Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories Third Quarter Earnings Conference Call. . I would now like to hand the conference over to your speaker today, Todd Spencer, Corporate Vice President of Investor Relations. Please go ahead, sir..

Thank you. Good morning, and welcome to Charles River Laboratories Third Quarter 2020 Earnings Conference 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 third 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 webcast replay of this call will be available beginning two hours after the call today and can also be accessed on our Investor Relations website. The replay will be available through next quarter's conference call.

I'd like to remind you of our safe harbor, all remarks that we make about future expects, 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 the call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results from operations and 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..

robust market trends, and increasing utilization of our new capacity. Last year, we opened and transitioned into our new biologics site in Pennsylvania, which more than doubled our capacity in the region. We have been filling this new capacity in 2020, due in part to robust client demand for testing, cell and gene therapies and COVID-19 therapeutics.

We believe cell and gene therapy and our core biologics testing work will continue to be significant growth drivers for years to come and that we will benefit from these trends and take market share because clients see the value in our extensive portfolio of services to support the safe manufacture of their biologics program and because we have available capacity to accommodate client demand.

The robust biologics growth and higher utilization of the new Pennsylvania site as well as the elimination of duplicate costs from last year's transition to the new site were the primary drivers of the 270 basis point increase in the Manufacturing segment's third quarter operating margin to 39.1%.

The Avian business also contributed, and we continue to be pleased with the benefits from enhanced operating efficiency in the Microbial Solutions business as a result of process improvements.

Our third quarter performance is indicative of several important factors that our leading portfolio of early stage and manufacturing support solutions continues to resonate with clients even more today than ever before.

That early stage market trends are strong, that our clients' appetite for outsourcing has become increasingly robust, and that we have the vision and experience to manage through challenging periods.

We believe that clients outsource more work to us this year because they trusted the resilience of our business model and our ability to remain fully operational, and also our ability to partner with them to advance their programs when they face significant COVID-related disruptions.

As clients resume more normalized research activities we believe they are actively reevaluating their longer-term outsourcing strategies. The COVID-19 pandemic has proven the ease and flexibility of partnering with a large stable CRO like Charles River as well as enhanced reliability, as clients seek greater research efficiency and continuity.

Therefore, we believe biopharma clients are already committing to outsource more than they did prior to the pandemic. Biotech funding levels were particularly strong in the third quarter, surpassing the $100 billion year-to-date. Biotech IPO activity is accelerating, and year-to-date funding through September has already exceeded last year's total.

We believe that biotech funding is particularly significant for our clients because many of them are emerging or smaller biotechs with programs in the discovery or preclinical development stages. That said, we see evidence from our clients, including global biopharmas that they are emphasizing greater investment in their preclinical pipelines.

The favorable market environment aids us in driving our top line growth, but is only one of the factors that we believe will continue to drive our strong financial performance. Operating margin expansion is also a key component of our strategy.

We believe the exceptional third quarter margin improvement of 330 basis points and our ability to expand operating margins in three of the last four quarters, demonstrate the underlying operating leverage in our business and our continued focus on driving efficiency.

We expect to be near our 20% target this year, essentially one year ahead of expectations. In order to continue to enhance our value to clients and our growth potential, it is imperative that we continue to expand our unique portfolio of potential products and services to more comprehensively support our clients' research needs.

Strategic acquisitions have always been our preferred use of capital, and we are continuing to evaluate new opportunities after a pause in the second quarter. There continues to be an abundance of M&A candidates available.

And we will also increasingly employ our strategic partnership strategy to stay current with new technologies and modalities and to add innovative capabilities in cutting-edge technologies with limited upfront risk. Before I conclude, I'd like to announce two recent appointments.

First, earlier this month, we appointed George Llado to our Board of Directors. George is currently Senior Vice President and Chief Information Officer at Alexion Pharmaceuticals after serving 25 years at MERC. George's unique view from a client perspective and his technological expertise will be invaluable.

He's a dynamic thought leader in the technology field, and we look forward to leveraging his insights as we continue to invest in our information technology platform and digital enterprise. I am pleased to welcome George to Charles River's Board.

I'd also like to congratulate Vicky Creamer to her promotion to Executive Vice President and Chief People Officer. Vicky joined us last year to lead the Human Resources function as a Senior Vice President.

During her time with Charles River, she has developed and executed a strategic HR plan that includes identifying and implementing world-class HR processes, developing and rewarding talent and optimizing the organizational design.

Most recently, Vicky has been instrumental in the company's COVID-19 strategy, ensuring our people are receiving the support and resources necessary to navigate this challenging time. Congratulations, Vicky.

We believe that the strength and resilience of our business model, our differentiated portfolio and our wavering focus on the client experience have enabled us to enhance our position as the leading early stage CRO to the COVID-19 crisis. Our success would not be possible without the collective efforts of the dedicated Charles River staff.

So I'd like to again express my sincere appreciation to them for their hard work and unwavering commitment that allows us to continue to fulfill our mission every day. I'd also like to thank our clients and shareholders for their continued support.

Now I'll ask David to give you additional details on our third quarter results and updated 2020 guidance..

discrete tax benefits associated with foreign tax credits; and a higher-than-expected excess tax benefit associated with stock-based compensation, which occurred because a higher stock price in the quarter generated more equity exercise activity.

Based on the favorable third quarter tax rate and an expectation of additional discrete tax benefits in the fourth quarter, we are reducing our full year non-GAAP tax rate outlook by 225 basis points at midpoint to a range of 19% to 19.5% compared to our prior outlook of 21% to 22%.

Our 2020 tax rate outlook includes substantial benefits related to stock compensation and other discrete tax items that are expected to lower this year's rate. However, over the longer term, we continue to expect our tax rate will be in the range of our low- to mid-20% target as we previously communicated at last year's Investor Day.

Free cash flow was $151.1 million in the third quarter, a substantial increase from $120.7 million in the same period last year. The increase reflected the strong underlying operating performance of our businesses and working capital improvements.

As a result, we have increased our free cash outlook for the year to approximately $415 million from our prior guidance of $350 million to $365 million. CapEx was $26.2 million in the third quarter, a decrease of $9 million from the prior year. Our expectation for CapEx remains at approximately $130 million for the full year.

With respect to our full year 2020 guidance, as Jim mentioned, we are increasing our revenue growth outlook to a range of 5% to 6% on an organic basis and 9.5% to 10.5% on a reported basis, reflecting the third quarter performance.

We also expect to achieve meaningful margin improvement, which, combined with the lower tax rate, is driving our higher full year non-GAAP earnings per share outlook to a range of $7.75 to $7.85. Our full year outlook for segment revenue growth is also more favorable, particularly for the RMS segment, given the recovery we are seeing in the business.

For the RMS segment, we now expect a mid-single-digit revenue decline on an organic basis and a mid-single-digit revenue growth on a reported basis. For the DSA segment, we continue to expect high single-digit organic and low double-digit reported revenue growth.

For the manufacturing segment, we expect high single-digit revenue growth on both a reported and organic basis. A detailed summary of our financial guidance can be found on slide 42. With one quarter remaining in the year, our fourth quarter outlook is embedded in our guidance for the full year.

On a year-over-year basis, we expect organic growth in the mid- to high single-digit range and reported revenue growth in the high single-digit range. Non-GAAP earnings per share is expected to increase at a low- to mid-single-digit range in the fourth quarter.

We are extremely pleased with the operating margin expansion that we have generated through the first three quarters of 2020, particularly amid the COVID-19 crisis. The fourth quarter has represented the highest quarter in the last two years.

But this year, we have tempered our expectations primarily because the COVID-19 revenue impact will not be behind us until we exit the year, and the COVID-related cost control benefits will also further moderate for the third quarter.

We believe we are well positioned to finish the year strong, including with the achievement of a full year operating margin near our 20% target and are excited for the prospects as we look ahead into 2021 and beyond. Thank you..

That concludes our comments. We will now take your questions..

And your first question is from the line of Dave Windley with Jefferies..

Hi, thank you. Good morning. I wanted to focus on, Jim, your comments about clients moving toward outsourcing more, committing to outsourcing more. You mentioned that at several points in your prepared remarks and that early on in 2020 with the COVID pandemic beginning to impact.

You were certainly talking about Charles River keeping its facilities open and operating and that providing some benefit and some motivation to use Charles River more. I'm wondering if you could flesh out the conversations that you're now having about that kind of temporary situation moving to a more permanent situation in terms of outsourcing.

And should we expect that this would manifest in bigger kind of headline type deals? Or will it just show up in the revenue growth rate on a kind of on a gradual organic basis?.

Yes. Thanks, Dave. We've been able to demonstrate in large measure because of the inflection point that the virus has given, provided. Unfortunately, it exists but really magnifies the power of our portfolio and magnify the criticality of outsourcing for clients who maybe didn't fully appreciate it.

And so at a time when clients had difficulty running their own operations, opening them, getting them moving, having facilities closed, not being able to depend on themselves. We remained open in providing the smooth services for them across -- pretty much across the whole portfolio.

And so, I think people that were either skeptical or had some kind of historical preference to do things internally now we have been enjoying the benefits of not having the study slow down because they couldn't do their own work. Hopefully, we're doing it as quickly.

And I think in a lot of cases, more quickly than them, our price points, I'm sure, are better. And in a lot of cases, our science is actually deeper. And so we think actually the more prolonged this goes on and the more sort of hesitancy and concern they have about their own infrastructure, the more pronounced, the strength of our capability is.

So, we're definitely seeing it, as we called out in the prepared remarks, we're definitely seeing it in GEMS. We're definitely seeing it in Biologics. We're definitely seeing it in Safety and Discovery. So most of our service businesses, we're seeing it.

And there's no reason to not believe, and that's just based upon client input that never one will retain a meaningful amount of the work that has been outsourced to us. On an ongoing basis, clients have historically preferred it or will we're getting some input from some of them.

They're rethinking their strategy that they're discussing the cost of their infrastructure and that we're part of the conversation. I wouldn't I don't know this for a fact.

I wouldn't want to mislead you to think we're going to have some huge announcement and some major pop, although we could have a client that hasn't outsourced much at all that could do that.

I think that's less likely and more likely that it will continue to be gradual but persistent across clients that have historically used us for outsourcing and some that have used us less.

And I guess the last thing I would say as we continue to enhance the portfolio, which we surely will through these complex strategic deals that we're doing and through M&A, that will make us even a more attractive resource for the clients to satisfy needs, which they thought for whatever reason that they could only satisfy internally..

Excellent, I'll stick to my one. Thank you..

Thank you, Dave..

Your next question is from the line of John Kreger with William Blair..

Hi. Thank you very much. Jim, question for you about the research models business. As the third wave plays out, do you think there's a risk that you could see a falloff in model order flow similar to what you saw in Q2? Or do you think client attitudes will have changed this time around? Thank you..

Yes. So, kind of a question did you are, John. We one doesn't know for sure, of course. And this virus is as predicted, right? Second wave already in the fall and the winter as it gets colder with increased infections and etc. So we think two things. The principal impact to our RMS business although other aspects were impacted.

But the principal impact was academic major academic medical centers across the world, particularly the U.S. and Europe closing abruptly really two or three weeks. And so we know that, number one, their -- sorry that, that happened in retrospect that, that wasn't a thoughtful response on their part.

Of course, they didn't understand this virus very well. And now that they do and now that they see the impact of that we're quite confident that the academic medical centers have made arrangements, both and they're very structured, how they work? How they PPE? How they stagger shifts? How they utilize, foods, etc.

That they'll be able to withstand this apparent and already increase in the incidence of infection. So we don't think that we're going to have a major dislocation again that they'll all take a deep breath. We don't know -- what I'm about to say, we don't know, but I would be very surprised.

Again, given the education that everybody has about the importance of mass and social distancing, and being careful who you hang out without sort of -- hang around without sort of work and staying home and you're sick, all of these things.

I would be surprised if small biotech companies and large pharma companies shut portions of their sites for any meaningful period of time, if at all. So, I don't know if we stated.

I mean I thought right now, and of course, we're in the midst of the second wave, the second wave, and the first wave and a new second wave for sure, you still think we're going to exit the year pretty much at a historical run rate for research models, both products and services. So, China will be strong in services. We'll be strong in the U.S.

and Europe, which would be by COVID will not be. And we think it's highly unlikely that there will be a major sort of, I mean, unless there's a major shutdown across these sites, which we can't imagine what the rationale would be given the learning curve that we all have and all these institutions have had. So highly unlikely, John..

Very helpful, thank you..

Sure..

Your next question is from the line of Eric Coldwell with Baird..

Thank you, very much. You mentioned the academic share gains said particularly strong there. I'm curious if you could talk about what's driving share gains within that client base versus competition? Number one. Number two, you highlighted that there were some stock ups, I think, specifically in Europe as institutions came back online.

I'm hoping you can talk a little bit about how those stock ups impacted the quarter. And what's the knock-on effect of that? How does that lead to future growth, future comps? How does that really play out in the academic marketplace? Thank you very much..

Sure. So, the stocking up is a result of clients being sort of out of business and not working for some period of time and getting that to work and wanting to repopulate colonies and begin their internal work as quickly as possible. Number one, it's challenging to do and number one, that's not something that you continuously do.

So, I don't think that's a continual process. I think that they stock up to get back to some steady state of operations that they were in prior to COVID. So we're happy to have it. We geared up for that, by the way, Eric.

So, we purposely prepared for that because we anticipated that, that would be this kind of pent-up demand and it would have been frustrating for our clients. If we said, well, we reduced our animal colonies during the second quarter because business was slow, and we just simply can't provide those animals to you. So, it was as anticipated.

The epidemic share gains -- it's quite interesting. So you have several things going on. You have academic medical centers that did some things internally that we obviously would say that unnecessary.

So, they would do a lot of the scale-up of the genetically engineered Model Colonies themselves thoughts of mode the molecular biology and the actual production on their own. And we would say that's a parochial way to run your academic institution.

And we do that every day, and we do that in a much larger scale than you, and we can do that at a lower price point, then we can deliver the animals to you on some sort of just-in-time basis whenever you need them. It could be weekly, it could be monthly, it could be daily. So we've demonstrated that.

And now they're getting used to it in this thinking, wow. So we have a bunch of people in a bunch of space, breathing animals for our work because as we want to start things and studies immediately. And we've seen that we haven't done that.

They also some of the academic institution had their own colonies of specialty strains that doctor X had developed some years ago, whatever, for whatever therapeutic area, Dr. X or Y was working on, and they just got used to, again being parochial and housing those colleagues themselves.

That's also a silly use of this space and pretty risky because I don't think they have the biosecurity environment to breed animals and keep them pristine and if they have some sort of internal outbreak, they can really hurt themselves. So again, they had to they actually outsource those colonies to us and we have them.

And on the GM side, they outsource the breeding work and molecular biology work to us and we have it. I can't tell you that nobody will bring it back in-house because there's a fair amount of parochial, but I can tell that we're getting just does the work is retaining the work.

We're getting incremental work, and we're getting a lot of feedback from clients saying we're so appreciative that you're up and running. We didn't realize how seamless this would be for you to do the work at your site and provide the animals to us at our site, and we actually don't feel like we've given up control.

And as we've probably discussed with you and everyone else on this line so many times, the principal thing that gets in the way of outsourcing for academic or pharma or biotech clients is perceived loss of control over whatever.

Mostly time, this notion that stuff has to be down the hall or across the hall and I think we've demonstrated now for years now that that's kind of an mechanistic view of the world and isn't necessary and isn't a smart way to work.

So, we're quite confident that our academic share -- opportunities, which we've been actually working for years is and will continue to accelerate because we've demonstrated this pretty unique value that we can provide them. And we would anticipate that share continues to grow..

Jim, that's a really excellent detailed discussion, and I don't mean to overly parse the semantics, but this your discussion sounded more like penetration into existing accounts as opposed to perhaps taking share from other providers servicing those accounts? And maybe it's a combination of both.

But to me, that sounded more like a penetration opportunity, selling new things that were done in-house to existing clients.

Is there also a component where you're taking share from other providers?.

I think it's both, Eric. I think what we heard from our clients, this isn't just our perception is that particularly when COVID hit, they were disappointed in some of our competitors' ability to get animals to them, to provide services to them or indeed even be open.

And as I know, because you know us well, some of our competitors, good competitors have a limited geographic footprint. So we also have competitors with a couple of sites where we have a dozen or more sites. And so if one of those sites was closed even for a short period of time, and that was one that was more proximate to the clients.

That would be a disruption in service. And so for sure, we again, this is we exemplified what we've said for years, which is that we have this big international infrastructure, and you can count on us even during tough times like COVID or a hurricane or tornado or whatever. So yes, we definitely got to demonstrate that.

And we heard back from clients with regard to specific competitors who weren't able to support them. And in some cases, competitors who had the lion's share of the work.

They kind of called us sheepishly and said, "I know we don't do work with you, but we're stuck, can you help us? And then, of course, the legacy of that is that we get some or all of the work going forward. I think it's both.

I think it's probably actually more share penetration of work that was done in-house at the clients which is actually, in some ways, more exciting because that wasn't available to anyone. That was just, as I've said before, this kind of internal historic ethos where they said, man, we just got to do the work ourselves.

And this has been a disruptor into that thought process..

Jim, thank you very much. Impressive result. Good luck with the future..

Thank you, Eric..

Your next question comes from the line of Tycho Peterson with JPMorgan..

Hey, good morning. Jim, question on DSA. Well, actually, you flagged the milestone that you received. I'm just curious if your discussions are mix shifting more toward embedded milestones and future work. And then it looks like COVID and other infectious diseases are helping drive safety assessment demand.

I'm wondering for DSA, if you could just talk about the percentage of bookings and coded tailwinds and how you think about the burn of that work, the COVID related work for DSA? Thank you..

Yes. So, I don't think we said it in the prepared remarks this time, maybe we did. So, we want to be careful to say that we are really pleased and proud to be doing so much COVID work for so many clients. I think that some drugs and vaccines, hopefully, to get to market, we will probably have work on. So, we're proud of that.

It's definitely some incremental revenue across multiple business streams, including safety, maybe particularly safety. So, pleased to have it. It's just not a meaningfully large number. So, we just want to be clear about that.

And I think that's actually a pretty good thing that business is so strong across so many different therapeutic areas and therapeutic modalities. With a slight enhancement from COVID. And by the way, we try to get COVID clients priority when we do the work.

The DSA stuff and particularly the discovery milestone work and particularly the milestone that actually paid out. Again, we try to be very flexible in listening and be open to the notion that a client wants to work with us on a milestone basis. I wouldn't say we like it or don't like it. We don't necessarily pursue those types of deals.

If the client wants it, and we think it's a drug. We think the molecule there has promise because we have deep scientific capabilities, and we can usually analyze these things well then we're open to taking a smaller amount of money upfront and a larger amount of money going forward.

For some clients, that's just a necessary way that they want to work. And if we don't work with them, they'll go to the competition. Sometimes, we let them do that, depending on who the client is and what the molecule is. But we are open to -- we have a small number of those deals. So, we don't overstate it. We're happy with them.

Obviously, we help them out on pay out. Some will, some won't. This one did, and that's obviously a really positive thing. Will that client come back and want to do another deal with us with a milestone? Probably, but that worked out really well for both of us. It doesn't mean we'll do the milestone deal if we don't like for a particular structure.

So I'm not sure it necessarily portends more of that work to come. But we are open to it, but I want to be clear that because I know that some people find the milestones, the concern with regard to our P&L and our business structure. And so I think that on the majority of our work is you pay us really well with our services upfront.

We do the work and you pay us with a small number of them, it's sort of you pay us as we both go together, and is that both go together, a portion of it, it's most critical because we definitely endear ourselves to our clients who think of us as having some skin in the game and literally being a partner with them.

And for those clients where that's important, we're likely to be more open to it..

Okay. And then on manufacturing, Biologics, obviously, you doubled your capacity. I know it's filling up quickly.

Are you able to just give us an update on where you are in terms of that capacity being filled and how you think about that for next year?.

Yes. So very, very big site, Tycho. And so it will be a few years. I hope faster, but we have a few years before that fills up. I mean the business is growing very quickly. So, that's a good thing. There's a causal relationship between the growth rate of that business and available capacity.

And while we had a good year in Biologics last year, it was not as because we were capacity constrained. In addition to that big Pennsylvania site, which is kind of the principal driver of growth.

We did add incremental space at several other sites that we had in Europe, particularly Ireland and Germany, and we would continue to probably add space suddenly in those two sites kind of continuously and be very thoughtful and prepared to make sure that well in advance of when we think we will max out in Pennsylvania to add a substantial amount of incremental space because.

So, we can stay ahead of it. It's a pretty good site from a biotech client support point of view. We have a big scientific infrastructure. So, sort of expanding around that would be a smarter thing to do than a totally new site elsewhere.

We also have a small Biologics component in Massachusetts, which obviously is close to Cambridge based and Boston-based biotech companies. So, capacity is in very good shape right now and certainly will be for 2021..

Great. And then just lastly, before I hop off, Jim, I'm wondering if you're willing to comment on '21 at all. I know you don't normally at this time, but a lot of your CRO peers have at least talked qualitatively. The streets got you growing just under 10% next year.

Are you able to talk at all about how you're thinking about the setup for next year?.

I think all I would say about '21 because it is premature for us. We usually do it during our February call, which is when we will do it again and give you greater clarity.

I think what I would say now, just kind of directionally is we don't see any indications that the current demand curve pretty much across the entire portfolio will be any different. The funding has been extremely robust for the biotech industry as strong or stronger than ever.

The numbers of IPOs has been dramatic, and the amount of M&A has been really good for that -- for those companies. A lot of pharma work, not just in COVID but outside of COVID, cell and gene therapy being a big driver of growth.

This outsourcing thing that I was just talking about earlier with one of your colleagues, I think that that will hold us in good stead as we'll see more outsourced work. Obviously, we have a good comp with I hope, with the second quarter of RMS. So, I think that should be beneficial for us.

Hopefully, we see the ability to install more units with microbial that -- which have been held up because of our inability to get into our clients. But the overall demand for our services across the portfolio should be consistent. So, that should give you a good sense of at least where we think the top line directionally is moving..

Okay, thank you..

Thank you..

Your next question comes from the line of Robert Jones with Goldman Sachs..

Great. Thank you for the question. Yes, Jim, clearly, RMS is probably the one segment this year that was a little volatile because of COVID. I think manufacturing support in DSA held its own fare pretty well. Certainly, this quarter seems like things are getting back to normal across all three segments.

If I think about the margin opportunity from here for those businesses, assuming things hopefully stay relatively normal as we look forward. Manufacturing support in RMS specifically, performing very well already above the long-term guidance from a margin standpoint.

Could you just maybe help us think through where the margin opportunity could be on the forward across the businesses, but I guess, in particular, as it relates to manufacturing support in RMS?.

Sure.

David, why don't you take that?.

Yes. So well, Jim has already mentioned that we don't want to get into too much detail about 2021 because that's not our normal cadence. What we would say about the margin is that we are still, of course, focusing on achieving that 20%, and this year, we expect to be very near it. We still believe there is potential to go beyond the 20%.

That is something that we've made public before, and we still stand by that statement. But at this stage, I think it would be too premature to get into detail.

What I would say is that there were two key drivers that we had outlined back in September last year at our investor conference, one of which was the DSA and we've seen in Q4, a 240 basis points increase. Q1 over Q1 was 340.

Q2 over Q2, 210 and this quarter, we've seen another 310 basis point increase so we are now getting into the ZIP code of that sort of mid- 20s with DSA. So, we're obviously very pleased with that.

We had called out that the way we got there was through integrating our acquisitions, generating synergies from those acquisitions, eliminating redundancies and just leveraging on the staff capacity that we have. The second driver that we've called out is leveraging our unallocated corporate costs.

And over the last several years, we've been bringing that down to about 50 basis points as a percentage of revenue and continuing to do that into this year as well, getting the leverage from the sort of way we've built our back office units.

So yes, I guess, we'll say more in February in terms of specifics as to where we think we would be going next..

Okay, great. Appreciate that. Thank you, David..

Okay. Next question comes from the line of Erin Wright with Credit Suisse..

Okay. And in terms of your view on the acquisition and partnership opportunities amid the pandemic? And would you say the pipeline is larger versus a year ago? Or what are you seeing out there from a steel pipeline standpoint? Thank you..

So, we're really enthused about the strategic partnership strategy that we have. And we have nine deals across a whole host of cutting-edge technologies from artificial intelligence to next-generation sequencing and on and on.

And they're wonderful relationships to actually do living due diligence on these companies, some of which we, for sure, will buy, and we will have really in-depth knowledge of how the businesses operate, responsive to clients, how robust the technology is.

And we expect to buy some of them, we expect that they will give us a competitive advantage because most of these technologies are unique. And highly proprietary. So there's a lot of those. So we have nine signs. We probably have an equal number under conversation pretty far along. Some at LOI stage, some in early discussions.

So we probably will have a universe kind of on a consistent ongoing basis of 20 or so of these all kinds, and some of them will fail, some of them will continue as joint marketing relationships, and some of them will be acquisitions. So, that's a really strong source. I would say that pipeline for straight up M&A is remains quite good.

I would say most of the sellers or private equity firms, which means that all of the companies are to sale at some point, you have to try to get in sync from a timing point of view. I can't make a generalization of what our expectations are with regard to margins because it depends on the asset and the competition for that asset.

But, we feel that we have refined methodology to value these businesses and we have got a strong balance sheet right now with reducing leverage. Our leverage has come down, I think, to the mid-2s. We have a bunch of conversations going on now, as we always do across several different products and services across different parts of our portfolio.

I would say, even though you didn't specifically ask us that none of the things we're looking at are very large, I'd say, a couple of modest size and some are small. But they all would very much improve and enhance the quality and competitive strength of our portfolio.

We have no artificial goals to buy a certain number of companies or add a certain amount of revenue, but we do have a very strong strategic goal to continue to broaden the portfolio.

And we think that we don't just say we know that our portfolio, the breadth of it, in particular, has become our principal distinct competitive advantage, so we want to continue to enhance that advantage..

Okay, great. Thank you..

Sure..

Our next question comes from the line of Elizabeth Anderson with Evercore ISI..

As a manufacturing operations, you were helpful in talking through the utilization in the new Pennsylvania side as we move forward, is there any other puts and takes there that we should think about? Or in terms of using that 3Q number sort of like a like run rate number to go forward with at this point?.

I'd probably would be careful to use the Q3 number since it was an exceptionally strong quarter, but that's -- this is a market that's probably low double-digit growth, we have two parts of the business in the but I think both of these businesses have the capability to continue to grow at low double-digit rates. We don't sort of break them out.

I think the market dynamics are really strong for both of them. I think COVID enhances it more for both of them. I think, cell and gene therapy enhances it even more than that. I think our ad capacity and biologics absolutely has meaningfully increased our prominence in that space.

I think our expanded manufacturing capability, the M&A that we've done, the new pieces of equipment, software enhancements that we've added to our microbial business has made us a leader in bacterial contamination and detection.

And so yes, I don't know whether you want to walk onto any particular quarterly run rate because, as we say almost every quarter, we don't have a linear business. We like you all to look at our business on an annual basis. I think our ability to call it on an annual basis has been quite accurate for the last few years.

But we think that we have a strong market demand and the right infrastructure to continue to take advantage of market demand and to take share across both of those markets.

So we would expect manufacturing, which obviously had an exhilaratingly high operating margin and very high-growth on the top line in the third quarter to continue to be a really strong business for us for a long time..

Perfect. That's very helpful..

Your next question comes from the line of Juan Avendano with Bank of America. Q - Juan Avendano Follow-up on the M&A pipeline.

As you look into that pipeline, are you focusing on service-oriented assets or what is your point of view on the numerous technology-oriented assets that are out there trying to describe drug discovery and clinical development space? I mean given your addition of George to the Board and his prior experience in information technology, should we expect Charles River to become more involved on the technology side of things?.

I think you should expect Charles River to continue to utilize data in more impactful ways, both to operate our business more efficiently, to connect with clients more efficiently, to design better studies with hopefully better outcomes for our clients and to hopefully use all of that data to accelerate the work that we do for our clients.

So yes, we have both products and service businesses that we're looking at. I don't think we have a preference for one, even though our business is we our lineage is product, and our current portfolio is principally services, it must be 75% or 80% services right now.

But of course, HemaCare and Solero product businesses with extremely high-growth and good operating margins. So the Animal business, so is the microbial business, so is the Avian business. And so we're good at product.

We're good at driving efficiency in manufacturing and delivery of those products, but also, we have, obviously, a larger and significant service component where I also think we've done a very good job in driving efficiency and better connectivity with our clients. So we're looking at both. We haven't sort of sought one out over the other.

There are definitely some product businesses that would like to add and hopefully will. And the -- there's probably more opportunity on the service side, just to put a punctuation on it..

Thank you, Jim. Congrats on the quarter..

Thank you..

Your next question comes from the line of Dan Brennan with UBS..

Microbial Solutions part. I know that business has been a little more impacted due to COVID, as you've talked about.

Any -- could you maybe give us a little more color on the extent of that impact? How much been hampering growth? Any color about kind of the rate of improvement that we could potentially see as we go forward?.

Yes. So, it's a tough one to call. It's an extremely well-run business with really terrific demand. It's been the business has been as strong as we've seen it. We have these three product lines, all of which I think there's a meaningful demand for, as I said a moment ago, cell and gene therapy and COVID have definitely enhanced the demand.

We sell these systems that have reagents or cartridges associated with them. So, let's get this razor blade capability or structure. And I think that aspect of it continues unabated for systems that are out there.

And so, people continuously need to use these reagents as they do testing to see whether the drugs will be contaminated, what the social contamination is. So it's a steady business, highly profitable business with, I think, good growth metrics.

We have a fair number of systems, mostly large systems that are very complicated, where we usually go in and do an install. People go in, our people go into the client, and the client has to work with us for some period of time to understand it, understand the software and understand how to qualify the system for their own regulatory folks.

And so we have two issues now. One is that sites are closed and such is just closed or sites are closed to outside people. And so we as we've just reported in the third quarter, we had some of those sites that were closed open.

And we were able to work out virtual installs with some clients for some of the less complex systems, particularly for clients that understood them. But you hit a little bit of a wall there.

I do think that out of necessity, and my analogy would be that the FDA is auditing Charles River facilities and USDA is auditing the Charles River facilities and clients are auditing our facilities virtually, which is something they've never done before. And they probably don't like it.

But that's the way we have to do business or R&D development grinds to a halt. So I do think that in the I'm not going to say likely or unlikely event. I don't know. Assuming the sites that we hope will open don't or COVID is so gets so red hot that they just don't allow outsiders in.

And the clients really need our gear to make sure that what they manufactured is safe enough to be sold to the clinical trials or to the end use market. Then I'm confident that both we and them and concert will figure out a way increasingly to virtually do this.

It will be -- it will feel less elegant and more awkward and probably take longer, but it's possible. So, we're working on that real-time to provide a simpler solution and I think as clients need it more, hopefully, we'll figure out a way. I don't want to give a prognosis on when I think will pass because it's impossible.

And it's sort of the only remaining legacy, a manageable one I might add. But the only remaining legacy, kind of headwind legacy from COVID, which we're delighted with is that we're moving through well, but it still exists..

Okay. Thank you, Jim..

Your next question comes from the line of Patrick Donnelly with Citi..

It's been one of the big beneficiaries of some of the COVID work.

Can you just talk about how you're prioritizing some of that work versus what's in the portfolio? And then also just kind of thinking about that over the next few quarters? Are you generally just going to see some of the early work in that phase as you get more toward the vaccine commercial process? Just trying to think about the durability of some of those tailwinds..

I meant the -- some reason I have a delay for the first few words of everybody's question.

So, what is your -- what was one of the question?.

It was on the safety side. Just around some of the COVID work, the durability, just given you guys tend to be a little on the earlier side in terms of seeing some of the revs.

Just wondering as we go through the next few quarters, how that trends?.

Yes. So, I just want to emphasize the fact that it's a subtle relatively minor amount of revenue. I think it's more about the pride and the financial impact. Yes, these drugs and vaccines that get into the clinic we'll have to have been safety tested first. They don't have to do it with us, but lots of them are. So we're seeing the benefit of that.

There's a pretty healthy number of drugs and vaccines in development, many of which aren't in the clinic yet. So without getting too specific, we still are enjoying some of the benefits of that, and we'll continue to. I think it's so minor and so subtle that as these drugs hopefully move through the clinic and get approval into the market.

And I think it will be room for a certain number of them. I mean, assuming they're effective COVID therapeutics. I don't know how many one needs, right? Or effective vaccines. I don't know how many we need. So unless effective drugs or vaccines are elusive.

And none of these things work, and they just keep making new ones and have new shots on goal, I think we sort of whatever minor positive impact we're getting -- we sort of moved beyond that. I don't think it will be discernible.

I think our business is so big now that this is a pretty modest part of what we do and even in safety, which, of course, is our biggest business. So as we've said before, happy to have the work. It we're happy to do the work as long as it's available, we probably will move through that at some period of time now..

Okay, that's all. Thank you, Jim..

Sure..

Our next question comes from the line of Jack Meehan with Nitram Research..

Good morning. Hey, Jim. There's been some discussion around some supply chain constraints when it comes to nonhuman primates just being shipped around.

I was curious if you've seen any of that? And how you manage through it?.

So, an important part of research in a whole host of areas, particularly for large molecules and have -- it's a model that's been important for years. Supply sources are pretty much external. They're coming from places like China and Mauritius and Cambodia and Vietnam.

And so we work really hard to have multiple supply sources from multiple geographies and multiple suppliers within those geographies and have close working relationships with them to ensure exceptional veterinary oversight and supply numbers that are consistent and preferably and hopefully always well in advance of when we need these animals because it's an important resource.

And so, we have always worked really hard at ensuring that supply -- overall supply and the numbers have ticked up over the last few years, so more suppliers are necessary. And we feel really good about our supply situation about our road to have certainly a sufficient number of analysts for the balance of this year and well into next year.

And it's a continual dialogue with the suppliers to try to match the supply with what we anticipate the need will be based upon what we hear from our clients. But I think we're doing very well resourcing in HPs..

Thank you, Jim..

Sure..

Our final question comes from the line of George Hill with Deutsche Bank..

Yes. Good morning, guys and thank you for taking the question. I'll keep this from brief. As it relates to kind of the cost reductions and the margin improvement as a result of COVID, some of it, I'm sure, has to be temporary.

Have you guys kind of quantified how much of the cost basis comes back as work kind of resumes to normal versus how much you think is permanent improvement? And then maybe, I guess, kind of, Jim, I know you're not talking about 2021, but what should the next margin target look like?.

I'll let David take that question..

Yes. So I'll cover both the revenue and the temporary cost reduction. So, when we sort of spoke to you in May, we thought that we could have a revenue impact, as high as $250 million in a sort of downside case. When we spoke in August, we felt good about what we saw in Q2 that we reduced that down to $100 million.

And now with the strong Q3 result, we've got that down to $70 million headwind. And of course, as you know, that's mainly in research models, a little bit to do with microbial and the inability to get the instruments installed. So, when we look at the temporary cost reductions, that's also come down.

When we last spoke, we said $40 million, and we're still holding to that $40 million. The majority of those cost savings came in Q2. But what I can share is that the amount in Q4 is going to be about half that of what we saw in Q3. So, that's beginning to tail off now in terms of the temporary cost reductions.

Of course, as we bleed into 2021, we may still see some benefits in terms of less travel than we used to do. But by and large, much of those cost reduction initiatives are now behind us. So, in terms of your question in terms of headwinds as we go in, clearly, there's a little headwind still legacy from Q2, where most of those savings took place.

But broadly speaking, we're exiting with the exception of travel, much of it now behind us..

Thank you..

Great. Thank you for joining us today on this morning's conference call. We look forward to speaking with you at several upcoming investor conferences. This concludes the conference call. Thanks..

Thank you ladies and gentlemen. You may now disconnect your lines..