Charles River Laboratories International, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories first quarter earnings conference call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. If you have a question, press 1 and then 0. Please press 1 and then 0 just once to be placed into the Q&A queue. If you should require assistance on today's call, press star and then 0. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

Thank you, Lisa. Good morning and welcome to Charles River Laboratories' first quarter 2022 earnings conference call and webcast. This morning, I'm joined by Jim Foster, Chairman, President, and Chief Executive Officer, David Smith, Executive Vice President and Chief Financial Officer, and Flavia Peace, Executive Vice President and incoming Chief Financial Officer. They will comment on our results for the first quarter of 2022. 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 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 from 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.

Thank you, Todd. Good morning. We're pleased to report solid financial results for the first quarter that were precisely in line with our expectations. Organic revenue growth was slightly below the 10 percent level, operating margin improved by 70 basis points year over year, and earnings per share growth was in the high single digits. Revenue growth rate is expected to increase from the first quarter level, positioning us well to achieve our robust outlook for the year. There are several factors that we believe support our outlook, including the continued strength of the biopharmaceutical market environment. We continue to benefit from strong, sustained business trends, particularly in our largest business, safety assessment, which represents approximately half of our total revenue. We are booking work well into 2023 and have over a billion dollars of backlog already for next year. We continue to get price and anticipate continued share gains. Our scale scientific expertise and geographic reach continues to resonate with our clients. We have added a significant number of staff in the second half of last year and continued hiring in the first quarter. Coupled with our growing backlog, we are poised to meet the escalating demand, which will result in a DSA organic revenue growth rate approaching 20% in the second half of this year. Another factor that supports our 2022 outlook is our well-funded client base, both large and small. Based on daily conversations with our clients and our key performance indicators, clients are continuing to spend at the rate that we anticipated and move their non-clinical development programs forward. Given our early stage focus, we are a canary in the coal mine should funding become a concern. This is not surprising as we believe biotech clients are resilient and continue to have an average of about three years of cash on hand based on both our internal assessment and our clients and industry resources. The biotech industry is more critical to biomedical innovation than ever. Our clients are generally unaffected by the recent headlines related to public biotech financing. Beyond the public markets, we believe that broader, balanced sources of funding will enable many biotechs to continue to access capital from the private sector. Venture capital firms continue to raise new, larger funds and invest heavily in startups, providing a sustained source of funding for the biotech industry. We believe that pharma, M&A, and partnering investments are also utilized to help ensure that promising molecules for unmet medical needs are funded and move forward. To provide some color on our biotech client base, roughly one-quarter of our clients can be defined as pre-commercial. Segmenting that further, there is a subset of public biotech clients with less than two years of cash on hand. We estimate that these clients make up only about 10% of the current DSA backlog. We have taken action in recent years to add staff capacity, scientific capabilities, and secure resources to accommodate client demand and provide them with exceptional service. These efforts have intensified recently in order to support the robust growth that we are experiencing and continue to forecast. We are confident that we are taking the necessary steps to effectively manage the business in today's market environment. and deliver on our commitments to clients. We believe that our ability to support our clients with flexible, efficient outsourcing solutions tailored to their needs and available when they need them has continued to distinguish us from the competition. I'll now provide highlights of our first quarter performance. We reported revenue of $913.9 million in the first quarter of 22, a 10.8% increase over last year. Organic revenue growth of 9.4% was driven by a solid performance from all three business segments and was in line with the outlook that we provided in February. Biotech clients continue to be the primary driver of revenue growth in the first quarter. The operating margin was 21.4%, an increase of 70 basis points year over year. The improvement was driven by the RMF segment, as well as lower unallocated corporate costs. Earnings per share were $2.75 in the first quarter, an increase of 8.7% from the first quarter last year. Strong mid-teens operating income growth was partially offset by a higher tax rate and interest expense compared to the prior year. Based on the first quarter performance and an expectation that the robust business trends will continue throughout the year, we are maintaining our organic revenue growth guidance of 12.5% to 14.5%. and our non-GAAP earnings per share guidance of $11.50 to $11.75 for 2022. Our guidance has incorporated two unfavorable changes in below-the-line items since the beginning of the year. The expectation for a slightly higher tax rate this year due to the impact of a lower stock price on stock-based compensation and higher interest expense as a result of the Federal Reserve's recent monetary policy changes. David will discuss both of these items in more detail shortly. I'd like to provide you with the details on the first quarter segment performance, beginning with the DSA segment. Revenue was $554.3 million in the first quarter, a 9.5% year-over-year increase on an organic basis. As expected, the DSA organic growth rate improved by nearly 300 basis points from the fourth quarter level, driven by the safety assessment business. We expect that growth to improve to the low double digits in the second quarter and approach 20 percent in the second half as the quarterly gating for the year continues to track to our initial plan. The safety assessment business continued to benefit from strong business trends as higher pricing and increased demand drove first quarter revenue growth. We are pleased with the sequential improvement in the safety assessment growth rate and expect continued acceleration during the year. This is supported by booking and proposal activity, which remain robust. DSA backlog was $2.8 billion at the end of the first quarter, an increase of more than 75% in the first quarter of last year, and over 15% since year end. Proposal dollar volume in the safety assessment business increased by 35% year over year. We also have an exceptionally high proportion of safety assessment revenues booked, into backlog already for this year, but do have sufficient capacity to start certain studies during the year. These trends reinforce our DSA organic revenue growth expectation for the year and affords us visibility into the strongest future demand that we have ever seen. Capacity is well utilized, both in terms of people and infrastructure, and we are continuing to add the necessary staff and space to accommodate these robust demand trends. As I mentioned earlier, we hired a significant number of safety assessment staff in the second half of last year, and hiring continued into the first quarter. With the staff now in place, we expect recent hires will help us meet our accelerating DSA growth outlook over the course of the year. Coupled with benefits from higher pricing continuing to work through the backlog, we are very confident in the anticipated DSA growth acceleration and our ability to achieve our mid-teens DSA organic revenue growth outlook for the year, including approaching 20% growth in the second half. Our clients are also accepting longer lead times required to start some of their studies, which is necessitating that they book projects further in advance to ensure they do not delay the drug development. Many are exploring new creative relationships with us to secure space. These discussions recently led to a large biopharmaceutical client to enter into a multi-year agreement with us to reserve safety assessment capacity in a take-or-pay arrangement. We anticipate that other clients will follow suit and believe that these developments demonstrate the sustained strength of the demand environment and our market position as a leading non-clinical contract research organization. Revenue for the discovery business increased in the first quarter, but growth rate was below its recent low double digit trend. This was largely the result of difficult comparison to the strong first quarter of last year, which included milestone payments and some COVID related work. Our integrated discovery portfolio continues to resonate with clients, and it is imperative that we enable them to have access to cutting edge scientific capabilities and expertise in major therapeutic areas, as well as biologics, so that we can be the scientific partner they work with to advance their research programs to IND filing and beyond. Our technology partnership strategy has been a very successful means to do this since it has enabled us to continue to add new capabilities across many of our businesses with limited risk. We believe our clients' willingness to outsource more of their discovery programs will be predicated on our ability to continue to add innovative capabilities to meet the critical research needs. The DSA operating margin decreased by 90 basis points to 22.9% in the first quarter, due primarily to higher staffing costs. We view this largely as a timing issue, given the significant number of new hires and wage environment over the past 6 to 12 months. For the year, we continue to expect the DSA segment will be the primary driver of modest operating margin improvement for the company, as leverage from the accelerated DSA growth rate offsets higher compensation costs. RMS revenue is $176.5 million, an increase of 8.7% on an organic basis over the first quarter of 21, and in line with our high single-digit outlook for the year. Organic revenue growth was driven by broad-based demand and meaningful price increases in the research model business, particularly in North America, which performed very well. China also continued to perform well, but the growth rate was impacted by the comparison to the exceptionally strong start last year. We also experienced a very small RMS revenue impact related to China's COVID restrictions this year and are closely monitoring the situation. At this time, we don't expect it will become a meaningful headwind. Research Model Services was also a significant contributor to the segment's growth, led by the Insourcing Solutions Business, or IS. Our CRADLE, or Charles River Accelerator and Development Labs Initiative, which is part of our IS business, has further accelerated the growth potential for the RMS segment, as both small and large biopharmaceutical clients are increasingly seeking to rent turnkey research capacity in key biohubs. To build upon our cradle strategy and capitalize on the significant growth opportunity, we acquired Explora Biolabs last month. San Diego-based Explora has a similar focus as Cradle, currently operating more than 15 preclinical vivarium facilities with greater presence on the West Coast. While the demand for turnkey laboratory capacity makes this an attractive transaction on its The enhanced value proposition is that clients utilizing Cradle or Explorer will be able to easily access additional services across a comprehensive discovery and non-clinical development portfolio, providing us with a new and unique pathway to connect with clients at earlier stages. With expansions currently underway in the United States and internationally, the combined Cradle and Explorer operation is expected to include at least 25 vivarium facilities by the end of 22, providing over 300,000 square feet of turnkey rental capacity in key biohubs. Explorer Biolabs will effectively double the revenue and footprint of our cradle operation, driving strong double-digit revenue growth that will solidify the RMS segment's position as a sustained growth engine for the company. In the first quarter, the RMS operating margin increased 120 basis points to 29.9%, driven primarily by operating leverage from robust sales of research models. RMS operating margin expansion will be limited for the remainder of the year due to the Explora BioLabs acquisition. Explora has healthy margins for service business, but the operating margin is below that of the RMS segment, creating a headwind to the segment margin this year. Explora is opening a number of new sites this year, so we expect the business to leverage these investments and be better positioned to enhance its operating efficiency thereafter. Revenue for the manufacturing segment was $193.1 million, a 10.1% increase on an organic basis over the first quarter of last year. Biologics testing services was the primary driver of the increase, with continued robust double-digit revenue growth. Microbial solutions growth rate was below the 10% level, resulting in the manufacturing segment's growth rate being below its mid-teens full-year target in the first quarter. This was timing-related and will not affect the outlook for the year, as we still expect microbial revenue growth in the 10% range. Demand for our biologics testing services associated with cell and gene therapies and other complex biologics continues to be robust. And we are confident that cell and gene therapies will continue to be significant growth drivers for our business, even as COVID-related vaccine testing revenue settles into a steady run rate. There is a significant market opportunity for a biologics testing business, which provides services that support the safe manufacture of biologics, including process development and quality control. We believe client interest in our consolidated biologic solutions offering, which provides both biologics testing and the cell and gene therapy CDMO services, will only increase as the synergies to produce complex biologics and conduct required analytical testing with one scientific partner are more broadly adopted by clients. Utilizing our biologic solutions offering will be a strategic advantage for clients who are looking to reduce bottlenecks and increased efficiency of their drug development and commercialization efforts. Our CDMO business also had a good quarter, and we continued to make excellent progress on our integration efforts. Our gene-modified cell therapy production business has gained traction and generated strong growth in the quarter as it continues to be one of the leaders in this emerging space. We benefited from commercial readiness milestones in the quarter. which are relatively common in the CDMO sector and demonstrate that clients are continuing to advance their programs into later stages of development and trust us to take the critical next steps with them. We also continue to position our gene therapy product offering, plasmid DNA and viral vectors, to be opportunistic in a marketplace that is greatly in need of more supply. The manufacturing segment's operating margin declined 240 basis points at 33.1% in the first quarter of 22 as a result of the inclusion of the cognate and bi-gene businesses, which have margins below the overall segment but expected to improve as we drive efficiency and leverage the significant growth potential for this business. We are operating in a robust business environment that gives us excellent growth potential. We have the best visibility that we have ever had with an average 12 to 18 months of backlog in our largest business. We have the capacity and the people in place to deliver on the accelerated demand throughout the year, and we are benefiting from escalating pricing. It is opportune that the market dynamics will remain robust at a time when we believe we have built the premier non-clinical contract research and manufacturing organizations. Before I conclude, I'd like to provide an update on our CFO transition plan. As we announced last month, Flavia Pease has been named our next Chief Financial Officer, replacing David Smith, who previously announced his plans to retire. I'd like to thank David for his dedicated service to Charles River and a remarkable career. David has been instrumental in Charles River's growth and success since he joined the company through the Argenta and BioFocus acquisition in 2014, and subsequently when he was promoted to Chief Financial Officer in 2015. During his tenure as CFO, Charles River's revenue has increased 17% annually and free cash flow by 14% annually. And David has played a critical role in his accomplishments by providing strategic financial counsel and direction to our global organization. David will remain with us through year end, but transitioned into a role as senior financial advisor shortly after earnings. I'm pleased to announce that Flavia Pease will assume the role of CFO at that time. Flavia is a highly regarded financial leader with more than 20 years of financial leadership experience at Johnson & Johnson. Her deep biopharmaceutical industry knowledge and experience managing the finance organizations of large, growing businesses will greatly benefit Charles River. I look forward to partnering with Flavia as we work to advance the company's growth strategy and mission. In conclusion, I'd like to thank our employees for their exceptional work and commitment, and our clients and shareholders for their support. Now, Flavia will provide a brief introduction before David gives you additional details on our first quarter financial performance and 22 guidance.

Thank you, Jim. I'm excited to join the Charles River family and become Chief Financial Officer. Charles River presents a compelling opportunity to join a life sciences industry leader, work with a deep and talented finance team, and collaborate with experienced senior leaders. I intend to leverage my experience as a trusted business partner to help the company achieve its financial goals, support its significant growth potential, and create value for shareholders. I look forward to meeting many of you in the investment community in the coming weeks and months. I would also like to thank David for his support and guidance over the past few weeks, and I will continue to work closely with him to ensure a smooth and seamless transition. Now I'll turn the call over to David.

Thank you, Jim, Flavia, 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 charges, costs related primarily to our global efficiency initiatives, our venture capital and other strategic investment performance, and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisition, divestitures, foreign currency translation, and the 53rd week in 2022. We are pleased with our first quarter performance, which included revenue and earnings per share growth in line with the outlook we provided in February. Organic revenue growth of 9.4%, operating margin expansion of 70 basis points were partially offset by a higher than expected tax rate, resulting in an earnings per share increase of 8.7% to $2.75. As Jim mentioned, we have reaffirmed our organic revenue growth and long-term earnings per share guidance for the full year. Our earnings per share guidance of $11.50 to $11.75 has effectively absorbed a higher than expected tax rate and interest expense compared to our initial outlook. I will discuss both of these items in more detail shortly. Our organic revenue outlook for the full year is unchanged at 12.5% to 14.5% growth. With the addition of Explorer buy-alouds, we've increased reported revenue growth guidance to a range of 13.5% to 15.5%. This includes a larger 1.5% headwind on foreign exchange due to the strengthening of the U.S. dollar. Given the robust top-line performance, we remain well positioned to wonderfully expand the operating margin in 2022. As I mentioned, our tax rates and interest expense outlooks have increased since the beginning of the year. We expect a slightly higher tax rate in 2022 because the low stock price during the first quarter resulted in a lower excess tax benefit associated with stock-based compensation. This led to a first quarter tax rate of 16.8%, a 230 basis point increase year-over-year, and above our prior outlook in the mid-teen. Our tax outlook remained within our initial low 20% range for the year, but has moved slightly higher due to the stock price movement since February. We now expect adjusted interest expense of $98 to $102 million in 2022, approximately $15 million higher than our prior outlook. The primary drivers of the increase are nearly evenly split between higher interest rate assumptions associated with the Federal Reserve's outlook provided in March and higher debt balances due to the Explorer acquisition in April which will not have a meaningful impact on non-GAAP earnings per share since the transaction is expected to be earnings neutral this year. For the first quarter, total adjusted net interest expense was $20.4 million, which was flat sequentially compared to the fourth quarter. At the end of the first quarter, we had an outstanding debt balance of $2.7 billion, equating to a gross leverage ratio of 2.5 times and a net leverage ratio of 2.4 times. As planned, We financed the Explorer acquisition through our revolving credit facility, and our leverage remains below three times pro forma for the transaction. For the remainder of 2022, we will continue to evaluate M&A opportunities, and absent any additional acquisitions, our capital priorities will be focused on debt repayment. By segment, our organic revenue growth outlook for 2022 remains unchanged. RMS organic revenue growth guidance remains in the high single digits. The reported revenue growth outlook for this segment is being increased to a high single-digit range to include the Explorer revenue contribution. We continue to expect the DSA segment to deliver mid-teens organic revenue growth driven by strong contributions from both the discovery and safety assessment businesses. And the manufacturing segment to achieve mid-teens organic growth as the microbial solutions growth rate improves from the first quarter level and the cognate and bi-gene acquisitions are included in the organic growth rate. Lower unallocated corporate costs totaling 5% of revenue contributed to the first quarter operating margin improvement. This is compared to 6.2% of revenue last year, with the decrease driven by several factors, including favorable fringe-related costs and quarterly fluctuations in the gating of corporate costs. Despite the favorability in the first quarter, we continue to expect unallocated corporate expenses to be in the mid-5% range as a percentage of revenue for the full year. Pre-cash flow was $22.2 million in the first quarter, compared to $142.2 million last year. The decrease of $120 million over the prior year was primarily due to planned increase in capital expenditures associated with projects to support future growth and higher performance-based bonus payments related to the strong 2021 results. Capital expenditures were $80.5 million in the first quarter compared to $28 million last year. For the year, our free cash flow and capital gains remain unchanged at approximately $450 and $360 million, respectively. As previously discussed, CapEx is expected to total approximately 9% of total revenue in 2022. A summary of our updated financial guidance for the full year can be found on slide 39. For the second quarter, our outlook reflects a continuation of the strong business trends and for the revenue growth rate to continue to accelerate. We expect the reported and organic revenue growth rates will be in low double digits. The DSA and RMS organic growth rates are expected to improve sequentially from the first quarter level, while the manufacturing segment will be slightly lower due to the strong comparison to the nearly 27% growth last year. Pennies per share are expected to increase in the mid to high single digits year over year in the second quarter. In closing, we are very pleased with our first quarter financial performance and are confident about our growth prospects for the remainder of the year. Given the strong DSA business development activity that Jim highlighted, our order book firmly supports our full year financial guidance, including DSA organic revenue growth approaching 20% in the second half of the year. Before concluding, I would like to say a few final words I'm pleased to welcome Flavia to the chart of the team. In the past few weeks, we've begun the transition of my responsibilities, and as such, this will be my final earnings call as Chief Financial Officer. I'm not officially retiring until after year end, but I will move into a new role shortly after this earnings call to ensure a smooth transition. It has truly been a privilege to serve as Child River CFO, and I would like to thank Jim, the board, and all of my colleagues for their support and collaboration during my time at Child River and for the successes that we have all shared together. I firmly believe our legal company is well positioned for continued success because of the sustained robust demand environment, our industry-leading portfolio, and the highly experienced leadership team. I would also like to thank each of you, the Child River shareholders and analysts, for the collaborative relationships that we have forged over the years and for your support. It's been a pleasure working with you. Thank you.

That concludes our comments. Operator, we will now take questions.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press 1 and then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1 and 0 command. If you are using a speakerphone, please pick up the handset before pressing the numbers. And please limit yourself to one question. Once again, if you have a question, please press 1 and then 0 at this time. Our first question will come from the line of Eric Caldwell with Baird. Please go ahead.

My question, two questions on DSA segment. First one. DSA growth expected to approach 20% in the second half. I'm curious if there's any additional color available on the split between 3Q and 4Q, i.e. would both be at a similar rate or would the ramp continue through the year, finishing out at or above that range in the fourth quarter? And then my second question, I believe I heard you say there was a take or pay deal in DSA done this quarter. juggling a few calls today, so I missed that section, but I'm curious if you can provide any more detail on that and what you think the client appetite for further take-or-pay deals might be at this time. Thanks very much.

Sure. So we do anticipate the ramp will continue through the back half of the year. Each quarter should be progressively stronger and will end. Well, the back half of the year would be at 20%. That's a combination of significant price, share gain, overall volume and mix, great capacity utilization, utilization of staff, which has been hired but being trained and sort of not contributing to the top or the bottom line in Q1, and just the strength of our competitors. position from a scale point of view, geographic proximity point of view, and the constituent scientific parts of our business. So we've never had backlog like this. It continues to elongate. It's a billion dollars of backlog already for next year. the volumes are up substantially over the prior year and over the last quarter. So we're quite confident in our numbers and the progression. Take a pacing, Eric, is really interesting. I don't know if I said it to you, but I've sort of been saying it at least to ourselves that we were surprised we weren't hearing more of this. So, you know, capacity is kind of appropriately tight. Clients are really busy. Clients are well financed. There's lots of new modalities. People are booking pretty far out. The booking pretty far out is a combination of lots of work and making sure they get a slot. And so I've often said that if I was running a drug company or the head of R&D, I certainly would try to lock up some space so I had some flexibility and could slot things in perhaps, slot priority things in perhaps earlier than we were giving them slots. So we signed the first one. It's nothing special about the client except it's a big one and it's multi-year. We feel pretty strongly that others will follow. It's just too much of an appropriate tool for them to use. as the demand continues to increase. That's kind of a safety valve, which I think takes a lot of the pressure off of them. We spent a lot of time with our clients over the last six to 12 months about, tell us what your real priorities are. Don't tell us every drug is important to start a study next month or it's going to have the same revenue contribution because, of course, that's not true. Help us prioritize that. And will, A, help slot those in earlier, and, B, if you want to really be sure of belt and suspenders, then lock up some space on a take-or-pay basis. So not surprised, pleased to see it. I think that's going to make the kind of scheduling more rational, more comfortable for everybody. And, you know, we can't project it because it hasn't happened yet, but we would be surprised if we don't see additional large companies do similar things by the end of the year.

Jim, thanks very much for the details. I'll jump back in queue if I have anything else. Congrats on the outlook. Thanks, Eric.

Thank you. Our next question comes from the line of Jacob Johnson with Stevens. Please go ahead.

Hey, good morning. Thanks for taking the question. Jim, I wanted to follow up on something you alluded to in your comments in terms of the cell and gene therapy clients you have in biologics and kind of your ability to, I don't know if we want to call it pull through or cross sell them into CDMO work. Can you just talk about the initial reception there and what your experience has been?

Yeah. I, you know, it was, I'd say the major strategic rationale for us to pivot back into the CDMO space, having exited several years ago and, we find ourselves with this escalating high growth, improving margin biologics business on a worldwide basis. So, you know, we're testing the drug before it goes into the clinic. We're testing the drug if it's approved after it goes into the clinic, perhaps indefinitely. And, you know, we began to have requests from clients to why can't you manufacture the drug? So there's a correlation. So if we If someone else manufactures it, we could still test it or vice versa. But I think there's a lack of elegance to that for the clients. I think it's less efficient for them and slows things down. So we have competitors who do both. Sorry, who do either but don't do both. So we think this is a strategic benefit for us. Also, the connection to safety discovery is also quite significant. You know, it's a little bit early to comment on the success except to say that, you know, we have a sales force that talks about all of it. We have clients that definitely are resonating to it both ways. So former biologics clients that are now beginning to talk to us about or use us for a CDMO manufacturing or buying gene therapy products or vice versa. So we're quite confident that that's the ultimate value proposition that we've invested in here. That's sort of the way we get one plus one equals three.

Got it. And then just maybe following up on that, just on Hemacare and Solero, can you just talk about the latest trends in cell supply of kind of the COVID headwinds that are abated? Are you seeing a rebound in those businesses?

So Hemacare and Solero has new management, has new capacity. and has much more sophisticated ways to access and hopefully retain donors. So the slope of that business is positive as we move through the back of the year.

Got it. Thanks for taking the questions.

Thank you. We do have a question from Elizabeth Anderson. Please go ahead.

Hi, guys. Thanks so much for the question, and welcome, Sylvia. It's nice to speak with you. I was wondering if you could talk to me a little bit more about sort of the OPEX spend in the quarter that, you know, came in a little bit under what we were suspecting, especially given the inflationary environment, just any additional puts and takes you can sort of talk about on that so we can sort of think about the run rate for the rest of the year. Thank you.

I'm not sure I heard the whole question. Speaking a little quickly.

Operating expenses in the current kind of inflationary environment.

Yeah. I don't think anybody has a crystal ball, but we feel that we accommodated well for inflationary pressures when we put our operating plan together, and it's embedded in our guidance. When I say that, I'm obviously talking about Supply chain costs, I'm talking principally about numbers of people and salary levels, hourly rates, whatever, compensation levels and what we anticipate that we have already done and may have to do additionally. There's no question that in the first quarter, tried to allude to this, my answer to the last question, We had a fair number of people that were hired, for instance, into the safety assessment business. So more people, higher salary levels, very much tied up in training and not really contributing to either revenue or profitability. So you'll see that sort of ameliorate through the back half of the year. You'll see pricing for a lot of studies that we book later in the year come through. So what we said... state this again carefully, is that the modest anticipated operating margin accretion that we believe that we'll get for this year will be principally as a result of the safety assessment business. And we think that those costs are embedded in that analysis.

Got it. That's very helpful. Thank you.

Thank you. We have a question from Elizabeth Raines with William Blair. Please go ahead.

Hi, this is Christine. Thanks for the question. I was hoping you'd give me an update on your plasmid DNA business, if this is an area of investment for Charles River, and how does it fit into your end-to-end offering for cell therapy innovators and that strategy? Thanks.

Yeah, so... working hard to, you know, enhance the management of all these businesses that we bought to sort of refine the strategy for both our plasma DNA and viral vector businesses, um, which are going to be sort of geographically based, um, sort of moving away from some of the work that one of those businesses was doing. There was very much COVID related, uh, both before we bought it and right after we bought it. And, and, uh, now that we have, uh, We have capacity available for our plasmid DNA. So we're positioned really well for this gene therapy product offering, which is going to allow us to be opportunistic in a marketplace where there appears to be insufficient supply to meet the demand. So we feel really good about our ability to provide those essential products to our clients in this space.

And does that answer your question? Yes, great. Thank you. Thank you. Our next question comes from Dave Windley with Jefferies. Please go ahead.

Hi, good morning. Thanks for taking my questions. David, congrats on your great career and best wishes in retirement. I wish I was following you. The question I have, I wanted to focus, Jim, I appreciated your data on your client mix and venture funding has actually, I think, held up even a little bit better than the public markets. I wondered if, in addition, you had any sense of what the mix is of your, you know, probably your pre-commercial that are venture versus public. Any sense of that?

I don't think we've sized this yet. I mean, we said less than 10% for these small pre-revenue businesses. I think a lot of those are public. I think that, as you said in your question, we have a lot of formal and informal relationships with pretty much all of the major healthcare venture capital firms, as I think you know. They're raising funds much more quickly than they used to. So the five to seven year raises are now two to three year raises. It seems like those companies are two things which are good for us. Extremely well financed and have no desire, ability, capability, or interest in developing any of their own internal capacity to frankly do any of the things that we do. So they're the in some ways, the best clients. They're always in a race to get to market, at least get to proof of concept. They're less price sensitive. They're well financed. And they're 100% outsourced, at least almost all of them are. So we feel that, just to give you a broader answer to maybe the broader question that was going to be your follow-up, We feel that the clients have three years of cash generally. We feel that those that may have less than two years of cash, I think three things. I think that pharmaceutical industry will bank a lot of those companies and a lot of those technologies and or the VCs. I think any new potential drug to deal with unmet medical needs that really is promising. I just don't think that the pharmaceutical industry is going to let that languish and not support it. So I think it's highly unlikely that these companies don't somehow flourish, don't somehow get funding, and don't somehow continue to work with us. Having said all of that, based upon the numbers that we just gave you and our prepared remarks, we see elongating backlogs. We see enhanced pricing. We see increased demand. We see our first client do a deal on a take-or-pay basis. So it seems like our client base is strong that has full product portfolios and is not concerned about their ability to fund those going forward.

Thank you. Yeah, that segues into my follow-up, which was Taker Pay. Eric asked us a little bit. It's been a while. You've talked about it recently, but it's been a while since we've seen one. I guess, practically speaking, I'm wondering, you did give us a backlog number this quarter that you don't usually do. How is that Taker Pay contract reflected in backlog, if at all? And Is, you know, I guess for the locking in the space, given demand, should we assume that you got, you know, kind of spot rate pricing on that take or pay contract? Or does a client, you know, asking for that much get a little bit of discount?

I mean, we're pleased with the pricing on this contract. It's part of our, you know, it's a client that has, you know, it's part of our backlog. I mean, it's only a single client. So we don't want to overstate it. We wanted to call it out because, as I said earlier, we've been anticipating it. I'm surprised nobody has done this sooner. I do think lots of others will follow, and I do think this is probably a template, not that we're going to share it with anyone else, a template for others to have the confidence that for the highest priority studies, they can slot things in earlier. And also that we get on the same side of the table with them and have a much better strategic dialogue about what's coming out of the pipe for them, when they'll need the space. It just gives us great visibility. It enhances our plans for how much incremental space we're building. It enhances our plans for how much incremental staff we'll continue to add. It just provides a much more rational working relationship. So we're thrilled with it. It's not like we weren't looking for it, but, you know, came up in the conversation. And our job is to listen carefully to what clients want to provide them with flexible solutions. They don't all want the same solution, but I do think that some of the larger companies with larger portfolios who so can afford this. I mean, the whole sort of pricing conversation is sort of silly, actually. The pharmaceutical companies with billions and tens of billions of dollars on their balance sheets, they can afford whatever they want. So as I said before, and probably to you specifically, Dave, for so many of these drug companies that have given up their internal capacity or reduced it somewhat, it's a very, very smart thing for them to do and was pretty much foreseeable and predictable.

Got it. Thank you.

Thank you. Our next question comes from Casey Woodring with JP Morgan. Please go ahead.

Hi, guys. Thanks for taking my questions, and congratulations, David. I guess so on DSA, you talked a lot about safety assessment, but can you elaborate on what you saw in discovery? You noted that the growth rate was below the recent double-digit trend there, so wondering how much of that is related to the tough comp versus maybe some shift in customer spend or pipeline rationalization from customers?

Yeah, I mean, Discovery Business continues to be a strong business. It was, it grew more slowly than it has previously. The comps were really, really tough. As we said, we had a bunch of COVID-related work, which we were happy to have and proud to have, but not sustainable. And we had some, you know, we had some one-time events that aren't repeatable. So if you take that out, you know, we feel good about the growth rate of that business going forward. Again, that's a service, a series of services that so many of our clients need, large or small, and an important service in terms of selling into the safety assessment business. So we like to look at DSA in whole, which is why we haven't peeled it back any further than that. But, you know, we did give a little bit of color that the quarter was a bit slower. But we anticipate a strong finish for DSA sequentially and a very strong back half of the year for that whole segment.

Got it. And then I'm just wondering how much of the RMS demand you saw in North America is catch-up work from canceled or delayed projects from COVID? And can you also quantify what the China lockdown impact was to RMS in 1Q what's implied there in 2Q and for the full year, and any other color around China. Thank you.

So all we can tell you about China, it's kind of a tale of two cities. The demand continues to be considerable. So we have a growth rate in China that totally outstrips the growth rate in other parts of the world. Had a nice first quarter, tiny impact from the lockdowns. We don't anticipate, as we said in our prepared remarks, that it will have a meaningful impact in the second quarter, but it's a little bit impossible to predict. Our overall feeling is that the RMS segment is so strong that unless the impact is greater than we anticipate, we'll be able to offset it. So we'll see. But right now, we feel quite good about it. We were particularly pleased with North America. I would say that's not a rebound from anything in particular COVID related, I would say that it's about the spending by our North American clients. It's about our strength versus the competition. It's about our continued investment in that business and the sophistication of the product line. It's about significant pricing, some mix and share gains. So I can't tell you how delighted we are. you didn't ask this, but I'm going to say it anyway. I mean, I do think that we are living in the renaissance in the RMS business, which between China, legacy businesses, the service businesses, particularly IS, now enhanced by this Explorer acquisition that we've done, you know, that we're going to see that business, you know, squarely in the high single digits as we move forward with hopefully strong operating margins. So we're really thrilled actually with pretty much all the constituent parts and pieces of that business, which, you know, it's been a while coming. So we'll feel really good about that. We'll obviously continue to give you updates on the China situation vis-a-vis RMS, but we think we'll be fine. Thank you.

Thank you. Our next question is from Justin Bowers with JP Morgan. I'm sorry, Deutsche Bank. Sorry about that.

Hi. Good morning, everyone. Just was hoping to get a little more context around the backlog growth and DSA. I think you said that you have $1 billion booked out for 2023 at this point. Versus my model, that's probably 40% of of forecasted revenue, plus or minus. And you really don't have to go too far back to where your total backlog for the year was a billion dollars. So I was just hoping to kind of understand how far out you're willing to go and also provide some historical context maybe around how much you would have booked at this point for the following year a few years back, for example.

I mean, it's unprecedented. Before this, the sort of best years we had were six, seven, and eight. This is way better. But it's a totally different industry. The competitive scenario has totally changed. The strength of Charles River has totally changed. The numbers of clients have totally changed. And biotech is a driver. has changed at all. So we have most of the revenue books. We have a backlog this year that will accommodate our guidance in safety. I'm not going to validate your number, but you can do the math as to how big you think our safety assessment business is, what will grow next year, and how much is in backlog. It's much higher than we would see at this point in the year. And I would anticipate that will continue to grow. So we hopefully will have a similar situation when we get in the next year, which is most of it is already in backlog. And that's enhanced by the highest pricing that we've been able to achieve, which is appropriate. It's commensurate with the fact that the studies are more complex than they've ever been. Capacity is appropriately tight. the clients have more drugs to work on than ever, and the availability of competitive capacity is somewhat limited. So it's obviously a very nice demand curve for us, and our job is to try to do all of it, to try to build enough space now to the end of 23 and 24 to accommodate incremental demand, to hire people slightly ahead of when they need them, to drive our digital portfolio such that we are more efficient and are more responsive to our clients, to kind of price appropriately and rationally, to continue to have more clients have these take-or-pay relationships if that's what they want, and also to continue to always save enough space for both shorter-term and longer-term studies that just simply absolutely have to start earlier for clients And we are having, as I've said now for several quarters, we're getting together with a lot of our clients and saying, just tell us what your priorities are in our portfolio and we'll try to accommodate it. So it's a very attractive business model. We're spending all of our time trying to execute against that demand. But we've never seen a demand like this. We're not going to take it for granted. We're going to respond really well. Our execution is going to be as flawless as possible. And we're going to have both people and physical capacity in place ahead of when we need it.

Appreciate the call. I'll hop back to you.

Thank you. We have a question from with Morgan Stanley. Please go ahead.

Hey, guys. Good morning. And Dave, congrats on your tenure and best of luck in retirement. And Flavia, looking forward to working with you. Jim, maybe to start things off, did you disclose what organic constant currency growth looked like when adjusting for the COVID impact last year? Any color you could share in that, you know, at the segment level perhaps would be helpful.

Yeah, I'd say that, Jim. So yeah, we did. We did call out the COVID impact by segment when we gave, as we went through 2001 and actually at the end of the year, we gave that color. So we had 980 basis points in RMS. We had 80 basis points in DSA and 210 basis points in manufacturing. So hopefully that gives you something that you're looking for.

Got it. That's helpful. And then, Jim, as we think about sort of operating margin expansion here, you did talk about continuing to expect modest expansion year over year. Can you just walk us through the impact from Explora? It sounds like it's going to be a little bit of a headwind on RMS. And then to Dave's point earlier and your commentary around expecting a lot more of these take-or-pay contracts, How confident are you that the magnitude of the pricing increases that you foresee working their way through the backlog here can help offset any take-or-pay sort of headwinds in addition to staffing costs and wage inflation?

So we don't look at the take-or-pay deals as headwinds. Clients are... very much in need of that sort of accommodation structure for us, they're going to pay us well for those accommodations and to have that space available. So I think that would be just part of the portfolio. It's impossible to predict how big it will be, but I think some of the larger clients will want to do the same thing. So don't see that as a headwind. uh the really nice strategic deal is going to double the size of our of our uh cradle-like business it's going to be a slight headwind of margins in that business we have to have very high margins in the charles river businesses and the scale at which they are opening up new facilities and just their overall structure has slightly lower margins, which should improve over time. So that's already baked into our guidance. So again, we feel confident that we'll deliver this modest improvement that we talked about that's going to come principally from I hope it comes from other places, but that's not what we're guiding to right now. But we do feel that the demand pretty much across the board is quite significant. We're in a strong competitive position. We don't really see any external disruptors to that overall demand.

Got it. That's helpful, Jim. And one final one on biologic safety testing. You spoke about sort of vaccine lot release work here, settling into steady state for the COVID component heading into the back half of this year in 23. Can you just help share some more color on what your assumptions are in terms of that steady state demand? And if there were to be a relatively sharp drop-off Should we be thinking of a slight moderation here versus that sort of 20% growth target you've spoken about for BSD?

No, I would anticipate a softening of demand. I think we said last year that we have a 30% growth quarter. I think we said if you take all the COVID work out, it's still growing at 20%. So this is a really strong growth business. It's all driven by large molecules. There's a multiplicity of different ways large molecules are utilized. Cell and gene therapy is definitely a big driver of our growth. So is our geographic scale. So, you know, we're going to do some vaccine work, COVID and not COVID. It's part of the portfolio, but we won't be whipsawed by any fundamental change in COVID vaccine revenue or testing.

Very helpful. Thank you.

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

Great. Thank you for joining the conference call this morning. We look forward to seeing you at upcoming investor conferences. This concludes the call.

Thank you. That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.