Ladies and gentlemen, thank you very much for standing by, and welcome to the Charles River Laboratories First Quarter 2020 Earnings Conference Call.I would now like to turn the conference over to your Vice President, Investor Relations, Todd Spencer..

And welcome to Charles River Laboratories First Quarter 2020 Earnings Call and Webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer; and David Smith, Executive Vice President and Chief Financial Officer, will comment on our results for the first quarter of 2020. 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 replay of this call will be available beginning at 12:30 p.m. today and can be accessed by calling (866) 207-1041. The international access number is (402) 970-0847.

The access code in either case is 5525940. The replay will be available through May 2020. You may also access an archived version of the webcast on our Investor Relations website. I'd like to remind you of our safe harbor.

All remarks that we make about future expectations, plans and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995.Actual results may differ materially from those indicated.

During this call, we will primarily discuss results from continuing operations and 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.

In addition, today's remarks will also include estimates of the COVID-19 impact on the company. Certain methodologies and assumptions related to how we develop these estimates can be found on slide three.I will now turn the call over to Jim Foster..

Good morning.Before I discuss our robust first quarter financial results and our revised outlook for the year, I will comment on the impact that the global COVID-19 pandemic has and will have on the company and our actions to address it.

The role that we play in biomedical research is of even greater importance during these unprecedented times, given that we are working collaboratively with our clients to discover and develop new therapies for the treatment of disease, including COVID-19.Our work would not be possible without the collective efforts of my dedicated Charles River colleagues, so I'd like to start by expressing my sincere appreciation to them for their hard work and unwavering commitment, which allows us to continue to fulfill our mission every day.To address the COVID-19 pandemic, we have implemented a number of measures that are focused on maintaining the health and safety of our employees and the continuity of our operations, ensuring our ability to support our clients' research programs and sustaining a solid financial position.We have comprehensive business continuity plans in place for each site globally and are continuously updating them to address the evolving COVID-19 situation.

We implemented the plans in China beginning in January and optimized the plans for other regions as the virus has spread.

We have encouraged employees to work remotely when possible.And for most of our employees who are essential and need to come into our sites to fulfill their responsibilities, we are adhering to any guidance from government, health and other regulatory agencies.

Due to the nature of our business, most employees already work in biosecure environments that require PPE, such as masks and gloves and follow other procedures to safely accomplish their daily responsibilities.

So we have found that these additional safety precautions have been relatively straightforward to implement.In this changing environment, we continue to review all applicable global stay-at-home orders and have determined that we currently meet the criteria to be designated as an essential business in each of the jurisdictions and in which we operate nearly 100 global sites.

As a result, the vast majority of our site-based staff are able to continue to work on-site, while other personnel are working remotely.This has enabled us to keep all of our operating sites open and adequately staffed to accommodate the continued significant client demand across most of our businesses.

Our business continuity plans also enable us to provide products and services to clients from their local or preferred site or if needed, utilize an alternate location when possible.In addition, procurement has played a pivotal role in business continuity as we proactively engaged with our suppliers beginning in January to limit the potential disruption to our supply chain.

We believe the long-term growth prospects of our business remain firmly intact.

And we have moved swiftly to mitigate the anticipated near-term revenue loss from COVID-19, which is expected to reduce 2020 revenue by $135 million to $215 million, with most significant headwind in the RMS segment.We have implemented temporary cost reduction initiatives, which are expected to result in meaningful savings this year, primarily by lowering compensation expense and discretionary spending.David will provide more detail on the cost reduction initiatives shortly.

We also intend to be prudent with regard to capital deployment slowing the pace of our planned M&A activity and meaningfully reducing our planned capital projects for the year.

Collectively, we believe that these actions will enable us to preserve most jobs, ensure our ability to continue to support our clients' research programs and to sustain our solid financial position.We believe that we are particularly essential to our clients now, and are in continuous communication with them to accommodate their evolving needs.

One biotech R&D had recently commented that we are the backbone required to support their programs.Many other clients have sent us notes of support and encouragement during this unprecedented time, noting that they couldn't move their research forward without us.

To date, we are partnering with more than 40 clients in our DSA and manufacturing segments on their development programs for potential vaccine candidates and therapeutics to treat COVID-19.We believe that this is one of the highest levels in the CRO industry, and is another example of our ability to work collaboratively and provide greater value to our clients.

Our safety assessment business is conducting safety testing on COVID-19 vaccines and other therapeutics in multiple sites across North America and Europe.We are conducting pathology studies in Maryland on an antibody treatment. Our Biologics site in Pennsylvania is conducting a study and reusing N95 masks.

And we will work with our partner, Distributed Bio, on antibody-based therapeutics.Clients are also opting to outsource more projects to us for non-COVID-19-related programs across multiple therapeutic areas, either because their own sites have become inaccessible or because of the ease and flexibility of outsourcing projects to an integrated early stage CRO like Charles River.

We believe that providing continued support to clients during the COVID-19 pandemic will lead to more outsourcing and long-term business opportunities for Charles River.Biopharmaceutical clients who are previously conducting more programs internally or with multiple CROs are now choosing to outsource some of their work to us.

During these unprecedented times, our global scale, scientific depth and breadth of our critical early stage solutions further differentiate us from the competition.Even more so today, clients value the stability and efficiency of working with one large scientific partner to accommodate their early stage research programs, and to support the safe manufacture of the therapies.

We are committed to providing flexible outsourcing solutions to our clients, while adapting to the challenges associated with the evolving COVID-19 situation.Overall, we believe healthcare will fare better than many sectors, since it will play a crucial role in finding a solution and caring for those affected by COVID-19.

Specific to Charles River, we believe that our unique nonclinical focus, global scale and comprehensive scientific capabilities are what make our business model more resilient.We believe we will be able to withstand the situation better than many others because of our critical nature of our work, our broad portfolio and our flexible outsourcing options.

When clients may be facing meaningful disruptions or delays, they can partner with us to continue to move their early stage programs forward across multiple therapeutic areas, including the incremental work they are doing on their COVID-19 programs.Through the first quarter, the biotech funding environment remained very strong, and client order activity was robust, including bookings and proposal activity in the Safety Assessment business, which led to our exceptional first quarter results.

COVID-19 caused only a moderate impact in the RMS segment. I'll now provide highlights on our first quarter performance.Quarterly revenues surpassed $700 million for the first time, at $707.1 million, a 17% increase over last year, with the acquisition of Citoxlab and HemaCare contributing 9.5% to the reported growth rate.

Organic revenue growth of 8.2% was driven by the robust performance of our DSA and Manufacturing Support segment.COVID-19 had a negligible effect on DSA and Manufacturing revenue in the first quarter; however, it reduced RMS revenue by $9 million, which resulted in a 150 basis point headwind to the consolidated revenue growth rate.

Last year's large stocking order in the Microbial Solutions business reduced consolidated revenue growth by an additional 120 basis points.

The operating margin was 19%, an increase of 270 basis points year-over-year.The improvement reflects the flow-through of the strong top line performance in the DSA and Manufacturing segments and lower corporate costs.

As I mentioned last quarter, we are well positioned to generate greater operating leverage in 2020 because investments in staff, capacity and infrastructure are more balanced now.Earnings per share were $1.84 in the first quarter, an increase of 31.4% from $1.40 in the first quarter of last year.

Strong revenue growth and operating margin expansion as well as a lower tax rate resulted in earnings per share that were well ahead of our outlook.

We were off to a spectacular start in 2020 through mid-March, when COVID-19 began to have an impact on our North American and European research models business.Going forward, COVID-19 is expected to have the most significant impact on RMS segment's revenue growth rate in 2020, specifically on the research models business and particularly in the second quarter.The DSA and Manufacturing revenue growth rates are only expected to be modestly affected.

In total, COVID-19 is expected to reduce full year 2020 revenue by $135 million to $215 million, resulting in a reduction of our organic revenue growth guidance by just over 500 basis points at midpoint to a range of 1.5% to 4.5% growth.We are reducing 2020 non-GAAP EPS guidance by $0.60 at the midpoint due to COVID-19 to a range of $6.75 to $7.10.

Our revised guidance is based on a range of recovery scenarios for our business, which David will provide in more detail shortly.I'd like to provide you with additional details on our first quarter segment performance as well as the impact of COVID-19 on our businesses, beginning with the RMS segment.

RMS revenue for the first quarter was $146 million, a decrease of 1.7% on an organic basis. COVID-19 reduced the first quarter revenue growth rate by 660 basis points or $9 million, which was nearly evenly split between China and Western markets.

When we provided our guidance in February, we had anticipated a modest first quarter impact related to COVID-19 on our research models business in China.The impact in China was in line with our expectations, but as the virus spread, there were incremental headwinds to our North American and European research models businesses, particularly during the last two weeks of the first quarter.

The research models business accounted for approximately 60% of global RMS revenue in 2019. It has been most affected by COVID-19-related closures of our clients' research facilities to date.The research models services businesses were largely unaffected.

We experienced a sharp decline in model demand as stay-at-home orders spread across the globe with diminishing order activity from academic clients, which represents about 1/3 of global RMS revenue, as these institutions closed abruptly.There was also a significant reduction in order activity for both large biopharmaceutical and smaller biotechnology clients, as these clients reduced or close their on-site activities.

We expect these trends will persist through the second quarter in North America and Europe, while China is already seeing a gradual ramp-up in order activity as the commercial sector returns to work and academia slowly reopens.In North America and Europe, we are cautiously optimistic that there will be a meaningful recovery beginning in the second half of the year, as clients are already inquiring whether we will have models available for them to rapidly expand or reconstitute their colonies when they return to work.We expect demand for research models will improve in the third quarter, as global biopharmaceutical and biotech clients resume more normal research activities, and expect academic demand will begin to rebound in the fall.

Overall, we expect COVID-19 will reduce RMS revenue by at least 10% organically in 2020, with the most significant impact in the second quarter.The Research Model Services business has performed very well in the first quarter, and are expected to experience very little impact from COVID-19.

We believe the strong performance reflects the value our clients see in outsourcing these critical services to us. Or in the case of Insourcing Solutions or IS, the efficiency of using our people or capacity to manage their research needs.The GEMS business benefited from strong demand and new business wins across most geographies.

Some clients had previously managed their proprietary, genetically modified model colonies in-house, have closed their facilities and are outsourcing this work to us.We anticipate that much of this GEMS work will remain outsourced after the COVID-19 crisis subside.

The IS business continued to perform very well, with contributions from new contract awards at the end of last year from the NIH and in Europe.We also continued to gain traction with new biopharma clients through our CRADL initiative, which provides turnkey research capacity in Boston, Cambridge and South San Francisco, both of which have remained open and accessible to clients during the COVID-19 crisis.

Occupancy of our newest site in South San Francisco has improved nicely since it opened earlier this year, with excellent client feedback.HemaCare, which we acquired in January, had a strong first quarter as part of Charles River. It performed in line with our acquisition plan, with pro forma revenue growth exceeding 30% in the first quarter.

You may recall that HemaCare is a premier provider of human-derived cellular products that are used as critical inputs throughout the cell therapy development and manufacturing processes.We believe HemaCare's offering will lead more clients to start their cell therapy discovery programs at Charles River, and remain with us through discovery, early stage development and manufacturing support process.As a result of COVID-19, we temporarily closed our clinic for donor collections at HemaCare in mid-March in order to ensure donor safety and pause certain integration activities.

But the business has remained operational and continues to ship its products to clients.

We believe COVID-19 will result in short-term disruption for this business, but over the longer term, beyond 2020, HemaCare's growth profile in excess of 30% annually remains intact.The operating margin declined by 510 basis points year-over-year to 23% in the first quarter, driven almost exclusively by the impact of COVID-19.

Due to the fixed cost nature of the RMS business, the cost reduction initiatives that we have implemented cannot offset the sharp short-term decline in research model volumes.We believe the RMS operating margin will improve once client order activity returns to more normalized levels later in the year.

DSA revenue was $438.7 million in the first quarter, an exceptional 11.6% increase on an organic basis over the first quarter of 2019.We continue to benefit from strong client demand for our Discovery and Safety Assessment services, which we believe is a testament to our position as the leading early stage CRO as well as the strength of the market environment in the first quarter.

We benefited from broad-based demand across our client segments, led by biotechnology clients. The acquisition of Citoxlab contributed 12.8% to DSA reported revenue growth.We marked the one year anniversary of its acquisition last week, and are pleased with the progress that Citoxlab has made as part of Charles River.

It has enhanced our leading market position, expanded our geographic footprint and global scale, and solidified our scientific capabilities, which further distinguishes us from the competition during these unprecedented times.The Safety Assessment business was a significant driver of DSA revenue growth, which resulted from strong volume and price increases as well as a tailwind from the healthy backlog existing in the fourth quarter.

As I mentioned earlier, proposal activity and bookings were robust, and these trends continued through the end of March, with March bookings being particularly strong.Large biopharmaceutical and mid-sized biotechnology clients have largely remained business as usual with regard to their early stage research programs.

We believe these clients are compensating for reduced on-site activities due to COVID-19, which increased outsourcing of their IND-enabling safety programs.We believe clients are actively reevaluating their CRO outsourcing strategies to work with few and trusted partners, to ensure business continuity amid the challenges of the COVID-19 crisis as well as their supply chains to reduce dependency on Asia, including the use of CDMOs and CROs in China and India.We believe our integrated early stage portfolio from target ID through nonclinical development is uniquely positioned to enable clients to work with one early stage CRO, whether it be for their time-sensitive COVID-19 programs or other important research efforts across multiple therapeutic areas.Combined with our own business continuity plans and COVID-19 preparedness, which clients have told us are a cut above other CROs, we believe that we offer the expertise, stability and flexibility that clients require as we collaboratively navigate today's challenges and those that arise in the future.COVID-19 headwinds for our DSA segment are expected to be modest, and partly offset by clients' opting to outsource projects in lieu of starting new studies in-house.

We expect an impact on Safety Assessment growth over the next one to two quarters, primarily as a result of study slippage.We have experienced a moderate increase in study slippage since the end of March, primarily due to client-driven delays and resource constraints.

The study slippage is associated with a number of factors, including test article availability from our clients, as shipments are temporarily delayed from their partners in India and China.For the year, we believe the overall impact from slippage and other factors will be modest, and the DSA segment will deliver organic revenue growth at least at the mid single-digit level.

The Discovery Services business also had a very good quarter, particularly Early Discovery services.

Our scientific expertise, track record for delivering clinical candidates and efforts to build a cohesive offering generated significant client interest.A small number of discovery clients appear to be slowing the initiation of new programs or delaying projects for at least one quarter, particularly for integrated drug discovery programs as they reduce their own on-site activities related to COVID-19.

We believe the Discovery business will rebound in the second half of the year as clients return to work and resume their programs or initiate new ones.The DSA operating margin improved by 340 basis points year-over-year in the first quarter to 22%, with significant improvement in both Discovery and Safety Assessment businesses.

The first quarter operating performance reflected greater leverage on the strong top line growth.Revenue for the Manufacturing Support segment was $122.4 million, a 9.6% increase on an organic basis over the first quarter of last year.

Last year's large stocking order from a non-pharma strategic partner in the Microbial Solutions business reduced the manufacturing growth rate by 680 basis points in the first quarter.

The Microbial Solutions, Biologics Testing Solutions and Avian businesses all had outstanding quarters, each delivering double-digit revenue growth when adjusting Microbial for the stocking order.Whether it be testing for microbial contamination are helping to optimize our clients' biologics development processes, these businesses play a crucial role in ensuring the quality and safety of our clients' manufacturing activities and finished products.We are seeing little disruption to our clients' manufacturing operations, and are attracting new business opportunities for treatments related to COVID-19.

As a result, we believe the pandemic will have a relatively small impact on our Manufacturing business. I expect the Manufacturing segment to generate high single-digit organic revenue growth in 2020.The Manufacturing segment's first quarter operating margin was 35.6% or 460 basis point increase over last year.

The significant improvement was related to enhanced operating efficiency from process improvements in the Microbial Solutions business and operating leverage from higher revenue in both the Biologics and Avian businesses.

In Biologics, the elimination of duplicate costs related to last year's transition of our new Pennsylvania facility also drove the improved operating margin.Before I conclude, I'd like to discuss the planned retirement of our General Counsel, Dave Johst, as the transition of this role.

Last spring, Dave announced his intention to retire as Corporate EVP, General Counsel and Chief Administrative Officer.

I want to thank Dave for nearly 30 years of service to the company.He has contributed to our growth and expansion by providing strategic counsel and direction to our global operations and to me, which has contributed to our market-leading position.

I'd also like to welcome John Kuo to Charles River, who will become our Executive Vice President, General Counsel, Corporate Secretary and Chief Compliance Officer at the end of this month.John has more than 25 years experience and joined us from Varian Medical Systems, where he was Senior Vice President, General Counsel and Corporate Secretary.

I'm pleased to have John join us, and believe he will continue to provide the strategic counsel and guidance that will support our future growth. We believe Charles River will endure this challenge better than many other companies. All of our operating sites are open and adequately staffed to accommodate our clients' needs.

Our client base is resilient.We believe that biotech clients, which have been our principal source of growth in recent years, had approximately three years of cash on hand at the end of Q1, which should enable them to withstand any near-term disruption caused by COVID-19.

Global biopharmaceutical clients have the financial strength and scientific resources to survive as well, and the biopharmaceutical industry as a whole is working tirelessly to find solutions to COVID-19 and other diseases on behalf of the patients who rely on them.We have taken a disciplined and determined approach to address the COVID-19 crisis.

And together with our clients, we are committed to delivering innovative, safe and effective medicines to patients as quickly and efficiently as possible.In conclusion, I'd like to thank our clients and shareholders for their support and, once again, our employees for their commitment to our mission.

I continue to be amazed by the dedication and hard work of our exceptional employees, especially during these unprecedented times.Now I'd like David Smith to give you additional details on the COVID-19 impact, our financial performance and revised guidance..

gross leverage, which must be no more than four times and interest coverage, which must be no less than 3.5 times.Even with the additional $150 million we borrowed, we were well within these requirements at the end of the first quarter at 3.44 times and 6.55 times, respectively, and we believe that we will be in compliant each quarter this year.

Given the fluidity of the COVID-19 situation, we have changed our capital priorities to conserve capital and enhance liquidity.We have slowed our planned M&A activity for at least the short term, and we are reevaluating our capital projects for the year.

We expect to move forward only with capital projects that have already commenced, or those which are critical to the business, either for maintenance purposes or to accommodate near-term client demand.This will result in a meaningful reduction in CapEx for the year by $30 million to approximately $120 million.

And as we have stated previously, we do not intend to repurchase any shares this year. Our balance sheet and financial position are very strong, and we intend to maintain both.I will now discuss aspects of our first quarter performance and our updated outlook for the year.

Free cash flow was $42.9 million in the first quarter, a significant improvement from a negative $1.9 million last year. The primary reason for this year's improvement was the strong first quarter operating performance.

For the full year, we have reduced expected free cash flow guidance to $325 million to $350 million due to the anticipated impact of COVID-19 on our operating performance, partially offset by lower CapEx.

Unallocated corporate costs were slightly favorable to our expectations, totaling 5.6% of total revenue or $39.8 million in the first quarter compared to 6.8% of revenue in the first quarter last year.This favorability was primarily the result of a discrete benefit associated with our deferred compensation program.

This resulted in a 50 basis point benefit to the first quarter operating margin, which we expect to normalize over the course of the year.

We continue to expect unallocated corporate costs to be approximately 5.5% of revenue for the full year.Total adjusted net interest expense for the first quarter was $19 million, which increased sequentially from $16.8 million, primarily as a result of higher debt balances associated with the HemaCare transaction.For the year, we continue to expect total adjusted net interest expense to be in the range of $78 million to $80 million as higher debt balances will be offset by lower expected interest rates as a result of the recent Federal Reserve rate cuts.

The first quarter tax rate was 14.3%, approximately 300 basis points lower year-over-year and at the bottom of our first quarter outlook.The decrease was largely the result of a favorable excess tax benefit associated with stock-based compensation related to higher stock price levels in February at the time of equity vesting activities.

We continue to expect our full year tax rate to be in a range of 22% to 23.5% on a non-GAAP basis.A summary of our revised financial guidance for the full year can be found on slide 43.

In the face of the challenges presented by the COVID-19 pandemic, our ability to respond quickly demonstrates that we have built the capabilities and processes necessary to make nimble decisions and fully support our clients' evolving need.

We will continue to work together to stay focused on executing our strategy and achieving our long-term financial and operational targets.Our strong first quarter results reflect the tremendous efforts of our employees around the world and the critical nature of the work that we do.

We believe our nonclinical focus, global scale and scientific expertise, coupled with our solid and stable financial position, underscore the resilience of our business model, and will enable us to withstand the current situation better than others.

We will continue to focus on our commitment to our clients, employees, communities and shareholders through these unprecedented times, and believe we will emerge as a more distinguished partner for all of our key stakeholders.Thank you..

Thank you, David. That concludes our comments. The operator will now take your questions..

[Operator Instructions] Our first question comes from the line of John Kreger with William Blair. Please go ahead..

Thanks for all the detail, Jim, I think it sounds like you're messaging that the primary COVID impact is showing up in RMS model orders being down, but not really in Safety Assessment, assuming I got that right.

Can you just talk a little bit about how you're seeing this crisis play out compared to 2009 and '10, when you saw RMS and Safety Assessment order flow get hit?.

Yes. So I absolutely confirm that the impact is principally in research models, the services part of the RMS business has been essentially unaffected.

So research models, and principally as a result of the rapid and almost sudden closure of academic institutions, both in Europe and the United States, as well as the closure of some small biotech companies and some of the pharmaceutical companies sites as well.So you're not going to buy animals that you can't use because you're not coming to work to do your study.

So that's a logical principal rationale for the situation, conversely. Steady volume and demand was pretty quite good across the rest of the business, including Safety Assessment.Totally different obviously, totally different set of circumstances from the 2008 situation, which was things weren't closed.

There was just a sort of pullback as the economy imploded, and there was less work for us. Academic institutions were open and pharma businesses were open. And I don't remember exactly what the impact was on a research model business, but it was less way less severe than this.People still did basic research.

As you recall at that time, we and all of our competitors have built an awful lot of safety assessment space. And for a rapidly growing marketplace and then the pullback close caused that space to essentially remain vacant for some period of time.So not enough work, vacant space, too much overhead that wasn't absorbed.

And revenue in safety was actually in free fall for several years following that, so totally different set of circumstances, I'd say, that our business was. And we're guiding it to be essentially largely unaffected.We're going to have some impact on the non-research models in DSA and Microbial in the second quarter, some, but not much.

A little bit of study slippage in the safety business principally, and then a rebound in the back half of the year also anticipate a rebound in the back half of the year, particularly, in the last quarter in research models. So different set of circumstances.

I think that our portfolio is weathering the storm has weathered and will continue to weather the storm quite well..

And our next question comes from the line of Eric Coldwell with Baird. Please go ahead..

A couple of quick ones here, hopefully. I'm curious on the academic sales research model sales. You've talked about reconstituting colony, something that we've picked up in our channel checks as well.

I'm curious if you can give us some history on what that might have normally looked like as academic institutions reconstitute individually over time? And then what kind of potential impact that could have either in 3Q or 4Q? My second question is on Avian.

And I'm curious if you've seen any impact from vaccine production for animal vaccines? The vet markets around the world are pretty slow. And also, any early thoughts on the potential impact from what should be a very heavy flu vaccine season? And I might have one follow-up..

Sure. The Avian business had a really strong first quarter, and we anticipate its continued strength. The vast majority of those actually is for veterinary pharmaceuticals and vaccines and some relatively small amount to use for human flu.

And we're the largest producer with a very limited production universe, so we should continue to see good results there.On the academic side, research models, you've got lots of academic institutions and some small biotech clients as well, particularly in academics that will develop specialty strains of animals, sometimes with our help, sometimes not, for some very discrete research that they're doing and breed the relatively small colonies of that just to have the so the elegance of the animals being right there.

And so you can imagine with this academic shut down and it was sudden, it was two weeks that they had to reduce those colonies, clear them out and stop their work. So they sent us a fair amount of that work.And so I think we'll see two things.

This isn't going to be a period of time for however prolonged this is, where our client base is going to rethink what they do internally and how they think about us.

And so obviously, we have lots of work that's outsourced to us on a growing basis pre-COVID.But there's some clients that have to split the work between multiple providers and some clients who like to do things internally, like have their own colonies, and I think there'll be less of that.

I think they'll utilize us more to produce colonies for them, which, by the way, we do in the genetically engineered models business quite robustly. Those models are much more complex to rear and raise and keep clean.And so we have a lot of business where we just breed those animals for them, and then we ship them to them on adjusted time basis.

And I wouldn't be surprised to see the colonies that clients have that, a, we'll reconstitute them and perhaps send them back or perhaps not send them back and there'll be more of that work that will be outsourced.So it's an opportunity for them to reconsider how they'll work with us.

And I think rely on us more, both in terms of our facilities and people because during this pandemic, our animal facilities are up and running. If we had all of the colones to begin with, we could have taken care of them and they wouldn't miss a beat, and now they're going to have to sort of start that back up again.

So we anticipate we'll see a lot more of this work..

If I may, a quick follow-up or a question on API issues. In all of my channel checks so far, I think I've probably heard of, I don't know, call it a dozen cases have been cited, where a preclinical CRO or a client has mentioned having to delay work because they couldn't get product out of India, typically.

I'm curious if you have any stats on what you've seen internally? And do you think that some of these global logistical issues that we're seeing could actually change the landscape for where product is sourced? And perhaps bring it back to, for lack of a better word, back to western markets?.

Yes, good question. I think lots of people are rethinking and reevaluating their reliance on China and India for API and the core ingredients of the drugs. So we have, as we said in the prepared remarks, we had some test article delays, which caused some study slippage.

And so in English, that means that the client says oh yes, we'd love to start the study that we're that we told you was booked for whenever, but we can't get our test article out of either it was China at first, and now it's India.

So that's obviously concerning to them.And I think this I don't want to get into the politics, but I think the continuing tensions between the U.S. and China, and just the distance, I think, it's getting people to rethink that paradigm. So tough to predict where we'll go, but definitely, we're hearing some of that.

And we've seen some work on the tox side and the discovery side come out of China to us.So yes, I would say it's subtle. We always have study slippage, a little bit more than usual related to difficulty getting the test article out.

We anticipate that, that will continue to some extent, some modest extent in the second quarter, and begin to ameliorate in the back half of the year, either because people have stopped relying on them or they've gotten over some of their issues..

And our next question comes from the line of Ricky Goldwasser with Morgan Stanley. Please go ahead..

My question, I mean, obviously there's some limited visibility for 2020, but thinking out for 2021, there are two parts to the question.

One is, how long will it take to catch up with the delayed project, based on the time frame that you built your assumptions around? And second of all, when you think about kind of like slowing your M&A activity, how is that going to impact kind of like your 2021?.

Yes. So I'm not sure how things catch up, but what we anticipate is, on the research model side, the academic institutions will begin to open slowly in Europe in the summer and open slowly in the fall in the U.S. And there were some people that think that they could open more quickly than that.

But we based our guidance on the assumptions that I just gave you. So I think that the research model activity and orders will commence third quarter and heavily in the fourth quarter.

And similarly, whatever modest slowdown we've experienced and it has been modest in the DSA segment.We had a little bit of a slowdown in these complex studies that we do for some small biotech companies in Discovery and this test article and dilemma that I was just talking about with Eric.

That should ameliorate in the third quarter and fourth as well.

So we would anticipate being on a kind of a regular steady clip in the back half of the year for our DSA segment, we've talked about mid-single digits, which, of course, is slower than we typically would have reported.And we would imagine we would anticipate that barring some untoward new twist to COVID that obviously, we're getting way ahead of ourselves and things are fluid and complicated, but it was kind of back to our usual growth rates in 2021 throughout the portfolio, with improved margins as well.M&A is an interesting one.

So my stream of consciousness on that would be that, we have multiple conversations going on real time, as we always do. We have while we are engaged with these folks, we have paused any sort of real movement in seriously moving forward with those.

Because we anticipate a challenging second quarter, which we've articulated I think quite well in our prepared remarks.And if it's no worse than we anticipated and we get through that well and we see things beginning to improve in the third quarter, we will relook at M&A. We'll relook at the wisdom of doing it, we'll see what prices are like.

We'll see what's still available, and we'll see whether these we still think these things are critically important for our portfolio.So it's been a critical part of our growth and development for at least the last decade. I think it's we've created a very powerful impactful portfolio.

And we want to continue to do that, but we want to continue to do that smartly. So pause, relook at it in the next quarter or two, and we will begin to see business generally be coming back well in the back half of the year, particularly in the fourth quarter..

And my follow-up is around the comment on clients rethinking their dependency on Asia.

How is that kind of like impacting your China expansion strategy? And if you can remind us what percent of your China business is domestic versus work for clients that are outside China?.

Yes. So good question. So I'll remind you of several things. Number one, our China business is well, it's primarily research models, we have a little bit of Microbial solutions. It is entirely for Chinese companies, Chinese biotech, pharma and, to a less extent, academic institutions.

And you'll recall that we're engaged in trying to dramatically enhance and improve the quality of research models in China. So I think the Chinese dialogue that we just talked about, with API tried to get API out for studies that are done in the U.S.

or Europe, is a totally unrelated comment to what we're doing in China.And of course, our activities are only research models-based. So we intend to continue to invest in China. We anticipate a significant high-growth rate as things get back to normal there.

We're beginning to get back to normal on the pharmaceutical side, and we anticipate the academic market will improve as well..

And our next question comes from the line of Tycho Peterson with JPMorgan. Please go ahead..

Jim, in terms of some of the offsets, I'm wondering if you could give us a sense of how much preclinical work can and is being done remotely? And then you noted some clients opting to outsource more projects because their own sites are inaccessible.

Is that anecdotal, or is that actually meaningful? And then and a follow-up to China, you noted both headwinds and tailwinds with RMS improving, but studies see slippage, I'm just curious, is China going to get better or worse in the second quarter?.

So China, for us, for the research model business, should continue to improve. As I said there, we're back to work. Increasingly, clients are open and back to work. I would say that the vast majority of our commercial clients are open and working and Tycho but pharma and biotech, similar to the U.S., the academic institutions closed abruptly there.

Again, barring research models. So sales were hampered significantly. And they're beginning to open up slowly.So should be a steady improvement and increase over the rest of the year, including in the second quarter. Sorry, the beginning of your question was about preclinical what was the specific....

Just about some of the offsets, how much preclinical work can actually be done remotely? And then also, you mentioned clients coming to you because their own sites are inaccessible, is that a meaningful trend?.

Yes. Well, we hope so. I'd say that preclinical is largely outsourced now, whatever we say, 55% to 60%, which means that you still get some clients that do it themselves, mostly big pharma, mostly kind of a historical preference to do that. And I think it's been a continuing process of outsourcing.

We've said often that it's going to get to at least 85% outsourced and probably 100%.I think that a situation like this could absolutely accelerate it that OK, so suddenly their sites are closed. They've got critical studies that have to move forward. They stop. They can't do anything about it, and yet they give them to us, and they continue.

So that's what the whole outsourcing paradigm is about. It's about we all need to do what we do best and who can you rely on? And how can you continue your velocity to get your drugs to market?So I think we're demonstrating that. We're demonstrating the power of the remote facilities.

We're demonstrating the power of an international footprint, we're demonstrating the power of having capacity available for them and being able to be nimble in moving that about.So I think that, while this is a horrible situation, and it was certainly we all wish we weren't in it, I do think it's magnified the benefits of working with us across the portfolio.

And in some ways, particularly safety, just because that footprint is so substantial there..

If I could ask just one last one on cancellations.

A lot of the discussion has been about delays, but are you able to comment at all on work getting canceled or at risk of getting canceled in the next quarter?.

Very few cancellations. So cancellations are no worse than usual. They happen all the time for a whole variety of reasons. Clients are charged for cancellations, meaning, we've usually set aside animals and staff and runs, and depending on the nature of the cancellation, we usually get paid something for that.

So usually a small percentage of what we do, it's not increasing. And as I said before, slippages has increased slightly, very modestly, but noticeably, with the explanation that, yes, I'd like to start my study, but I can't get my test article out of China or India..

Our next question comes from the line of Robert Jones with Goldman Sachs. Please go ahead..

I guess just the first one, Jim, to follow-up on RMS, obviously, that's where the impact seems to be felt the most so far and where you anticipate to see the impact felt.

Are there any milestones that you can share with us as far as what you're looking for or what you're hearing from your clients that have had these issues in accessing their own sites, as far as their comfort in getting back online? Anything that they've shared with you as far as what they're looking for to get back up and running?.

The only anecdotal information I can give you is that we've had several calls from clients, and this is in the script, I believe, just saying, we anticipate we'll be back up at a certain time frame. We need to make sure that you are up and running, and you've got all the strains and species of animals available, because we're going to need them.

Implications are that there'll be some significant sort of kind of surge in demand, either they're going to crank up a bunch of research seemingly all at once, so they're going to reconstitute colonies that they had to take down.So I'd say I don't want to overstate it, but some level of concern or almost nervousness on their part and that might be because they're concerned about some of our competition, maybe not, not being as available or as robust or this hurting them more than us.

So it's very basic. We'll see it immediately.

Animals that typically purchased, particularly by big pharma and biotech companies consistently week after week after week, based upon early orders in the year or in the quarter, and they just buy them every week.So it's quite consistent and predictable, and it's quite consistent and predictable that it's not going to happen when their facilities are closed.

And pretty much I don't know that literally the minute they're open, but the week that they're open or the second week that they're opened, you can see them getting back to getting the studies cranked up again.So I think there's a huge interest.

I think that there's one other thing I'd like to point out is, there's a lot of dialogue going around right now about whether colleges will start in the fall. I've heard that Harvard might not and MIT might, for instance.

So there's even a dichotomy between big well-funded institutions like that.I think that even if students don't come back, that academic medical centers and research organizations, research parts of those institutions will open. Think about R&D labs, where people are gowned up, off and working in hoods, so they'll spread them out a little bit more.

I think the potential of the virus is very, very low in those domains. So they shut down the whole institution, I think the first things that will open are the research centers within them..

Yes. I think that makes sense. I guess just a follow-up, taking a step back on the guidance, and clearly, you guys have factored in a number of scenarios it seems around the guidance and the outlook. Just playing out a scenario where maybe things take longer to come back, or are they worse.

Other than the cost measures that you guys outlined today, are there other levers you could talk about as far as what you can do to offset maybe a more prolonged impact to demand?.

Sure. So if the academic institutions don't open up as anticipated, let's say they don't open up, they're a quarter later or they don't open up at all this year, and/or the second wave of the virus is way worse than everyone is anticipating, and they open and they shut again, we have played through countless scenarios.

But that would be a couple of bad situations.

We have additional cost control measures, a continuation of some of the things that we have started on the compensation side, for sure on the travel side, for sure, that we can and would execute, which would backstop certainly some of the operating margin and EPS associated with a lower revenue delivery.So yes, we I think we have substantial ability to offset a worse story.

Our guidance is based on a very realistic to quasi-pessimistic story, but there's a lot of parts and pieces. We have different assumptions for different businesses and different parts of the world.

But based on where we sit now, based upon you have to understand that we have conversations with hundreds, if not thousands of clients a week about what they anticipate, what they'll buy, what's happening to them, how they're thinking about their studies on the academic side, when they're thinking about opening.We do have a couple of high-level academics on our board, deans of a veterinary school and a medical school, who are still quite connected to the academic milieu and have given us their the best prognosis.

So we think that we've done it realistically, but we definitely have more cost control measures to offset a further decline if it gets worse than we've guided you to..

And our next question comes from the line of Patrick Donnelly with Citi. Please go ahead..

Maybe another one on the cost side. DSA, you guys long talked about kind of this mid-20% op margin goal, saw some pretty nice progress this quarter to the 22% number. Can you just talk about the implementations you have going in that segment? Again, it seems like it's hanging in a little better, very temporary in terms of the pullback.

How aggressive are you being in preserving the margins there, kind of pursuing that mid-20% goal in the near-term here?.

Yes. I mean our cost control measures have pretty much cut across all of our businesses, and we would prefer and intend to have them be temporary. By that, I mean the sales will increase, and we don't have to continue with them or make them more severe, and that's what we anticipate seeing.

I think on the DSA business, as we said in our prepared remarks, we're looking for a meaningful and there's only been a modest impact, and there will only be a modest impact for the year.We're looking for a strong back half of the year, particularly in safety assessment, which is the largest business that we have, given the desire of our clients to continue to prosecute the drugs that they have in development, particularly for IND-enabling studies, both for COVID-related de novo work for COVID stuff, but also multitude of therapeutic area-based work.So the work is continuing, and there's been a very modest decline.

So we would continue to see believe we continue to see strong demand there and our ability to continue to generate strong operating margins, particularly in that segment..

Okay. And then maybe just a quick follow-up on the Discovery side, and I know you talked about clients in some situations slowing projects, delaying things maybe just a quarter.

I guess, how confident are you that's just going to be a quarter? What's your visibility into those conversations, things coming back in two or three months rather than getting pushed out longer, again, assuming things normalize somewhat in the near term?.

Discovery had a really strong first quarter, which was great.

And the type of work that we're talking about slowing down is these very complicated, we call them integrated drug discovery projects, that they tend to be multiple years and multiple millions of dollars, they're very expensive and very complex.And so we're seeing and by the way, we don't do a lot of them. There's a relatively small number of them.

And they're for pretty sophisticated but often small biotech companies. So you can imagine as this pandemic has broken that clients that we were in discussions with about initiating these studies would just want to pause, so they've said, let's pause and see how this thing rolls out.So I think it's possible that they continue to pause.

If they do, again, it's a small piece of Discovery, and Discovery is a small piece of DSA. So we're talking about a very modest impact to the Discovery business and to the DSA segment.

The rest of the Discovery segment has done quite well, and we would anticipate continuing to see that happen and perhaps some benefit, some work that was historically done internally, and clients getting comfortable or preferring to utilize outside resources to get that work done. So we feel pretty good about the trajectory there..

And our next question comes from the line of Elizabeth Anderson with Evercore. Please go ahead..

I think you've answered it partly in bits and pieces, but I just want to make sure I understand how you guys are seeing the bookings trend in April into May, and then also among sort of different sized clients? Obviously, biotech is well funded, but are you seeing any differences as we progress through in different sized clients?.

Yes. The proposal line in bookings for Q1 were really strong, and I think we said in the prepared remarks that March was really strong. So we ended the first quarter with in a very good place. We had a really strong April, particularly in Safety Assessment on the bookings side of the situation.

So as we said, it's pretty much business as usual for a whole host of clients, and it's hard to tease out much of a discernible difference between big pharma and biotech.I would say that biotech's feeling well-funded if they've got drugs that they need to develop, particularly for IND-enabling studies, particularly kind of worried about the FDA going to be too busy, so let me get my work in early.

I think that's a pretty good push there.

So we would anticipate continuing to see strong proposal volume and bookings across DSA, but particularly in SA, particularly in Safety, for both large and small clients, we have a really big international footprint and the capacity to accommodate that work.And there's no logical reasons, even with the virus situation being more prolonged because there's not much the clients have to do.

So they give us the molecule and we literally do the work for them. We have to talk to them, but we can do that by computer. So they simply have to be able to they simply have to have the molecule and be able to afford it.

So being closed or shut down or disrupted doesn't really have much of an impact on this, which is the whole basis of the bargain of our outsourcing model. So we will continue anticipate continuing to see that be strong demand..

And our next question comes from the line of Sandy Draper with SunTrust. Please go ahead..

I guess, maybe a follow-up on HemaCare, Jim. You commented that you shut down the facilities there, and you're expecting that to stay down and so there to be a negative impact.

Can you talk about sort of and I don't know if this is the right way to think about it, sort of how long the supply or how big a supply you typically keep in inventory? So like how long you can run the business before you, you absolutely need to start reopening? And just trying to think through the dynamics of how HemaCare reacts to this environment?.

Yes. Fair questions, Sandy. So we've shut so the business is still operational. We have product that we're shipping. We also have product that we can source from others. So we don't think the inventory will be a problem. All we've closed is the donor clinic, where people come in and donate their blood for obvious reasons in the midst of COVID.

And so we have plans to reopen that. I can't give you an exact date, but it won't be too prolonged.So we'll get that business cranked up again. Inventory won't be a problem.

Obviously, it's been disrupted from a revenue and profit-generating point of view for some a short period of time, but given the strength and interest in the work that's being done in the cell therapy space, we anticipate it will continue to be a very strong business in the back half of the year and going forward..

Our next question comes from the line of Dave Windley with Jefferies. Please go ahead. We'll go on to the next question from Juan Avendano with Bank of America. Please go ahead..

I guess, can you give us a quantitative update on your current level of capacity utilization in Safety Assessment? What you define as full? And how does it compare to the last couple of years?.

Yes. Capacity utilization is we have good flexibility and in a good place. Citox, we picked up a bunch of new sites, where we have some capacity. We still have a substantial amount of capacity from the MPI deal, that's a big site in Michigan, which gives us enormous amount of flexibility to bring studies in there as long as we have the staff.

And in 2019, as we have in the prior five or six years, we've added incremental modest incremental space at multiple sites, let's say five or six sites at once.So we definitely have sufficient capacity to take on the work. Our headcount is in a good place.

As you recall, we worked really hard in 2018 and 2019 to get our staffing hired and trained, so that we could accommodate an increase in work, we're in a really good place right now, overtime is low; turnover is low; people are well-trained and actually happy to have not only happy to have jobs, but proud to be working in this environment on work generally and specifically with COVID.

So our definition has never really changed.Full capacity utilization is kind of in the low-80s. I'm not going to give you an exact number, it would not be useful, except that we're essentially very efficient. You can see that in the margin accretion in the first quarter.

So we've been able to add capacity slightly ahead of where we need it, which we have done and will continue to do. And then we have kind of this Mattawan facility, which is kind of our ace in the hole, because it's so large, and we do provide so many different services there, that we can accommodate a lot of clients' demands.

So capacity is in a good place..

And our next question comes from the line of David Windley with Jefferies. Please go ahead..

This is Dan Layenne on for Dave. Can you hear me? I don't know if I was on mute earlier. Okay. Great. I just want to say congrats on the quarter.

My question is, you put through a rate increase in 2018 because of a somewhat tight labor market, does the spike in unemployment change that dynamic? And when will the cost savings need to be reinstated?.

So I don't think it changes the dynamic. I'm not really sure what you mean. We certainly feel that we're paying people well. So we don't feel that we have the need to do anything additionally. We certainly don't want to pay people less because the economy is difficult.

So I think we're in a good place, as I said a moment ago, from a staffing point of view.From a turnover point of view, I think the economy has, generally helps with that. But in the locales where we needed to catch up, we did catch up well.

And we're going to stay more vigilant on just testing the local markets, because demand changes from time to time from a competitive point of view, depending on who else is hiring folks. So that should not be an issue for us going forward..

Our next question comes from the line of Erin Wright with Credit Suisse. Please go ahead..

Just one quick one here on your Manufacturing.

I just want to ask about the relative resiliency across the Manufacturing segment? I guess, what parts of that business are inherently more or less immune or insulated to the COVID environment?.

So manufacturing has been relatively unscathed, those three pieces, and we're providing products and services related to our clients, principally producing drugs and vaccines and, to some extent, sterile products. So I would say, it's pretty clear that Manufacturing is happening, in some ways, in a more robust fashion than pre-COVID.

I mean lots of drugs are being manufactured.

Lots of new drugs will be manufactured to be tested in the clinic for COVID, and hopefully, to get into the market in the fall, both vaccines and drugs.So I think we'll see, worst-case, sort of a continued demand and potentially an intensified demand for manufacturing for our manufacturing products and services, that business has held up really well in the first quarter.

We're anticipating relatively unscathed by this going forward. The work that we do is essential to products being released to go into the clinic, and products that have been manufactured to go into the market for sale to patients can't be released until we do the testing on them.

So it's a really critical sort of FDA-required aspect of the whole drug development and delivery paradigm..

And our next question comes from the line of Dan Brennan with UBS. Please go ahead..

Thanks for taking the questions. Jim, I was hoping to get a little color just on safety assessment. I think the DSA, you guys have talked about mid-single-digit-plus for the year, and you qualified it as a modest impact, but yet it sounds like after Q2, it sounds like you're expecting a pretty sharp recovery.

So I'm just wondering, is that mid-single-digit-plus? Is that you also mentioned with your guidance it likely has a bit of a quasi conservative element.

So should we characterize that area as conservative? Just kind of maybe clarify some of the commentary on DSA?.

So what we said was at least mid-single digits, so we were pretty clear about that comment. It's obviously a segment that's been in the high single digits, so it will be lower. It would be great if it would be higher than that. But we're guiding exactly to that language. I don't think I said that our guidance is conservative.

We always try to have our guidance be realistic based upon what we see in here and what we predict for the rest of the year. I did say that it's kind of a patchwork of, obviously, different businesses and different geographies, which will be impacted more or less.

The challenge with this situation is obviously that the there's not a lot of historical guideposts here.So we don't know how this virus will continue to develop or not. And we don't know exactly what the impact will be on us. We know what we think and we know what our clients are telling us.

So yes, so you could apply the word conservatism, only I would use a different word, which is that there's a fair amount of unknowns. But we as we stand here today, we have a high level of confidence in our guidance. We obviously hope it's better, but we're not going to guide to that. So I wouldn't read too much into it.

If we deliver mid-single digits in DSA, we'll be quite pleased with that..

Great. And maybe one follow-up. Just clinical peers, kind of a topic a lot of folks have latched onto is the percentage of sites that are affected today and how that potentially could progress throughout the year as maybe a signpost toward the rate of acceleration or kind of the pickup in revenue growth.

So for your businesses, obviously you're talking to hundreds of customers a week, you have deans of a university on your Board.

Absent us digging in with customer calls, like what are some of the signposts you think we can watch to kind of assess kind of the pace of recovery? Obviously, biotech funding is critical, so that's something we'll all watch.

But if we're thinking about research models and DSA, what are some of the things you think we should be looking at?.

Yes. I mean, just the dialogue around the reopening of major academic institutions in the U.S. and Europe and the reopening of some of the smaller biotech companies, many of which closed for short periods of time and some of the big pharma sites as well. So there clearly will be announcements of that, particularly on the academic side. Yes.

I mean, you can watch biotech funding, and then funding comes in from a bunch of different sources. First quarter was really strong. VC funding continues to be strong. IPOs are slowly coming back.Pharma will continue to bank biotech companies as they always have. And I would imagine, as the at least the U.S.

economy gets has a take on how this COVID situation will develop and/or it continues to see the biotech companies distinguish themselves developing drugs for COVID and other diseases that I think that continues to be one of the few places to put your money if you're an investor that has a likely positive outcome.

So those are indices that are easy to watch, and I think should give you comfort in the demand curve for our portfolio..

Excellent. Thank you for joining us on the conference call this morning. We look forward to meeting with you at several virtual investor conferences this spring. This concludes the conference call..

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you very much for your participation. You may now disconnect..