Charles River Laboratories International, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories fourth quarter and full year 2022 earnings conference call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this period, you will need to press star 1 on your telephone. If you want to remove yourself from the queue, please press star 2. Lastly, if you should need operator assistance, please press star zero. I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead, sir.

Thank you and good morning, and welcome to Charles River Laboratory's fourth quarter and full year 2022 earnings and 2023 guidance conference call and webcast. This morning, I am joined by Jim Foster, Chairman, President, and Chief Executive Officer of and Flavia Pease, Executive Vice President and Chief Financial Officer. They will comment on our results for the fourth quarter of 2022, as well as our financial guidance for 2023. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which will be 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 also accessed on our investor relations website. The replay will be available through the 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 the core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the investor relations section of our website. I will now turn the call over to Jim Foster.

Good morning. Before I speak about our strong fourth quarter results, I want to provide an update on the non-human primate or NHP supply situation. As many of you are aware, there has been an ongoing industry-wide investigation into NHP imports from Cambodia. On February 17th, we received a subpoena from the U.S. Department of Justice relating to an investigation into the Cambodian NHP supply chain. We've been informed that this investigation relates specifically to shipments of NHPs received by Charles River from our Cambodian supplier. We intend to fully cooperate with the U.S. government. Once the Department of Justice concludes its investigation, we believe it will find that any concerns with respect to Charles River are without merit. As we have stated before, we are committed to ensuring our operations are fully compliant with all U.S. and international laws and regulations, and we maintain risk-based supplier due diligence, audit, and management practices to help ensure the quality of our supplier relationships and compliance of applicable laws, including the status of the NHPs we import. Based on ongoing investigations and the heightened focus on the Cambodia NHP supply chain in recent months, we have voluntarily suspended planned future shipments of Cambodian NHPs until such time that we in the U.S. Fish and Wildlife Service can develop and implement new procedures to reinforce confidence that the NHPs we import from Cambodia are purpose-bred. This will take time to implement and the duration of which is unknown. The investigation and current NHP supply situation will result in study delays in our safety assessment business. By way of background, NHPs are the most scientifically relevant large model for the regulatory required safety testing of biologics drugs as mandated by the FDA and other international regulatory agencies. Biologic drugs cannot be approved for commercial use without NHPs. And given the proliferation of biologic drug development activity in recent years, NHPs have been in high demand. As an example, all of the COVID-19 vaccines developed in the United States and Europe utilized NHPs. In recent years, NHPs sourced from Cambodia have been responsible for approximately 60% of the NHP supply to the United States and to Charles River for drug research and development. While there is no other near-term global source to replace this supply, we are continuing to actively work to diversify our NHP supply chain It's critical that we work diligently to resolve the NHP supply situation and collaborate with all agencies of the U.S. government, including the U.S. Fish and Wildlife Service, to restore this important supply chain because the U.S. pharmaceutical industry and the patients who need new life-saving treatments are counting on us. The current Cambodian NHP supply constraints and the corresponding impact to our safety assessment business are expected to reduce our consolidated revenue growth forecast by approximately 200 to 400 basis points this year, resulting in organic revenue growth guidance of 4.5% to 7.5% for the total company. The non-GAAP earnings per share are expected to be in a range of $9.70 to $10.90 in 2023, with the wider ranges encompassing a number of scenarios related to the timing of the resumption of Cambodian NHP imports this year. The top end of our guidance ranges anticipate that we will have Cambodian NHPs available for studies in the fourth quarter, whereas the bottom end of our guidance assumes that we will have no Cambodian NHP imports for the remainder of 2023. In either case, we expect to begin to experience a more meaningful impact from NHP supply constraints in the second quarter. In addition to NHP supply, several non-operating items are significantly affecting the year-over-year earnings per share comparison in 2023, including higher interest expense, a higher tax rate, and the divestiture of our Avian vaccine business, which was completed in December. These items will generate a combined earnings per share headwind of $1.20 to $1.40 in 2023, partially offset by up to a 25-cent benefit from foreign exchange. Flavia will discuss these items in more detail shortly. Now I'll speak with you about an outstanding finish to another strong year for Charles River. We reported robust operating performance in 2022, highlighted by 13.4% organic revenue growth against the backdrop of escalating macroeconomic pressures. 2022 performance demonstrates the continued execution of our strategy, which enables us to enhance our position as a scientific partner of choice to accelerate biomedical research and therapeutic innovation. Let me give you the highlights of our fourth quarter and full year performance. We reported record quarterly revenue of $1.1 billion in the fourth quarter of 2022, exceeding the $1 billion mark for the first time and representing an increase of 21.5% on a reported basis. Organic revenue growth of 18.8% was driven by increases from all three business segments, with the most significant contribution from the DSA segment due to another robust performance in the safety assessment business. In the second half, DSA organic growth rate rose to 23.6%, as we exceeded the second half growth acceleration that we had forecast since the beginning of last year. For 2022, revenue was $3.98 billion with a reported growth rate of 12.3% and an organic growth rate of 13.4%. The revenue growth rate exceeded the top end of our guidance range by 140 basis points, driven primarily by outperformance in both the discovery and safety assessment businesses. The operating margin was 20.4% in the fourth quarter, a decrease of 50 basis points year over year, driven primarily by the manufacturing and RMS segments. For the full year, the operating margin was unchanged at 21%. We are pleased to have held the operating margin steady in a year with substantial cost inflation and the CDMO business generating significant margin pressures. Earnings per share were $2.98 in the fourth quarter, an increase of 19.7% from $2.49 in the fourth quarter of 2021. For the full year, earnings per share were $11.12, a 7.8% increase over the prior year. We exceeded our last guidance range of $10.80 and $10.95 due primarily to the robust fourth quarter revenue growth particularly in the DSA segment. We believe our 2022 performance thoroughly demonstrated the successful execution of our strategy to position Charles River as the non-clinical drug development partner of choice for our valued clients, as well as the sustained pace of demand from these clients despite macroeconomic headwinds. Our exceptional market position, unique early stage focus, and our large diversified client base give us confidence that many of the underlying business trends will remain intact in 2023. I'd like to provide you with additional details on our fourth quarter segment performance and our expectations for 2023, beginning with the DSA segment's results. DSA revenue in the fourth quarter was $691.7 million, a substantial 26.5% increase on an organic basis. The safety assessment business continued to be the principal driver of DSA revenue growth, with significant contributions from study volume, pricing, and NHP pass-throughs in order of magnitude. As we have often mentioned, our business is nonlinear. In this case, the record fourth quarter DSA revenue growth was driven by a combination of the current robust demand and pricing environment, as well as the comparison to the fourth quarter of 21, when the business experienced some resource constraints, including staffing. The Discovery Business Services growth rate also improved in the quarter. For the full year, DSA organic revenue growth was also a record 17.5%, exceeding our midterms outlook. As of year-run, the DSA backlog had increased 32% year-over-year to $3.15 billion. The backlog remained robust in 2022, and continues to support a long growth runway and also normalized during the year as expected because the backlog duration stabilized after substantially elongating in prior years. We are continuing to see broad-based and sustained client demand across our safety assessment business as we have the staffing and capacity to accommodate this client demand. The current NHP supply situation may restrict the revenue growth rate and margin expansion in 2023, but the underlying strength and resilience of demand, environment, and pricing should afford us with healthy DSO growth opportunities once the NHP supply situation is resolved and we have an adequate supply of these large models. The discovery services business had a good quarter with improvement in the revenue growth rate from the third quarter level. Many of our clients who previously lengthened the timeframes to start new projects move forward with their programs in the fourth quarter. Discovery booking and proposal activity also support a healthy growth profile as we begin 2023. In order to strengthen our position as a single source partner to support our clients' early stage research needs, we continue to expand our discovery capabilities through our technology partnership strategy and through M&A.