The operator welcomes everyone to the Charles River Laboratories' Third Quarter 2023 Earnings Conference Call and introduces the speakers, Todd Spencer, Jim Foster, and Flavia Pease. The speakers will discuss the results for the third quarter of 2023 and answer questions. The presentation slides can be found on the company's website and a webcast replay will be available later. The speakers will also discuss non-GAAP financial measures and remind listeners of the Safe Harbor statement.

The company reported third quarter results that exceeded their previous outlook, with organic revenue growth of 4.1% and earnings per share of $2.72. The biopharmaceutical end market is showing signs of improvement, but clients remain cautious with their spending. This has had a significant impact on some of the company's businesses, but they believe the demand environment will stabilize. The Safety Assessment business saw sequential improvement in study cancellations and net book-to-bill ratio, supported by a stable biotech funding environment. Revenue for the quarter was $1.03 billion, a 3.8% increase over last year.

The company experienced organic revenue growth of 4.1% in the third quarter, driven by all three business segments and led by a mid-single-digit increase in the DSA segment. Growth was slower for small and midsized biotech clients, but there was still solid demand from global biopharma clients and academic institutions. The operating margin increased slightly, but there was margin pressure in the RMS and Manufacturing segments. Earnings per share exceeded expectations due to top line outperformance and a decrease in interest expense. The company has adjusted their revenue and earnings guidance for 2023, narrowing the ranges.

The guidance update for the company is primarily due to changes in the forecast and lower third quarter cancellations in the Safety Assessment business. The DSA segment saw an increase in revenue, driven by base pricing and higher study volume. However, the Discovery Services business continues to be impacted by a decrease in demand from biopharma clients. The third quarter showed some positive trends, with a lower cancellation rate and improved net book-to-bill ratio. The DSA backlog declined, but this is seen as a result of clients reprioritizing their pipelines, which is expected to lead to a more reliable book of business.

The net book-to-bill ratio is below one, indicating a continuation of current demand trends in the near future. Despite a difficult comparison to last year's growth, the company expects to achieve high single-digit organic revenue growth in the DSA segment in 2023. The DSA operating margin has increased by 100 basis points due to higher revenue in the Safety Assessment business. The company provides additional information on the impact of NHP pricing on DSA revenue growth, stating that it is expected to benefit revenue by $230 million over a three-year period and represent 30% of DSA revenue in 2022 and 2023. NHP pricing has increased due to supply constraints and the rise of biologic drugs in development.

Due to increased biopharmaceutical demand and a focus on post-IND safety assessment work, the use of NHPs has decreased by 25%, leading to a $20,000 increase in pricing per model since 2020. The company is committed to responsible animal use and has introduced virtual control groups to reduce animal usage. They plan to provide an update on their NHP strategic initiatives in 2024 and will continue to lead in preclinical drug development and prioritize patient safety.

The company is focused on ensuring a sustainable supply chain for NHPs and is working on a longer-term strategy to lead the industry in adopting animal alternatives. They have made investments in non-animal technologies and will provide an update on their NHP strategy in 2024. The RMS revenue for the third quarter of 2023 increased by 3.2% on an organic basis, but was lower than the year-to-date growth rate due to slower demand from mid-tier clients and the timing of NHP shipments in China. However, they expect NHP revenue to improve in the fourth quarter and for overall RMS organic revenue growth to be in the mid to high single-digit range for the year. The small research models and services businesses saw growth, driven by demand from global biopharma clients and academic institutions. Small molecules revenue also increased, particularly in China, due to price increases. The services business reported healthy growth, led by in-sourcing solutions and CRADL operations.

In the third quarter, the RMS operating margin decreased due to a shift towards academic clients and timing of NHP shipments in China. However, the margin is expected to rebound in the fourth quarter and the company is reviewing the profitability of certain Insourcing Solutions contracts. The Manufacturing Solutions segment experienced softness in the market due to COVID-related slowdowns, but the company expects long-term growth to return. The Microbial Solutions business has been affected by reduced testing volumes and investments, particularly in China, but other areas of the business, such as Accugenix microbial identification services, have performed well.

The third quarter of 2023 saw similar trends in biologics testing as the previous quarters, with challenges due to tighter funding and reduced demand for certain services. However, the CDMO business had a strong quarter due to initiatives implemented since the beginning of the year. The Manufacturing segment's operating margin declined year-over-year but improved sequentially, and efforts are being made to improve profitability, particularly in the CDMO business. The company's focus on being a leading outsourcing partner in drug discovery and development is helping them manage in the current demand environment.

Charles River provides IND enabling and nonclinical services that are essential for clients to advance their drug programs and eventually commercialize drugs. Its unique focus on early-stage R&D solutions and ability to leverage its significant DSA backlog sets it apart in the marketplace. The company's value proposition of delivering excellent science and driving efficiency and speed to market is well-received by its budget-focused clients. The company thanks its employees, clients, and shareholders for their support. Flavia Pease then provides details on the company's third quarter financial performance, including a 4.1% organic revenue growth and a 20.5% operating margin. Non-GAAP earnings per share for the quarter increased by 3.4% compared to the previous year.

The company's earnings growth rate is being restricted by increased interest expenses, higher tax rate, and the divestiture of a business. However, the headwind is starting to dissipate. The company's third quarter results exceeded expectations, but they remain cautious about the demand for biopharmaceuticals. They have narrowed their revenue and earnings guidance for the year, with lower expectations for the Manufacturing segment offset by a more favorable outlook for the DSA segment. The company will continue to manage the business in a disciplined manner and focus on achieving financial targets, managing costs, and improving performance in the current environment.

The company is constantly evaluating its operations and making adjustments to align with the current business environment. They have implemented cost-saving measures that are expected to generate $40 million in annual savings. The revenue growth outlook has been revised for each segment, with the Manufacturing segment expected to have flat to low single-digit organic growth and the RMS segment expecting mid to high single-digit growth due to timing issues and softer demand. The DSA segment is expected to have high single-digit growth due to lower cancellations and study delays. Non-operating items, such as unallocated corporate costs and non-GAAP tax rate, have also been discussed.

The higher tax rate in the third quarter was due to the geographic mix of earnings, but was still favorable due to discrete tax benefits. Interest expense decreased due to debt repayment, and the company's leverage ratios are stable. Free cash flow increased due to favorable changes in working capital and lower capital expenditures. The company has narrowed its guidance for the full year and continues to manage capital deployment carefully. The fourth quarter outlook is already included in the full year guidance.

The company expects a decline in revenue for the fourth quarter, largely due to a challenging comparison to the previous year. Non-GAAP earnings per share are projected to be between $2.30 to $2.50. Despite a cautious biopharma spending environment, the company remains pleased with their solid third quarter performance. They will continue to manage their business prudently and work towards achieving their financial targets. The first question during the Q&A session was about the gross bookings in DSA, which were above one in the third quarter. The backlog decreased slightly from the previous quarter to $2.6 billion, and the company expects it to stabilize at some point, but it is uncertain when the net reductions will come to an end.

The speaker, Eric Coldwell, asks a question about the company's Investor Day and its impact on their outlook. Jim Foster, the speaker, responds by saying that they are confident in their three-year guidance and that the numbers are achievable. However, they are still monitoring the complex market environment and it is too early to provide details on 2024. The next question from Elizabeth Anderson asks about DSA bookings and any potential impact from push-outs or timing issues. She also asks about the company's cash flow, which was weaker than expected.

Jim Foster and Flavia Pease discuss the company's performance in the third quarter and its impact on cash flow. They note that there has been a slowdown in cancellations and a return to pre-COVID levels, but there are still some uncertainties. Flavia mentions that the quarter had solid cash flow, with a 130% increase compared to the previous year. However, the overall cash flow for the year has been slightly pressured due to changes in working capital and lower capital expenditures.

The speaker is addressing the concerns of investors regarding the impact of NHPs on margins and EPS since 2019. They mention a $3 benefit to earnings this year and state that pricing trends will help clarify the situation.

Flavia Pease and Jim Foster discuss the impact of NHP pricing on the company's EPS and how they have already taken into consideration a potential modulation of pricing in their outlook. They also mention that the rise in prices has not been as significant as predicted and that they expect prices to moderate or potentially decrease due to sufficient supply. They decline to give specific numbers but mention that NHP sales in China are not consistent. Derik De Bruin also asks about the impact of the NHP push-out to China on RMS, but no specific numbers are given.

The company is seeing shifts in their business quarter-to-quarter and is looking at their performance on an annual basis. They expect to see more shifts in the fourth quarter, possibly carrying over into 2024. The microbial business has faced some challenges with supply and a decrease in demand for testing services. However, the company remains optimistic about the potential for growth in the future due to the availability of recombinant products. The impact of these factors on the company's revenue in the third quarter is modest.

In this paragraph, Flavia Pease responds to a question about bookings and revenue per NHP. She mentions that cancellations have dropped and gross bookings have grown sequentially. She also explains that the low cancellation level in the third quarter was due to a normalization of the domain environment and prioritization of compounds. Additionally, she mentions that the gross book-to-bill in the quarter was above 1 and the lower cancellations helped improve the net book-to-bill. Finally, she discusses the trend of higher revenue per NHP due to less NHPs being used and mentions that this trend is expected to continue.

The paragraph discusses the company's recent financial results, specifically the gross margin and operating margin. The gross margin was impacted by lower manufacturing and slower growth in the RMS business, while the company was able to leverage fixed overhead in the G&A department. Overall, the operating margin expanded by 100 basis points year-over-year.

In the paragraph, the speaker discusses the company's performance in the third quarter and mentions that their margin was 10 basis points better than in the previous quarter and the previous year. They also mention implementing restructurings to adjust to the current demand environment, which will result in annualized savings of $40 million. The speaker also mentions that the gross book-to-bill was above one in both Q2 and Q3 and that cancellations were lower in Q3, leading to a higher net book-to-bill. The questioner asks for more information on the gross bookings and the speaker states that they have not disclosed a specific number but that it was above one in both quarters.

Flavia and Jim discuss the impact of Casey's question on revenue per NHP. Flavia explains that the primary driver of the decrease in units is due to longer post-IND studies, which generate higher revenue. Jim also mentions that there has been a shift towards prioritizing post-IND work. They also touch on the potential for technology to reduce the use of animals in the future, but acknowledge that it is still a long way off.

Jim Foster, CEO of Charles River, discusses the company's responsibility to utilize alternative technologies in the research industry. They have made multiple investments in technologies such as AI, next-generation sequencing, and 3D modeling, and believe that these advancements will have a significant impact in the next five years. Foster believes that these technologies will help speed up the process of identifying lead compounds and moving towards clinical trials, and is optimistic about their potential for the industry.

The speaker discusses the use of non-animal technologies in toxicology and how it is unlikely that they will replace animal models in the near future. They plan to continue researching and utilizing these technologies and believe it is important for them to lead in this area. They also mention the importance of parentage testing and ensuring the purpose of animals, but acknowledge that it may take some time for government agencies to adopt this approach. However, they believe it is essential for them to take a leadership position in this area.

The speaker discusses the stabilization of bookings and the implications for future revenue, noting that the guidance for 4Q suggests flat DSA revenues compared to the previous quarter. They also mention an improvement in cancellations, which could be attributed to reduced concerns about availability and funding for studies.

The speaker discusses the challenges of planning for animal studies and staff allocation due to the unpredictability of cancellations. They also mention the positive impact of normalization of cancellations and the demand for their services from biotech and pharmaceutical companies. They stand by their three-year guidance but note that the exact timing and pace of growth is uncertain.

Flavia Pease, CFO of DSA, clarifies that the company's guidance for the fourth quarter is based on organic growth and may be impacted by a negative growth due to strong performance in the previous year. She also reassures that the current weakness in their Discovery segment will not have a significant impact on their safety business, which is their main focus. She states that if Discovery improves, it will benefit their safety business, but overall, the two segments have different trajectories.

The safety business at the company is performing well despite the current economic climate. The company is seeing good results from their studies and their capacity is being fully utilized. The future of the business will not be significantly affected by the current state of the economy, but a strong recovery could bring in additional revenue. The Discovery business, while slower, has also been profitable and is expected to bounce back as companies continue to focus on post-IND preclinical and clinical work. The pendulum will eventually swing back and the company is confident in the strength of their scientific modalities. They will continue to monitor the situation and inform investors when Discovery starts to pick up again.

Jim Foster clarifies that the turnaround time and pricing for studies in the CDMO business is fast, and the majority of their manufacturing business is focused on clinical products. However, there has been a slowdown in the development and prosecution of portfolios by their clients due to budget constraints and reprioritization. This is expected to be temporary.

The decline in RMS margin in the third quarter was due to a combination of factors, including the lack of significant shipments of NHPs in China and a mix of businesses within the RMS segment. The impact is expected to continue into the fourth quarter, but the margin is expected to pick up due to NHP shipments. The company had previously indicated that the third quarter would see a decline in margin due to the lack of shipments.

In the paragraph, the speaker discusses the company's expected government contracts, margin outlook, and revenue projections for 2023. They mention that the company will likely start exiting lower margin contracts in 2024 and that they are still on track to achieve a 150 bps margin expansion over a three-year period. The speaker also mentions that the company has adjusted for the current demand environment and will provide more guidance in February. A question is then asked about the company's NHP-related revenue in 2023, which is estimated to be around $780 million.

The NHP work has slightly higher margins compared to other species, and this has been a favorable impact on the company's financials. The slowdown in discovery does not change the company's strategy in preclinical, and there is no need for concern as this is not the first time this has happened. The company is not close to the point where the slowdown in discovery will start to impact gross bookings and safety assessment, and there is no need to worry about its impact on the pipeline towards clinical trials.

The speaker discusses the balanced spending in discovery and development during good times and how it benefits their portfolio. They also mention how the focus on revenues can affect the clinic and preclinical stages. They state that their discovery business is still relatively small compared to their safety assessment business and that they do not see it as a detriment. The speaker also addresses the question of how to think about the fourth quarter guidance and mentions that it was typically their strongest quarter pre-COVID, but that this year may be different due to tough comps and current trends.

The speaker is discussing the potential impact of the COVID pandemic on the company's fourth quarter earnings. They mention that the backlog and cancellation rates are starting to normalize, and this may lead to a more normal period in the future. However, they caution that the fourth quarter may not be a good indicator of future growth rates due to high performance in the same quarter last year. They suggest looking at the company's performance on an annual basis instead.

The company has had complicated comparisons in the past year due to differences in timing of shipments. They advise against assuming that the fourth quarter growth rate will continue, as it may result in an inaccurate prediction. The difference in timing of shipments has always been present, but has become more noticeable recently. The company has a limited number of NHPs available and sometimes their Chinese clients do not take them as expected. The company expects to sell all the NHPs they had anticipated during the fiscal year. The number of animals available has decreased, which has impacted sales. The company advises against assuming that the fourth quarter growth rate will continue.

The speaker asks about the impact of supply constraints on NHP revenue and manufacturing testing demand for vaccines. The response is that the team has done a great job mitigating the impact of supply disruptions and that the demand for testing is currently higher than historical norms due to a focus on getting drugs through the clinic.

The speaker discusses the current state and future outlook of the company's various business segments, including the growth and margins of the biologic and microbial businesses, as well as the potential impact of the CDMO business. They also mention that they are not seeing any major changes in the competitive landscape for their safety assessment business, and they believe they are holding and gaining market share due to their larger size, scientific capabilities, and broader footprint compared to their competitors.

The company has a large international infrastructure with multiple sources of supply for NHPs. They have long-term contracts and do not anticipate any disruptions in supply. They encountered some disruptions at the beginning of the year, but it was not as severe as initially thought. They have sufficient NHPs and are not expecting any significant margin headwinds from this undertaking.

The speaker cannot guarantee anything about the future, but assures that they are in good standing with local authorities and have a stable supply of high-quality animals. They do not anticipate any disruptions and have taken measures to ensure stability. The recent acquisition of a majority stake in a large animal model supplier further strengthens their position.

The speaker discusses a high-quality source of supply they have worked with for years and their confidence in closing the deal. They mention participating in running and expanding the site, and assure listeners that they will provide more information in the future. They also address a question about NHP pricing and clarify that the costs have gone up significantly in the past 3 years. The speaker thanks listeners for joining the call and concludes the discussion.

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