Q3 2022 Charles River Laboratories International Inc Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories third quarter 2022 earnings Conference call.
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I would now like to turn the conference over to our host Todd Spencer Vice President of Investor Relations. Please go ahead Sir.
Good morning, and welcome to Charles River Laboratories, third quarter, 2022 earnings conference call and webcast.
This morning, I'm joined by Jim Foster Chairman, President and Chief Executive Officer, and Flavio <unk> Executive Vice President and Chief Financial Officer, They will comment on our results for the third quarter of 2022.
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 Dot C. Robert Dot com.
A webcast replay of this call will be available beginning approximately two hours after the call today and can also be accessed on our Investor Relations website.
The replay will be available through the next quarters conference call.
Like to remind you of our safe Harbor, our 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 $19 95 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.
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.
I'm very pleased to speak with you today about our third quarter results.
Solid financial performance was highlighted by 15, 3% organic revenue growth and non-GAAP earnings per share of $2 63.
Both of which exceeded our prior outlook.
Third quarter organic growth rate accelerated 580 basis points from the second quarter level due primarily to the DSA segment, which delivered an outstanding growth rate for more than 20%.
In line with our outlook since the beginning of the year.
<unk> growth acceleration reflects continued robust price increases and meaningfully higher steady volume and the safety assessment business.
<unk>, which have been supported by the strength of its backlog.
It continues to afford us with excellent visibility into the future client demand.
This strong operating performance against the backdrop of escalated macroeconomic pressures demonstrates the power of our unique portfolio, which differentiate Charles River from other companies that provide R&D support services to the biopharmaceutical industry.
Especially from the late stage clinical service providers.
We are uniquely positioned as a leading global non clinical drug development partner working with clients from discovery and early stage development through the safe manufacture of lifesaving therapies.
Our focus is centered on preclinical R&D, which requires extensive scientific knowledge and the ability to innovate I understand at distinguish valuable molecules from those that are not.
Post pandemic, we are even Morris and EBIT more essential partner to our biopharmaceutical clients because of our core competencies are precisely tailored to their intensified focus on scientific breakthroughs personalized medicine and speed to market.
With a comprehensive portfolio spanning small molecules biologics and cell and gene therapies, we provide a flexible and efficient platform that accelerates early stage biomedical research and therapeutic innovation.
We are a leading global partner for outsource discovery and regulated safety assessment services.
We are also the largest provider of small research models and associated services that enable our clients to conduct their own research and.
We offer a comprehensive portfolio of manufacturing solutions from quality control testing solutions to the production of cell and gene therapies that enable us to continue supporting our clients as they work with other providers to conduct human clinical trials and reach commercialization.
We have a large and diversified client base, which makes us an exceptional barometer for the health of the broader biopharmaceutical industry and I'm like clinical providers greatly reduces our reliance on a small group of clients. We have worked with more than 2000 biopharmaceutical clients this year and our top 25 clients.
Primarily large biopharmaceutical clients that are well financed.
And had been a stable source of sustained revenue growth with accelerated spending in the third quarter. Our top 25 clients represented only 28% of total revenue last year.
And our largest client represented just above 3% of total revenue.
We also believe that our biotech clients will remain a sustained growth engine for Charles River, we have averaged adding more than 400, new biotech clients per year since 2017.
And are already above that level this year.
Our biotech clients continued to be a principal driver of revenue growth increasing at healthy double digit growth rates in the third quarter and year to date, a trend that we believe supports our view that biotechs with promising molecules.
Continuing to find available funding.
In addition, we saw early indications of the return of Ipos and secondary offerings in the third quarter.
Venture capital funding remained very healthy and large pharma continued to support the biotech industry.
Concentration of at risk Biotechs remains low at approximately 5% with both DSA in total revenue for public biotechs with less than two years of cash on hand. This is slightly below our prior estimate which evaluated DSA backlog.
We believe the early stage research that we conduct is instrumental in our biotech clients achievement of the important milestones that enable them to secure the next rounds of funding and therefore, we believe they are you continuing the regulated safety assessment programs as critical to their continued success.
The total cost of a safety assessment program, it's a fraction of the cost of clinical trials, typically ranging from $6 million to $8 million, including post <unk> studies.
Yes. It is an important milestone to demonstrate to clients the efforts of driving innovation.
Validating the efficacy and safety profile of their lead compounds at five to 10 times less than the cost of clinical trials.
<unk> clients are motivated to plan their spending around the achievement of IND approval before seeking additional funding or finding a larger biopharmaceutical partner to move into clinical trials.
As a result of the importance both biotech and large biopharma clients are continuing to move the regulated safety assessment programs through their pipelines.
I will now provide additional highlights of our third quarter performance, we reported revenue of $989 2 million in the third quarter of 2002 at 10, 4% increase over last year organic revenue growth of 15, 3% exceeded our prior outlook of at least low double.
Digit increase.
All three business segments reported solid revenue growth, particularly the DSA segment due to the robust performance of the safety assessment business. The operating margin was 24% a decrease of 100 basis points year over year.
The decline was driven by lower margins in the manufacturing and RMS segments as well as higher unallocated corporate costs, both of which were previously anticipated earnings per share were $2 63 in the third quarter, a decrease of two 6% from the third quarter of last year higher revenue.
Was offset by the operating margin decline increased interest expense and a higher tax rate.
Based on the third quarter performance, we are narrowing our 2022 revenue growth and non-GAAP earnings per share guidance to the upper end of the previous ranges, we expect organic revenue growth in a range of 11% to 12% and non-GAAP earnings per share of $10 80 to.
To $10 95.
I'll now provide details on the third quarter segment performance beginning with the DSA segment.
Revenue for the DSA segment was $619 5 million in the third quarter, a 28% year over year increase on an organic basis, the DSA growth rates surpassed the 20% level.
Tracking to our initial plan that had forecast meaningful DSA growth acceleration throughout the year, the exceptional demand, which has manifested itself in sustained backlog growth is a function of our clients robust pipelines, our competitive strengths and the scientific breadth and geographic reach of our portfolio.
Broad based growth in our safety assessment business was the principal driver of the nearly two fold increase in the DSA revenue growth rate from the second quarter level.
The factors that led to this meaningful step up were substantially higher steady volume and continued meaningful price increases.
Steady volume was a significant contributor driven by strong demand across the safety assessment business for most major study types general and specialty toxicology as expected steady volume rebounded meaningfully from first half levels and we were able to accommodate additional client demand as a result of.
Having hired and trained additional staff over the last year.
We are continuing to successfully recruit and retain staff to support future growth and do not foresee challenges with staffing levels as we head into next year.
Pricing also continued to trend meaningfully higher year over year and sequentially, which we believe reflects the complexity and specialized nature of the work we do today's inflection that inflationary cost environment and the fact that capacity remains well utilized.
Although pass throughs are higher costs for certain study related resources that are passed directly to clients were higher in the third quarter. They accounted for less than half of the sequential step up in the safety assessment growth rate.
And had effectively no margin impact.
Pricing exclusive of the impact of pass throughs increased broadly in the third quarter.
Clients continue to emphasize the breadth of capabilities steady lead times and the availability of space more so than price when determining the preferred partner for their preclinical programs.
The premier partner for our clients non clinical development programs, it's not surprising that clients are continuously choosing to work with Charles River for our broad and scientifically differentiated portfolio superior client service and speed as we aim to take an additional year out of the early stage development timelines.
As expected the discovery services growth rate moderated in the third quarter, primarily due to the lengthening of clients' decision, making timeframes to start new projects a trend, which we discussed in August we believe the discovery business will demonstrate favorable long term growth prospects as many of our clients.
<unk> biotechs prefer to outsource their drug discovery projects, rather than maintain in house infrastructure and given the critical importance of the early stage research in which they are engaged they prefer an integrated full service partner like Charles River.
We continue to expect mid teens DSA organic revenue growth in 2022.
CSA backlog and booking activity through the third quarter continued to support sustained growth and for next year, we have a significant amount of safety assessment work already booked.
The strong safety assessment performance has been under the leadership of Shannon Paris Soto.
Shannon has been with the company for over 20 years, starting at our Nevada site. Shortly after it became our first acquisition in the safety assessment space.
With significant operational and finance experience Shannon recently assumed responsibility of our discovery services. In addition to safety.
Put it to an executive Vice President.
I'd like to congratulate Shannon and wish her continued success in driving our long term growth of our global discovery and safety assessment segment.
DSA operating margin increased by 190 basis points to 26, 2% in the third quarter, driven primarily by operating leverage from the substantial quarterly increase in safety assessment study volume and pricing.
RMS revenue was $180 1 million, an increase of 8% on an organic basis over the third quarter of 2021, the RMS business continued to sustain high single digit growth consistent with our outlook for the year. The RMS growth potential has trended upward recently from low to mid single.
Digit several years ago due to a combination of accelerating growth for research model services and research models, the Cradle initiative or Charles River accelerator and development labs, including a recent explorer acquisition is.
As a significant driver of the growth rate increase in addition, our renewed focus in on Biomedical research has led to increased demand and share gains for small research models, particularly in North America and China.
We are also benefiting from meaningful price increases in part to offset inflationary cost pressures. These factors were the principal drivers of RMS revenue growth in the third quarter.
And the research models business North America continued to generate strong revenue growth and China rebounded following the impacts from Covid related restrictions in the second quarter. There was no meaningful impact on client order activity from Covid related restrictions in the third quarter. We are also continuing to.
Spanned in China outside of Beijing, and Shanghai regions to gain additional market share and believe the level of biomedical research activity, coupled with our expansion plans in China will continue to generate robust double digit growth in the region.
Research model services also had another excellent quarter led by the insourcing solutions business, particularly our cradle and explore operations.
Clients are increasingly adopting this flexible model.
To access laboratory space without having to invest in internal infrastructure explorer has continued to perform very well with the integration on track. We added five new sites over the last six months in California, and Washington State and now operate 27 vivarium facilities totaling over 370.
<unk> thousand square feet of turnkey rental capacity creep.
Explore provide us with a new and unique pathway to connect with clients at the earliest stages, enabling these clients to easily access additional services across a comprehensive discovery and non clinical development portfolio.
In the third quarter, the RMS margin declined by 260 basis points to 23, 5%.
Driven primarily by the revenue mix and higher costs in China due in part to our regional expansions.
We also experienced a modest margin impact from opening new cradle and explorer sites this year.
For which the profitability will improve as client utilization increases and the newly.
<unk> sites.
Revenue for the manufacturing segment was $189 6 million, an increase of 6% on an organic basis.
Lower revenue and the CMO business the drivers of which we discussed last quarter was more than offset by higher growth rates for both the biologics testing and microbial solutions businesses.
The growth prospects for these legacy manufacturing quality control businesses remain robust.
And they will continue to be principally driven by demand for biologic drugs, including cell and gene therapies and other complex biologics.
Microbial solutions benefited from broad based growth across the sand is safe endotoxin testing and <unk> microbial identification testing platforms. We are continuing to convert the marketplace to a more efficient and reliable quality control testing platform the <unk>.
<unk> expansion of the installed base of instruments drives demand for the consumable cartridges and reagents, which provides a healthy recurring revenue stream.
<unk> testing business also had a strong quarter with virology viral clearance and microbiology testing services driving growth in both the U S and Europe demand for traditional biologics remains strong, but cell and gene therapy clients are driving a disproportionate amount of growth.
We have been continuing to add capabilities to our extensive portfolio to support the manufacturer biologics, including the addition of new cell and gene therapy assays.
The initiatives, we have implemented to improve the performance of our CMO business, beginning to gain traction and earn positive feedback from clients.
Still early and we don't expect the financial performance to meaningfully improve until next year, but we're pleased with the initial progress.
<unk> of centers of excellence for cell therapies viral vectors and plasmids has been well received and coupled with our focus on <unk> business development efforts, we are generating new client interests.
We recently announced the gene therapy manufacturing partnership with nano scope therapeutics to produce plasmid DNA and viral vectors for their late stage clinical trials.
<unk> targeting degenerative ocular diseases.
A number of other clients who are in late stage clinical trials with this cell or gene therapies, and we are investing in our sites to ensure that we are commercially ready should our clients receive regulatory approval.
We mentioned last quarter Memphis cell therapy site received European approval for.
The EMA to commercially manufactured cell therapy products.
Continue to believe in the long term growth prospects for cell and gene therapies and are enhancing our service offering to generate new business and provide incremental opportunities for clients to streamline their biologics development workflows by utilizing Charles River for their analytical testing process development and manufacturing.
Factoring activities the manufacturing segment's operating margin declined by 410 basis points to 28, 6% in the third quarter of 2022.
Similar to the second quarter was almost entirely driven by the <unk> business.
As we announced this morning, we have signed an agreement to divest our avian vaccine business, which is part of our manufacturing solutions segment for approximately $170 million in cash plus potential contingent payments of up to an additional $30 million.
We routinely evaluate the strategic fit and fundamental performance of our global infrastructure and as we did at this time last year have sold or closed operations that did not meet our key business criteria.
Decision to divest the avian business was consistent with this evaluation process as we determine that production of SPF eggs, principally for avian vaccine manufacturers and researchers with no longer a core competency Flavio will provide additional details on the financial impact of this transaction.
We are confident that we will finish the year on a strong note and are encouraged by the solid growth prospects as we head into the new year. The economy will present challenges in the coming year, but we believe we are well positioned to meet these challenges and continue to deliver exquisite science superior client support.
Greater efficiency to our clients our focus in recent years on enhancing our capabilities in biologics and cell and gene therapies.
Investing in our people in space and continuing to build greater digital connectivity with our clients has further differentiated us from our competition and enabled us to forge even deeper relationships with our clients.
We are the bridge between the biopharmaceutical industry and patients that enables innovation to move forward and we will continue to distinguish ourselves scientifically and through our preclinical focus.
To conclude 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 additional details on our third quarter financial performance and 2022 guidance.
Thank you Jim 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 adjustment costs related primarily to our global efficiency initiatives.
Gains or losses from our venture capital and other strategic investments and certain other items.
Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions divestitures and foreign currency translation and the 50 <unk> week in 2022.
We're very pleased with our third quarter results with revenue and earnings outperforming prior outlook organic revenue growth of 15, 3% resulted in earnings per share of $2 63.
I will now provide some additional details on the non operating items that drove our third quarter performance.
On allocated corporate costs increased in the third quarter totaling $57 5 million or five 8% of total revenue compared to 5% of revenue last year.
The increase was primarily the result of higher health and fringe related costs.
For the year, we continue to expect unallocated corporate costs to be approximately 5% of total revenue.
Total adjusted net interest expense for the third quarter was $27 $3 million, an increase of $4 $4 million sequentially and $6 $6 million year over year, reflecting the federal reserve interest rate increases this year and on a year over year base.
This higher debt balances from recent acquisitions.
For the year, our total adjusted net interest expense outlook remains unchanged in a range of $106 million to $110 million.
We expect that more aggressive interest rate hikes will be offset by additional debt repayment.
Our current interest expense guidance can accommodate an additional 75 to 100 basis point increase should that be the outcome of today's federal reserve meeting.
Given the late timing of a potential December increase we do not expect it would have a material impact on interest expense for 2022.
This week, we entered into an interest rate swap agreement on $500 million.
U S dollar denominated debt on our revolving credit facility.
For the next two years this swap will effectively fix the interest rate at four 7% plus our current spread of 112 five basis points for a total of $5 825%.
With the swap approximately two thirds of our $2 9 billion and that is now at a fixed rate.
Of the remaining floating rate that are revolving credit facility uses the one month LIBOR rate or equivalents plus the current spreads.
Looking beyond 2020, Q and to help with modeling in light of the federal Reserve's current policy of more aggressive interest rate hikes.
100 basis point increase in rates is expected to result in incremental interest expense of approximately $9 million on an annualized basis.
Just on our remaining floating.
Debt levels after the swap.
Our gross and net leverage ratios were both.
Approximately two seven times at the end of the third quarter.
Over the longer term, we continue to believe that strategic M&A will generate the greatest shareholder returns and enhance our growth potential.
In the near term, we will also focus on shorter term initiatives like debt repayment.
As Jim mentioned, we plan to divest our avian vaccine business by the end of the year.
<unk> received gross proceeds of $170 million upfront and intend to redeploy that capital with a portion used to repay debt.
The third quarter GAAP tax rate was 22% representing a 320 basis point increase from the same period last year.
The higher tax rate.
Year over year was due primarily to a lower tax benefit associated with stock based compensation related to the lower stock price as well as higher discrete tax benefits in 2021 associated with the R&D tax credit.
For the full year, we now expect the tax rate to be approximately 20% on a non-GAAP basis.
Slightly below the outlook provided in August and that's a low end of our longer term target.
20%.
Free cash flow was $64 million in the third quarter compared to $119 $2 million last year.
The 49% decrease was primarily due to changes in working capital and higher capital expenditures.
Capital expenditures were $72 $4 million in the third quarter, an increase of nearly $17 million compared to the $55 $5 million last year as we continue to make growth related investments.
For the year free cash flow and Capex guidance remain unchanged.
<unk> 360, and $340 million respectively.
As Jim mentioned, we have narrowed our revenue growth and non-GAAP earnings per share guidance to the upper end of the prior ranges.
We now expect reported revenue growth in a range of 10 to 11.
7% for the full year, including the 350 basis point foreign exchange headwind that we forecasted in August .
Our organic revenue growth outlook was also narrowed to a range of 11% to 12%.
We continue to expect that the consolidated operating margin will be essentially flat with 2021 and that will have narrowed our earnings per share guidance to a range of $10 80.
So $10 95.
Approximately $4, 5% to 6% growth versus the prior year.
Excluding an estimated foreign exchange headwind of 43 cents this year as well as a <unk> 20 headwind from interest expense compared to our initial outlook earnings per share growth would be in the low double digit range. This year.
By segment, our revenue growth outlook for 2022 remains unchanged, we expect organic revenue growth in the high single digits for the RMS segment.
Mid teens for the DSA segment.
Mid single digits for the manufacturing segment.
As noted in this morning's press release, the avian divestiture will not have a meaningful impact on our 2022 financial results.
In 2023, the transaction will reduce annual revenue by approximately $80 million and non-GAAP EPS by approximately 35 sets, but we expect to offset a portion of this dilution through the benefits of redeploying the proceeds towards other capital priorities.
A summary of our updated financial guidance for the full year can be found on slide 43.
With one quarter remaining in the year, our fourth quarter outlook is effectively embedded in our full year guidance.
I'd like to remind you that this year includes a 50 <unk> week at the end of the fourth quarter to chew up our fiscal year two at December 31 calendar year end.
The 50 <unk> week, historically has been characterized as a partial week of revenue and a full week of costs and for 2022, we expect the impact will be of benefit to reported revenue growth of approximately 550 basis points for the fourth quarter and a modest operating.
Margin headwind in the fourth quarter, particularly in the RMS segment.
For the fourth quarter on a year over year basis, we expect reported revenue growth will be in the low to mid teens.
Organic revenue growth will be at least in the low double digit range.
Earnings per share growth is expected to be in a range of approximately $2 65.
To $2 80 in the fourth quarter.
Based on our updated full year guidance.
In conclusion, we are well positioned to finish the year on a strong note. The second half DSA growth acceleration is occurring as expected.
Substantial backlog.
Only supports our full year financial guidance.
As we look to the future we're focused on continuing to drive growth.
<unk> on our strategy and enhancing our position as the leading global non clinical drug development partner working with our clients from discovery and preclinical development.
Safe manufacture of their life saving therapies. Thank you.
That concludes our comments, we will now take questions.
Thank you at this time, if you would like to ask a question. Please press star one on your Touchtone phone you may remove yourself from the queue at any time by pressing star Q until everyone. The opportunity to ask a question. We ask that you. Please limit yourself to one question. Once again that is star one to.
Ask a question.
Our first question comes from Eric Coldwell with Baird. Your line is open. Please go ahead.
Okay first question worst question.
Probably the one of the biggest debates this quarter is when are you going to give 2003 formal outlook.
I was hoping I could maybe put the put the pressure on for you just to tell us when that will be so we can in the debate.
We very much want to see the end of the year.
Oh I see.
Following year begins.
We moved away from that last year, but thats a normal cadence.
Given the uncertainties in the complexities in the world So.
Highly likely to do.
This in February yes, I appreciate that Jim.
Fundamental question on.
The avian divestiture.
I'm a bit curious you say, it's no longer a core competency, but you've been here forever you've run it well it's been extremely profitable.
And there is some earnings dilution with the divestiture, it's not the first time here in the last year, you've sold something that.
I had a similar I guess characteristic of maybe low growth no growth, but very high profit and very earnings accretive.
What do we learn from that.
I'm kind of interested in why this was no longer a core competency what was the main driver was it more of the revenue growth rate or.
Was there something more to that or would maybe this would be a signal that you're shifting your attention on higher growth businesses. Thanks, so much.
Okay.
This was a business when we bought it at that.
Much higher growth characteristics. It was a more meaningful part of the company. It was more strategic it was more.
Central.
What we were doing.
Because what I would say, it's more of a core competency so margins or margins are good. So true statement I would say that it's moved into a no growth genre, which we obviously don't like so it's dilutive to our topline.
It's a business that.
Has been okay, but we've been we've been unable we've owned that business by the way.
David we've been unable to really.
Crank it up in any meaningful way by moving into Adjacencies, which we've tried.
So it seems that we should.
Monetize that.
Use the proceeds for.
In this case, probably debt pay down but.
Yeah.
Use our assets for more.
Basic.
Relevant activities, so just sort of moved out of.
Yeah.
Our central focus.
The other risk is when a business is not within your major focus here given the timing of detection that.
Maybe you would have otherwise.
Given that we're in a kind of double digit growth methodology right now.
Wanted to maintain that.
Sounds good.
Six the floor here so.
Thanks, Jim Okay.
Thanks, Eric.
Our next question comes from Derik de Bruin with Bank of America. Your line is open. Please go ahead.
Hey, good morning, everyone. Thank you for taking my question.
So.
Realizing that a lot has moved in the world since your 2021 analyst day, but can you talk a little bit about the margin cadence as we sort of think about going into 2023 and 2024, you have that roughly 22, 5% op margin target for 2024.
And I just sort of curious how we should think about it realizing you've got FX moving divestitures, just the investment in the business inflationary cost would love some thoughts on how youre thinking about the margin progression.
Sure.
Hey, Derek good morning, its favia.
To your point since we provided that long term outlook about 18 months ago, a lot has changed right in the crowd and macroeconomic.
I'll make conditions.
So we're certainly going to take the.
Time to finish the budget for 2023, which will be an important jump off point for us too.
Confirm that term outlook, we continue to aspire to deliver long term.
Hi.
Long term healthy revenue growth and operating margin expansion. So the attendance of about.
Our long term aspirations remain.
This weekend.
Need to go back to the dry bulk block and look at.
The numbers in more detail since to your point a lot has changed since we went out.
18 months ago.
Got it.
If I can do a follow up.
One of the other.
<unk> space yesterday called out some headwinds.
In their developmental services across biotech and pharma, which was sort of a surprise to us.
I hate to belabor the point given your conversation on biotech, but do you see any sort of like weirdness.
Discovery business get worse did you did anything sort of soften between the time you had August between August analysis, we're making more cautious on the outlook it doesn't sound like it but I'm just trying to reconcile some of the comments from some other companies.
I'll get back in the queue. After this.
We didn't see anything conservative slowed down any more than the discovery growth rate has moderated pretty much pretty much totally in line with our expectations.
As we said in our last call we've had a lengthening of decision making.
Had no clients.
Very very few clients really focusing on the reason for the delay.
Relative to funding.
But if they have to make those decisions.
Doing slightly less discovery in order to do more R&D work, they're going to do that all day long. So we haven't seen any fundamental difference in the cadence since last time, we talked about this.
Thank you.
Our next question comes from Sandy Draper with Guggenheim. Your line is open. Please go ahead.
Yes.
Thank you very much.
Just a question.
On the price side and not sure. If this is for you Jim or Flavio when I think about your comments about strong pricing et cetera should we think about that as a.
That's going to flow through the model for the next.
Four quarters were really into next year is that something that just hitting this quarter I'm just trying to think about the cadence of those of the pricing.
Pricing changes and how they flow through the model and just to think about because that's clearly been very impressive it sounds like it's going to spill into next year I'm just trying to understand how we should be thinking about.
Those price increases flowing through and how sustainable they are.
Yeah, we were very clear about the fact that the back half of this year as exemplified by the third quarter would have increased volume and increased price which of course, we just delivered.
And tightened up our guidance for the year so.
That cadence is pretty clear, we have a unusually high amount of safety assessment booked for next year.
At escalating in increasing prices.
Books related to inflation.
Primarily related to the complexity increased complexity of the work.
The depth of the science that we do vis a vis competitors envy 70.
Big pharmaceutical companies so we.
We feel very good about our pricing power and sort of the leverage we have with our clients. We feel really good about capacity utilization, we feel really good about head count where we have it right now and our ability to do the work and.
And as we've been saying for a few years.
As the work has gotten more complex, we really feel that we've got to be paid well for it there were years historically.
We didn't think were being paid well for it I do think that's change. So as you know as we look to next year without getting too granular.
Of course, we have been even finish the planning yet, but we do have a lot of work.
At higher prices.
That's really helpful. Thanks, so much and congrats on the quarter in a challenging environment.
Thanks, Andy.
Our next question comes from Dave Windley with Jefferies. Your line is open. Please go ahead.
Hi, Good morning, Thanks for taking my question, Jim I wanted to.
To kind of understand I guess relative movement within discovery and safety assessment, you've you've commented on that this morning and previously.
I guess, we're hearing Derrick.
Derek mentioned it from yesterday, but we're hearing from a number of different.
Players, including you talking about slower decision, making.
I guess I'm wondering.
How you distinguish between discovery and safety assessment like if.
What's the protection or the boundary if they slow down discovery should we be braced or are you braced for that bleeding over into safety assessment.
And maybe another way to get comfortable with that you mentioned, the $6 million to $8 million in.
Total cost of I think an IND, enabling program I think was the point of those numbers how much of that comes after IND.
Such that it might run congruent with or sorry, coincident with clinical trial activity and be therefore very important.
So we think it's a tale of two cities right. So we think that.
Any company larger small.
St compound, particularly for high unmet medical need we will do anything.
Humanly possible financially possible to get this thing.
Two in AMD and.
Ultimately in the clinic.
Where they often monetize the asset sale the company felt with drugs out of the U S rights.
Whatever so that would jive with the strength of the backlog, which is increasing the prices that are escalating the sheer volume.
We're seeing.
In 2023, which is unprecedented even though we have some of that in 'twenty two.
Obviously, the discovery, where it comes earlier and at some point, Dave If you don't have.
Significant volume of discovery work that that will impact the volume of safety work I think we're a long way away from that I think we're seeing some thoughtful pauses with some of our clients just saying in a small number of clients by the way a very small percentage just saying a lot of uncertainty in the world in terms of access to additional.
<unk> capital, particularly in the capital markets and so we're going to prioritize had discovery assets, well, having said that the inflows.
From the capital markets are increasingly better third quarter was better than the second second bedroom third this will end up being a strong year venture capital inflows are at an all time high and pharma access to capital for pharmaceutical companies is probably at an all time high so again, we feel strongly that.
Quality assets.
Will be funded.
And one of those three incarnations or or all of the above so we're watching it closely as we just reiterated really not hearing a lot of conversation from clients, saying you really have to pause because we're worried about our cash.
<unk>.
Pausing.
So, we're inferring that which efficacy the right inference, but.
Discovery is still a relatively small percentage of DSA and so we're really thrilled with what we delivered in the third quarter.
Optimistic about delivering.
Delivering the fourth quarter.
And I'm pleased with the backlog that we have into fiscal 'twenty three.
If I may add Dave.
We started sharing the DSA backlog earlier this year.
I know that has been.
A slowdown in biotech funding going into this year, so right now.
11 months into the year.
And every quarter, we have seen that DSA backlog increased sequentially and pretty substantially year over year. So.
We really haven't seen any slowdown on the PSA backlog that would point to any adjustments or anything.
Sure.
Being impacted by the biotech funding.
Dynamics, which every quarter I know you all ask about so we feel good as Jim said that we have a substantial portion of the backlog booked already for 2023.
Excellent.
A question for that one thank you.
I did want to follow up.
On your comments around.
Pricing and complexity you did include some comments around pass throughs in the deck today, which I think is the first time, you've done that maybe that might be my fault.
I guess I'd love for you to comment on that because obviously, we do think that.
The pricing of some of the inputs to some of your studies has gone up.
Just massively and.
I guess, the part that I wouldn't quite be able to follow as if you are treating those pass throughs, though those would have a very dampening effect on your margin and we're not seeing that and so maybe you could.
So youre not going to get into great detail, but maybe help us understand the mechanics of that just a little bit.
Yes, so Dave.
You are correct.
Some costs have increased and.
We are passing those increased costs to clients and keeping the same level of margin that we have.
So they are either dilutive or accretive to margin if that makes sense.
That does help yes. Thank you.
We will go next to Elizabeth Anderson with Evercore ISI.
Hi, guys. Thanks, so much for that question.
And then wondering if you could comment on how today's dulera makiya growing in the quarter I know that you guys. Obviously did a lot of work to sort of make changes earlier in COVID-19.
Sort of increase the growth of that part of the business.
How does that sort of panning out in these in these current days.
Days.
Panning out slowly.
We've made a bunch of changes in that business. Thanks to most fundamental changes in that business.
Product line, the nature of the product line versus sort of off the shelf fix in specialty.
Items and also access ad.
Social methodology to access doughnuts. So all of that is now in place we're optimistic things.
Sequentially and continue to improve.
I would say, it's improving slowly.
Got it so it's more of a cross like 2023 kind of dynamic as the way we should think about that.
We certainly hope so okay got it and then just in terms of the CMO sales pipeline.
We had heard that there were some sort of.
Rebalancing efforts maybe between some.
Pharma sponsors.
Having some internal capabilities for some of the CMO work that they had developed during Covid and then potentially.
Some dynamics in terms of using up some of that capacity versus.
Starting to outsource as they grow what have you heard on that front in terms of that are people sort of continued continuing to sort of outsource. There is there any kind of residual like internal capacity demand or maybe you haven't actually been seeing that at all.
I would say that capacity is tight.
<unk> capabilities are complex both in terms of analytical work in process development and ultimately scale up.
It is inconceivable to us that.
Biotech companies sort of large.
Medium would even contemplate this.
Few big companies that we've heard of that.
Built their own space less because they don't.
So like the external providers, but more about concerns about available capacity, so I think theres going to be.
A lot of work outsourced theres going to be some work that's going to be internally.
Facilities built internally and the work done internally.
We'll see whether that work is just for clinical trial lots or whether that will be commercial.
Work is well I think the biotech companies have done a wonderful job utilizing external resources.
To do their work and so we have.
We think plenty of work and lots of conversations going on right now.
Have added incremental capacity and feel that we're in a good place to get our share of the pie.
Got it that's helpful. Thank you.
Yeah.
We will go next to Patrick Donnelly with Citi. Your line is open. Please go ahead.
Hey, guys. Thank you for taking the questions.
Jim maybe on the DSA side talked.
<unk> talked a little bit about the backlog there.
Staffing piece.
Earnings season from some of your peers, you've seen some labor shortages out there that prevented other companies from converting over a pretty strong demand backdrop, you guys backlog is growing as you talked about you seem to be ahead of the curve there kind of prioritized hiring late last year into early 'twenty. Two are you better positioned here now is the potential for share gains given you.
We will take on more work how capacity constrained are you guys given the labor side, maybe just talk to that a little bit.
Yeah, we feel really good about our.
A labor component and we've worked really hard at it for several years now both in terms of starting wages. Both in terms of numbers of recruiter has in terms of.
Explicit career development opportunities. So we can attract really talented people and keep them thinking.
Some of the cell and gene therapy folks that we've added over the last year or so so in terms of numbers of people to initiate or could it continue to do work as we move into fiscal 'twenty three we feel really good about where we're at.
I think we got ahead and stay ahead of the.
Salary levels, both starting and otherwise for fiscal 'twenty, two and we have that embedded in our plan and our guidance.
While our 'twenty three plan is done yet we will do the same thing we hope I mean, it's a little bit vague out there but.
We will continue to be appropriately aggressive in terms of being able to bring in new folks. So.
We feel really good about our labor component, we feel really good about our capacity available capacity at multiple sites, we feel really good about.
Pricing power, we feel really good about clients waiting.
A significant amount of time to initiate studies getting in line and prioritizing what studies they want to do first that so new we've been doing this a long time that you have sort of new the last couple of years. This is an industry that historically had some planned well and theres lots of changes but.
They really do have to plan well now and Thats I think holding us in good stead. So.
Labour component into it in a good place.
Okay. That's helpful. And then maybe just on the capital deployment side you guys. Obviously have some money coming in the door from the divestiture sounds like maybe near term a little more priority on the debt pay down, but maybe just talk about I guess the M&A funnel you guys are obviously executing on some of the more recent deal does it put a pause on that pay down some debt.
What's the right way to think about near term priorities priorities before you're going to get back to the normal.
Normal kind of cadence there.
So both.
It sort of aspects of that question I would say a couple of things number one that we.
We're deep into the integration of our cell and gene therapy assets, which obviously.
It has been more complex and more challenging than we have than we thought.
But in the nature of the science and the newness of the science and some of the <unk>.
<unk>.
Going well really pleased with the.
Facilities, the staff, the sales organization and our regulatory folks and.
New clients and also sort of a massive marketing initiative to make sure the people.
I understand that we're in this business.
I don't want to use the word pause because we did the explorer deal.
And we would do a small tuck in deal.
But technology deal.
Depending on when it was available.
We certainly don't always.
Control the timing of these deals.
But I would say that directionally, our balance sheet is increasingly in good shape to do do some meaningful M&A I don't want to say when that might be except to say that we have multiple conversations going on right now.
With potential acquisition targets, almost all of which are owned by private equity.
And we are always having conversations with them.
We.
I'll, let Ravi answer.
We are likely to do with the proceeds from avian yes, Patrick so thanks for the question and we regularly evaluate obviously uses of capital.
As Jim said M&A has served us well and has been in strategic lean.
Levered for the company for the growth for us.
As to acquire the scientific wherewithal to distinguish us.
With our clients, but in the short term the near term.
Likely to focus on our capital priorities on debt repayment and so I would expect a portion.
All of the ATM proceeds to indeed to indeed go towards paying down debt.
And we will continue to look at.
Our capital priorities.
We discuss regularly with our board.
And we'll continue to evaluate other uses but in the short term likely.
Sizable portion of the avian proceeds will go towards debt pay down, especially given the high interest expense interest rate environment that we're in right now.
I appreciate all the color. Thank you guys.
Your next question comes from Casey Woodring with J P. Morgan. Your line is open. Please go ahead.
Hi, Thanks for fitting me in.
Can you guys just talk towards the volume growth in DSA in the quarter, how much of that was just based on the increased capacity that you had come online.
And then also just wanted to get a sense on the volumes are trending meaningfully higher than where maybe you had expected them to be heading into 2023.
Maybe at the time of the initial.
Initiation of guidance and maybe versus even several months ago.
And then just as a follow up I don't think I caught it backlog growth number for DSA wondering.
Wondering if you could provide that and if you have any line of sight towards.
Double digit growth in DSA next year I think the street has you at 9% in 2023 for DSA growth. Thanks.
So we worked really hard for a number of years probably longer than I recall.
Probably probably approaching a decade actually of.
Adding incremental capacity at multiple locations simultaneously every year and then that was increasing as the old.
Size of the business has increased.
And we have to build it.
12 to 24 months in advance so we have to call. It right now so we'll go into space right now we have to call that at the end of 2003 and much of 24 or so.
To some extent we have to be prescient.
It does help obviously that have so much backlog in so much in the future and so much demand.
And having such a strong franchise. So yes, we're getting a lot of volume.
For sure taking share.
Okay.
That's our that's our goal and necessity, we have new companies.
Three 400, new companies every year that are going to need safety assessment, eventually and we want to have as much of that work as possible.
We have a lot of big pharma work increasingly so and intensifying and obviously a lot of mid and large biotech.
A lot of share gains from competition and a lot of just de novo work that wasn't available.
For anybody so we will continue to hopefully get price, we will continue to hopefully get volume as we have this space.
We were very careful not to build too much incremental capacity, so that we're swimming in adversely impacts our operating margins by the same token.
If you look at last year, where we definitely crush our operating plan.
Very important that we have incremental space, where we were able to take time.
New business.
To answer the other part yes sure.
A couple of additional comments before I give you the backlog number.
I think as Jim pointed out.
Incumbent upon us to get it all right right, we'd have to have physical capacity expanding our facilities at the appropriate time not too soon actually we have to have the people I think Patrick talked about that we feel really good that we.
We got ahead, if you will.
And you saw it.
When we provided guidance earlier in the year, we talked about a stronger second half of DSA, which I think there might have been some skeptics out there, but we are seeing that materializing in the volume acceleration in the second half vis vis the first half as all of those folks that we hire now become productive they are.
Training and they can really be available to support the strong client demand that we're seeing and allow us to gain share as Jim said, So I think we really have done a nice job of.
Ensuring we had the available physical labor.
Input capacity available to absorb the increase in demand.
In terms of the backlog the backlog in the third quarter was $3 2 billion. So it was about seven 5% sequentially growth versus the second quarter.
That's helpful. Thank you.
We'll go next to Jacob Johnson with Stephens. Your line is open. Please go ahead.
Hey, Thanks, Good morning, just one on the <unk> business.
You call out that you don't expect it to meaningfully improve until next year. So as we think about improvement into 2023, as Derek and Dave alluded to there was a steady amount of talking about the funding environment impacting their development pipeline yesterday I am just curious any thoughts on kind of the demand backdrop for CDMA services.
Think about.
Kind of that that business returning to growth next year. Thanks.
Yes, so we are optimistic about next year.
<unk>.
It's a business that has limited providers both of the services or the products required. So that provides enormous opportunities for us going back to the previous question about <unk>.
Clients doing it themselves 3000 ish molecules at least two thirds of which are in our preclinical domains. So there's an awful lot of.
Work available so we've been working hard to that.
On the right staff.
Facilities and the right dialogues with clients now that with deep in this in concert with our.
Dialogic business, which gives us I think a competitive advantage also in concert.
With our safety assessment business, so we feel really good about.
Our portfolio.
And the ability to service a whole range of cell and gene.
Therapy customers across the whole CMO.
Really paradigm.
Got it thank you.
We'll go next to Justin Bowers with Deutsche Bank. Your line is open. Please go ahead.
Hi, good morning.
Could.
Could you give us a sense of what the.
Growth was for the QVC business and manufacturing.
And then.
Gosh, I mean, I think its still a monkey 10 years since since pod nine one in depth on the avian business, but as I recall.
There is some seasonality to that.
Can you can you just remind us of that as we as we just think about model.
Yes.
We're not going to break out the growth rates of the specific pieces.
Manufacturing, except to say that we were pleased with the growth rate in microbial Im pleased with the growth rate of biologics.
And so the growth rate.
Which is why we sold it.
<unk>.
I don't think that business was particularly seasonal by the way we had pretty consistent client.
Orders for a long period of time for almost entirely behavior.
Avian vaccines, a little bit of human flu.
So it was time to divest that business.
Yes, and I'll just add that.
Other component manufacturing is obviously the CMO.
Our business in <unk>.
While Aegean strategically we have determined not to be.
The best fit with our strategic aspirations and ambitions.
Biggest headwind I would say currently in manufacturing is <unk> talked about in the second quarter earnings.
Yes, I got it for some reason I thought I recall that the first quarter there was.
There was.
That's kind of an outsized contribution there but.
Okay.
That's clearly not the case, maybe just a quick just a quick follow up on what what's kind of like the rule of thumb for.
For every one point move in FX on the year.
In terms of like the.
Operating.
Profit impact.
Yes, I think just saying we can take that offline with you.
Yes.
Exposure.
Very different currency, so it's hard to give you.
Besides impact depending on which currency it moves it can have more or less of an impact. So it is not.
One equals X.
Got it I'll take the rest offline. Thank you.
We'll go next to John <unk> with UBS. Your line is open. Please go ahead.
Hi, Thanks for taking my question, maybe just one on the CMO in cell and gene therapy manufacturing.
The turnaround recovery next year do you see any areas of gaps or maybe areas that could be complementary within the portfolio there.
And organically or inorganically that could help accelerate that turnaround into next year.
Not really I mean, we probably have some subtle gaps that yes.
Business matures strengthens that will take a look at.
I think while it's possible to do it organically, it's probably some modest amount of M&A, but I wouldn't say that any of those issues are getting in the way of the growth and development of the business. So I think that's it.
We feel that we're making all the right moves to strengthen that to access clients to distinguish our portfolio from.
The competition.
And to have both the space that the people and the regulatory acumen to.
To move work forward.
Certainly enter the clinic and hopefully eventually.
Commercial genre.
Yeah, and I'll, just add I think in the second quarter earnings we talked about obviously, what we've learned in the <unk>.
The assets.
The longer sales cycle cycles, but I think actually at this point those longer sales cycles and the efforts that we have been doing and putting in our BD teams are bearing fruit and us having good visibility into potential opportunities for next year. So we feel good not only that we're going to have.
On easier comps, but that we have line of sight too.
The underlying demand that Jim talked about.
Got it thank you for taking the question.
We'll go next to Dan Leonard with Credit Suisse. Your line is open. Please go ahead.
Thank you just a question for you Claudia I just want to make sure I'm clear on how you are framing interest expense for 2023 did you say that if rates go up by 100 basis points today than the starting point for interest expense is $119 million for 'twenty three or is there a different base on which you are calculating.
This sensitivity.
So I just I provided.
I tried to provide some help for you guys.
Model that.
In 2023 about 100 basis point change in interest rates would result in about $9 million of impact.
Our interest expense.
To your point this year because the fed has moved pretty much every quarter and every quarter, we have updated our <unk>.
Interest expense.
Outlook, it's hard to establish from which base. So I just wanted to provide you some more.
<unk> health that for next year 100 basis points is worth $9 million.
What would the Q4 number be a good base the Q4 run rate be a good base to calculate from.
You have different basis. So every quarter is going to be a little bit different and that's why it's challenging given what has been the escalating interest rate.
Rate hikes this year.
Okay I understand thank you.
Our next question comes from Max Smock with William Blair. Your line is open. Please go ahead.
Hi, it's Christina <unk>.
Just one from me.
DSA business, if youre willing how much of the 28% organic growth is coming from price increases.
Assuming that you are not willing to quantify that.
Do you currently view as the more normalized sustainable growth in demand for both discovery toxicology. Thank you.
I'm not going to be.
Give you the pricing.
Yes.
We really don't want to package. So we're really pleased with both the volume growth.
Pricing power in that business, which has improved pretty much sequentially year after year as the demand has increased as our competitive.
Sure and capabilities have increased so we're.
Happy to be getting a share taking share and getting paid well for our business very pleased with the.
Improvement in operating margin.
Good quarter.
Particularly pleased with the.
Volume of work, that's already booked into fiscal 'twenty.
Sure.
Hey, Thank you.
We will go next to Taz <unk> with Morgan Stanley . Your line is open. Please go ahead.
Hey, guys good morning.
So quick one on safety assessment here is there any color you can share on proposal volume growth in the quarter.
And Jim if you can comment on lead times I mean, how do you see those sort of moderating at all sequentially or are they still where they were a couple of quarters ago for the business.
Proposal volume, we're busy lots of proposals and lots of work being booked.
Don't really see any rationale structurally demand wise or otherwise.
Why things would moderate.
We've.
More about that as we finish the year in the year and obviously, but.
Our competitive posture seems to continue to strengthen.
Pricing power continues to strengthen there's a lot of where our clients are really busy with.
Whole range of large and small molecules a lot of cell and gene therapy work.
And so the.
The thing that we've seen enough stuff is great.
Amortization of what drugs they wanted to get an earlier, we try to accommodate that.
But we didn't have it in our prepared remarks, but we do have some clients that have signed up for dedicated space with us I think thats, a really important happening and really an important sort of commentary.
Both acknowledgement from our client's product that they need some vehicles to move relatively.
To the front of the line so.
I would be surprised if we don't see more arrangements like that.
Got it that's helpful and a quick follow up on on RMS a near term one and then sort of the medium term one so in the near term Jim can you just comment on thoughts on RMS margins in China, and how you see those trending.
Can you just parse out how much of the headwind that it was from your expansion plans versus other factors and then the medium term question was related to the FDA modernization Act.
How are you thinking about that over the medium term for the animal model side of things and are you starting to hear anything from your clients at all on that.
So China has been.
Place with strong growth rate.
Sure.
With margins.
Some pricing power.
And.
Part of that is associated with access to incremental animals or another.
Geographic locales.
Very large countries. So we've continued to increase capacity both for the product and the service side in RMS in China and.
We're really we're pleased with the results.
And.
While we definitely have competition over there most of its local when most of it is much less sophisticated.
Animal quality.
Okay.
Veterinary point.
Point of view.
The dialogue about.
In vitro technologies <unk> models.
I mean, all of that it is not new.
We're interested in and have always been interested of Charles River and making sure that.
Minimal amounts of animals that are used and used appropriately for studies.
We've seen that mix in animal models over the years with more.
More refined higher ASP models, so hypertensive animal immuno compromised animals double triple quadruple the immuno compromised animals, and brad's hybrid et cetera, with higher asps in the last sort of Alfred.
Bottles.
I'd say a couple of things that while I think.
Zaire.
The part of whoever public Navy.
For there to be a reduction or replacement.
<unk>.
New technologies for animal models.
The way, we see most of those technologies.
<unk>.
They will not provide a sufficient safety profile most many of the drugs.
Many of the diseases for which we have drugs.
I just don't understand the mechanism of action that both diseases.
Don't have drugs, they definitely don't understand the mechanism of action, so trying to replicate that with a computer or a cell culture or ex vivo system is very complicated.
It's unlikely that the drug companies would take the time to validate those technologies or the regulatory agencies would.
Yes.
Would be comfortable with that yes, I think it's a little bit different with discovery. So thats regulated safety. So we don't see any changes you're going to need a whole animal model to get good results in most cases two different species. The discovery side most of the big pharma companies have been wrong in vitro screens.
They don't share with anybody else.
We've made a couple of investments right now in AI and machine learning will make more investments in AI and machine learning.
We can see a time, where some of the early discovery answers.
Three getting into animals could be done ANV.
In vitro and could be faster I think that's one of the places that we will I'll save time, so a little bit of a tale of two cities.
Got it Super helpful. Thank you.
Sure.
Our next question comes from Tim Daly with Wells Fargo. Your line is open. Please go ahead.
Great. Thanks for the time, just a quick modeling question for me.
So the comps for DSA growth is from <unk> and historically, there's been a bit of a sequential lift.
Dollar revenues into the fourth quarter. So just curious is there anything specific that you all are seeing today, which would limit.
Over quarter expansion in either the revenue dollars are the percent organic growth in DSA.
The year.
So I don't think so.
Just to remember Tim.
Also our 50 <unk> week this year.
That I alluded to so from a reported perspective theres going to be that impact.
Alright, great. Thanks, that's it for me.
Thank you and that is all the time, we have for questions I'll turn the conference back to Todd Spencer for closing remarks.
Great. Thank you for joining the conference call. This morning, we look forward to seeing you on upcoming conferences. Thank you and have a good day.
Thank you, ladies and gentlemen that will conclude today's Charles River Laboratories third quarter 2022 earnings Conference call. Thank you for your participation you may disconnect at this time.
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