Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories Third Quarter 2022 Earnings Conference Call. This call is being recorded. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to our host, Todd Spencer, Vice President of Investor Relations. Please go ahead, sir.

Good morning and welcome to Charles River Laboratories third quarter 2022 earnings conference call and webcast. This morning, I am joined by Jim Foster, Chairman, President and Chief Executive Officer; and Flavia Pease, Executive Vice President and Chief Financial Officer. They will comment on our results for the third quarter of 2022. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which will be posted on the Investor Relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately 2 hours after the call today and can also be accessed on our Investor Relations website. The replay will be available through the next quarter's conference call. I'd like to remind you of our safe harbor. All remarks that we make about future expectations, plans and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated. During this call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the Investor Relations section of our website. I will now turn the call over to Jim Foster.

Good morning. I'm very pleased to speak with you today about our third quarter results. Our solid financial performance was highlighted by a 15.3% organic revenue growth and non-GAAP earnings per share of $2.63, both of which exceeded our prior outlook. Third quarter organic growth rate accelerated 580 basis points from the second quarter level due primarily to the DSA segment, which delivered an outstanding growth rate of more than 20%, in line with our outlook since the beginning of the year. The DSA growth acceleration reflects continued robust price increases and meaningfully higher study volume in the Safety Assessment business, trends which have been supported by the strength of its backlog that continues to afford us with excellent visibility into the future client demand. The strong operating performance against the backdrop of escalating macroeconomic pressures demonstrates the power of our unique portfolio which differentiates Charles River from other companies that provide R&D support services to the biopharmaceutical industry, especially from the late stage clinical service providers. We are uniquely positioned as the leading global non-clinical drug development partner, working with clients from discovery and early stage development through the safe manufacture of life-saving therapies. Our focus is centered on preclinical R&D which requires extensive scientific knowledge and the ability to innovate, understand and distinguished viable molecules from those that are not. Post-pandemic, we are even more -- an even more essential partner to our biopharmaceutical clients because our core competencies are precisely tailored to their intensified focus on scientific breakthroughs, personalized medicine and speed-to-market. With a comprehensive portfolio spanning small molecules, biologics and cell and gene therapies, we provide a flexible and efficient platform that accelerates early stage biomedical research and therapeutic innovation. We are a leading global partner for outsourced discovery and regulated safety assessment services. We are…

Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition-related adjustments, costs related primarily to our global efficiency initiatives, gains or losses from our venture capital and other strategic investments and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, divestitures, foreign currency translation and the 53rd week in 2022. We're very pleased with our third quarter results with revenue and earnings outperforming prior outlook. Organic revenue growth of 15.3% resulted in earnings per share of $2.63. I will now provide some additional details on the non-operating items that drove our third quarter performance. Unallocated corporate costs increased in the third quarter, totaling $57.5 million, or 5.8% of total revenue compared to 5% of revenue last year. The increase was primarily the result of higher health and fringe related costs. For the year, we continue to expect unallocated corporate costs to be approximately 5% of total revenue. Total adjusted net interest expense for the third quarter was $27.3 million, an increase of $4.4 million sequentially and $6.6 million year-over-year, reflecting the Federal Reserve's interest rate increases this year and on a year-over-year basis, higher debt balances from recent acquisitions. For the year, our total adjusted net interest expense outlook remains unchanged in the range of $106 million to $110 million because we expect that more aggressive interest rate hikes will be offset by additional debt repayment. Our current interest expense guidance can accommodate an additional 75 basis point to 100 basis point increase, should that be the outcome of today's Federal Reserve meeting. Given the late timing of a potential December increase, we do not expect it would have a material impact…

That concludes our comments. We will now take questions.

Thank you. [Operator Instructions] Our first question comes from Eric Coldwell with Baird. Your line is open. Please go ahead.

Okay. First question, worst question. Probably one of the biggest debates this quarter is when are you going to give '23 formal outlook. I was hoping I could maybe put the pressure on for you just to tell us when that will be so we can end the debate?

We very much want to see the end of the year. We want to see how the following year begins. We moved away from that last year, but that's our normal cadence given the uncertainties and the complexities in the world. So we are highly likely to do this in February.

Yeah. I appreciate that, Jim. Fundamental question on the Avian divestiture. I'm a bit curious, you say it's no longer a core competency, but you've been here forever. You've run it well. It's been extremely profitable, and there is some earnings dilution with the divestiture. It's not the first time here in the last year you've sold something that had a similar, I guess, characteristic of maybe low growth, no growth, but very high profit and very earnings accretive. What do we learn from that? I'm kind of -- I'm interested on why this was no longer a core competency. What was the main driver? Was it more the revenue growth rate or was there something more to that or would maybe this be a signal that you're shifting your attention on higher-growth businesses? Thanks so much.

This was a business when we bought it, it had much higher growth characteristics. It was a more meaningful part of the company. It was more strategic. It was more central to what we were doing because I would say it's more of a core competency. So margins are good. It's a true statement. I would say that it's moved into a no growth genre, which we obviously don't like, so it's dilutive to our top line. It's a business that has been okay, but we've been unable -- we've owned that business, by the way, since the mid-'80s. We've been unable to really crank it up in any meaningful way by moving into adjacencies, which we tried. So it seems that we should monetize it, use the proceeds for, in this case, probably debt pay down, but use our assets for more basic and relevant activities. So just sort of moved out of central focus. The other risk is when the business is not within your major focus, you don't give it the time and attention that maybe you would have otherwise. And given that we're in a kind of double-digit growth methodology right now, we certainly want to maintain that.

Yeah. Sounds good. I'll cease the floor here. So, thanks, Jim.

Thanks, Eric.

Our next question comes from Derik De Bruin with Bank of America. Your line is open. Please go ahead.

Hey. Good morning, everyone. Thank you for taking my question. So realizing that a lot has moved in the world since your 2021 Analyst Day. But can you talk a little bit about the margin cadence as we sort of think about going into 2023 and 2024? You have that roughly 22.5% off margin target for 2024. And I'm just sort of curious how we should think about it realizing you've got FX moving divestitures, just investment in the business, inflationary cost. Would love some thoughts on how you're thinking about the margin progression.

Sure. Hi, Derik. Good morning. It's Flavia. And to your point, since we provided that long term outlook about 18 months ago, a lot has changed, right? In the world in macroeconomic conditions, so we're certainly going to take the time to finish the budget for 2023, which will be an important jump off point for us to consider the longer term outlook. We continue to apply to deliver long term high -- long term healthy revenue growth and operating margin expansion. So the tenets of our long term aspirations remain, but we're obviously going to need to go back to the dry block and look at the numbers in more detail since to your point, a lot has changed since we went out 18 months ago.

Got it. And if I can do a follow-up, one of the other CDMOs in the space yesterday called out some headwinds in their developmental services across biotech and pharma, which was sort of a surprise to us. I hate to belabor the point given your conversation on biotech, but do you see any sort of like weirdness? Did the Discovery business get worse? Did you -- did anything sort of soften between the time you had August -- between August and now to sort of making more cautious on the outlook? It doesn't sound like it, but I'm just trying to reconcile some of the comments from some other companies. Thanks. And I'll get back in queue after this.

We didn't see anything conservative slowdown anymore down the Discovery, growth rate has moderated, pretty much totally in line with our expectations. As we said on our last call, we've had a lengthening of decision making. We've had no clients or very few clients really focusing on the reason for the delay relative to funding. But if they have to make those decisions of doing slightly less discovery in order to do more IND work, they're going to do that all day long. So we haven't seen any fundamental difference in the cadence since the last time we talked about this.

Thank you.

Our next question comes from Sandy Draper with Guggenheim. Your line is open. Please go ahead.

Maybe just a question on the price side, and I'm sure if this is for you, Jim or Flavia. When I think about your comments about strong pricing and et cetera., should we think about that as a -- that's going to flow through the model for the next four quarters or really into next year? Is that something that's just hitting this quarter? I'm just trying to think about the cadence of those of the pricing changes and how they flow through the model and just to think about it because that's clearly been very impressive. It sounds like it's going to spill into next year. I'm just trying to understand how we should be thinking about those price increases flowing through and how sustainable they are. Thanks.

Yeah. We were very clear about the fact that the back half of this year, as exemplified by the third quarter, would have increased volume and increased price, which, of course, we just delivered and tightened up our guidance for the year, so that cadence is pretty clear. We have a unusually high amount of our safety assessment booked for next year at escalating and increasing prices, both related to inflation, but primarily related to the complexity, increased complexity of the work, the depth of the science that we do vis-a-vis our competitors and vis-a-vis big pharmaceutical companies. So we feel very good about our pricing power and some of the leverage we have with our clients. We feel really good about capacity utilization. We feel really good about headcount where we have it right now and our ability to do the work. And as we've been saying for a few years, as the work has gotten more complex, we really feel that we ought to be paid well for it. There were years historically, where we didn't think we were being paid well for it. I do think that, that's changed. So as we look to next year without getting too granular, of course, we haven't even finished the plan yet, but we do have a lot of work booked at higher prices.

That's really helpful. Thanks and congrats on the quarter in a challenging environment.

Thanks, Sandy.

Our next question comes from Dave Windley with Jefferies. Your line is open. Please go ahead.

Hi. Good morning. Thanks for taking my question. Jim, I wanted to kind of understand, I guess, relative movement within Discovery and Safety Assessment, you've commented on that this morning and previously. I guess we're hearing -- Derik mentioned it from yesterday, but we're hearing from a number of different players, including you, talking about slower decision making. I guess I'm wondering how you distinguish between Discovery and Safety Assessment? Like if -- what's the protection or the boundary, if they slow down Discovery? Should we be braced or are you braced for that bleeding over into Safety Assessment? And maybe another way to get comfortable with that, you mentioned the $6 million to $8 million in kind of total cost of, I think, an IND enabling program, I think, was the point of those numbers. How much of that comes after IND such that it might run congruent with or sorry, coincident with clinical trial activity and B, therefore, very important?

So we think it's a tale of two cities, right. So we think that any company, large or small with the promising compound, particularly for unmet medical need, will do anything humanly possible or financially possible to get this thing to an IND and ultimately in the clinic, where they often monetize the asset, right, sell the company, sell the drug, sell the U.S. rights or whatever. So that would jive with the strength of the backlog, which is increasing, the prices that are escalating, the share volume that we're seeing in 2023, which is unprecedented even though we had some of that in '22. Obviously, the discovery work comes earlier. And at some point, Dave, if you don't have a significant volume of discovery work that will impact the volume of safety work, but I think we're a long way away from that. I think we're seeing some thoughtful pauses with some of our clients just saying -- and a small number of clients, by the way, a very small percentage, just saying a lot of uncertainty in the world in terms of access to additional capital, particularly in the capital markets, and so we're going to prioritize our discovery assets well. Having said that, the inflows from the capital markets are increasingly better. Third quarter was better than the second, second better than the third. This will end up being a strong year. Venture capital inflows are at an all-time high. And pharma access to capital for pharmaceutical companies is probably at an all-time high. So again, we feel strongly that quality assets will be funded in one of those three incarnations or all of the above. So we're watching it closely as we just reiterated really not hearing a lot of conversations from clients saying, we really have to pause because we're worried about our cash. They're just pausing. So we're inferring that, which I think is the right inference, but Discovery is still a relatively small percentage of DSA. And so we're really thrilled with what we delivered in the third quarter. Optimistic about what we'll be able to deliver in the fourth quarter and pleased with the backlog that we have into fiscal '23.

If I may add, Dave, we started sharing the DSA backlog earlier this year. And I know that has been a slowdown in biotech funding going into this year. So we're now 11 months into the year. And every quarter, we have seen the DSA backlog increase sequentially and pretty substantially year-over-year. So we really haven't seen any slowdown on the DSA backlog that would point to any adjustments or anything being impacted by the biotech funding dynamics, which every quarter I know you all asked about. So we feel good, as Jim said, that we have a substantial portion of the backlog booked already for 2023.

Excellent. I have to use the question for that one. Thank you. I did want to follow up on your comments around pricing and complexity. You did include some comments around pass-throughs in the deck today, which I think is the first time you've done that, maybe that might be my fault. I guess, I'd love for you to comment on that because, obviously, we do think that the pricing of some of the inputs to some of your studies has gone up just massively. And I guess the part that I wouldn't quite be able to follow is if you are treating those as pass-throughs, those would have a very dampening effect on your margin and we're not seeing that. And so maybe you could -- I know you're not going to get into great detail, but maybe help us understand the mechanics of that just a little bit?

Yeah. So Dave, you're correct that some costs have increased, and we are passing those increased costs to clients and keeping the same level of margin that we have whole. So they're neither dilutive or accretive to margin, if that makes sense.

That does help. Yes. Thank you.

We'll go next to Elizabeth Anderson with Evercore ISI.

Hi, guys. Thanks so much for the question. I was wondering if you could comment on how Solaris HemaCare growing in the quarter. I know that you guys obviously did a lot of work to sort of make changes earlier in COVID to sort of increase the growth of that part of the business. How is that sort of panning out in these current days?

Panning out slowly. We've made a bunch of changes in that business. I think the two most fundamental changes in that business, the product line, the nature of the product line versus sort of off-the-shelf things and specialty items and also our access that social methodology to access donors. So all of that is now in place. We're optimistic that things will sequentially and continue to improve. But I would say it's improving slowly.

Got it. So it's more of a cross the like 2023 kind of dynamic is the way we should think about that?

We certainly hope so.

Okay. Got it. And then just in terms of the CDMO sales pipeline, we had heard that there were some sort of rebalancing efforts maybe between some biopharma sponsors in terms of having some internal capabilities for some of the CDMO work that they had developed during COVID and then potentially some dynamics in terms of using up some of that capacity versus starting to outsource as they grow. What have you heard on that front in terms of that? Are people sort of continuing to sort of outsource there? Is there any kind of residual like internal capacity demand or maybe you haven't actually been seeing that at all?

I'd say that capacity is tight and expensive and the capabilities are complex, both in terms of analytical work and process development and ultimately scale up. It's inconceivable to us that biotech companies sort of large or medium would even contemplate this. There's a few big companies that we've heard of that have built their own space, less because they don't trust or like the external providers, but more about concerns about available capacity. So I think it's going to be a lot of work outsourced. There's going to be some work that's going to be internally -- facilities built internally and the work done internally. We'll see though whether that work is just for clinical trial lots or whether that will be commercial work as well. I think the biotech companies have done a wonderful job utilizing external resources to do their work. And so we have, we think, plenty of work and lots of conversations going on right now and have added incremental capacity and feel that we're in a good place to get our share of the pie.

Got it. That’s helpful. Thank you.

We'll go next to Patrick Donnelly with Citi. Your line is open. Please go ahead.

Hey, guys. Thank you for taking the questions. Jim, maybe on the DSA side, talked a little bit about the backlog there. On the staffing piece, you've heard this earnings season from some of your peers, you've seen some labor shortages out there that prevented other companies from converting over a pretty strong demand backdrop and your guys' backlog is growing, as you talked about, you seem to be ahead of the curve there, kind of prioritized hiring late last year into early '22. Are you better positioned here now? Is there potential for share gains, given you're able to take on more work? How capacity-constrained are you guys given the labor side, maybe just talk through that a little bit?

Yeah. We feel really good about our labor component. We've worked really hard at it for several years now, both in terms of starting wages, both in terms of numbers of recruiters, in terms of explicit career development opportunities so we can attract really talented people and keep them, I'm thinking about some of the cell and gene therapy folks that we've added over the last year or so. So in terms of numbers of people to initiate work or to continue to do work as we move into fiscal '23, we feel really good about where we're at. I think we got ahead and stayed ahead of the salary levels, both starting and otherwise for fiscal '22, and we had that embedded in our plan and in our guidance. While our '23 plan isn't done yet, we will do the same thing. We hope, I mean, yes. It's a little bit vague out there, but we will continue to be appropriately aggressive in terms of being able to bring in new folks. So we feel really good about our labor component. We feel really good about our capacity, available capacity at multiple sites. We feel really good about our pricing power. We feel really good about clients waiting a significant amount of time to initiate studies, getting in line and prioritizing what studies they want to do first, that's so new. We've been doing this for a long time, that sort of new the last couple of years. This is an industry that historically had some planned well, and there's lots of changes, but they really do have to plan well now, and that's, I think, holding us in good stead. So labor component is in a good place.

Okay. That's helpful. And then maybe just on the capital deployment side. You guys obviously have some money coming in the door from the divestiture. Sounds like maybe near term, a little more priority on the debt paydown. But maybe just talk about, I guess, the M&A funnel. You guys are obviously executing on some of the more recent deals. Is it put a pause on that, pay down some debt? What's the right way to think about near-term priorities before you kind of get back to the normal kind of cadence there?

So both Flavia and I will answer aspects of that question. I would say a couple of things. Number one, that we're deep into the integration of our cell and gene therapy assets, which obviously it has been more complex and more challenging than we thought given the nature of the science and the newness of the science and some of the challenges. So going well, really pleased with the facilities, the staff, the sales organization, the regulatory folks and new clients and also on sort of a massive marketing initiative to make sure that people understand that we're in this business. I think I want to use the word pause because we did the Explora deal. And we would do a small tuck in deal of a technology deal, depending on when it was available. We certainly don't always control the timing of these deals. But I would say that directionally, our balance sheet is increasingly in good shape to do some meaningful M&A. I don't want to say when that might be, except to say that we have multiple conversations going on right now with potential acquisition targets, almost all of which are owned by private equity. And we are always having conversations with them. I'll let Flavia answer what we're likely to do with the proceeds from Avian.

Yeah, Patrick. So thanks for the question. And we regularly evaluate obviously uses of capital. As Jim said, M&A has served us well and has been in strategic revert for the company for the growth for us to acquire the scientific wherewithal to distinguish us with our clients. But in the short term, the near term, we're likely to focus our capital priorities on that repayment. And so I would expect a portion of the Avian proceeds to indeed go towards paying down debt. And we'll continue to look at capital priorities. We discussed it regularly with our Board, and we'll continue to evaluate other uses. But in the short term, likely a sizable portion of the Avian proceeds will go towards debt paydown, especially given the high interest expense -- interest rate environment that we're in right now.

Appreciate all the color. Thank you, guys.

Your next question comes from Casey Woodring with JPMorgan. Your line is open. Please go ahead.

Hi. Thanks for fitting me in. Can you guys just talk towards the volume growth in DSA in the quarter? How much of that was just based on the increased capacity that you had come online? And then also just wanted to get a sense on if volumes are trending meaningfully higher than where maybe you had expected them to be heading into 2023, maybe at the time of the initial initiation of guidance and maybe versus even several months ago. And then just as a follow-up, I don't think I called a backlog growth number for DSA. I'm wondering if you could provide that. And if you have any line of sight towards double-digit growth in DSA next year, I think the Street has you at 9% in 2023 for DSA growth. Thanks.

So we worked really hard for a number of years, probably longer than I recall, probably approaching a decade actually of adding incremental capacity at multiple locations simultaneously every year. And then that was increasing as the size of the business has increased. And we have to build it 12 months to 24 months in advance. So we have to call it right now -- so we're building space in that right now. We have to call that for the end of '23 and much of '24. So to some extent, we have to be present. It does help, obviously, to have so much backlog and so much in the future and so much demand and us having such a strong franchise. So yeah, we're getting a lot of volume. We're, for sure, taking share. That's our goal and necessity. We have new companies, 300, 400 new companies every year that are going to need safety assessment eventually, and we want to have as much of that work as possible. We have a lot of big pharma work increasingly so and intensifying and obviously, a lot of mid and large biotech. Lot of share gains from competition and a lot of just de novo work that wasn't available for anybody. So we will continue to hopefully get price. We will continue to hopefully get volume as we have the space. We were very careful not to build too much incremental capacity so that we're swimming in and it adversely impacts our operating margins by the same token. Particularly if you look at last year, where we definitely crush our operating plan, it was very important that we had incremental space, and we were able to take on new business. You want to answer the other part?

Yeah. Sure. And Casey, just a couple of additional comments before I give you the backlog number. I think as Jim pointed out, it's incumbent upon us to get it all right, right? We have to have physical capacity, expanding our facilities at the appropriate time, not too soon, not too late. We have to have the people. I think Patrick asked about that. We feel really good that we got ahead, if you will. And you saw, when we provided guidance earlier in the year, we talked about a stronger second half for DSA, which I think there might have been some skeptics out there but we are seeing that materializing in the volume acceleration in the second half vis-a-vis the first half as all of those folks that we hire now become productive, they're out of training, and they can really be available to support the strong client demand that we're seeing and allow us to gain share, as Jim said. So I think we really have done a nice job of ensuring we had the available physical labor input capacity available to absorb the increase in demand. In terms of the backlog, the backlog in the third quarter was $3.2 billion. So it was about 7.5% sequentially growth versus the second quarter.

That’s helpful. Thank you.

We'll go next to Jacob Johnson with Stephens. Your line is open. Please go ahead.

Hey. Thanks. Good morning. Just one, on the CDMO business, you call out that you don't expect it to meaningfully improve until next year. So as we think about improvement into 2023 as Derik and Dave alluded to, there was CDMO talking about the funding environment impacting their development pipeline yesterday. I'm just curious any thoughts on kind of the demand backdrop for CDMO services as we think about kind of that business returning to growth next year? Thanks.

Yeah. So we are optimistic about next year. It's a business that has limited providers, both of the services or the products required. So that provides enormous opportunity for us going back to the previous question about clients doing it themselves. 3,000-ish molecules, at least two-thirds of which are in a preclinical domain. So there's an awful lot of work available. So we've been working hard to have the right staff, the right facilities and the right dialogue for the clients know that we're deep in this in concert with our biologics business, which gives us, I think, a competitive advantage, also in concert with our Safety Assessment business. So we feel really good about our portfolio and the ability to service a whole range of cell and gene therapy customers across the whole CDMO really paradigm.

Got it. Thank you.

We'll go next to Justin Bowers with Deutsche Bank. Your line is open. Please go ahead.

Hi. Good morning. Could you give us a sense of what the growth was for the QC business and manufacturing? And then, gosh, I mean, I think it's been like eight to 10 years since Todd and I went in depth on the Avian business. But if I recall, there is some seasonality to that. Can you just remind us of that as we just think about modeling?

Yeah. So we're not going to break out the growth rates and the specific pieces of manufacturing, except to say that we were pleased with the growth rate of Microbial, I'm pleased with the growth rate of Biologics. And not pleased with the growth rate of Avian, which is why we sold it. I don't think that business was particularly seasonal, by the way. We had a pretty consistent client orders sort of a long period of time for almost entirely Avian Vaccines, a little bit of human flu. So it was time to divest that business.

Yeah. And I would just add that the other component of manufacturing is obviously the CDMO business. And to Jim's point, while agent strategically, we have determined not to be the best fit with our strategic aspirations and ambitions. The biggest headwind, I would say, currently in manufacturing is CDMO, as we have talked about in the second quarter earnings.

Yeah. I got it. For some reason, I thought I recall like the first quarter, there was kind of an outsized contribution there, but it's -- that's clearly not the case. Maybe just a quick follow-up on what's kind of like the rule of the thumb for every kind of one point move in FX on the year in terms of like the operating profit impact?

Yeah. I think Justin, we can take that offline with you. There...

Okay.

We have exposure into various different currencies. So it's hard to give you a precise impact on -- depending on which currency it moves, it can have more or less of an impact. So it's not one point equals x.

Got it. I'll take the rest offline. Thank you.

We'll go next to John Sourbeer with UBS. Your line is open. Please go ahead.

Hi. Thanks for taking my question. Maybe just one on the CDMO and cell and gene therapy manufacturing and just the turnaround recovery next year. Do you see any areas of gaps or maybe areas that could be complementary within the portfolio there that invest in organically or inorganically that could help accelerate that turnaround into next year?

Not really. I mean we probably have some settled gaps that as this business matures and strengthens that we'll take a look at. I think while it's possible to do it organically, it's probably some modest amount of M&A. But I wouldn't say that any of those issues are getting in the way of the growth of development of business. So I think it's -- we feel that we're making all the right moves to strengthen it, to access clients to distinguish our portfolio from the competition and to have both the space and the people and the regulatory acumen to move work forward, certainly into the clinic and hopefully, eventually into a commercial genre.

Yeah. And I'll just add, I think in the second quarter earnings, we talked about, obviously, what we've learned in the CDMO as we took the assets, they're longer sales cycles. But I think actually, at this point, those longer sales cycles and the efforts that we have been doing and putting in our BT teams are very prudent us having good visibility into potential opportunities for next year. So we feel good, not only that we're going to have easier comps, but that we have line of sight to the underlying demand that Jim talked about.

Got it. Thank you for taking the question.

We'll go next to Dan Leonard with Credit Suisse. Your line is open. Please go ahead.

Thank you. Just a question for you, Flavia. I just want to make sure I'm clear on how you're framing interest expense for 2023. Did you say that if rates go up by 100 basis points today, then the starting point for interest expense is $119 million for '23 or is there a different base on what you're calculating this sensitivity?

So I just -- I provided -- I tried to provide some help for you guys is, how you model that. In 2023, about a 100 basis point change in interest rates would resulted about $9 million of impact to our interest expense. It's -- to your point, this year, because the Fed has moved pretty much every quarter, right? And every quarter, we have updated our interest expense outlook, it's hard to establish from which base. So I just wanted to provide you some modeling help that for next year, 100 basis points is worth $9 million.

Would the Q4 number be a good base, the Q4 run rate be a good base to calculate from?

You have different bases. So every quarter, it's going to be a little bit different. That's why it's challenging given what has been the escalating interest rate high this year.

Okay. I understand. Thank you.

Our next question comes from Max Smock with William Blair. Your line is open. Please go ahead.

Hi. It's Christine Rains on for Max Smock. Just one for me. So for the DSA business, if you're willing, how much of the 20.8% organic growth is coming from price increases? Assuming that you're not willing to quantify that, what do you currently view as the more normalized sustainable growth in demand for both Discovery and toxicology? Thank you.

Not going to give you the pricing and we really don't want to unpack it. So we're really pleased with both the volume growth and the pricing power in that business, which has improved pretty much sequentially year after year as the demand has increased as our competitive posture and capabilities have increased. So we're happy to be getting share, taking share and getting paid well for our business. We're very pleased with the improvement in operating margin in the third quarter. And particularly pleased with the volume of work that's already booked into fiscal '23.

Great. Thank you.

We'll go next to Tejas Savant with Morgan Stanley. Your line is open. Please go ahead.

Hey, guys. Good morning. So a quick one on safety assessment here. Is there any color you can share on proposal volume growth in the quarter? And Jim, if you can comment on lead times. I mean, do you see those sort of moderating at all sequentially or are they still where they were a couple of quarters ago for the business?

Proposal volume, we're busy, lots of proposals and lots of work being booked. Don't really see any rationale structurally demand-wise or otherwise and why things would moderate. We'll talk more about as we finish the year and throughout the year. And obviously, but our competitive posture seems to continue to strengthen. Pricing power, as I said, continues to strengthen and there's a lot of work. Clients are really busy with a whole range of large and small molecules, a lot of cell and gene therapy work. And so the thing that we've seen the most of is prioritization of what drugs they want to get in earlier. We tried to accommodate that. We also -- we didn't have it in our prepared remarks, but we do have some clients that have signed up a dedicated space with us. I think that's a really important happening and really an important sort of commentary on both the acknowledgment on the client's part that they need some vehicle to move relatively to the front of the line. So we'd be surprised if we don't see more arrangements like that.

Got it. That's helpful. And a quick follow-up on RMS, a near-term one and then sort of the medium-term one. So in the near term, Jim, can you just comment on thoughts on RMS margins in China and how you see those trending? And can you just pass out how much of the headwind there was from your expansion plans versus other factors? And then the medium-term question was related to this FDA Modernization Act. How are you thinking about that over the medium term for the animal model side of things? And are you starting to hear anything from your clients at all on that?

So China has been a place with strong growth rate and good margins, some pricing power. And a lot of that is associated with access to incremental animals and other geographic locals in a very large country. So we've continued to increase capacity, both for the product and the service side in RMS in China, and really, we're pleased with the results. And while we definitely have competition over there, most of its local and most of it is much less sophisticated from an animal quality and veterinary point of view. The dialogue about in-vitro technologies, 3D models, AI, I mean, all of that is not new. We're interested and have always been interested at Charles River in making sure that a minimal amount of animals are used and used appropriately for studies. We've seen the mix in animal models over the years with more refined, higher ASP models, so hypertensive animals, immunocompromised animals, double, triple quadruple immuno-compromised animals, inbreds, hybrids, et cetera., with higher ASPs and less sort of outbred models. I'd say a couple of things that, while I think there's a desire on the part of -- we have a public maybe for there to be a reduction or replacement of new technologies for animal models. And by the way, we see most of those technologies, they will not provide a sufficient safety profile. Most -- many of the drugs, many of the diseases for which we have drugs scientists don't understand the mechanism of action in most diseases. If we don't have drugs, they definitely don't understand the mechanism of action. So trying to replicate that the computer of cell culture or ex vivo system is very complicated, and it's unlikely that the drug companies would take the time to validate those technologies or the regulatory agencies with would be comfortable with that. Yeah. I think it's a little bit different with Discovery. So that's regulated safety. So we don't see any changes. You're going to need a whole animal model to get good results and in most cases, two different species. On the Discovery side, most of the big pharma companies have their own in vitro screens, which they don't share with anybody else. We've made a couple of investments right now in AI and machine learning. We'll make more investments in AI and machine learning. And we can see a time where some of the early discovery answers pre getting into animals, could be done in vitro and could be done faster. I think that's one of the places that we will all save time. So a little bit of a tale of two cities.

Got it. Super helpful. Thank you.

Sure.

Our next question comes from Tim Daley with Wells Fargo. Your line is open. Please go ahead.

Great. Thanks for the time. Just a quick modeling question for me. So the comps for DSA growth eased from 3Q to 4Q. And historically, there's been a bit of a sequential lift in the dollar revenues into the fourth quarter. So just curious, is there anything specific that you all are seeing today, which would limit quarter-over-quarter expansion in either the revenue dollars or the percent organic growth in DSA in the year?

No, I don't think so. Just remember, Tim, that there's also a 53rd week this year that I alluded to. So from a reported perspective, there's going to be that impact.

All right. Great. Thanks. That’s it from me.

Thank you. And that is all the time we have for questions. I'll turn the conference back to Todd Spencer for closing remarks.

Great. Thank you for joining the conference call this morning. We look forward to seeing you all at upcoming conferences. Thank you and have a good day.

Thank you. Ladies and gentlemen, that will conclude today's Charles River Laboratories third quarter 2022 earnings conference call. Thank you for your participation. You may disconnect at this time.