Charles River Laboratories International Q1 2022 Earnings Call Transcript

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Provided by Quartr
May 4, 2022

Key Takeaways

  • Charles River delivered Q1 revenue of $913.9 million (+10.8% YoY; +9.4% organic), a 21.4% operating margin (+70 bps) and EPS of $2.75 (+8.7%), in line with expectations.
  • The DSA segment generated 9.5% organic growth on $554.3 million revenue, with backlog rising to $2.8 billion (up 75% YoY) and over $1 billion already booked for 2023, positioning for ~20% organic growth in H2.
  • Research Models (RMS) saw high single-digit organic revenue growth and margin expansion to 29.9% (+120 bps); the Explora Bio Labs deal doubles Cradle vivarium capacity to 25 sites, boosting turnkey research offerings.
  • The Manufacturing segment grew 10.1% organically, led by double-digit biologics testing and CDMO milestones, while margins eased to 33.1% due to integration of Cognate and Biogen acquisitions.
  • Management reaffirmed full-year organic revenue growth of 12.5%–14.5% and non-GAAP EPS of $11.50–$11.75, noting biotech clients’ resilient funding (average ~3 years cash) and diverse financing sources.
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Earnings Conference Call
Charles River Laboratories International Q1 2022
00:00 / 00:00

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Operator

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

Todd Spencer
Todd Spencer
VP of Investor Relations at Charles River Laboratories

Thank you, Lisa. Good morning, and welcome to Charles River Laboratories first quarter 2022 earnings conference call and webcast. This morning, I'm joined by Jim Foster, Chairman, President, and Chief Executive Officer, David Smith, Executive Vice President and Chief Financial Officer, and Flavia Pease, Executive Vice President and incoming Chief Financial Officer. They will comment on our results for the first quarter of 2022. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is posted on the investor relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately 2 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.

Todd Spencer
Todd Spencer
VP of Investor Relations at Charles River Laboratories

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.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Thank you, Todd. Good morning. We're pleased to report solid financial results for the first quarter that were precisely in line with our expectations. Organic revenue growth was slightly below the 10% level. Operating margin improved by 70 basis points year-over-year. Earnings per share growth was in the high single digits. Revenue growth rate is expected to increase from the first quarter level, positioning us well to achieve our robust outlook for the year. There are several factors that we believe support our outlook, including the continued strength of the biopharmaceutical market environment. First, we continue to benefit from strong, sustained business trends, particularly in our largest business, safety assessment, which represents approximately half of our total revenue. We are booking work well into 2023, and have over $1 billion of backlog already for next year.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We continue to get price and anticipate continued share gains. Our scale, scientific expertise, and geographic reach continues to resonate with our clients. We have added a significant number of staff in the second half of last year and continued hiring in the first quarter. Coupled with our growing backlog, we are poised to meet the escalating demand, which will result in a DSA organic revenue growth rate approaching 20% in the second half of this year. Another factor that supports our 2022 outlook is our well-funded client base, both large and small. Based on daily conversations with our clients and our key performance indicators, clients are continuing to spend at the rate that we anticipated and move their non-clinical development programs forward. Given our early-stage focus, we are a canary in the coal mine should funding become a concern.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

This is not surprising as we believe biotech clients are resilient and continue to have an average of about three years of cash on hand based on both our internal assessment and our clients and industry sources. The biotech industry is more critical to biomedical innovation than ever. Our clients are generally unaffected by the recent headlines related to public biotech financing. Beyond the public markets, we believe that broader, balanced sources of funding will enable many biotechs to continue to access capital from the private sector. Venture capital firms continue to raise new, larger funds and invest heavily in startups, providing a sustained source of funding for the biotech industry. We believe that pharma M&A and partnering investments are also utilized to help ensure that promising molecules for unmet medical needs are funded and moved forward.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

To provide some color on our biotech client base, roughly one quarter of our clients can be defined as pre-commercial. Segmenting that further, there is a subset of public biotech clients with less than two years of cash on hand. We estimate that these clients make up only about 10% of the current DSA backlog. We have taken action in recent years to add staff capacity, scientific capabilities, and secure resources to accommodate client demand and provide them with exceptional service. These efforts have intensified recently in order to support the robust growth that we are experiencing and continue to forecast.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We are confident that we are taking the necessary steps to effectively manage the business in today's market environment and deliver on our commitments to clients. We believe that our ability to support our clients with flexible, efficient outsourcing solutions tailored to their needs and available when they need them has continued to distinguish us from the competition. I'll now provide highlights of our first quarter performance. We reported revenue of $913.9 million in the first quarter of 2022, a 10.8% increase over last year. Organic revenue growth of 9.4% was driven by a solid performance from all three business segments and was in line with the outlook that we provided in February. Biotech clients continue to be the primary driver of revenue growth in the first quarter.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

The operating margin was 21.4%, an increase of 70 basis points year-over-year. The improvement was driven by the RMS segment as well as lower unallocated corporate costs. Earnings per share were $2.75 in the first quarter, an increase of 8.7% from the first quarter last year. Strong mid-teens operating income growth was partially offset by a higher tax rate and interest expense compared to the prior year. Based on the first quarter performance and an expectation that the robust business trends will continue throughout the year, we are maintaining our organic revenue growth guidance of 12.5%-14.5% and our non-GAAP earnings per share guidance of $11.50-$11.75 for 2022.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Our guidance has incorporated two unfavorable changes in below-the-line items since the beginning of the year. The expectation for a slightly higher tax rate this year due to the impact of a lower stock price on stock-based compensation and higher interest expense as a result of the Federal Reserve's recent monetary policy changes. Dave will discuss both of these items in more detail shortly. I'd like to provide you with the details on the first quarter segment performance, beginning with the DSA segment. Revenue was $554.3 million in the first quarter, a 9.5% year-over-year increase on an organic basis. As expected, the DSA organic growth rate improved by nearly 300 basis points from the fourth quarter level, driven by the safety assessment business.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We expect that growth to improve to the low double digits in the second quarter and approach 20% in the second half as the quarterly gating for the year continues to track to our initial plan. The safety assessment business continued to benefit from strong business trends as higher pricing and increased demand drove first quarter revenue growth. We are pleased with the sequential improvement in the safety assessment growth rate and expect continued acceleration during the year. This is supported by booking and proposal activity, which remain robust. DSA backlog was $2.8 billion at the end of the first quarter, an increase of more than 75% from the first quarter of last year and over 15% since year-end. Proposal dollar volume in the safety assessment business increased by 35% year-over-year.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We also have an exceptionally high proportion of safety assessment revenues booked into backlog already for this year, but do have sufficient capacity to start certain studies during the year. These trends reinforce our DSA organic revenue growth expectation for the year and affords us visibility into the strongest future demand that we have ever seen. Capacity is well utilized, both in terms of people and infrastructure, and we are continuing to add the necessary staff and space to accommodate these robust demand trends. As I mentioned earlier, we hired a significant number of safety assessment staff in the second half of last year, and hiring continued into the first quarter. With this staff now in place, we expect recent hires will help us meet our accelerating DSA growth outlook over the course of the year.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Coupled with benefits from higher pricing continuing to work through the backlog, we are very confident in the anticipated DSA growth acceleration and our ability to achieve our mid-teens DSA organic revenue growth outlook for the year, including approaching 20% growth in the second half. Our clients are also accepting longer lead times required to start some of their studies, which is necessitating that they book projects further in advance to ensure they do not delay their drug development. Many are exploring new creative relationships with us to secure space. These discussions recently led to a large biopharmaceutical client to enter into a multiyear agreement with us to reserve safety assessment capacity in a take-or-pay arrangement. We anticipate that other clients will follow suit and believe that these developments demonstrate the sustained strength of the demand environment and our market position as a leading nonclinical contract research organization.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Revenue for the discovery business increased in the first quarter, but growth rate was below its recent low double-digit trend. This was largely the result of difficult comparison to the strong first quarter of last year, which included milestone payments and some COVID-related work. Our integrated discovery portfolio continues to resonate with clients, and it is imperative that we enable them to have access to cutting-edge scientific capabilities and expertise in major therapeutic areas as well as biologics so that we can be the scientific partner they work with to advance their research programs to IND filing and beyond.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Our technology partnership strategy has been very successful means to do this since it has enabled us to continue to add new capabilities across many of our businesses with limited risk. We believe our clients' willingness to outsource more of their discovery programs will be predicated on our ability to continue to add innovative capabilities to meet their critical research needs. The DSA operating margin decreased by 90 basis points to 22.9% in the first quarter, due primarily to higher staffing costs. We view this largely as a timing issue, given the significant number of new hires and wage environment over the past 6 to 12 months. For the year, we continue to expect the DSA segment will be the primary driver of modest operating margin improvement for the company, as leverage from the accelerated DSA growth rate offsets higher compensation costs.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

RMS revenue is $176.5 million, an increase of 8.7% on an organic basis over the first quarter of 2021, and in line with our high single-digit outlook for the year. Organic revenue growth was driven by broad-based demand and meaningful price increases in the research model business, particularly in North America, which performed very well. China also continued to perform well, but the growth rate was impacted by the comparison to the exceptionally strong start last year. We also experienced a very small RMS revenue impact related to China's COVID restrictions this year and are closely monitoring the situation. At this time, we don't expect it will become a meaningful headwind. Research Model Services was also a significant contributor to the segment's growth, led by the Insourcing Solutions business, or IS.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Our CRADL, or Charles River Accelerator and Development Labs initiative, which is part of our IS business, has further accelerated the growth potential for the RMS segment, as both small and large biopharmaceutical clients are increasingly seeking to rent turnkey research capacity in key biohub. To build upon our CRADL strategy and capitalize on a significant growth opportunity, we acquired Explora BioLabs last month. San Diego-based Explora has a similar focus as CRADL, currently operating more than 15 preclinical vivarium facilities with greater presence on the West Coast. While the demand for turnkey laboratory capacity makes this an attractive transaction on its own, the enhanced value proposition is that clients utilizing CRADL or Explora will be able to easily access additional services across our comprehensive discovery and non-clinical development portfolio, providing us with a new and unique pathway to connect with clients at earlier stages.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

With expansions currently underway in the United States and internationally, the combined CRADL and Explora BioLabs operation is expected to include at least 25 vivarium facilities by the end of 2022, providing over 300,000 sq ft of turnkey rental capacity in key biohubs. Explora BioLabs will effectively double the revenue and footprint of our CRADL operation, driving strong double-digit revenue growth that will solidify the RMS segment's position as a sustained growth engine for the company. In the first quarter, the RMS operating margin increased 120 basis points to 29.9%, driven primarily by operating leverage from robust sales of research models. RMS operating margin expansion will be limited for the remainder of the year due to the Explora BioLabs acquisition.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Explora has healthy margins for a service business, but the operating margin is below that of the RMS segment, creating a headwind to the segment margin this year. Explora is opening a number of new sites this year, so we expect the business to leverage these investments and be better positioned to enhance its operating efficiency thereafter. Revenue for the manufacturing segment was $193.1 million, a 10.1% increase on an organic basis over the first quarter of last year. Biologics testing services was the primary driver of the increase, with continued robust double-digit revenue growth. Microbial solutions growth rate was below the 10% level, resulting in the manufacturing segment's growth rate being below its mid-teens full year target in the first quarter.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

This was timing related and will not affect the outlook for the year, as we still expect microbial revenue growth in the 10% range. Demand for our biologics testing services associated with cell and gene therapies and other complex biologics continues to be robust, and we are confident that cell and gene therapies will continue to be significant growth drivers for our business, even as COVID-related vaccine testing revenue settles into a steady run rate. There is a significant market opportunity for our biologics testing business, which provides services that support the safe manufacture of biologics, including process development and quality control.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We believe client interest in our consolidated Biologic Solutions offering, which provides both biologics testing and the cell and gene therapy CDMO services, will only increase as the synergies to produce complex biologics and conduct the required analytical testing with one scientific partner are more broadly adopted by clients. Utilizing our Biologic Solutions offering will be a strategic advantage for clients who are looking to reduce bottlenecks and increase efficiency of their drug development and commercialization efforts. Our CDMO business also had a good quarter, and we continued to make excellent progress on our integration efforts.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Our gene modified cell therapy production business has gained traction and generated strong growth in the quarter, as it continues to be one of the leaders in this emerging space. We benefited from commercial readiness milestones in the quarter, which are relatively common in the CDMO sector, and demonstrate that clients are continuing to advance their programs into later stages of development and trust us to take the critical next steps with them. We also continue to position our gene therapy product offering, plasmid DNA, and viral vectors, to be opportunistic in a marketplace that is greatly in need of more supply.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

The manufacturing segment's operating margin declined 240 basis points to 33.1% in the first quarter of 2022 as a result of the inclusion of the Cognate and Vigene businesses, which have margins below the overall segment, but expected to improve as we drive efficiency and leverage the significant growth potential for this business. We are operating in a robust business environment that gives us excellent growth potential. We have the best of visibility that we have ever had, with an average 12-18 months of backlog in our largest business. We have the capacity and the people in place to deliver on the accelerated demand throughout the year, and we are benefiting from escalating pricing. It is opportune that the market dynamics will remain robust at a time when we believe we have built the premier non-clinical contract research and manufacturing organization.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Before I conclude, I'd like to provide an update on our CFO transition plan. As we announced last month, Flavia Pease has been named our next Chief Financial Officer, replacing David Smith, who previously announced his plans to retire. I'd like to thank David for his dedicated service to Charles River and a remarkable career. David has been instrumental in Charles River's growth and success since he joined the company through the Argenta and BioFocus acquisition in 2014, and subsequently when he was promoted to Chief Financial Officer in 2015. During his tenure as CFO, Charles River's revenue has increased 17% annually and free cash flow by 14% annually, and David has played a critical role in his accomplishments by providing strategic financial counsel and direction to our global organization.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

David will remain with us through year-end, but transition into a role as senior financial advisor shortly after earnings. I'm pleased to announce that Flavia Pease will assume the role of CFO at that time. Flavia is a highly regarded financial leader with more than 20 years of financial leadership experience at Johnson & Johnson. Her deep biopharmaceutical industry knowledge and experience managing the finance organizations of large, growing businesses will greatly benefit Charles River. I look forward to partnering with Flavia as we work to advance the company's growth strategy and mission. In conclusion, I'd like to thank our employees for their exceptional work and commitment, and our clients and shareholders for their support. Now Flavia will provide a brief introduction before David gives you additional details on our first quarter financial performance and 2022 guidance.

Flavia Pease
Flavia Pease
CFO at Charles River Laboratories

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

David Smith
Executive Vice President and CFO at Charles River Laboratories

Thank you, Jim, Flavia, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition-related charges, costs related primarily to our global efficiency initiatives, our venture capital and other strategic investment performance, and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, divestitures, foreign currency translation, and the fifty-third week in 2022. We are pleased with our first quarter performance, which included revenue and earnings per share growth in line with the outlook we provided in February. Organic revenue growth of 9.4% and operating margin expansion of 70 basis points were partially offset by a higher-than-expected tax rate, resulting in an earnings per share increase of 8.7% to $2.75.

David Smith
Executive Vice President and CFO at Charles River Laboratories

As Jim mentioned, we have reaffirmed our organic revenue growth and non-GAAP earnings per share guidance for the full year. Our earnings per share guidance of $11.50-$11.75 has effectively absorbed a higher-than-expected tax rate and interest expense compared to our initial outlook. I will discuss both of these items in more detail shortly. Our organic revenue outlook for the full year is unchanged at 12.5%-14.5% growth. With the addition of Explora BioLabs, we've increased reported revenue growth guidance to a range of 13.5%-15.5%. This includes a larger 1.5% headwind on foreign exchange due to the strengthening of the US dollar. Given the robust top-line performance, we remain well positioned to modestly expand the operating margin in 2022.

David Smith
Executive Vice President and CFO at Charles River Laboratories

As I mentioned, our tax rate and interest expense outlooks have increased since the beginning of the year. We expect a slightly higher tax rate in 2022 because the lower stock price during the first quarter resulted in a lower excess tax benefit associated with stock-based compensation. This led to a first quarter tax rate of 16.8%, a 230 basis point increase year-over-year, and above our prior outlook in the mid-teens. Our tax outlook remains within our initial low 20% range for the year, but has moved slightly higher due to the stock price movement since February. We now expect adjusted interest expense of $98 million-$102 million in 2022, approximately $50 million higher than our prior outlook.

David Smith
Executive Vice President and CFO at Charles River Laboratories

The primary drivers of the increase are nearly evenly split between higher interest rate assumptions associated with the Federal Reserve's outlook provided in March and higher debt balances due to the Explora acquisition in April, which will not have a meaningful impact on non-GAAP earnings per share since the transaction is expected to be earnings neutral this year. For the first quarter, total adjusted net interest expense was $20.4 million, which was flat sequentially compared to the fourth quarter. At the end of the first quarter, we had an outstanding debt balance of $2.7 billion, equating to a gross leverage ratio of 2.5 times and a net leverage ratio of 2.4 times. As planned, we financed the Explora acquisition through our revolving credit facility, and our leverage remains below 3 times pro forma for the transaction.

David Smith
Executive Vice President and CFO at Charles River Laboratories

For the remainder of 2022, we will continue to evaluate M&A opportunities, and absent any additional acquisitions, our capital priorities will be focused on debt repayment. By segment, our organic revenue growth outlook for 2022 remains unchanged. RMS organic revenue growth guidance remains in the high single digits. The reported revenue growth outlook for this segment is being increased to a high single-digit range to include the Explora revenue contribution. We continue to expect the DSA segment to deliver mid-teens organic revenue growth, driven by strong contributions from both the discovery and safety assessment businesses. In the manufacturing segment to achieve mid-teens organic growth as the Microbial Solutions growth rate improves from the first quarter level and the Cognate and Vigene acquisitions are included in the organic growth rate. Lower unallocated corporate costs totaling 5% of revenue contributed to the first quarter operating margin improvement.

David Smith
Executive Vice President and CFO at Charles River Laboratories

This is compared to 6.2% of revenue last year, with the decrease driven by several factors, including favorable fringe-related costs and quarterly fluctuations in the gating of corporate costs. Despite the favorability in the first quarter, we continue to expect unallocated corporate expenses to be in the mid-5% range as a percent of revenue for the full year. Free cash flow was $22.2 million in the first quarter compared to $142.2 million last year. The decrease of $120 million over the prior year was primarily due to planned increase in capital expenditures associated with projects to support future growth and higher performance-based bonus payments related to the strong 2021 results. Capital expenditures were $80.5 million in the first quarter compared to $28 million last year.

David Smith
Executive Vice President and CFO at Charles River Laboratories

For the year, our free cash flow and capital guidance remain unchanged at approximately $450 million and $360 million, respectively. As previously discussed, CapEx is expected to total approximately 9% of total revenue in 2022. A summary of our updated financial guidance for the full year can be found on slide 39. For the second quarter, our outlook reflects a continuation of the strong business trends and for the revenue growth rate to continue to accelerate. We expect the reported and organic revenue growth rates will be in low double digits. The DSA and RMS organic growth rates are expected to improve sequentially from the first quarter level, while the manufacturing segment will be slightly lower due to the strong comparison to the nearly 27% growth last year.

David Smith
Executive Vice President and CFO at Charles River Laboratories

Earnings per share are expected to increase in the mid to high single digits year-over-year in the second quarter. In closing, we are very pleased with our first quarter financial performance and are confident about our growth prospects for the remainder of the year. Given the strong DSA business development activity that Jim highlighted, our order book firmly supports our full year financial guidance, including DSA organic revenue growth approaching 20% in the second half of the year. Before concluding, I would like to say a few final words. I'm pleased to welcome Flavia to the Charles River team. In the past few weeks, we've begun the transition of my responsibilities, and as such, this will be my final earnings call as Chief Financial Officer.

David Smith
Executive Vice President and CFO at Charles River Laboratories

I'm not officially retiring until after year-end, but I will move into a new role shortly after this earnings call to ensure a smooth transition. It has truly been a privilege to serve as Charles River's CFO, and I would like to thank Jim, the board, and all of my colleagues for their support and collaboration during my time at Charles River and for the successes that we have all shared together. I firmly believe I'm leaving the company well positioned for continued success because of the sustained robust demand environment, our industry-leading portfolio, and the highly experienced leadership team. I would also like to thank each of you, the Charles River shareholders and analysts, for the collaborative relationships that we have forged over the years and for your support. It's been a pleasure working with you. Thank you.

Todd Spencer
Todd Spencer
VP of Investor Relations at Charles River Laboratories

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

Operator

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

Eric Coldwell
Eric Coldwell
Senior Research Analyst at Baird

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Sure. We do anticipate the ramp will continue through the back half of the year. Each quarter will be progressive, should be progressively stronger, and we'll end well, the back half of the year will be at 20%. That's a combination of significant price share gain, overall volume and mix, great capacity utilization of staff, which has been hired but being trained and sort of not contributing to the top or the bottom line in Q1. Just the strength of our competitive position from a scale point of view, geographic proximity point of view, and the constituent scientific parts of our business. You know, we've never had backlog like this. It continues to elongate. You know, it's $1 billion of backlog already for next year.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

It's the volumes are up substantially over the prior year and over the last quarter. We're quite confident in our numbers and the progression. Take-or-pay thing, Eric, is really interesting. I don't know if I said it to you, but I've sort of been saying it at least to ourselves that we were surprised we weren't hearing more of this. You know, capacity is kind of appropriately tight. Clients are really busy. Clients are well-financed. There's lots of new modalities. People are booking pretty far out. You know, the booking pretty far out is a combination of lots of work and making sure they get a slot.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I've often said if I was running a drug company or the head of R&D, I certainly would try to lock up some space so I had some flexibility and, you know, could slot things in perhaps, slot priority things in perhaps earlier than we were giving them, giving them slots. We signed the first one. It's nothing special about the client except it's a big one, and it's multi-year. We feel pretty strongly that others will follow. It's just too much of an appropriate tool for them to use, you know, as the demand continues to increase. That's kind of a safety valve which I think takes a lot of the pressure off of them.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We spent a lot of time with our clients over the last 6-12 months about tell us what your real priorities are. Don't tell us every drug is important to start a study next month, or it's gonna have the same revenue contribution because of course that's not true. Help us prioritize and we'll, A, help slot those in earlier, and B, if you wanna really be sure, belts and suspenders, then lock up some space on a take-or-pay basis. Not surprised. Pleased to see it. I think that's gonna make this, the kind of scheduling more rational, more comfortable for everybody. You know, we can't project it because it hasn't happened yet, but we would be surprised if we don't see additional large companies do similar things by the end of the year.

Eric Coldwell
Eric Coldwell
Senior Research Analyst at Baird

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Thanks, Eric.

Operator

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

Jacob Johnson
Jacob Johnson
Managing Director and Research Analyst at Stephens Inc.

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Yeah, you know, it was, I'd say the major strategic rationale for us to pivot back into the CDMO space, having exited it several years ago, we find ourselves with this escalating high growth, improving margin biologics business on a worldwide basis. Yeah, we're testing the drug before it goes into the clinic. We're testing the drug if it's approved after it goes into the clinic, perhaps indefinitely. You know, we began to have requests from clients to why can't you manufacture the drug? There's a correlation. If someone else manufactures it, we could still test it or vice versa, but I think there's a lack of elegance to that for the clients. I think it's less efficient for them. It slows things down.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We have competitors who do either, but don't do both. We think this is a strategic benefit for us. Also the connection to safety discovery is also quite significant. You know, it's a little bit early to comment on the success except to say that, you know, we have a sales force that talks about all of it. We have clients that definitely are resonating to it both ways. Former biologics clients that are now beginning to talk to us about or use us for CDMO manufacturing or buying gene therapy products or vice versa. We're quite confident that that's the ultimate value proposition that we've invested in here, and it's sort of the way we get one plus one equals three.

Jacob Johnson
Jacob Johnson
Managing Director and Research Analyst at Stephens Inc.

Got it. Then just maybe following up on that, just on HemaCare and Cellero, can you just talk about the latest trends in cell supply as kind of the COVID headwinds there abated? Are you seeing a rebound in those businesses?

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

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

Jacob Johnson
Jacob Johnson
Managing Director and Research Analyst at Stephens Inc.

Got it. Thanks for taking the questions.

Operator

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

Elizabeth Anderson
Elizabeth Anderson
Senior Managing Director at Evercore ISI

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I'm not sure I heard the whole question.[crosstalk]

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Speaking a little quickly. Yeah.

Todd Spencer
Todd Spencer
VP of Investor Relations at Charles River Laboratories

Operating expenses in the current kind of inflationary environment.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

You know, I don't think anybody has a crystal ball, but we feel that we accommodated well for inflationary pressures when we put our operating plan together and it's embedded in our guidance. When I say that, I'm obviously talking about supply chain costs. I'm talking principally about numbers of people and salary levels, hourly rates, whatever, compensation levels and what we anticipate that we have already done and may have to do additionally. There's no question that in the first quarter, tried to allude to this in my answer to the last question, we had a fair number of people that were hired, for instance, into the safety assessment business.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

More people, higher salary levels, very much tied up in training and not really contributing to either revenue or profitability. You'll see that sort of ameliorate through the back half of the year. You'll see pricing for a lot of studies that we book later in the year come through. What we've said, and I want to state this again carefully, is that the modest anticipated operating margin accretion that we believe that we'll get for this year will be principally as a result of the safety assessment business. We think that those costs are embedded in that analysis.

Elizabeth Anderson
Elizabeth Anderson
Senior Managing Director at Evercore ISI

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

Operator

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

Analyst at William Blair

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

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

Operator

Does that answer your question?

Analyst at William Blair

Yes. Great. Thank you.

Operator

Thank you. Our next question comes from Dave Windley with Jefferies. Please go ahead.

Dave Windley
Dave Windley
Managing Director at Jefferies

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I don't think we've sized this yet. I mean, we said, you know, less than 10% for these small pre-revenue businesses. I think a lot of those are public. I think that, as you said in your question, you know, we have a lot of formal and informal relationships with pretty much all of the major healthcare venture capital firms, which as I think you know, they're raising funds much more quickly than they used to. So the 5-7 year raises are now 2-3 year raises. It seems like those companies are two things which are good for us, extremely well financed and have no desire, ability, capability, or interest in developing any of their own internal capacity to frankly do any of the things that we do.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

They're the best clients in some ways. They're always in a race to get to market, or at least get to proof of concept. They're less price sensitive. They're well financed, and they're 100% outsourced, at least on almost all of them are. We feel that just to give you a broader answer to the maybe the broader question that was gonna be a follow-up, that we feel that the clients have three years of cash generally. We feel that those that may have less than two years of cash, I think three things. I think that pharmaceutical industry will bank a lot of those companies and a lot of those technologies and/or the VCs.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I think any new potential drug to deal with unmet medical needs that really is promising. I just don't think that the pharmaceutical industry is gonna let that languish and not support it. I think it's highly unlikely that these companies don't somehow flourish, don't somehow get funding, and don't somehow continue to work with us. Having said all of that, based upon the numbers that we just gave you in our prepared remarks, we see elongating backlogs. We see enhanced pricing. We see increased demand. We see our first client do a deal on a take-or-pay basis. It seems like our client base is strong, but has full product portfolios and is not concerned about their ability to fund those going forward.

Dave Windley
Dave Windley
Managing Director at Jefferies

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I mean, we're pleased with the pricing on this contract. It's part of our, it's a client that has, it's part of our backlog. I mean, it's only a single client, so we don't wanna overstate it. We wanted to call it out because, as I said earlier, we've been anticipating it. I'm surprised nobody has done this sooner. I do think lots of others will follow, and I do think this is probably a template, not that we're gonna share it with anyone else, template for others to have the confidence that for the highest priority studies, they can slot things in earlier.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Also that we get on the same side of the table with them and have a much better strategic dialogue about what's coming out of the pipe for them, when they'll need the space. Just gives us greater visibility. It enhances our plans for how much incremental space we're building. It enhances our plans for how much incremental staff we'll continue to add. Just provides a much more rational working relationship. We're thrilled with it. It's not like we went looking for it, but, you know, it came up in the conversation. You know, our job is to listen carefully to what clients want to provide them with flexible solutions.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

They don't all want the same solution, but I do think that some of the larger companies with larger portfolios who so can afford this. I mean, the whole sort of pricing conversation is sort of silly actually. The pharmaceutical companies with billions and billions, tens of billions of dollars on their balance sheets, they can afford whatever they want. As I said before, and probably to you specifically, Dave, for so many of these drug companies that have given up their internal capacity or reduced it somewhat, it's a very, very smart thing for them to do and was pretty much foreseeable and predictable.

Dave Windley
Dave Windley
Managing Director at Jefferies

Got it. Thank you.

Operator

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

Casey Woodring
Casey Woodring
Equity Research Associate at JPMorgan

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Yeah, I mean, the discovery business continued to be a strong business. It was, it grew more slowly than it has, previously. The comps were really tough, as we said. We had a bunch of COVID-related work, which we were happy to have and proud to have, but not sustainable. We had some, you know, one-time events that aren't repeatable. If you take that out, you know, we feel good about the growth rate of that business going forward. Again, that's a service, a series of services that so many of our clients need, large or small, and an important service in terms of selling into the safety assessment business. We like to look at DSA as a.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

In whole, which is why we haven't peeled it back any further than that. You know, we did give a little bit of color that the quarter was a bit slower. We anticipate a strong finish for DSA sequentially and a very strong back half of the year for that whole segment.

Casey Woodring
Casey Woodring
Equity Research Associate at JPMorgan

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

All we can tell you about China, it's kind of a tale of two cities. The demand continues to be considerable. We have a growth rate in China that totally outstrips the growth rate in other parts of the world. Had a nice first quarter, tiny impact from the lockdowns. We don't anticipate, as we said in our prepared remarks, that it will have a meaningful impact in the second quarter, but it's a little bit impossible to predict that. You know, our overall feeling is that the RMS segment is so strong that unless the impact is greater than we anticipate, we'll be able to offset it. We'll see. But right now we feel quite good about it. We were particularly pleased with North America. I would say that's not a rebound from anything in particular COVID-related.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I would say that it's about the spending by our North American clients. It's about our strength versus the competition. It's about our continued investment in that business and the sophistication of the product line. It's about significant pricing, some mix and share gains. I can't tell you how delighted we are. You didn't ask this, so I'm gonna say it anyway. I mean, I do think that we are living in the renaissance in the RMS business, which between China, legacy businesses, the service businesses, particularly IS, now enhanced by this Explora acquisition that we've done, you know, that we're gonna see that business, you know, squarely in the high single digits as we move forward with hopefully strong operating margins.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We're really thrilled actually with pretty much all the constituent parts and pieces of that business, which, you know, it's been a while coming. We'll feel really good about that. We'll obviously continue to give you updates on the China situation vis-à-vis RMS, but we think we'll be fine.

Casey Woodring
Casey Woodring
Equity Research Associate at JPMorgan

Thank you.

Operator

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

Justin Bowers
Justin Bowers
Equity Research Analyst at Deutsche Bank

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

I mean, it's unprecedented. The best before this, the sort of best years we had were six, seven, and eight. This is way better. It's a totally different industry. You know, the competitive scenario has totally changed. Strength of Charles River has totally changed. Numbers of clients have totally changed. Biotech as a driver has changed it all. We have most of the revenue booked for the, you know, we have a backlog this year that will accommodate our guidance in safety. I'm not gonna validate your number, but you can do the math as to how big you think our safety assessment business is, what it'll grow next year, and how much is in backlog.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

It's much higher than we would see at this point in the year, and I would anticipate that will continue to grow. We hopefully will have a similar situation when we get in the next year, which is most of it is already in backlog. And that's enhanced by the highest pricing that we've been able to achieve, which is appropriate. It's commensurate with the fact that the studies are more complex than they've ever been. Capacity is appropriately tight. The clients have more drugs to work on than ever. The availability of competitive capacity is somewhat limited.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

It's obviously a very nice demand curve for us, and our job is to try to do all of it, to try to build enough space now to the end of 2023 and 2024 to accommodate incremental demand, to hire people slightly ahead of when they need them, to drive our digital portfolio such that we are more efficient and are more responsive to our clients, to kind of price appropriately and rationally to, you know, to continue to have more clients have these take-or-pay relationships if that's what they want. Also to continue to always save enough space for both shorter term and longer term studies that just simply absolutely have to start earlier for clients.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We are having, as I've said now for several quarters, we're getting together with a lot of our clients and saying, "Just tell us what your priorities are in our portfolio, and we'll try to accommodate it." It's a very attractive business model. We're spending all of our time trying to execute against that demand, but we've never seen a demand like this. We're not gonna take it for granted. We're gonna respond really well. Our execution is gonna be as flawless as possible. We're gonna have both people and physical capacity in place ahead of when we need it.

Justin Bowers
Justin Bowers
Equity Research Analyst at Deutsche Bank

Appreciate the color there. I'll hop back in queue.

Operator

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

Tejas Savant
Executive Director and Healthcare Equity Analyst at Morgan Stanley & Co. LLC

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

Company Representative at Charles River Laboratories

Yeah, I'll take that, Jim. So yeah, we did call out the COVID impact by segment when we gave, as we went through 2021, and actually at the end of the year, we gave that color. We had 980 basis points in RMS. We had 80 basis points in DSA and 210 basis points in manufacturing. Hopefully that gives you the numbers you're looking for.

Tejas Savant
Executive Director and Healthcare Equity Analyst at Morgan Stanley & Co. LLC

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

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

Yeah. We all look at the take-or-pay deals as headwinds. You know, clients are very much in need of that sort of accommodation structure for us. They're gonna pay us well for that, for those accommodations, and they have that space available. I think that would be just part of the portfolio. It's impossible to predict how big it'll be, but I think some of the larger clients will want to do the same thing, so don't see that as a headwind. Explora's. It's a really nice strategic deal. It's gonna double the size of our CRADL-like business. It's gonna be a slight headwind in margins in that business.

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

We have very high margins in the Charles River businesses and the scale at which they are opening up new facilities and just their overall structure has slightly lower margins, which should improve over time. That's already baked into our guidance. Again, we, you know, we feel confident that we'll deliver this modest improvement that we talked about that's gonna come principally from safety. I hope it comes from other places, but that's not what we're guiding to right now. We do feel that the demand pretty much across the board is quite significant. We're in a strong competitive position. We don't really see any external disruptors to that overall demand.

Tejas Savant
Executive Director and Healthcare Equity Analyst at Morgan Stanley & Co. LLC

Got it. That's helpful, Jim. One final one on biologic safety testing. You spoke about sort of vaccine lot release work here, you know, settling into steady state for the COVID component heading into the back half of this year in 2023. Can you just, you know, help share some more color around what your assumptions are, you know, in terms of that steady state demand? If there were to be a, you know, relatively sharp drop off, should we be thinking of a slight moderation here versus that sort of 20% growth target you've spoken about for BST?

Jim Foster
Jim Foster
Chairman, President, and CEO at Charles River Laboratories

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

Tejas Savant
Executive Director and Healthcare Equity Analyst at Morgan Stanley & Co. LLC

Very helpful. Thank you.

Operator

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

Todd Spencer
Todd Spencer
VP of Investor Relations at Charles River Laboratories

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

Operator

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

Analysts
    • Casey Woodring
      Equity Research Associate at JPMorgan
    • Dave Windley
      Managing Director at Jefferies
    • David Smith
      Executive Vice President and CFO at Charles River Laboratories
    • Elizabeth Anderson
      Senior Managing Director at Evercore ISI
    • Eric Coldwell
      Senior Research Analyst at Baird
    • Flavia Pease
      CFO at Charles River Laboratories
    • Jacob Johnson
      Managing Director and Research Analyst at Stephens Inc.
    • Jim Foster
      Chairman, President, and CEO at Charles River Laboratories
    • Justin Bowers
      Equity Research Analyst at Deutsche Bank
    • Tejas Savant
      Executive Director and Healthcare Equity Analyst at Morgan Stanley & Co. LLC
    • Todd Spencer
      VP of Investor Relations at Charles River Laboratories
    • Analyst at William Blair
    • Company Representative at Charles River Laboratories
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