Charles River Laboratories International, Inc. (NYSE:CRL) Q4 2023 Earnings Call Transcript

Charles River Laboratories International, Inc. (NYSE:CRL) Q4 2023 Earnings Call Transcript February 14, 2024

Charles River Laboratories International, Inc. beats earnings expectations. Reported EPS is $2.46, expectations were $2.39. Charles River Laboratories International, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

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.

Todd Spencer: Good morning and welcome to Charles River Laboratories fourth quarter and full-year 2023 earnings and 2024guidance conference call and webcast. This morning, I’m 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 fourth quarter of 2023, as well as our financial guidance for 2024. 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 the next quarter’s conference call. I would 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.

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.

Flavia Pease: Thank you, Jim, and good morning. Before I begin, may I remind you that I will 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, gains on the avian divestiture and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, divestitures, foreign currency translation and the 53rd week in 2022. Our fourth quarter 2023 revenue and earnings per share were in line with our expectations and our prior guidance ranges and reflected the continuation of a cautious biopharmaceutical and market demand environment, which we expect will persist into 2024.

Therefore, we expect reported revenue growth of 1% to 4% organic revenue that will be flat to 3% growth in 2024. Higher revenue and moderate margin improvement are expected to drive non-GAAP earnings per share to a range of $10.90 to $11.40 this year, representing year-over-year growth of approximately 2% to 7%. Our guidance also assumes that the tax rate is less of a headwind to earnings growth than in the prior year, and that interest expense will be slightly below 2023. I will provide more detail on the non-operating items a bit later. As Jim mentioned, in November, we acquired an additional 41% equity stake in Noveprim, a high-quality supplier of NHPs in Mauritius. Noveprim has been a long time supplier to Charles River, and we made our first equity investment in 2022, acquiring a 49% stake.

Now that we own a 90% controlling interest, we will consolidate Noveprim’s operations into our financial results. The acquisition is expected to be the primary contributor of our operating margin improvement in 2024 and add at least $0.30 to non-GAAP earnings per share. The majority of the financial contribution this year will be derived from NHB sold to third-party clients, which will be included in the RMS segment. We expect Noveprim will generate $40 million to $50 million of third-party revenue for the Full-Year 2024, which will not impact organic revenue growth until we anniversary the transaction in late November. NHPs that will be utilized in regulatory required studies will be included in the DSA segment. The transaction will be a small benefit to our DSA financial results as we will now be sourcing these models internally instead of a third-party supplier.

With regard to the quarterly dating of our 2024 outlook, as we have said many times, our business isn’t linear and its quarterly performance can fluctuate based on mix, the status of clients’ programs, the timing of NHB shipments and other related factors. We expect the second half of 2024 will be stronger for both year-over-year revenue growth and operating margin than the first half, due in part to the challenging growth comparisons in the first half of 2023. We expect organic revenue will decrease at a low to mid-single-digit rate in the first half, followed by a second half increase at a mid- to high single-digit rate. I will now provide additional details on our 2024 outlook, starting with our reportable segments. The RMS segment is expected to generate flat to low single-digit organic revenue growth based on modest growth for research models driven principally by price as well as accelerating growth in the services business with the ramp of new cradle facilities in the second half.

The DSA segment is also expected to generate flat to low single-digit organic revenue growth based on the expectation that early stage demand trends will stabilize during the first half of the year and begin to improve later in the year. The Manufacturing segment is expected to achieve low to mid-single-digit growth, primarily driven by the CDMO business as well as modest revenue growth in the Microbial Solutions and Biologics Testing businesses. In 2023, the operating margin declined by 70 basis points to 20.3%. This was caused by higher unallocated corporate costs that reduced the consolidated operating margin by 30 basis points, which I will discuss shortly and the moderating domain environment during the year, which particularly impacted the RMS and Biologics Testing businesses.

The manufacturing margin was also impacted by higher costs in the CDMO business necessary to prepare for regulatory audits and commercial readiness as well as a lease impairment in the first quarter of 2023. We implemented cost-saving actions in 2023 and 2024 to manage our cost structure and align it with the current demand environment, but it takes time for the savings to ramp. These restructuring initiatives will generate approximately $60 million to $70 million in annualized cost savings. Despite the slower top-line growth, we expect to generate operating margin improvement of at least 50 basis points. As I mentioned earlier, this improvement will primarily be generated by Noveprim. The balance of the improvement will be derived from continued efforts to manage costs and drive efficiency.

On a segment basis, we expect meaningful operating margin improvement from the RMS and Manufacturing segments. Noveprim is expected to contribute at least 200 basis points to the RMS margin. In the manufacturing segment, we expect the profitability of each business unit will improve commensurate with sales volume, but expect the CDMO business will be the largest contributor as it grows in scale and adds commercial revenue and as costs related to regulatory audit preparation and commercial readiness moderate. The DSA operating margin is expected to be slightly below the 2023 level. We expect unallocated corporate expenses in 2024 to be similar to the 2023 level at just above 5% of total revenue. The 30 basis point increase in 2023 to 5.3% was primarily attributable to continued investments in our digital strategy as well as higher health and fringe-related costs, which was the primary driver of the fourth quarter increase.

The non-GAAP tax rate for 2024 is expected to be in the range of 23% to 24%, an increase from 22.1% in 2023. The anticipated increase in the tax rate is principally due to the impact related to stock-based compensation as well as the geographic mix of revenue. In addition, we do not expect discrete tax benefits, which benefited 2023 to repeat. The headwind from stock-based compensation will cause the first quarter tax rate to be in the mid-20% range because of the more pronounced impact on the tax rate from the timing of vesting of equity awards at current stock price levels. Total adjusted net interest expense in 2024 is expected to be in the range of $125 million to $130 million, compared to $131.5 million last year. The decrease will be primarily driven by debt repayment as well as anticipated lower variable interest rates later in 2024.

At the end of the fourth quarter, we had outstanding debt of $2.65 billion compared to $2.5 billion at the end of the third quarter. The sequential increase reflected borrowing to fund the Noveprim acquisition. At the end of the fourth quarter, approximately 75% of our $2.65 billion in outstanding debt was at a fixed interest rate. Our gross leverage ratio was 2.3x, and our net leverage ratio was 2.2x at the end of the fourth quarter. For 2024, we expect free cash flow will be in a range of $400 million to $440 million, representing a meaningful increase over $365 million in 2023. This increase will be driven by our earnings growth as well as our continued focus on working capital management. In addition, capital expenditures are expected to decline both on a dollar basis and as a percent of revenue.

CapEx for 2024 is expected to be approximately $300 million or about 7% of total revenue, down from $318.5 million or 7.7% of revenue in 2023. This outlook is in line with our long-term target level of 7% to 8% of revenue for CapEx and reflects our disciplined approach to aligning capacity and capital investments with market demand. A summary of our 2024 financial guidance, including Noveprim can be found on Slide 38. With regard to the first quarter of 2024, we expect revenue will decline in a low to mid-single-digit range on a reported basis and declined in a mid-single-digit range on an organic basis as we expect demand trends will be similar to the fourth quarter of 2023. As a reminder, despite the stronger first quarter in 2023, there is typically a seasonal impact in safety assessment, reflecting fewer study starts at the beginning of the year.

The Biologics Testing business is also impacted by seasonally lower sample volumes in the first quarter. From an earnings perspective, we expect non-GAAP earnings per share of at least $2 in the first quarter. The decline from the fourth quarter will be primarily driven by a lower operating margin due in part to seasonal business trends. Unallocated corporate costs will also remain above 6% of revenue in the first quarter and similar to the fourth quarter level. A challenging comparison to the robust DSA operating margin in the first quarter of last year also impacts the year-over-year comparison. As I mentioned, we expect a meaningfully higher tax rate in the mid-20% range, reflecting a headwind from stock-based compensation. We do expect revenue and operating margin will improve sequentially after the first quarter as we move beyond the seasonal trends at the beginning of the year, and market demand improves marginally as the year progresses.

In closing, despite the ongoing cautious biopharma spending environment, our business continues to be resilient, and we remain confident in the long-term health of the industry. Our solid 2023 performance reflected our ability to manage the challenges in the marketplace while continuing to focus on making disciplined investments to support our businesses and managing costs to capture efficiencies. Although 2024 organic revenue growth is forecasted to be below our long-term targets, we remain confident in our Investor Day targets of averaging 6% to 8% organic revenue growth through 2026 and delivering meaningful margin expansion, which is supported by the sustained long-term fundamentals for drug development and our position as an industry leader.

Thank you.

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

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Q&A Session

Operator: [Operator Instructions] We will take our first question from Derek De Bruin with Bank of America.

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?

James Foster: Sure. This would not be the first time it actually would be the third time that we have had a ramp. 23% was in the first half of the year, 22% was in the back half of the year and they were pretty big ramps. So I don’t want to say it is the nature of the business, but it is not been unusual. The first quarter tends to be a little bit slower as the clients sort of sort out what molecules are going to work on and what they are going to delay and then there is obviously a lot of issues, right? So I guess we are looking at a lot of things. Yes, cancellation rates were higher than we would like, and that is somewhat concerning. And by the same token, we think those will ameliorate we are seeing sort of a stabilization in demand in as much as seeing our microbial folks destocking, meaning that they loaded up in the prior year, and they have been working through that bolus of inventory now that we believe there getting out to buy incrementally.

We saw increased proposal activity in Biologics in the fourth quarter, and that business was down last year. Again, that is one of those businesses where the work comes in very quickly. The studies are relatively short term. So you turn them around very quickly and building very quickly. And that is a bit of a commentary on the necessity to test and the growth rate of large molecules, which we still feel really positive about it. I think everybody has. We are looking at a ramp of new cradles that we either built at the end of last year or are opened or will open this year. So we should see more of that in the back half of the year. We are watching biotech IPOs carefully as you all are, as everybody is or about half a dozen – in the first quarter, they priced well, but $8 billion was raised.

And so we feel good about that. We are seeing an enormous amount of biopharma M&A. So that is injecting a lot of cash into the system of VCs are flexed with cash. So sequential movement after the first quarter is, I want to use the word normal. It tends to be quite usual. So look, we are piecing together without trying to over-read the situation that there are a bunch of sort of smaller subtle things that in the aggregate are coming together to provide confidence. Lots of questions about NHP pricing. So just to sort of bottom line that for you. Our prices never got as high as some of the competition, including some of the much smaller competitors. So we didn’t pay as much we didn’t pass along extremely high prices to our competitors. And that is a manifestation, I think, of supply sources that we have.

And now we have this new supply source, Noveprim in Mauritius which was always – we have used a few years, but it is always been the highest quality provider, and that is going to both provide NHP for safety and also to sell directly to clients. And so we do think we can have a modest price increase, which is where you are seeing that $15 million to $35 million that we pointed to. Lots of noise from the competition about reducing prices. That is not just positive of anything that we are going to do because their prices interestingly, have been higher than us. And so if they bring the prices down, whatever they said, I think 10%, 20%, 30% they are going to get in the same zip-code that we are. So we think we have a modest amount of NHP pricing.

And those aren’t huge numbers, but we’d be happy to get that incremental revenue. Supply sources are in really good shape. Solidified by the Noveprim acquisition in a whole litany of smaller, I don’t want to say unrelated smaller strengthening activities across portfolio. So while it definitely is back-end loaded, we do think it is doable. We also have very easy comps. I don’t necessarily like to say that, but that is a mathematical fact. So the weak back half of the year in 2023. So we have a meaningful level of confidence the ramp and definitely in our guidance for the year, Derek.

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?

James Foster: There continues to be conversations about it. We haven’t seen anything either from an importing point of view or an exporting point of view. So while it is possible, I think it is unlikely. I mean, the thesis has clearly keep those animals within country to provide some sort of competitive advantage, although I don’t think it is going to be. But they think that is an important sort of natural resource and scientific resource that gives them a leg up. So I think we are going to want to hold on to those things and use them inside. I think there is been a little bit of noise around that just because the economy has been tougher over there than people anticipated. And the investment in life sciences has been a little less robust.

There has been a fair amount of speculation that they would export. And by the way, anything is possible, we are just not seeing it. And I’m not sure there is actually a logical reason for them to do it, particularly not yes, but when things heat up again in China.

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

Patrick Donnelly: Jim, maybe on the DSA piece, you talked about the cancellation rates picking up a little bit. It seemed like the book-to-bill was stable. Can you just talk about what you are seeing there? It seemed like 3Q, there were signs of a little bit of improvement on the cancellation rates. Now we are kind of taking another step back. What do you see in there? Again, you mentioned the biotech IPOs, does that give you a little more confidence? How are you thinking about just that backlog step down as we work our way forward here.

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.

Patrick Donnelly: Okay. That is helpful. And then maybe, Flavia, one for you. Just on the margin cadence for the year. Can you just talk about the ramp? Obviously, the 1Q earnings number is a bit light in terms of a percentage of the year a lot smaller than typical – so can you just talk about the moving pieces as we work our way through the year on the margin and just visibility into the ramp and the exit rate there?

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.

Operator: And we will take our next question from Elizabeth Anderson with Evercore ISI.