Charles River Laboratories International, Inc.

gentlemen thank you for standing by and welcome to the Charles River Laboratories first quarter 2024 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 0. I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead.

Good morning and welcome to Charles River Laboratories' first quarter 2024 earnings conference call and webcast. This morning, I am joined by Jim Foster, Chair, President, and Chief Executive Officer, and Flavia Pease, Executive Vice President and Chief Financial Officer. They will provide comments on our first quarter of 2024. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our website at ir.criver.com. The 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.

Good morning. I'd like to begin by providing an update on the overall market trends. There has been an increasing focus on market sentiment through the first four months of this year from clients, investors, and other stakeholders. We still believe that the end market trends for our biopharmaceutical clients remain stable with signs that demand will begin to improve later this year, which is consistent with the outlook that we gave in February. One of these signs is an improvement in biotech funding after two years of tempered activity. Biotech funding increased significantly in the first quarter of 2024 to approximately $23 billion, the fourth highest quarter on record. These trends and the improving market sentiment have led to positive discussions with our clients, including at the annual Society of Toxicology conference in mid-March, with clients specifically referencing the improving funding environment and optimism that this would lead to additional spending on the early stage programs this year. We saw increased proposal activity in the first quarter, and while this is encouraging and we have available capacity to start certain types of work relatively quickly, our outlook for the year remains appropriately measured. We expect it will take time for additional funding and proposal activity to translate into new DSA bookings and revenue generation. Therefore, we continue to expect demand will improve later this year, consistent with our initial outlook from February. Our first quarter financial results reflect a continuation of the demand trends and client spending patterns that we experienced at the end of last year, resulting in an organic revenue decline of 3.3% in the first quarter, in line with our outlook in February. The manufacturing and RMS segments both reported solid quarters, primarily driven by a rebound in order activity in the microbial solutions and biologics testing businesses, as well as the timing of NHP shipments benefiting the RMS segment. As expected, DSA revenue declined at a high single-digit rate organically, due in part to the challenging comparison to the strong organic growth rate of nearly 24% in the first quarter of last year. Demand trends are continuing to stabilize, reflecting the more positive sentiment in our end markets and reinforcing our financial outlook for the year. There has also been an increasing focus on the BioSecure Act this year. it is too early to determine the final outcome of this proposed legislation, both the content of the final bill, if passed, and the potential impact on the broader biopharmaceutical industry. With approximately 95% of our revenue based in North America and Europe, we assume that the potential impact on Charles River would likely be a net positive should a bill be passed, but it's too early to determine the magnitude of the potential impact. The long-term industry fundamentals for drug development also remain firmly intact because the overwhelming demand to find life-saving treatments for rare diseases and many other unmet medical needs is unchanged. Biotechs are beginning to move back into favor in the capital markets and will lead the way while large pharma has consistently adapted to scientific advancements, the regulatory environment, and a drive to be more efficient. Therefore, we firmly believe the industry's healthy growth prospects will re-accelerate. It's not a matter of if but when clients will reinvigorate their investments in early-stage R&D. As the leader in preclinical drug development, Charles River is the logical outsourcing partner to advance our clients' programs and enhance their speed to market. I will now provide highlights of our first quarter performance. we reported revenue of $1.01 billion in the first quarter of 2024, a 1.7% decrease on a reported basis over last year. Organic revenue declined 3.3% as solid performances from the manufacturing and RMS segments were offset by the anticipated decline in DSA revenue. By client segment, revenue from small and mid-sized biotechs declined, partially offset by higher revenue from global biopharmaceutical and academic clients. The operating margin was 18.5%, a decrease of 270 basis points year over year. The decline was principally driven by a lower DSA operating margin, reflecting the impact of lower sales volume as well as higher unallocated corporate costs. The restructuring initiatives that we implemented have not yet generated full quarterly cost savings, which will occur in the second half of 2024. Earnings per share were $2.27 in the first quarter, a decrease of 18.3% from the first quarter of last year. The decline reflects a lower revenue and operating margin as well as a higher tax rate. First quarter earnings per share exceeded our initial outlook in February, due in part to a timing shift of NHP shipments, which moved into the first quarter and benefited RMS results. For the full year, we are reaffirming our revenue and non-GAAP earnings per share guidance. We continue to expect revenue growth of 1 to 4 percent on a reported basis and flat to 3 percent growth on an organic basis. Our non-GAAP earnings per share guidance remains in a range of $10.90 to $11.40. As I mentioned, there were some movements in the forecast between quarters, but our outlook for the year is essentially unchanged. I'd like to provide you with additional details on our first quarter segment performance, beginning with the DSA segment's results. DSA revenue in the first quarter was $605.5 million, a decrease of 8.7% on an organic basis. Quarterly decline reflected a challenging comparison to the 23.6% growth rate last year, as well as lower revenue in both discovery services and safety assessment businesses. Lower study volume in the safety assessment business was partially offset by a small benefit from pricing. We are modestly adjusting price and new proposals when appropriate to drive incremental volume. Looking at the broader demand trend, safety assessment proposal activity, and cancellations improved on both a year-over-year and sequential basis. This has not yet translated fully into improved bookings, but we are cautiously optimistic that these trends will lead to improved demand during the second half of the year. As we have noted in the past, the study mix routinely shifts back and forth over time. We believe that new funding will enable our clients to shift their R&D focus back to R&D enabling studies from post-IND work that has been the focus for much of the past year. As a reminder, there's a natural lag between the time that a client gets new funding and reaches out for a study proposal to when the client will book and subsequently begin the new work with us. The process can take a few quarters, which is factored into our expectation that demand will improve modestly later in the year. As a result of these trends, the DSA backlog decreased modestly on a sequential basis to $2.35 billion at the end of the first quarter from $2.45 billion a year end. Gross bookings remained stable at about one times, while the net book to bill ratio remained below one times, but did improve slightly due to the lower cancellation rate in the first quarter. The DSA operating margin was 23.5% in the first quarter, a 550 basis point decrease from the first quarter of 2023. The year-over-year decline reflected the challenging comparison to last year's outstanding operating margin performance. However, the first quarter operating margin was also below our longer-term targeted level in the mid-to-high 20% range because lower sales volume and moderating price increases in discovery and safety assessment businesses were unable to cover cost inflation. We expect the DSA operating margin to move towards targeted levels as demand rebounds in the second half of the year. RMS revenue was $220.9 million, an increase of 3.3% on an organic basis over the first quarter of 2023. The RMS segment benefited primarily from higher NHP revenue, as well as from higher sales of small research models in all geographic reasons, due primarily to sustained pricing increases and from research model services. Revenue for small models increased in North America, Europe, and China, due primarily to pricing, with growth in China leading all regions. While the growth rate in China has been compressed by the well-chronicled macroeconomic challenges in the country, we believe RMS demand has been less affected than other life science sectors, We believe the resilience of the research models business, both in China and the rest of the world, comes from the fact that small models are essential, low-cost tools for research, and without which research cannot proceed. From a services perspective, revenue increased modestly. Insourcing Solutions, or IS, continued to generate higher revenue led by the cradle operations. And we also signed new contracts for our legacy IS librarian management solutions. As we mentioned in February, the cradle growth rate is expected to accelerate during the year. We are monitoring the occupancy rates and new facility ramp in light of the biotech demand environment, which remains healthy overall. We are balancing opening new sites in higher demand bio hubs like Boston, Cambridge, and San Diego with consolidation capacity in more saturated regions like South San Francisco. The timing of NHP shipments to third-party clients also benefited first-quarter results, both in China and from Novoprim, the Mauritius-based supplier in which we acquired a controlling interest late last year. These shipments accelerated into the first quarter, so although it would not change our RMS revenue outlook this year, it will affect the quarterly gating and pressure the second-quarter RMS revenue growth rate. In the first quarter, the RMS operating margin increased by 420 basis points to 27.6%. The robust improvement was primarily driven by the benefit from higher NHP revenue in the first quarter, including the contribution from Novoprim. We do not expect the RMS operating margin will be sustained at this level for the full year as the gating of NHP shipments normalizes. but continue to expect margin improvement in the RMS and manufacturing segments will enable us to achieve our outlook for the year. Revenue for the manufacturing solutions segment was $185.2 million, an increase of 10.4% on an organic basis compared to the first quarter of last year. Each of these segments' businesses contributed to the revenue growth led by the CDMO business. We were pleased that, as expected, revenue rebounded in both our biologics testing solutions and microbial solutions businesses in the first quarter. In biologics testing, improved fourth quarter proposal volume led to the solid first quarter performance. Proposal and booking activity also increased meaningfully year over year in the first quarter, which confirmed the trends that emerged at the end of last year are continuing. Clients appear to be returning to the core testing activities including cell banking and viral clearance, which were the services that slowed at the beginning of 2023. In microbial solutions, we continue to see signs that destocking activity is winding down and believe it is now largely complete. Clients have resumed their purchases of reagents and consumables, and spending on new instruments was reactivated with an increase of new orders, particularly for the EndoSafe MCS endotoxin testing system. We believe that our comprehensive manufacturing quality control testing portfolio, which continues to resonate with clients, and will help to reinvigorate the manufacturing segment's growth rate in 2024. Our biologics testing and microbial solutions businesses are excellent examples of our focus on sustainable practices and the advancement of non-animal alternatives. In biologics testing, we have launched an initiative with our clients to end the remaining in vivo testing used for viral safety and lot release testing, replacing it with in vitro methodologies. One of the alternative methods is next-generation sequencing testing that we are able to offer to clients through our partnership with PathoQuest. Our microbial solutions business also introduced the cartridge technology to our animal-free endosave Trillium endotoxin testing platform. which will promote Trillium's adoption to those clients who are looking to implement more sustainable testing practices. These are two examples of how we are already responsibly driving progress to reduce animal use and adopt alternative technologies, and I will provide additional details shortly on our new program to advance alternatives. The CDMO business drove the segment's growth rate in the first quarter as it did for most of last year, generating solid double-digit growth. Client interest continues to be strong, with new projects starting almost weekly across the various phases of clinical development. Cell therapy production activities for our two commercial clients are beginning to ramp up as well. The second quarter growth comparison will be more challenging for the CDMO business as we anniversary the recovery of the business in the second quarter of last year. But the sales funnel remains robust, and we continue to expect solid double-digit growth this year. The manufacturing segment's first quarter operating margin was 25.3%, a significant improvement from 13.7% in the first quarter of last year. The increase was driven primarily by higher sales volume, as each of the manufacturing segment's businesses are regaining traction, as well as a comparison to last year's lease impairment in the CDMO businesses. Before turning the call over to Flavia, I'd like to provide an update on new initiatives that we are implementing to maintain our leadership position in non-clinical drug development. Last quarter, I discussed client-facing initiatives that we had implemented to become an even stronger scientific partner to our clients, as well as actions to drive greater operational efficiencies. In April, we launched our AMAP program to drive positive change and better position the company for the future state of the industry. AMAP, or the Alternative Methods Advancement Project, is aimed at initiatives dedicated to developing alternatives to reduce animal testing. We intend to remain at the forefront of evaluating and implementing new and innovative technologies, including alternative technologies, to enhance the role that we play in and helping our clients bring their life-saving therapies to market more efficiently. We anticipate these technologies will have greater impact on drug discovery, as they already have begun with screening for lead compounds, rather than a regulated safety testing process. Change will take time, which is why we intend to engage key stakeholders, including clients, partner organizations, thought leaders, policymakers, and NGOs in the pursuit of scientific, and technological innovation focused on advancing animal alternatives. We had already been exploring alternatives to reduce animal testing through our initial investment of $200 million over the past four years. A portion of that investment enabled us to acquire a partner and internally develop more sustainable technologies, including the animal-free endosave Trillium endotoxin test and our partnership with PathRequest for next-gen sequencing that I just mentioned. Over the next five years, our goal is to invest an additional $300 million to fund similar initiatives under AMAP to enhance the development and utilization of alternative technologies. We intend to continue to lead the way in driving our industry to its next frontier. To conclude, I'd like to thank our employees for their exceptional work and commitment, and our clients and shareholders for their continued support. Now, Flavia will provide additional details on our first quarter financial performance and 2024 guidance.