Charles River Laboratories International, Inc. (NYSE:CRL) Q1 2023 Earnings Call Transcript

Charles River Laboratories International, Inc. (NYSE:CRL) Q1 2023 Earnings Call Transcript May 11, 2023

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. I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

Todd Spencer: Good morning, and welcome to Charles River Laboratories first quarter 2023 earnings conference call and webcast. This morning, I am joined by Jim Foster, Chairman, President and Chief Executive Officer; and Flavia Pease, Executive Vice President and Chief Financial Officer. They will comment on our results for the first quarter of 2023. Following the presentation, they will respond to questions. There is a slide presentation associated with today’s remarks, which is posted on the Investor Relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately two hours after the call today and can also be accessed on our Investor Relations website. The replay will be available through next quarter’s conference call.

I’d like to remind you of our safe harbor. All remarks that we make about future expectations, plans and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated. During this call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the Investor Relations section of our website.

I will now turn the call over to Jim Foster.

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 wildly 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, our purpose brand. 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 and HP-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% and 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 AVN 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 segments 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.

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 our global efficiency initiatives, gains or losses from our 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. We are pleased with our first quarter results, which included revenue and earnings per share well above the outlook that we provided in February. We delivered strong organic revenue growth of 15.4%, wildly outperforming our prior expectations.

Higher revenue and a solid operating performance contributed to earnings per share of $2.78, a 1.1% increase over the prior year compared to the outlook we provided in February of a mid-single-digit decline. As Jim mentioned, we have narrowed our previous revenue growth and non-GAAP earnings per share guidance to reflect the strong first quarter performance. We now expect to deliver reported revenue growth of 2% to 4.5% and organic revenue growth of 5% to 7.5% for the full year. As well as non-GAAP earnings per share in a range of $9.90 to $10.90 for the full year. Our 2023 revenue guidance ranges continue to reflect the estimated impact from the NHP supply constraints, resulting in wider guidance ranges to account for multiple outcomes with respect to our mitigation plans.

We are expecting stronger revenue growth rates in the first half of 2023 due to both the comparison to last year when growth accelerated throughout the year, as well as the anticipated gating of the NHP supply impact, which will principally impact the second half. Our segment outlook for 2023 revenue growth remains largely unchanged, as noted on Slide 34. We also continue to expect that the consolidated operating margin will be flat to lower versus prior year depending on the ultimate success of our plans to mitigate the NHP supply constraints. Unallocated corporate costs were favorable in the quarter totaling 4.3% of total revenue compared to 5% of revenue in the first quarter of last year. The decrease was primarily the result of climbing of health and fringe costs, which are expected to normalize over the course of the year.

Despite the favorability in the first quarter, we expect unallocated corporate costs to total approximately 5% of revenue for the full year, which is similar to 2022. The first quarter tax rate was 21.7% approximately 490 basis points higher year-over-year as anticipated. The increase was primarily due to a lower benefit from stock-based compensation. We continue to expect our full year tax rate will be in the range of 22.5% to 23.5%, which is unchanged from our previous outlook. Total adjusted net interest expense was $33.6 million in the first quarter, essentially flat on a sequential basis. The significant year-over-year increase from $20.4 million in the first quarter of 2022, which compressed earnings growth in the quarter, primarily reflected meaningfully higher interest rates as a result of the Federal Reserve’s monetary policy actions since March of 2022.

For the year, we continue to expect net interest expense of $133 million to $137 million. As a reminder, nearly three quarters of our $2.75 billion debt at the end of the first quarter was at a fixed rate. With regards to the remaining variable rate portion of our debt, our outlook can accommodate an additional 50 basis point increase in rates by the Federal Reserve during the remainder of 2023. At the end of the first quarter, our gross leverage ratio was 2.2 times, and our net leverage ratio was 2.1 times. Free cash flow was $2.5 million in the first quarter compared to $22.2 million last year, with higher capital expenditures driving the decrease. As a reminder, the first quarter is a seasonally softer period for free cash flow generation.

Capital expenditures were $106.9 million in the first quarter compared to $80.5 million last year, due primarily to ongoing expansion projects to support continued growth across our business. Today, we’re initiating 2023 guidance for free cash flow and capital expenditures. We expect free cash flow to be in the range of $330 million to $380 million, which is flat to a 15% increase from $330 million in 2022. CapEx is expected to be slightly below our recently stated target of 9% of revenue. At $340 million to $360 million this year. The lower capital intensity reflects our disciplined approach to capital deployment. We are investing in our business based on the growth potential of each business unit and are modifying certain projects in light of the temporary disruption from the NHP supply constraints.

Normalizing the main trends will result in less capital required than we previously anticipated. A summary of our 2023 financial guidance can be found on Slide 40. Looking ahead to the second quarter, we expect year-over-year reported revenue growth in a high single-digit range and organic revenue growth of 10% or better. Reflecting continued strong growth trends across many of our businesses. We expect the NHP supply issue will have only a limited impact on the second quarter DSA growth rate as we’re able to schedule flexibly and expect to leverage the strength of our backlog to slot in other studies when necessary. Earnings per share are expected to decline at a mid-single-digit rate compared to $2.77 in the second quarter of last year.

As the higher tax rate and increased interest expense will continue to restrict the year-over-year earnings growth rate. In closing, we’re pleased with our first quarter performance and are confident about our prospects for the second quarter as well as our ability to achieve our full year financial outlook. Even as macroeconomic and biopharmaceutical market conditions evolve, we will continue to execute our strategy of expanding our business to both meet the needs of our clients and to enhance our position as the scientific partner of choice to accelerate biomedical research and therapeutic innovation. Thank you.

Todd Spencer: That concludes our comments. We will now take your questions.

Q&A Session

Operator: We’ll take our first question from Eric Coldwell with Baird.

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.

Flavia Pease: Good morning Eric, it’s Flavia. Thank you for your question. The range is – of the 200 to 400 basis points of the supply NHP impact remains consistent with what we provided earlier in the year.

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.

Jim Foster: Hi Eric, Certainly, it’s prudent for us not to bring NHPs at least from Cambodia into the U.S. And I would say that the U.S. government is – is fine with that strategy. So they’re certainly not supportive of us doing otherwise. So we’re going to cooperate and we’re going to run our business with multiple supply sources, doing a work in multiple sites and try to work hard to have new testing protocols that show parentage accepted and used universally, we would hope. We’re quite confident in our ability to do that. A little bit difficult for us to have much impact on the cadence of how quickly that goes and then what the receptivity will be. But we feel good about the science behind that. We actually feel good about all of our supply sources.

And we do the best we can to accommodate for the situation as a result of that we should have slightly better performance in the second quarter than was embedded in our guidance. But it’s still fluid. And I was saying the fact that I think we have good program and plan to satisfy the needs and demands of our clients. There are things that continue to be on our control, which is why we have such a – while we continue to have a guidance range that we do and we’ll continue to give you as much information as we can and as things if and as things change.

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

Jim Foster: Thanks, Eric.

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

Derik De Bruin: Hey, good morning.

Jim Foster: Hi, Derik.

Derik De Bruin: Hey Jim, two questions. I think the first one is, are the Cambodian NHPs currently being sold as where is the – supply that was destined to the U.S. going into China or going to China. And then if you – assuming the situation does get resolved, is it going to be difficult to get back to the U.S., i.e., are you going to have to pay a lot more money to get them there? I’m just sort of curious where are the supplies going right now? And can you get them back?

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 both 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 studies oversight that’s required for purpose spread. We also think that the veterinary oversight and nutritional oversight and transportation oversight and the fund 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 basis as possible.

Derik De Bruin: Great. Thank you. I’ll stick to one question. Thanks, Jim.

Jim Foster: Sure. Thanks, Derik.

Operator: And we’ll take our next question from Sandy Draper with Guggenheim.

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.

Jim Foster: We’ll both answer this. I would say we were not surprised. As we reported all of last year and probably the prior year, demand for safety assessment was unrelenting and growing and well in excess of a year, in some cases, 1.5 years. So strong demand, this NHP disruption really was not a factor. RMS has been growing really nicely for several years now. I don’t know whether anybody remembers, I hope you did, but if not, we’ve reminded you. We knew that manufacturing would be behind the prior year because of some milestone payments that we – substantial amount payments we had in the first quarter with our CDMO business and COVID work for biologics. So quarter track pretty much as we anticipated. We’re obviously pleased with that level of growth. The Safety Assessment business is a very large part of what we do. As you know, and so it has had a really meaningful impact on our results. I’ll let Flavia answer the rest of the year question.

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.

Jim Foster: Sandy, it’s worth reminding you and everybody else listening what the cadence was last year. Flavia’s point, right? So we had a safety, we had a slow first half of the year and a really strong second half of the year, I think some of our shareholders didn’t think that, that was going to happen. We again, 26% growth rate, I think, in the third quarter. So we’re going to have these year-over-year comparisons less tough in the first half, tougher in the second half, some impact from the NHPs, but would have a cadence anyway. Linearity is impossible for us to design or even predict studies sort of start when they start and when they had. But as always, you want to listen to our guidance for full year, particularly in the safety business.

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

Operator: And we’ll take our next question from Patrick Donnelly with Citi.

Unidentified Analyst: Good morning. 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.

Jim Foster: No more NHP question. Just kidding. It’s really difficult to say what the rollout is. The science is not trivial, but relatively straightforward. It’s not all that complicated. We have several places that we could do it or people could do it for us or all of the above. And we’re quite confident from what we know that our supplier purpose reading these animals according to all of our expectations and we can demonstrate that. It’s just the communications is just – as I said a couple of times earlier, is a little bit slower than we would like. We understand that, and we’ll do the best we can. So we’ll give you clarity when we have it. I would say, we – so we’ve been very responsive in terms of coming up with the program, providing that to the various authorities, they’ve looked them over, and we just continue to go back and forth.

And so as a parallel strategy, we’re using our international infrastructure and we’ll continue to always held us in good stead in all of our businesses, but in this case, particularly in safety that we do the work in so many geographic locales, that it really helps with the current situation when things are a little more complicated in the U.S. But we’re confident that we can prove it and demonstrate it scientifically without a shadow of a doubt, at some point, that will be kind of standard and as I said earlier, we’d really like to come up with something that works for the whole industry and maybe not necessarily just for CRL.

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.

Unidentified Analyst: Appreciate the color there. Thanks.

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

Max Smock: Hi, thanks for taking the question. So I wanted to drill down on a decrease in DSA backlog because I think there’s been a fair level of concern around some of the perhaps lower book-to-bill as we’ve seen here in this part of the business. What are you seeing in terms of proposals and bookings so far here in the second quarter? Are you expecting backlog to continue to get work down here over the next couple of quarters given the tougher macro environment? And then digging ahead, where do you think you need to see backlog in this year in order to support double-digit organic growth for the DSA segment in 2024? Thank you.

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.

Flavia Pease: Yes. So I think if you look at our book-to-bill on a trailing 12-month basis, which is how many clinical CRs look at their book-to-bill, we’re still above 1x, and that formally supports our DSA revenue growth outlook for 2023. We got a question earlier around the NHP supply impact, and I commented again on the 200 to 400 basis points, you kind of do the math, you would be able to back into what would the DSA growth be, had we not had that disruption, and it would support a high single-digit, low double-digit growth in 2023. So I think that answers your question.

Max Smock: Got it, thank you.

Operator: And we’ll take our next question from Steve Windley with Jefferies.

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.

Jim Foster: It’s a good question, Dave. Our methodology hasn’t changed very much. We believe we deal with suppliers who are certainly producing purpose spread animals under strict veterinary oversight and complying with cities permitting procedures. And of course, as we talked about for the last two or three years, we have multiple sources of supply, in other words, multiple countries, in some cases, multiple providers in those countries. We own some firms. We own pieces of some firms. We have long-term supply agreements with, I would say, almost all of them. So – and we go and we audit them. We have a little disruption in that audit because of – those audits because of COVID but we go and audit them. So we are familiar with the situation.

So just to use your parlance, I think we were more shocked with the indictments because that’s not the nature of the work that we’re doing and other people that we’re working with and that’s obviously concerning any sort of allegations like that. So we’ll continue to get closer to our suppliers. And I mean that in every way in terms of ownership, people on the ground, constant audits, the testing that we talked about 10 minutes ago with all of them. And dealing openly and appropriately and professionally with the various oversight bodies in a variety of countries, for competitive and security and a whole bunch of other reasons, we want to not be too granular on how we’re dealing the situation right now, except to underscore the fact that we have multiple sources of supply, and we’re using the entire Charles River portfolio, which is worldwide, and I know you’ve been to a lot of sites and the ones who haven’t been to, I think you know where they all are.

And we think that’s always been a competitive advantage for us and being able to use those sites is really be beneficial. Then the last thing I would say, which we haven’t said yet, although I think it’s in the earlier materials is that we’ve had extensive conversations with the clients who have been terrific. And we said, okay, here’s a situation we don’t know exactly how many animals will be able to bring in. So you need to prioritize studies that you do in terms of what you need to start and when, and they’re doing that. And you also have to be flexible about where you do it. So as you know, some of our clients, less all the time and some of our clients like I only want to do the work wherever because I’ve always done to say I did a post stock with the guy or gal that runs the site.

So they’ve been terrific. I’d say our client base has really been very collaborative, working hard with us being open to gain the work done. They just want the work to start in the most timely fashion. So I would say, we’re doing a very good job so far disrupting as few clients as possible. We had a strong Q1. We will have a better Q2 with regard to the NHPs than we originally thought the back half of the year will be more challenging because of the comps. And we – it’s a fluid situation. We hope it’s a positively fluid situation. So we’ll – when there’s something granular that we think is permanent and beneficial for you all to know, we will tell you, but it’s too changeable. And we don’t want to be providing very detailed information that may not be sustainable, but we’re very pleased with the way we’re handling it in the way our clients are accepting the current situation.

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.

Flavia Pease: Thanks, Dave. So a couple of things. Yes, the DSA margin was very robust in the first quarter. And a primary source of that continues to be underlying strong demand, specialty volume and also price outside of NHP. So we’re very pleased with that. The NHP impact on margin, specifically as you’re saying, at a macro level, as you pointed out, it’s a pass-through, so it should be neither accretive or dilutive to the percentage margin. The timing on when we start NHP studies can have an impact on the mix that they have – that they contribute towards to the margin. So depending on that and how we ended up the year and how many new NHP studies we’re starting on in each quarter can have a modest impact on the margin. But what I would focus all of you on is the strength of the margin in the first quarter in DSA is primarily behind volume and underlying price.

Dave Windley: Okay. Thank you. Thanks for the extra question.

Operator: And we’ll take our next question from Casey Woodring with JPMorgan.

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.

Flavia Pease: Yes. So I think we talked about the normalization of the demand trends to more pre-pandemic levels. We had printed out throughout all of last year that the backlog had an extended meaningfully in terms of the length of it with people working really ahead as we had never seen before. And that has definitely normalized. I think our clients are focusing on study starts that are sooner rather than a lot into the future. And as they do that, they also look at studies that were booked before and whether they’re ready to initiate them or not. So as we said, we see the demand normalization from extraordinary levels in 2022. And then just on the Manufacturing Solutions, I think we had commented and expected a lighter first quarter vis-à-vis the overall guidance for the year that originally was low double digit.

We not only saw the first quarter impact of the tough comps with the CDMO milestones and the COVID volume in biologics, but we also talked about a slightly slower start of the year for testing. And there might be some comments around the industry on bioprocessing. So we widened our guidance range a little bit on manufacturing to accommodate for that.

Todd Spencer: I think we’re ready for the next question.

Operator: And we’ll take our next question from Tejas Savant with Morgan Stanley.

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?

Flavia Pease: So maybe I’ll just take the first question. We had provided a wider guidance range obviously this year given the NHP supply situation. And to your point, it included 200 basis points to 400 basis points of impact. As Jim commented, the second quarter is certainly a little bit better than we had planned given the collaboration with our clients to work and schedule flexibly. So we continue to include the 200 basis points to 400 basis points in our guidance range, given also what Jim talked about, which is, it continues to be a fluid situation. We’re working very hard to be at the lower end of that range, but it’s still early in the year. So I’ll leave it at that. Jim, do you want to…

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.

Tejas Savant: Thanks guys. Appreciate it.

Jim Foster: Sure.

Operator: And we’ll take our next question from John Sourbeer with UBS.

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.

Jim Foster: So on the CDMO business has three parts. We have a cell therapy manufacturing business, which is our largest business in Memphis is doing quite well, certainly compared to the prior year. I was just down there, fabulous new facilities, new management team, new sales organization significant number of new clients, both large and small. We are producing our first commercial product, I can’t divulge it, but we are. And we have other clients that are moving in that direction. By that I mean, either filing with various government agencies in the U.S. and Europe and/or telling us to get ready for audits by either the FDA or the EMA. So moving in the commercial direction, we have new production suites, which are available.

Some of those have been reserved by clients that are either commercial now or think they will be soon, because obviously they don’t want to have a product approved and not get this. So we’re pleased with the way it’s progressing. We also have a viral vector business in Rockville, Maryland that it also has been enhanced facilities and management team and sales organization, which is strengthening nicely. And we have a plasma DNA business in the UK, which again, has been somewhat transformed. We have centers of excellence in both of those sites now where they used to do multiple things. So CDMO business will have nice growth rate this year, notwithstanding the predetermined and expected difficult comps for Q1 that business will continue to strengthen through each quarter both on the top line and the bottom line from a comparative basis.

The horseshoe crab thing, that’s the reagent that we use for our endotoxin test. I’ll remind you that that test is used for medical devices and injectable drugs required by law as a law release test. I’ll also remind you that that was our first major foray into in vitro systems. That’s actually considered in vitro system, even though uses the blood of horseshoe crabs. Those crabs are harvested in variety of places. We have a little bit of pressure in one of our locations in South Carolina that’s lawsuits related to that. I won’t get into all the details, but the punchline is we have some restrictions in fishing those waters, but we also have new locations to harvest crabs in other parts of the U.S., which should hold us in good stead.

We’re also building the inventories nicely. And I guess the last thing I would say is that our technology as opposed to the conventional technology, which is 96% well place and we still sell lots of that. But our forward-looking technology is a more sophisticated device which uses 95% less crude. So, our need for crude, which is the blood from the horseshoe crabs is actually as we transfer the clients, the new technology is actually decreasing all the time. So we’re in good shape there.

John Sourbeer: Thanks for taking the questions.

Operator: And we’ll take our next question from Justin Bowers with Deutsche Bank.

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?

Jim Foster: Well, we’re expecting that those businesses in the aggregate, again, with Memphis being by far of the largest piece will grow at 20% to 25%, which is what we had anticipated when we bought them. So that’s a great growth rate, obviously accretive to the growth rate of the manufacturing segments and at a certain scale, obviously somewhat accretive to the growth rate company as a whole. But as it grows, it will be increasingly more accretive. So lots of demand, limited competitive scenario, I mean, some clients are doing it themselves, but I’m talking about on a contract basis. We have good competitors, but not a lot of them. Lots of drugs in development that we’re working on the preclinical sector. And then obviously, lots of those moving into the clinical domain.

Only a few have been approved still think it’s 13 to 14 totally. We’re now making one of those gene-modified cell therapy products. So, we’re very pleased and proud of that. Early days from a volume point of view, so it’s not transformational necessarily from that point of view. But I think reputationally, with regard to other potential current clients being comfortable with our capability and also the regulatory agencies having and being pleased with what they saw holds us in good stead. So, we’re happy with our infrastructure, with the growing client base with our scientific capabilities with our ability to sell more effectively. It’s a pretty long sales cycle. So, we’re out and about well in advance it is a fair amount of price power in this business, because it’s complicated and expensive to set it up.

And while you may have some very big companies set their own shop up small and medium-sized biotech is not going to be able to afford it. So like in safety, well, like in all of our businesses, we’ve got to need to be paid well for recurrent and future investment in this space. But we’re pleased with the way it’s gone. We learned a lot last year. We made a lot of fundamental changes in the physical plant and in the scientific and G&A staff and just getting the word out that this is something that we do as we go to more scientific meetings and present more paper. So we should hit the growth rates that we originally anticipated in our acquisition model.

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?

Jim Foster: We have supply sources in China that have to stay in China. So, we sell the animals to clients in China. Usually, we can predict the time frame. So this just slipped out a little bit. So nothing fundamentally changed. It’s a huge part of the business, but it’s meaningful certainly to our Chinese business and slightly less meaningful, but still meaningful to our RMS. Margins are good. Animal quality is good. And so yes, that will continue to be part of our situation over there. But nothing has fundamentally changed, just slid out a little bit.

Flavia Pease: Yes. It’s purely timing. I would characterize.

Justin Bowers: Okay. Got it. Thanks so much.

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

Elizabeth Anderson: Hi guys, thanks so much for the question. You could comment on sort of backlog cancellations in the first quarter. Is that something that you’re sort of seeing as broadly steady sequentially? Are you seeing any sort of changes in the characterization of that at all? Thanks.

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.

Elizabeth Anderson: Got it. That’s super helpful. And then just one follow-up, like, obviously, the margin in manufacturing this quarter was impacted a bit by the lower revenue growth, I would imagine in the quarter. But the OpEx growth in general seemed a little bit higher than your usual kind of run rate on that. Can you just talk to maybe like the cadence of that in the back half of the year and sort of how much was sort of specifically a function of maybe some of the deleveraging and manufacturing support versus how you’re seeing any kind of cadence changes in the spend over the rest of the year? Thank you.

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.

Elizabeth Anderson: Got it. Thank you.

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

Tim Daley: Great. So Jim, just moving away from all these near-term factors here. I wanted to clarify some comments made at a broker conference in March around the RMS segment long-term growth rate. So over the past two years, you guys have formally up indexed long-term growth forecast in RMS from low-single, mid-single to mid-single, high-single and DSA from high-single to 10%. So where we sit today, are those still the official goalposts or any further updates here on that framework on the segment level?

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. 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.

Tim Daley: Great. And then a quick one for Flavia. What’s the overall China exposure as a percent of revenues, an update on that? And then are any big businesses or segments over under indexed to China? And thanks for the time. I appreciate it.

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 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.

Jim Foster: I think it’s still less than 5% of total revenue, probably 3% or 4%. I mean – I think last time we updated, it’s like 10% or 15% of revenue.

Tim Daley: Great. Thank you.

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

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: Thank you. That does conclude to today’s Charles River Laboratories First Quarter 2023 Earnings Call. Thank you for your participation. And you may now disconnect.