and will be filing and one that has moved into a commercial zone. So the sales funnel feels solid, consistent, persistent and pretty varied in terms of the scale of the companies. The market itself, the – it’s probably a number we should update, but we – when we quantified it last time, we said they were about 3,000 cell and gene therapy drugs in development, probably two-thirds of which were in the preclinical domain. And obviously, some meaningful portion of these we’ll get to work on. The differentiating factor for us and the reason we went into CDMO space having kind of fleet from a few years ago because it’s kind of a crowded space is that this is kind of an interesting niche. We have a couple of other very good players in the space, which is fine. The market needs them, but what the differentiating feature is that we don’t just manufacture a drug. We have the Biologics Testing business, which is kind of how we ended up pivoting back into this space because clients were saying speed is of the essence. We give you our molecule and develop it for us. We can’t tolerate you sending us out to find some of the manufacturer negotiating prices, maybe someone we don’t know or trust. We’d like you to be able to do that for us. So if you think about it, we can do some of the discovery development. We can do all the toxicology work to say it’s safe, then we can test that molecule before it goes into the clinic – sorry, we can now manufacture the molecule, and then test it before it goes into the clinic and then test it as it goes into commercialization. So I do think it holds true not just for cell and gene therapy but pretty much everything we do. We just have this – we have a broader portfolio than the competition. And even if they’re bigger companies and even if they’re bigger and have a larger reputation than us for being a CDMO, they don’t have the pull-through that we have, and they don’t have a comprehensive portfolio. We think that gives us a significant and distinct competitive advantage.

Jim Foster:

Sure.

Dan Leonard:

Thank you for taking the question. I have a couple of follow-ups to Derik’s question at the start on what customers are doing with the NHP supply constraints. How actively are they pivoting to different models like many pigs or dogs? And are clients being more discriminating about NHP use in line with the recent FDA guidance? And then finally, is there any chance, Jim, that the heightened NHP concern reduces long-term demand for NHPs from biopharma as clients reconsider their NHP needs? And if that happens, what does that do to Charles River’s business opportunity? Thank you.

Dan Leonard:

Thank you for that perspective. And if I could ask a quick follow-up, can you help me better understand the complexity of showing parentage for NHPs? Presumably, this isn’t just a 2023 Ames test. It’s more complicated than that, but I’d love to be able to better understand that.

Dan Leonard:

Appreciate that perspective. Thank you.

Operator:

Thank you. Our next question will come from Casey Woodring with JPMorgan. Your line is open.

Jim Foster:

Yes. So I’m going to stay away from 2024. Just – it’s too far away, and we don’t know how this year is going to unfold in terms of access to new animals. And so the supply will be – yes, it’s hard to call what it will be going to next year, which, of course, is more than 10 months away. We believe based upon everything we know today and based upon our conversations with the Fish and Wildlife and others that the guidance range that we have out and now accommodates for sort of close to the best case and close to the worst case. And so we’re pretty comfortable with that. So we like our shareholder base to just sort of get in that genre. The price points for work in kind of the back half of this year and definitely for 2024 continue to escalate. It might not be quite at the escalating point that we had last year to really cover our inflationary costs but meaningful prices. I don’t know. It feels unclear as to what we do from a pricing point of view to accommodate for this lack of demand. I think we need to be paid well for the complexity of the work we do and for the animals that we have. But we may have a small amount of pricing power only if the costs go up dramatically. But I wouldn’t think that we can make up much of this by significantly increasing the cost to our clients.

Tim Daley:

Great. Thanks. First, I wanted to ask on RMS. So within the RMS organic growth guidance for the year, are you assuming any divergence in product versus service above or below the segment average? And then secondly, a few quick yes, no for you, Jim, on DSA. Will you be providing intra-quarter updates to investors regarding developments in the NHP dynamics? Does your guidance assume any resumption of China NHP exports to the U.S.? And just a quick follow on to Dan’s first question on the FDA Modernization Act. Where you sit today, is there any meaningful mid- to long-term risk to the Safety Assessment addressable market due to synthetic models? Thank you.

Tim Daley:

Great. Thanks. And sorry for the multi part there.

Operator:

Thank you. Our next question will come from Dave Windley with Jefferies. Your line is open.

Jim Foster:

Yes. The domestic colony question is a really good one, Dave. I can’t tell you how many times we’ve discussed it. And I think you know that we did it once. So, we set up a domestic colony in Southern Florida. It’s extraordinarily significant expense and had the bad luck of even though we have built hurricane proof of closures [ph] having a hurricane, which really grew in the bunch of the facility actually a bunch of monkeys got out. The – at the time this was a long time ago, Dave, it was – I remember the project was like cash flow negative for over a decade. It’s just a brutal drop. So you have two problems with it. One is it’s crazy expensive now. I think underlying your question was, could you go to the federal government and say, can you help us with this? It is a critical national resource. And they probably would. So that would take some of the financial sting out of it, but it still would take forever. We’re talking about what can we do between now and the end of this year. And it just would be forever. So it’s just – it’s not a practical approach. On the test, I think it’s both. The answer to your question is both. There are current tests that can be utilized but are set up not on a very large scale. So, we have to scale them up or find a partner to scale them up. So minimally we’ll do that. What we’re really hoping for, particularly with one or two of the collaborators that we began to talk to is that the quality of their science is so sophisticated that they can help us refine the test in a way that we can do more, have more throughput faster with better and unequivocal results. And obviously, you got our own labs. As you know, Dave, we have big labs all around the world in our facilities. So we have really good capacity and really capable people that would know how to do this work. We just would like to get ahead of it. So it’s kind of a work in progress literally as we speak. We’re working on. I’m confident that we will minimally have kind of something relatively new and not yet standard and potentially something better than even something that’s new that would be – care so much about the cost as speed and accuracy. So, we’re all over that, and we’ll update you folks on what our progress is. And if the relevance of the partners and we have an appropriate partner, if we think that’s meaningful to our shareholder base, we’ll share that with you as well.

Jim Foster:

I mean, eventually, I think it’s good for the industry if you can even call what we do an industry and certainly for our clients, if you could – certainly they are an industry. I think it would be good if the whole Cambodian source, and there are a couple of really big players and then some smaller ones if they could use a similar methodology to show who are the moms and who are the offsprings. So if we’re successful, we won’t be selfish about it. I think the way we see the landscape right now, we’re unlikely to work with anybody besides our principal supplier because we just know them so well. We like the scale at which they were again, and they really take our advice and counsel really well. So, we are quite confident that work with us. And so maybe that will be the nice edge. We’ll start with our supplier. We’ll work with them. We’ll show Fish and Wildlife what we’ve accomplished. And then we can offer to share that. I don’t care. We can share that with our competition. We don’t have 100% share. So we just want the biopharmaceutical industry to be well resourced here and have access to companies that can do the work well for them. So – and I do think that the U.S. providers are quite – will be quite reliant on Cambodia for the foreseeable future, just given the genetic similarity between the Cambodian monkeys and the Chinese ones. And it’s much better for the research just sort of background data point of view. So that’s how we see it unfolding. It’s possible that our competition will do something similar. And maybe they get there first. I don’t even care. We’re not going to spend a lot of time, I think, working with them because we just have a different, I think, viewpoints and capabilities and scale and just the way we deal with suppliers and the government. So while we may talk to them and get each other’s support, I think we have to do this alone. And I think we have to do it quite quickly.

Jim Foster:

Sure, Dave.

Operator:

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories Third Quarter 2022 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead, sir.

James Foster:

Good morning. I'm very pleased to speak with you today about our third quarter results. Our solid financial performance was highlighted by a 15.3% organic revenue growth and non-GAAP earnings per share of $2.63, both of which exceeded our prior outlook. Third quarter organic growth rate accelerated 580 basis points from the second quarter level due primarily to the DSA segment, which delivered an outstanding growth rate of more than 20%, in line with our outlook since the beginning of the year. The DSA growth acceleration reflects continued robust price increases and meaningfully higher study volume in the Safety Assessment business, trends which have been supported by the strength of its backlog that continues to afford us with excellent visibility into the future client demand. The strong operating performance against the backdrop of escalating macroeconomic pressures demonstrates the power of our unique portfolio which differentiates Charles River from other companies that provide R&D support services to the biopharmaceutical industry, especially from the late stage clinical service providers. We are uniquely positioned as the leading global non-clinical drug development partner, working with clients from discovery and early stage development through the safe manufacture of life-saving therapies. Our focus is centered on preclinical R&D which requires extensive scientific knowledge and the ability to innovate, understand and distinguished viable molecules from those that are not. Post-pandemic, we are even more -- an even more essential partner to our biopharmaceutical clients because our core competencies are precisely tailored to their intensified focus on scientific breakthroughs, personalized medicine and speed-to-market. With a comprehensive portfolio spanning small molecules, biologics and cell and gene therapies, we provide a flexible and efficient platform that accelerates early stage biomedical research and therapeutic innovation. We are a leading global partner for outsourced discovery and regulated safety assessment services. We are also the largest provider of small research models and associated services that enable our clients to conduct their own research, and we offer a comprehensive portfolio of manufacturing solutions from quality control testing solutions to the production of cell and gene therapies that enable us to continue supporting our clients as they work with other providers to conduct human clinical trials and reach commercialization. We have a large and diversified client base which makes us an exceptional barometer for the health of the broader biopharmaceutical industry. And unlike clinical providers, greatly reduces our reliance on a small group of clients. We have worked with more than 2,000 biopharmaceutical clients this year, and our top 25 clients are primarily large biopharmaceutical clients that are well financed and have been a stable source of sustained revenue growth with accelerated spending in the third quarter. Our top 25 clients represented only 28% of total revenue last year, and our largest client represented just above 3% of total revenue. We also believe that our biotech clients will remain a sustained growth engine for Charles River. We have averaged adding more than 400 new biotech clients per year since 2017 and are already above that level this year. Our biotech clients continue to be a principal driver of revenue growth, increasing a healthy double-digit growth rates in the third quarter and year-to-date, a trend that we believe supports our view that biotechs with promising molecules are continuing to find available funding. In addition, we saw early indications of the return of IPOs and secondary offerings in the third quarter. Venture capital funding remained very healthy and large pharma continue to support the biotech industry. Our concentration of at-risk biotech remains low at approximately 5% of both DSA and total revenue for public biotechs with less than two years of cash on hand. This is slightly below our prior estimate, which evaluated DSA backlog. We believe the early stage research that we conduct is instrumental in our biotech clients achievement of the important milestones that enable them to secure their next round of funding. And therefore, we believe they view continuing the regulated safety assessment programs as critical to their continued success. The total cost of the safety assessment program is a fraction of the cost of clinical trials, typically ranging from $6 million to $8 million including post-IND studies. Yet it is an important milestone to demonstrate that clients' efforts are driving innovation and validating the efficacy and safety profile of their lead compounds. At 5 times to 10 times less than the cost of clinical trials, biotech clients are motivated to plan their spending around the achievement of IND approval before seeking additional funding or finding a larger biopharmaceutical partner to move into clinical trials. As a result of the importance, both biotech and larger biopharma clients are continuing to move their regulated safety assessment programs through their pipelines. I will now provide additional highlights of our third quarter performance. We reported revenue of $989.2 million in the third quarter of '22, a 10.4% increase over last year. Organic revenue growth of 15.3% exceeded our prior outlook of at least low double-digit increase. All three business segments reported solid revenue growth, particularly the DSA segment, due to the robust performance of the Safety Assessment business. The operating margin was 20.4%, a decrease of 100 basis points year-over-year. The decline was driven by lower margins in the manufacturing in RMS segments as well as higher unallocated corporate costs, both of which were previously anticipated. Earnings per share were $2.63 in the third quarter, a decrease of 2.6% from the third quarter of last year. Higher revenue was offset by the operating margin decline, increased interest expense and a higher tax rate. Based on the third quarter performance, we are narrowing our 2022 revenue growth and non-GAAP earnings per share guidance to the upper ends of the previous ranges. We expect organic revenue growth in the range of 11% to 12% and non-GAAP earnings per share of $10.80 to $10.95. I'll now provide details on the third quarter segment performance, beginning with the DSA segment. Revenue for the DSA segment was $619.5 million in the third quarter, a 20.8% year-over-year increase on an organic basis. The DSA growth rate surpassed the 20% level, tracking to our initial plan that had forecast meaningful DSA growth acceleration throughout the year. The exceptional demand, which has manifested itself in sustained backlog growth is a function of our clients' robust pipelines, our competitive strengths and the scientific breadth and geographic reach of our portfolio. Broad based growth in the Safety Assessment business was the principal driver of the nearly two-fold increase in the DSA revenue growth rate from the second quarter level. The factors that led to this meaningful step-up were substantially higher study volume and continued meaningful price increases. Study volume was a significant contributor, driven by strong demand across the Safety Assessment business for most major study types of general and specialty toxicology. As expected, study volume rebounded meaningfully from first half levels, and we were able to accommodate additional client demand as a result of having hired and trained additional staff over the last year. We are continuing to successfully recruit and retain staff to support future growth and do not foresee challenges with staffing levels as we head into next year. Pricing also continued to trend meaningfully higher year-over-year and sequentially, which we believe reflects the complexity and specialized nature of the work we do. Today's inflationary cost environment and the fact that capacity remains well utilized. Although pass-throughs are higher costs for certain study related resources that are passed directly to clients were higher in the third quarter, they accounted for less than half of the sequential step up in the Safety Assessment growth rate and had effectively no margin impact. Pricing, exclusive of the impact of pass-throughs, increased broadly in the third quarter. Clients continue to emphasize the breadth of capabilities, study lead times and the availability of space more so than price, when determining the preferred partner for their preclinical programs. As the premier partner for our clients' non-clinical development programs, it's not surprising that clients are continuously choosing to work with Charles River for our broad and scientifically differentiated portfolio, superior client service and speed as we aim to take an additional year out of the early stage development time lines. As expected, the Discovery Services growth rate moderated in the third quarter, primarily due to the lengthening of clients' decision making time frames to start new projects, a trend which we discussed in August. We believe the Discovery business will demonstrate favorable long-term growth prospects as many of our clients, including biotechs, prefer to outsource their drug discovery projects rather than maintain in-house infrastructure. And given the critical importance of the early stage research in which they are engaged, they prefer an integrated full service partner like Charles River. We continue to expect mid-teens DSA organic revenue growth in 2022. DSA backlog and booking activity through the third quarter continues to support sustained growth. And for next year, we have a significant amount of safety assessment work already booked. The strong Safety Assessment performance has been under the leadership of Shannon Parisotto. Shannon has been with the company for over 20 years, starting at our Nevada site shortly after it became our first acquisition in the safety assessment space. With significant operational and finance experience, Shannon recently assumed responsibility of our Discovery Services in addition to Safety and was promoted to an Executive Vice President. I would like to congratulate Shannon and wish her continued success in driving the long-term growth of our Global Discovery and Safety Assessment segment. DSA operating margin increased by 190 basis points to 26.2% in the third quarter, driven primarily by operating leverage from the substantial quarterly increase in Safety Assessment study volume and pricing. RMS revenue was $180.1 million, an increase of 8% on an organic basis over the third quarter of 2021. The RMS business continued to sustain high single-digit growth, consistent with our outlook for the year. The RMS growth potential has trended upward recently from low to mid-single digits several years ago due to a combination of accelerating growth for research model services and research models. The CRADL initiative, or Charles River Accelerator and Development Labs including a recent Explora acquisition is a significant driver of the growth rate increase. In addition, our renewed focus on biomedical research has led to increased demand and share gains for small research models, particularly in North America and China. We are also benefiting from meaningful price increases, in part to offset inflationary cost pressures. These factors were the principal drivers of RMS revenue growth in the third quarter. In the Research Models business, North America continued to generate strong revenue growth and China rebounded following the impact from COVID related restrictions in the second quarter. There was no meaningful impact on client order activity from COVID related restrictions in the third quarter. We are also continuing to expand in China outside of Beijing and Shanghai regions to gain additional market share and believe the level of biomedical research activity, coupled with our expansion plans in China, will continue to generate robust double-digit growth in the region. Research Model Services also had another excellent quarter, led by the Insourcing Solutions business, particularly our CRADL and Explora operations. Clients are increasingly adopting this flexible model to access laboratory space without having to invest in internal infrastructure. Explora has continued to perform very well with the integration on track. We added five new sites over the last six months in California and Washington state and now operate 27 vivarium facilities totaling over 370,000 square feet of turnkey rental capacity. CRADL and Explora provides us with a new and unique pathway to connect with clients at earlier stages, enabling these clients to easily access additional services across our comprehensive discovery and non-clinical development portfolio. In the third quarter, the RMS margin declined by 260 basis points to 23.5%, driven primarily by the revenue mix and higher costs in China due in part to our regional expansions. We also experienced a modest margin impact from opening new CRADL and Explora sites this year for which the profitability will improve as client utilization increases in the newly open sites. Revenue for the Manufacturing segment was $189.6 million, an increase of 6% on an organic basis. Lower revenue in the CDMO business, the drivers of which we discussed last quarter was more than offset by higher growth rates for both the Biologics Testing and Microbial Solutions businesses. The growth prospects for these legacy manufacturing quality control businesses remain robust, and they will continue to be principally driven by demand for biologic drugs, including cell and gene therapies and other complex biologics. Microbial Solutions benefited from broad based growth across SezendaSafe endotoxin testing and Accugenix microbial identification testing platforms. We are continuing to convert the marketplace to our more efficient and reliable quality control testing platform. The continued expansion of the installed base of instruments drives demand for the consumable cartridges and reagents which provides a healthy recurring revenue stream. The Biologics Testing business also had a strong quarter with virology, viral clearance and microbiology testing services driving growth in both the U.S. and Europe. Demand for traditional biologics remains strong, but cell and gene therapy clients are driving a disproportionate amount of recent growth. We have been continuing to add capabilities to our extensive portfolio to support the manufacture of biologics, including the addition of new cell and gene therapy assays. The initiatives that we have implemented to improve the performance of our CDMO business are beginning to gain traction and earn positive feedback from clients. It's still early, and we don't expect the financial performance to meaningfully improve until next year, but we're pleased with the initial progress. Our creation of Centers of Excellence for cell therapies, viral vectors and plasmids has been well received and coupled with our focus on CDMO business development efforts, we are generating new client interest. We recently announced a gene therapy manufacturing partnership with Nanoscope Therapeutics to produce plasmid DNA and viral vectors for their late stage clinical trials of a therapy targeting degenerative ocular diseases. We have a number of other clients who are in late stage clinical trials with their cell or gene therapies, and we are investing in our sites to ensure that we are commercially ready should our clients receive regulatory approval. As we mentioned last quarter, our Memphis cell therapy site received European approval from the EMA to commercially manufacture cell therapy products. We continue to believe in the long-term growth prospects for cell and gene therapies and are enhancing our service offering to generate new business and provide incremental opportunities for clients to streamline their biologics development workflows by utilizing Charles River for their analytical testing, process development and manufacturing activities. The Manufacturing segment's operating margin declined by 410 basis points to 28.6% in the third quarter of 2022. And similar to the second quarter, it was almost entirely driven by the CDMO business. As we announced this morning, we have signed an agreement to divest our Avian Vaccine business, which is part of our Manufacturing Solutions segment for approximately $170 million in cash plus potential contingent payments of up to an additional $30 million. We routinely evaluate the strategic fit and fundamental performance of our global infrastructure. And as we did at this time last year, have sold or closed operations that did not meet our key business criteria. The decision to divest the Avian business was consistent with this evaluation process as we determine the production of SPF eggs principally for Avian Vaccine manufacturers and researchers was no longer a core competency. Flavia will provide additional details on the financial impact of this transaction. We are confident that we will finish the year on a strong note and are encouraged by the solid growth prospects as we head into the new year. The economy will present challenges in the coming year, but we believe we are well positioned to meet these challenges and continue to deliver exclusive science, superior client support and greater efficiency to our clients. Our focus in recent years on enhancing our capabilities in biologics and cell and gene therapies, investing in our people and space, and continuing to build greater digital connectivity with our clients has further differentiated us from the competition and enabled us to forge even deeper relationships with our clients. We are the bridge between the biopharmaceutical industry and patients that enables innovation to move forward and we will continue to distinguish ourselves scientifically and through our preclinical focus. To conclude, I'd like to thank our employees for their exceptional work and commitment and our clients and shareholders for their support. Now Flavia will provide additional details on our third quarter financial performance and 2022 guidance.

Todd Spencer:

That concludes our comments. We will now take questions.

Eric Coldwell:

Okay. First question, worst question. Probably one of the biggest debates this quarter is when are you going to give '23 formal outlook. I was hoping I could maybe put the pressure on for you just to tell us when that will be so we can end the debate?

Eric Coldwell:

Yeah. I appreciate that, Jim. Fundamental question on the Avian divestiture. I'm a bit curious, you say it's no longer a core competency, but you've been here forever. You've run it well. It's been extremely profitable, and there is some earnings dilution with the divestiture. It's not the first time here in the last year you've sold something that had a similar, I guess, characteristic of maybe low growth, no growth, but very high profit and very earnings accretive. What do we learn from that? I'm kind of -- I'm interested on why this was no longer a core competency. What was the main driver? Was it more the revenue growth rate or was there something more to that or would maybe this be a signal that you're shifting your attention on higher-growth businesses? Thanks so much.

Eric Coldwell:

Yeah. Sounds good. I'll cease the floor here. So, thanks, Jim.

Operator:

Our next question comes from Derik De Bruin with Bank of America. Your line is open. Please go ahead.

Flavia Pease:

Sure. Hi, Derik. Good morning. It's Flavia. And to your point, since we provided that long term outlook about 18 months ago, a lot has changed, right? In the world in macroeconomic conditions, so we're certainly going to take the time to finish the budget for 2023, which will be an important jump off point for us to consider the longer term outlook. We continue to apply to deliver long term high -- long term healthy revenue growth and operating margin expansion. So the tenets of our long term aspirations remain, but we're obviously going to need to go back to the dry block and look at the numbers in more detail since to your point, a lot has changed since we went out 18 months ago.

James Foster:

We didn't see anything conservative slowdown anymore down the Discovery, growth rate has moderated, pretty much totally in line with our expectations. As we said on our last call, we've had a lengthening of decision making. We've had no clients or very few clients really focusing on the reason for the delay relative to funding. But if they have to make those decisions of doing slightly less discovery in order to do more IND work, they're going to do that all day long. So we haven't seen any fundamental difference in the cadence since the last time we talked about this.

Operator:

Our next question comes from Sandy Draper with Guggenheim. Your line is open. Please go ahead.

James Foster:

Yeah. We were very clear about the fact that the back half of this year, as exemplified by the third quarter, would have increased volume and increased price, which, of course, we just delivered and tightened up our guidance for the year, so that cadence is pretty clear. We have a unusually high amount of our safety assessment booked for next year at escalating and increasing prices, both related to inflation, but primarily related to the complexity, increased complexity of the work, the depth of the science that we do vis-a-vis our competitors and vis-a-vis big pharmaceutical companies. So we feel very good about our pricing power and some of the leverage we have with our clients. We feel really good about capacity utilization. We feel really good about headcount where we have it right now and our ability to do the work. And as we've been saying for a few years, as the work has gotten more complex, we really feel that we ought to be paid well for it. There were years historically, where we didn't think we were being paid well for it. I do think that, that's changed. So as we look to next year without getting too granular, of course, we haven't even finished the plan yet, but we do have a lot of work booked at higher prices.

James Foster:

Thanks, Sandy.

David Windley:

Hi. Good morning. Thanks for taking my question. Jim, I wanted to kind of understand, I guess, relative movement within Discovery and Safety Assessment, you've commented on that this morning and previously. I guess we're hearing -- Derik mentioned it from yesterday, but we're hearing from a number of different players, including you, talking about slower decision making. I guess I'm wondering how you distinguish between Discovery and Safety Assessment? Like if -- what's the protection or the boundary, if they slow down Discovery? Should we be braced or are you braced for that bleeding over into Safety Assessment? And maybe another way to get comfortable with that, you mentioned the $6 million to $8 million in kind of total cost of, I think, an IND enabling program, I think, was the point of those numbers. How much of that comes after IND such that it might run congruent with or sorry, coincident with clinical trial activity and B, therefore, very important?

Flavia Pease:

If I may add, Dave, we started sharing the DSA backlog earlier this year. And I know that has been a slowdown in biotech funding going into this year. So we're now 11 months into the year. And every quarter, we have seen the DSA backlog increase sequentially and pretty substantially year-over-year. So we really haven't seen any slowdown on the DSA backlog that would point to any adjustments or anything being impacted by the biotech funding dynamics, which every quarter I know you all asked about. So we feel good, as Jim said, that we have a substantial portion of the backlog booked already for 2023.

Flavia Pease:

Yeah. So Dave, you're correct that some costs have increased, and we are passing those increased costs to clients and keeping the same level of margin that we have whole. So they're neither dilutive or accretive to margin, if that makes sense.

Operator:

We'll go next to Elizabeth Anderson with Evercore ISI.

James Foster:

Panning out slowly. We've made a bunch of changes in that business. I think the two most fundamental changes in that business, the product line, the nature of the product line versus sort of off-the-shelf things and specialty items and also our access that social methodology to access donors. So all of that is now in place. We're optimistic that things will sequentially and continue to improve. But I would say it's improving slowly.

James Foster:

We certainly hope so.

James Foster:

I'd say that capacity is tight and expensive and the capabilities are complex, both in terms of analytical work and process development and ultimately scale up. It's inconceivable to us that biotech companies sort of large or medium would even contemplate this. There's a few big companies that we've heard of that have built their own space, less because they don't trust or like the external providers, but more about concerns about available capacity. So I think it's going to be a lot of work outsourced. There's going to be some work that's going to be internally -- facilities built internally and the work done internally. We'll see though whether that work is just for clinical trial lots or whether that will be commercial work as well. I think the biotech companies have done a wonderful job utilizing external resources to do their work. And so we have, we think, plenty of work and lots of conversations going on right now and have added incremental capacity and feel that we're in a good place to get our share of the pie.

Operator:

We'll go next to Patrick Donnelly with Citi. Your line is open. Please go ahead.

James Foster:

Yeah. We feel really good about our labor component. We've worked really hard at it for several years now, both in terms of starting wages, both in terms of numbers of recruiters, in terms of explicit career development opportunities so we can attract really talented people and keep them, I'm thinking about some of the cell and gene therapy folks that we've added over the last year or so. So in terms of numbers of people to initiate work or to continue to do work as we move into fiscal '23, we feel really good about where we're at. I think we got ahead and stayed ahead of the salary levels, both starting and otherwise for fiscal '22, and we had that embedded in our plan and in our guidance. While our '23 plan isn't done yet, we will do the same thing. We hope, I mean, yes. It's a little bit vague out there, but we will continue to be appropriately aggressive in terms of being able to bring in new folks. So we feel really good about our labor component. We feel really good about our capacity, available capacity at multiple sites. We feel really good about our pricing power. We feel really good about clients waiting a significant amount of time to initiate studies, getting in line and prioritizing what studies they want to do first, that's so new. We've been doing this for a long time, that sort of new the last couple of years. This is an industry that historically had some planned well, and there's lots of changes, but they really do have to plan well now, and that's, I think, holding us in good stead. So labor component is in a good place.

James Foster:

So both Flavia and I will answer aspects of that question. I would say a couple of things. Number one, that we're deep into the integration of our cell and gene therapy assets, which obviously it has been more complex and more challenging than we thought given the nature of the science and the newness of the science and some of the challenges. So going well, really pleased with the facilities, the staff, the sales organization, the regulatory folks and new clients and also on sort of a massive marketing initiative to make sure that people understand that we're in this business. I think I want to use the word pause because we did the Explora deal. And we would do a small tuck in deal of a technology deal, depending on when it was available. We certainly don't always control the timing of these deals. But I would say that directionally, our balance sheet is increasingly in good shape to do some meaningful M&A. I don't want to say when that might be, except to say that we have multiple conversations going on right now with potential acquisition targets, almost all of which are owned by private equity. And we are always having conversations with them. I'll let Flavia answer what we're likely to do with the proceeds from Avian.

Patrick Donnelly:

Appreciate all the color. Thank you, guys.

Casey Woodring:

Hi. Thanks for fitting me in. Can you guys just talk towards the volume growth in DSA in the quarter? How much of that was just based on the increased capacity that you had come online? And then also just wanted to get a sense on if volumes are trending meaningfully higher than where maybe you had expected them to be heading into 2023, maybe at the time of the initial initiation of guidance and maybe versus even several months ago. And then just as a follow-up, I don't think I called a backlog growth number for DSA. I'm wondering if you could provide that. And if you have any line of sight towards double-digit growth in DSA next year, I think the Street has you at 9% in 2023 for DSA growth. Thanks.

Flavia Pease:

Yeah. Sure. And Casey, just a couple of additional comments before I give you the backlog number. I think as Jim pointed out, it's incumbent upon us to get it all right, right? We have to have physical capacity, expanding our facilities at the appropriate time, not too soon, not too late. We have to have the people. I think Patrick asked about that. We feel really good that we got ahead, if you will. And you saw, when we provided guidance earlier in the year, we talked about a stronger second half for DSA, which I think there might have been some skeptics out there but we are seeing that materializing in the volume acceleration in the second half vis-a-vis the first half as all of those folks that we hire now become productive, they're out of training, and they can really be available to support the strong client demand that we're seeing and allow us to gain share, as Jim said. So I think we really have done a nice job of ensuring we had the available physical labor input capacity available to absorb the increase in demand. In terms of the backlog, the backlog in the third quarter was $3.2 billion. So it was about 7.5% sequentially growth versus the second quarter.

Operator:

We'll go next to Jacob Johnson with Stephens. Your line is open. Please go ahead.

James Foster:

Yeah. So we are optimistic about next year. It's a business that has limited providers, both of the services or the products required. So that provides enormous opportunity for us going back to the previous question about clients doing it themselves. 3,000-ish molecules, at least two-thirds of which are in a preclinical domain. So there's an awful lot of work available. So we've been working hard to have the right staff, the right facilities and the right dialogue for the clients know that we're deep in this in concert with our biologics business, which gives us, I think, a competitive advantage, also in concert with our Safety Assessment business. So we feel really good about our portfolio and the ability to service a whole range of cell and gene therapy customers across the whole CDMO really paradigm.

Operator:

We'll go next to Justin Bowers with Deutsche Bank. Your line is open. Please go ahead.

James Foster:

Yeah. So we're not going to break out the growth rates and the specific pieces of manufacturing, except to say that we were pleased with the growth rate of Microbial, I'm pleased with the growth rate of Biologics. And not pleased with the growth rate of Avian, which is why we sold it. I don't think that business was particularly seasonal, by the way. We had a pretty consistent client orders sort of a long period of time for almost entirely Avian Vaccines, a little bit of human flu. So it was time to divest that business.

Justin Bowers:

Yeah. I got it. For some reason, I thought I recall like the first quarter, there was kind of an outsized contribution there, but it's -- that's clearly not the case. Maybe just a quick follow-up on what's kind of like the rule of the thumb for every kind of one point move in FX on the year in terms of like the operating profit impact?

Justin Bowers:

Okay.

Justin Bowers:

Got it. I'll take the rest offline. Thank you.

John Sourbeer:

Hi. Thanks for taking my question. Maybe just one on the CDMO and cell and gene therapy manufacturing and just the turnaround recovery next year. Do you see any areas of gaps or maybe areas that could be complementary within the portfolio there that invest in organically or inorganically that could help accelerate that turnaround into next year?

Flavia Pease:

Yeah. And I'll just add, I think in the second quarter earnings, we talked about, obviously, what we've learned in the CDMO as we took the assets, they're longer sales cycles. But I think actually, at this point, those longer sales cycles and the efforts that we have been doing and putting in our BT teams are very prudent us having good visibility into potential opportunities for next year. So we feel good, not only that we're going to have easier comps, but that we have line of sight to the underlying demand that Jim talked about.

Operator:

We'll go next to Dan Leonard with Credit Suisse. Your line is open. Please go ahead.

Flavia Pease:

So I just -- I provided -- I tried to provide some help for you guys is, how you model that. In 2023, about a 100 basis point change in interest rates would resulted about $9 million of impact to our interest expense. It's -- to your point, this year, because the Fed has moved pretty much every quarter, right? And every quarter, we have updated our interest expense outlook, it's hard to establish from which base. So I just wanted to provide you some modeling help that for next year, 100 basis points is worth $9 million.

Flavia Pease:

You have different bases. So every quarter, it's going to be a little bit different. That's why it's challenging given what has been the escalating interest rate high this year.

Operator:

Our next question comes from Max Smock with William Blair. Your line is open. Please go ahead.

James Foster:

Not going to give you the pricing and we really don't want to unpack it. So we're really pleased with both the volume growth and the pricing power in that business, which has improved pretty much sequentially year after year as the demand has increased as our competitive posture and capabilities have increased. So we're happy to be getting share, taking share and getting paid well for our business. We're very pleased with the improvement in operating margin in the third quarter. And particularly pleased with the volume of work that's already booked into fiscal '23.

Operator:

We'll go next to Tejas Savant with Morgan Stanley. Your line is open. Please go ahead.

James Foster:

Proposal volume, we're busy, lots of proposals and lots of work being booked. Don't really see any rationale structurally demand-wise or otherwise and why things would moderate. We'll talk more about as we finish the year and throughout the year. And obviously, but our competitive posture seems to continue to strengthen. Pricing power, as I said, continues to strengthen and there's a lot of work. Clients are really busy with a whole range of large and small molecules, a lot of cell and gene therapy work. And so the thing that we've seen the most of is prioritization of what drugs they want to get in earlier. We tried to accommodate that. We also -- we didn't have it in our prepared remarks, but we do have some clients that have signed up a dedicated space with us. I think that's a really important happening and really an important sort of commentary on both the acknowledgment on the client's part that they need some vehicle to move relatively to the front of the line. So we'd be surprised if we don't see more arrangements like that.

James Foster:

So China has been a place with strong growth rate and good margins, some pricing power. And a lot of that is associated with access to incremental animals and other geographic locals in a very large country. So we've continued to increase capacity, both for the product and the service side in RMS in China, and really, we're pleased with the results. And while we definitely have competition over there, most of its local and most of it is much less sophisticated from an animal quality and veterinary point of view. The dialogue about in-vitro technologies, 3D models, AI, I mean, all of that is not new. We're interested and have always been interested at Charles River in making sure that a minimal amount of animals are used and used appropriately for studies. We've seen the mix in animal models over the years with more refined, higher ASP models, so hypertensive animals, immunocompromised animals, double, triple quadruple immuno-compromised animals, inbreds, hybrids, et cetera., with higher ASPs and less sort of outbred models. I'd say a couple of things that, while I think there's a desire on the part of -- we have a public maybe for there to be a reduction or replacement of new technologies for animal models. And by the way, we see most of those technologies, they will not provide a sufficient safety profile. Most -- many of the drugs, many of the diseases for which we have drugs scientists don't understand the mechanism of action in most diseases. If we don't have drugs, they definitely don't understand the mechanism of action. So trying to replicate that the computer of cell culture or ex vivo system is very complicated, and it's unlikely that the drug companies would take the time to validate those technologies or the regulatory agencies with would be comfortable with that. Yeah. I think it's a little bit different with Discovery. So that's regulated safety. So we don't see any changes. You're going to need a whole animal model to get good results and in most cases, two different species. On the Discovery side, most of the big pharma companies have their own in vitro screens, which they don't share with anybody else. We've made a couple of investments right now in AI and machine learning. We'll make more investments in AI and machine learning. And we can see a time where some of the early discovery answers pre getting into animals, could be done in vitro and could be done faster. I think that's one of the places that we will all save time. So a little bit of a tale of two cities.