This paragraph introduces the Charles River Laboratories second quarter 2023 earnings conference call, which will be hosted by Todd Spencer, Vice President of Investor Relations. Jim Foster and Flavia Pease will be joining him to comment on the results for the second quarter. The remarks will be accompanied by a slide presentation which will be posted on the Investor Relations section of the company's website. The webcast replay of the call will be available two hours after the call and will be available until the next quarter's conference call. The remarks made about future expectations, plans and prospects for the company are forward-looking statements. The call will primarily discuss non-GAAP financial measures.

The company reported strong second quarter financial performance, with organic revenue growth of 11.2%. The DSA segment had a successful quarter with double digit revenue growth and operating margin improvement. The company is narrowing its revenue and non-GAAP earnings per share guidance to the upper ends of the previous ranges. However, the DSA segment faces a challenging year-over-year comparison and there is a near-term impact from NHP supply constraints in the third quarter. Biopharmaceutical clients are reprioritizing their pipelines and tightening their R&D budgets, which is affecting the industry and the company. The company is leveraging its significant DSA backlog to manage the business amidst a more cautious biopharma spending environment.

Charles River has successfully mitigated supply constraints caused by the suspension of Cambodian imports into the U.S. by leveraging their global safety assessment infrastructure and conducting more studies outside of the U.S. This has enabled them to narrow their DSA organic growth and growth outlook to the mid single digits or the upper end of the prior range, although the favorable impact will be largely offset by current DSA demand trends.

In the second quarter of 2023, the company reported revenue of $1.06 billion, an 8.9% increase from the previous year. Organic revenue growth was 11.2%, driven by strong performance in the RMS and DSA segments and an improvement in the manufacturing growth rate. The operating margin was 20.4%, a decrease of 140 basis points year-over-year. Earnings per share were $2.69, a decrease of 2.9% from the same period in the prior year. The company has narrowed their revenue and non-GAAP earnings per share guidance for the year to the upper ends of their ranges due to successful implementation of their NHP mitigation efforts.

DSA revenue increased 11.7% in the second quarter due to Safety Assessment business growth, base pricing, and study volume. However, the discovery services business posted lower revenue compared to the prior year. DSA backlog decreased to $2.8 billion from $3 billion at the end of the first quarter, and net bookings and proposal activity trended lower, with a higher than normal cancellation rate. This is likely due to clients rationalizing lower priority projects, but it is expected that the cancellation rate will decline and the backlog will more reliably reflect the actual study demand.

In the second quarter, cancellations of Safety Assessment business declined as incoming new Business Awards and gross booking activity remained robust. This suggests that solid underlying growth prospects will return once the rate of cancellation subsides. Biotech funding has also shown increases on a trailing twelve month basis, and the company has an average of thirteen months of revenue coverage and a solid backlog coverage, both of which afford the company the ability to manage the business through fluctuations in demand. The DSA margin increased due to operating leverage associated with higher revenue, and the company is closely monitoring capacity utilization for physical infrastructure and labor to keep these metrics aligned with the current demand environment.

RMS revenue increased 13.9% in the second quarter of 2022, driven by growth in small research models and end sourcing solutions. Growth was particularly strong in China due to the timing of large model shipments and in North America and Europe due to stable demand and pricing. Services businesses, particularly CRADL, are the primary growth drivers for RMS, with 32 sites across five states and London and China. The Philadelphia location is expected to cater to a large base of cell and gene therapy companies in the region.

The CRADL network supports the growth of the life sciences ecosystem, and the second quarter of the RMS saw a 150 basis point increase in operating margin. The Manufacturing Solutions segment saw a 6.6% organic increase, driven by the CDMO and Microbial Solutions businesses. The CDMO business saw a strong quarter with double digit growth, and initiatives to improve performance have been successful. The business is now working with a commercial self-therapy client in Memphis and a few other clients who are nearing commercial launches.

Microbial Solutions delivered a successful second quarter performance due to the Accugenix Microbial Identification platform. The launch of the Endosafe Trillium recombinant cascade reagent, which is animal free, provides superior accuracy and testing outcomes compared to competitors. The introduction of the Trillion solution supports their advancement of responsible science and further solidifies their position as the only provider offering a comprehensive solution for rapid manufacturing and quality control testing. Testing volume in the biologics testing business improved from the seasonally soft first quarter level, but the year-over-year growth rate was still pressured due to clients reprioritizing projects and becoming more budget conscious.

Charles River Laboratories saw a year-over-year decline in their manufacturing segment's operating margin, but they anticipate it to improve in the future. They are confident in their ability to manage through any near-term fluctuations due to their scientific expertise, global network of facilities, digital transformation, and unique portfolio. They recently completed a review of the market environment, growth prospects, and strategic imperatives for their company.

Jim thanked employees, clients, and shareholders for their support and Flavia provided additional details on their second quarter financial performance and 2023 guidance. The results for the second quarter included organic revenue growth of 11.2% and non-GAAP earnings per share of $2.69, which are consistent with their prior outlook. The increased interest expense, higher tax rate, and divestiture of the Avian vaccine business continue to restrict the year-over-year earnings growth rate, but the first half results and updated NHP supply outlook support their revenue growth and earnings per share guidance for the full year.

In the second quarter, unallocated corporate costs totaled $65.1 million, or 6.1% of total revenue. The company expects to deliver reported revenue growth of 2.5% to 4.5%, organic revenue growth of 5.5% to 7.5%, non-GAAP earnings per share between $10.30 and $10.90, and free cash flow of $330 million to $380 million for the year. The DSA segment is expected to have mid single digit growth on a reported and organic basis, while the Manufacturing segment is expected to have a low to mid single digit decline and a high single digit increase on an organic basis. The RMS segment growth outlook remains unchanged with a high single digit growth on both a reported and organic basis. The consolidated operating margin for the full year is expected to be flat to slightly lower than in 2022.

In the second quarter, corporate expenses averaged 5.2% of revenue and the tax rate was 23.3%. The total adjusted net interest expense was $33.6 million, and the full year outlook is now in the range of $131 million to $134 million. The company's debt balance at the end of the second quarter was 2.1 times gross leverage ratio and 2 times net leverage ratio. In the near term, the company will focus on debt repayment, but in the long term, strategic acquisitions are seen as generating greater shareholder returns.

In the second quarter, free cash flow increased year-over-year due to favorable changes in working capital and capital expenditure was lower due to the timing of projects. For the full year, the company expects to make capital investments in the 8% range as a percent of total revenue. The second half of the year is expected to have slower growth due to a modest supply impact, a more cautious biopharma spending environment, and difficult growth comparisons to the second half of last year. The third quarter is expected to have low single digit revenue growth on both a reported and organic basis, and non-GAAP earnings per share is expected to decline by approximately 10%. The company is focusing on executing its strategy and delivering solid financial and operational results.

Jim Foster notes that demand for the company's services is broad-based, with big pharma companies exhibiting careful spending due to their large budgets and small biotech companies being cautious due to potential concerns of running out of cash. However, the second quarter saw strong performance from the pharmaceutical sector.

Jim Foster discusses the impact of NHPs on the third quarter and the current backlog of $2.8 billion. He notes that the market was "frothy" and clients were booking slots far out, resulting in a backlog of thirteen months. He states that it is difficult to say where the backlog will settle out.

Slippage has increased due to the volume of work, but as things normalize, there should be a reduction in slippage. Price will continue to be an important factor, as will a substantial volume of business. The business is good and the demand is solid, and clients are expected to focus on studies to start more quickly than in the past two years. There is no linearity in the business, with a slow first half and a strong second half in the past year, and a strong first half pointing to a less strong second half this year.

Jim is asked about how NHP pricing will affect margins and how he is planning to mitigate it. He explains that NHP pricing has had an impact on margins, but gross bookings are still supporting healthy growth. He cautions Derik not to draw a direct conclusion from the 12% revenue growth in the segment and the gross bookings.

Jim Foster states that the NHP pricing has been a pass-through, and that it is difficult to predict the availability of NHP. He believes the pricing is appropriate given the complexity and labor involved. In regards to the Manufacturing segment, the microbial business has the potential to reach low double-digit growth due to the pricing and product line. The CDMO business is improving both top and bottom line, and it is feasible for the segment to reach double-digit growth by 2024.

Biologics business has been slow in the first and second quarters, but is expected to improve in the back half of the year. Investing in capacity and staffing for cell and gene therapy is expensive and is causing a drag on margin. The company is planning for their investor conference at the end of September and will provide clarity on the businesses across the portfolio. Tejas Savant asked how pricing should be considered into the back half of the year and into 2024, given the shift in focus from start times to safety assessment.

Jim Foster explains that the capacity for drug development is tight and that pricing will continue to be meaningful. Flavia Pease notes that inflation has been unusually high and they have been able to pass those pressures to clients. Tejas Savant follows up with a question.

Jim Foster of Mass Q discussed the implications of the NHP situation on margins. He explained that Mass Q has a large infrastructure and expertise in NHPs around the world, and that they will be able to utilize multiple sources and suppliers in order to maintain competitive prices. He also noted that the costs are not identical everywhere, but that they will be able to achieve a healthy blended margin.

Jim Foster explains that the company is undergoing vigorous regulatory and client audits, which could give them a competitive advantage if successful. He notes that the volume of the cell and gene therapies that have been approved is still relatively low, but they are thrilled to have multiple clients that are either commercial or going through these audits. He also mentions that they are working on efficiency initiatives to ensure that clients receive the same quality of work regardless of where it is being done, and that this could lead to increasing better margins.

Jim Foster of DSA explains that it is difficult to compare current biotech funding cycles with previous ones due to the different economic conditions, client base, and modality. He also notes that the current cycle is slightly cyclical with clients favoring clinical work over early discovery work.

Jim Foster discusses the effects of COVID on the safety work of the clinic and expects a better place where clients can book sooner and prices hold up. He also mentions that the big and small companies are saying the same thing, that there needs to be caution until the economy improves. He also states that there is an interest from non-Chinese clients in doing NHP work in China, but it is mostly done by Chinese CROs for Chinese biotech or pharma companies.

Jim Foster discussed the work that has been done to make international organizations comfortable with the supply chain for non-Cambodian animals, which is different from the Fish and Wildlife Service. He suggested that with continued conversations, they will eventually be able to have multiple sources of supply from multiple locations.

Jim Foster discussed the positive aspects of their ability to pivot in complex situations, and mentioned that there is some discounting in the market from their competitors, depending on the type of work. He also mentioned that they have long-term contracts with bigger clients that provide price protection, and they are trying to maximize their return and be responsive to different types of clients.

Jim Foster explains that the RMS business is doing well due to NHP sales in China, service revenue, and sales of research models. He believes the emphasis on one area or another will be short lived and that the company will continue to sell research models to everyone and get good prices. He also notes that the company has a broader portfolio and geographic footprint than the competition.

James Foster discusses the complexity and expense of viral clearance and how it is often done later in the development process. He explains that it is a smart decision for companies to wait to spend money on this until their drug is in Phase 2 or 3, and that it is difficult to predict whether there will be a bolus of work in the future. He also notes that companies may be shelving programs rather than canceling them, which could lead to a bolus of work across multiple streams.

James Foster and Flavia Pease both discuss the impact of backlog and cancellations on the company's future plans. They state that it is difficult to compare this situation to anything they have seen historically, but they are normalizing the situation and still have 13 months of backlog. Patrick Donnelly then asks about the impact of NHP supply on the fourth quarter and the outlook for 2024. Flavia Pease states that there should be no impact in the fourth quarter, and they will provide more clarity on 2024 at their Investor Day on September 21.

Jim Foster discusses the fluctuations in the demand for DSA's services, which is heavily influenced by the financial stability of their smaller and midsized clients. He notes that the availability of capital for these clients has been a cause of concern, but it appears to be improving. He also mentions that the demand for their services can change quickly, depending on the financial stability of their clients.

Jim Foster discusses the improvements made to the CDMO business since it was acquired a few years ago. He explains that the business now has three centers of excellence, which is a change from when it was purchased. He also notes that the business is performing better than expected.

The company had a rough year last year due to retooling their businesses, however, clients seem much happier now and the company anticipates higher growth rates and improved margins. The company had high hopes for the businesses in terms of top line growth and accretive margins. Justin Bowers asked about the normalization of DSA and what it was like pre-COVID and pre supply chain disruption; the company believes it will return to that or somewhere in the middle.

James Foster discusses the backlog of tax work, the capacity of their business, and the growth of their microbial business within manufacturing. He states that they have strong technology and IP, a broad portfolio, and are using less crude oil and more automation and digitization. He does not give a specific growth rate for the quarter.

Charles River's Cradle business has been very successful, with a client base that includes a mix of small biotechs, midsized companies, and big pharma companies. The business has high growth rates and margins, and some sites even fill up before they open. Cross-selling opportunities from new client wins are also opening up new doors for Charles River.

Todd Spencer announced that the last question would be taken from Tim Daley, who asked about RMS China's expectations for 2023. Spencer discussed the increased competition in the large model side of RMS China, and reiterated the previously communicated expectations for RMS China to grow double digits in 2023. He also provided additional color on the split between large and small models.

Charles River Laboratory's Second Quarter 2023 Earnings Call has concluded. James Foster discussed the large models and number of animals at the price points, which had a beneficial impact on the RMS top line growth rate and margin for the quarter. Competition continues to be local and they are seeing a decent price. They are also beginning to see significant improvement in the service businesses in China and Europe. Lastly, they are surprised by the lack of global players still not getting into China.

This summary was generated with AI and may contain some inaccuracies.