Charles River Laboratories International, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories third 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, press star 2. Lastly, should you require 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.

Good morning, and welcome to Charles River Laboratories' third 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 comment on our results for the third quarter of 2024. 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 at approximately two hours after the call today and can also be accessed on the investor relations section of our 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 our 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.

Our third quarter of financial performance exceeded the outlook that we provided in August. Biopharmaceutical demand environment remains challenging but consistent with the trends that we discussed in detail on last quarter's call, leading to an organic revenue decline of 2.7% in the third quarter. Revenue from small and mid-sized biotech clients was stable compared to the second quarter. However, forward-looking demand indicators for biotechs continued to trend more favorably versus last year, leading to our belief that the demand environment for this client base will continue to recover just at a more gradual pace than anticipated at the beginning of the year. We had already seen more favorable biotech funding translate into higher DSA bookings earlier this year, and subsequently incremental revenue for this client base. But there are still puts and takes in terms of the funding environment and interest rate sentiment. to keep our outlook appropriately measured. After slightly increasing in the first half of the year, revenue from global biopharmaceutical clients declined in the third quarter, both sequentially and year over year. This was expected due to tighter budgets and accelerated pipeline reprioritization activities this year, in conjunction with the major restructuring actions that many of our large clients have implemented within the past six to 12 months. and for some clients, more recently. We believe these recent restructuring actions further validated our commentary last quarter. However, the forward-looking demand trends for global biopharmaceutical clients did not show signs of further deterioration in the third quarter and actually improved from second quarter levels. Coupled with the numerous discussions that we have had with clients, this leads us to believe that we have correctly called the near-term demand outlook for this client base. Overall, these trends translated into slight sequential improvement in the forward-looking demand indicators for the safety assessment business in the third quarter, including improvements in net book to bill and the cancellation rate. This is important because it supports our belief that we appropriately reset our financial guidance for the year in August. The net book to bill remains below one times, so it would still be too early to assume when a recovery will occur. but we are pleased that the demand environment does not appear to have deteriorated further. At this time, it's too early to provide any specific commentary on 2025 guidance, but we expect the current trends will persist into 2025 and continue to pressure the year-over-year growth rates. This is particularly true in the DSA segment, as we anticipate continued headwinds based on the current pricing environment, and until we anniversary the step-down of global biopharma demand, that has occurred during the second half of this year. As I discussed in August, we are taking decisive action to manage the company through the current demand environment, including appropriately rightsizing our infrastructure. We are committed to initiatives to generate more revenue, contain costs, and protect shareholder value. As I outlined last quarter, and to ensure our further success, we are focused on taking strategic actions in three areas. Restructuring initiatives to maintain costs, and generate efficiency by reducing staffing levels to align with the pace of demand, as well as evaluating our global footprint to optimize, consolidate, and simplify operations. We have made meaningful progress on our footprint optimization efforts since we last spoke. The second area is focusing on commercial enhancements to promote a client-centric focus and gain additional market share. Our goal is to enhance the client experience and reinforce our role as a flexible and responsive partner to our clients, including through leveraging technology such as our Apollo platform and RMS e-commerce initiatives. And finally, we are continuing to evaluate additional strategies to take additional costs out and to drive efficiency. We are working on initiatives to further transform how we operate, ranging from continuing to better leverage technology to adopting a global business service model to streamline processes, as well as generating greater procurement savings. The restructuring initiatives that we have implemented to aggressively manage our cost structure are already generating significant savings. And as planned, we continue to further reduce staffing levels in the third quarter. The initiatives that we have implemented since late 2023 have reduced our total headcount by over 6%. It is imperative in this environment to keep our staff well utilized in order to protect the operating margin, which is our goal. We have also undertaken a comprehensive review of our global footprint. To provide some context, we built many of our businesses through acquisitions, accumulating over 150 sites at peak. We have periodically consolidated or divested smaller sites over the past several years to manage our global infrastructure, including the consolidation of seven small sites within the past year. Our global footprint optimization efforts are focused on consolidating capacity that is no longer needed, and in many cases, transitioning the services and clients to other larger sites. We have also taken a client-centric approach towards these actions with the goal of serving our clients more efficiently and seamlessly in order to capture synergies and savings that extend beyond the facility costs. Through these optimization initiatives, we have already begun to implement a process to close or consolidate approximately 15 smaller sites, principally focused on the DSA and RMS segments. By the time the program is completed in 2026, we expect it will generate an incremental $40 million in annualized net savings through the elimination of overhead and facility costs, as well as by reducing headcount. We view these as durable savings because we do not believe reinvestment in similar infrastructure will be required when demand improves. These footprint optimization efforts will enhance the efficiency in economies of scale in our global infrastructure, leading to a more disciplined operating model. In total, the restructuring initiatives that we have implemented since late 2023, including headcount reductions and global footprint optimization efforts, are expected to generate approximately $200 million in cumulative annualized cost savings, eliminating more than 5% of our cost structure. Approximately half of the annualized cost savings will be realized this year, and at least $150 million in total will be realized in 2025. Before I provide more detail on our third quarter results, I want to provide a brief update on capital allocations. we were pleased to report that we generated record-free cash flow of over $200 million in the third quarter. Strong cash generation is a long-term hallmark of the company. This, coupled with moderating capital intensity of our businesses and lower debt, has enabled us to reevaluate and rebalance our capital priorities to include modest stock repurchases this year, totaling approximately $100 million in the third quarter. These collective efforts, from restructuring to capital allocations, are aimed at emerging as a leaner, more efficient organization when demand returns, a stronger partner to our clients, and better positioned to capture new business opportunities as well as to protect and ultimately enhance shareholder value. I'll now provide highlights of our third quarter performance and updated guidance. We reported revenue of $1.01 billion in the third quarter of 2024, a 1.6% decline on a reported basis over last year. Organic revenue declined by 2.7%, driven by the anticipated decline in DSA, partially offset by low double-digit growth in the manufacturing segment and slightly higher RMS revenues. By client segment, revenue declined for both the small and mid-sized biotech and the global biopharmaceutical client segments in the third quarter, as expected. But as I mentioned earlier, revenue from biotech clients was stable sequentially. The operating margin was 19.9%, a decrease of 60 basis points year over year. The operating margin improved in each of our three business segments due in part to the benefit of cost savings. However, higher unallocated corporate costs resulted in the consolidated operating margin decline in the third quarter. Flavio will provide more details on unallocated corporate costs shortly. Earnings per share were $2.59 in the third quarter, a decrease of 4.8% from the third quarter of last year, reflecting the lower revenue and operating margin. Despite the decline, third quarter earnings per share exceeded the outlook we provided in August, due primarily to the better-than-expected top-line performance, particularly in the DSA segment. We are narrowing and slightly raising our full-year guidance for revenue and non-gap earnings per share from the midpoint of the previous ranges to reflect the third quarter performance, We are narrowing our revenue outlook to a 3% to 4% decrease on an organic basis, and non-GAAP earnings per share has been slightly raised to a range of $10.10 to $10.30. While we're never pleased with declining revenue, our financial outlook already demonstrates that we are beginning to see the benefits of the discipline management of our cost structure. I'd now like to provide you with additional details on our third quarter segment performance, beginning with the DSA segment's results. DSA revenue in the third quarter was $615.1 million, a decrease of 7.4% on an organic basis, driven by lower sales volume in both the discovery services and safety assessment businesses. DSA revenue modestly exceeded our prior outlook of a 10% second-half decline because global biopharma demand trends held up better than we expected. We now believe the DSA segment revenue will decline at a high single-digit rate organically in the second half of the year, consistent with our full-year outlook. In the safety assessment business, the revenue decrease was primarily driven by lower study volume. Pricing was essentially flat year over year and is expected to turn slightly lower in the fourth quarter, which is consistent with our previous expectations. From our perspective, the safety assessment pricing environment or spot market for new proposals has not materially changed for most of the year. We were pleased that gross bookings and cancellations improved from second quarter levels resulting in an improvement in the net book to bill ratio to the most favorable level since the first quarter of 2023. As I mentioned earlier, these forward-looking indicators for global biopharmaceutical clients rebounded in the third quarter, which reassured us that the demand environment was not further deteriorating. In addition, biotech trends remain stable in the third quarter, and overall, the forward-looking demand KPIs for this client base remain more favorable in 2024 than last year. Headwinds still exist, ranging from the net book-to-bill ratio remaining below 1 times to pricing and the overhang from our clients' major restructuring efforts. Therefore, we will continue to take a cautious view with respect to the near-term outlook for our safety assessment business until the sustained demand trends are more supportive of a return to revenue growth. The DSA backlog decreased just slightly on a sequential basis to 2.5%, $12 billion at the end of the third quarter from $2.16 billion at the end of the second quarter. As part of our ongoing efforts to promote a client-centric approach and refine our operating model, we are working to further integrate our global discovery and safety assessment operating structure to one DSA over the next year. For the last two years, our global DSA operations have been managed by one senior leader, Shannon Parasoto. During this time, Shannon has comprehensively evaluated the strengths and opportunities that exist within the businesses and focused on enhancing its future vision, and in concert with senior management, has developed a plan that we believe will unlock greater synergies and ultimately make us a stronger and even more responsive partner for our clients. Many of the changes will be settled, both internally and from a client perspective. They were focused on a combined sales force and leadership approach, integrated scientific programming, and a more seamless client experience as their programs transition from the discovery to the early development phase. The insights we have already gained from migrating towards this model have influenced our global footprint optimization plans, including consolidation of several smaller sites and transitioning services to other DSA locations. The DSA operating margin was 27.4% in the third quarter, 20 basis point increase from the third quarter of 2023, and a 30 basis point increase sequentially. The year-over-year and sequential improvements were primarily driven by the increasing benefits from the cost savings actions that we have implemented. RMS revenue is $197.8 million, an increase of 0.6% on an organic basis over the third quarter of 2023. RMS revenue is primarily driven by the benefit of higher pricing and small model sales volume in China, largely offset by lower revenue for research model services and sales solutions. As has been the case all year, small model revenue in North America and Europe has been driven by higher pricing. Unit volume for small animals has declined this year in conjunction with large farmer restructuring activities that have led to spending cuts. and a reduction in research staff, and the funding environment has resulted in a slowdown in new biotech company creation. These trends have largely been reflected in our original outlook for the year. To offset the volume declines, we also continue to realize price increases because small models are essential low-cost tools for drug research. Our China business continues to perform well this year, despite the macroeconomic pressures in the country, primarily driven by share gains associated with our geographic expansions. Research model services, including our cradle operations, experienced a modest revenue decline in the third quarter, largely reflecting the overall biopharma demand environment. While cradle's business model continues to resonate with clients, experienced low occupancy as clients selectively narrowed room utilization to cut costs. And GEMS has been modestly affected by a similar slowdown in client demand. As part of our footprint optimization efforts, we are in the process of consolidating several cradle sites and have also consolidated our cell solutions operation at its largest site in California. Existing demand trends are expected to result in essentially flat RMS organic revenue in 2024. In the third quarter, the RMS operating margin increased by 210 basis points to 21%. The improvement was primarily due to higher pricing, a favorable revenue mix related to Novoprim, and the benefit of cost savings actions. Revenue for the manufacturing solutions segment was $196.9 million, an increase of 11.8% on an organic basis compared to the third quarter of last year. Each of the segments' businesses contributed to the robust revenue growth, and given its continued strong performance, we are raising the segment's full-year revenue outlook to high single-digit organic growth from a prior outlook of mid- to high single-digit growth. The CDMO business led the way with a robust quarter, particularly for cell therapy. Its client interest and booked activity were strong in the third quarter. CDMO business remains on track to have another solid year. The biologics testing business also continued to perform well, driven by demand for our core testing activities, including cell banking, viral clearance, and viral safety testing. We are also pleased that the synergies between our CDMO and biologics testing businesses continue to strengthen, as it is critical to provide analytical testing capabilities to expedite the production processes for our clients' cell and gene therapies. More than half of our CDMO clients now utilize our biologics testing capabilities, which is a testament to the synergies between these businesses. The microbial solutions business also had a strong quarter, driven primarily by demand for our end-of-safe tested consumables, as well as improving instrument placements. We believe the third quarter performance demonstrated that demand for microbial products has rebounded from the pressures last year, which resulted from clients' destocking activity and tighter budgets in the drug manufacturing sector. Our belief was supported by the placement of seven of our large automated systems from our End-to-Safe Nexus platform during the third quarter, and a similar number of placements are expected in the fourth quarter. In addition to the fact that these high-throughput systems are expected to drive meaningful incremental cartridge use, we view installation of these systems as further evidence that both existing and new clients are utilizing our comprehensive, rapid manufacturing quality control testing solutions to enhance their product release testing speed and efficiency. Manufacturing segment's third quarter operating margin was 28.7%, representing an increase of 420 basis points year over year. The improvement was largely a result of leverage from higher sales volume across each of the segment's business. To conclude, we are continuing to navigate through this challenging period by remaining laser-focused on our strategy, by aggressively managing our cost structure, by enhancing our clients' experience to gain additional share, and by protecting shareholder value. We have always distinguished ourselves through our explicit science and preclinical focus, extending our leading position as our clients' preferred global non-clinical drug development partner. We have navigated challenges before, and we expect to emerge from this period as a stronger, leaner, and more profitable company, and an even more responsive partner for our clients. 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 third quarter financial performance and 2024 guidance.