Good day, and thank you for standing by. Welcome to the Charles River Laboratories First Quarter 2021 Earnings Conference Call. I would now like to hand the conference over to your speaker today, Todd Spencer, Vice President of Investor Relations. Thank you. Please go ahead, sir..

Thank you. Good morning, and welcome to Charles River Laboratories First Quarter 2021 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 first quarter of 2021.

Following the presentation, they will respond to questions..

Thanks, Todd. Good morning. I'm very pleased to speak with you today about another exceptional quarter at Charles River.

Our robust first quarter financial performance, highlighted by 13% organic revenue growth and 170 basis points of year-over-year operating margin improvement demonstrates the strength of the biopharmaceutical market environment and the power of our unique portfolio, both of which we believe are as strong as they have ever been.

We believe clients are increasingly choosing to partner with us for our flexible and efficient outsourcing solutions, with scientific depth and breadth of our portfolio and our unwavering focus on seamlessly serving their diverse needs.

Clients are opting to work with a smaller number of CROs who offer broader scientific capabilities which enables them to drive greater efficiency and accelerate the speed of the research, nonclinical development and manufacturing programs.

The complexity of scientific research is also increasing our clients' reliance on a high-science outsourcing partner like Charles River. To further differentiate ourselves from the competition, we are strategically expanding our portfolio in areas that deliver the greatest value to clients and offers significant growth potential.

Already this year, we have enhanced our scientific capabilities for advanced drug modalities through the acquisitions of Distributed Bio, Cognate BioServices and Retrogenix. Distributed Bio and Retrogenix strengthen our discovery portfolio..

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 charges, costs related primarily to our global efficiency initiatives, our venture capital and other strategic investment performance and certain other items.

Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation. We're very pleased with our accomplishments in the first quarter, which widely outperformed our outlook.

We delivered strong revenue growth, well above the 10% level on an organic basis and significant operating margin expansion of 170 basis points, which drove earnings-per-share growth of 37.5% to $2.53.

The operating margin performance was particularly encouraging as the consistent margin improvement reflects our efforts to build a more scalable and efficient infrastructure and leverage the robust growth in our end market.

As Jim mentioned, we have increased this year's financial guidance to reflect the enhanced growth profile for the full year, including the strong performance for the first quarter and the addition of Cognate and other acquisitions that we have completed.

We now expect to deliver reported revenue growth of 19% to 21% and organic revenue growth in a range of 12% to 14% for the full year. Given the robust top line performance, we expect to drive meaningful operating margin improvement this year with the full year margin approaching 21.

This is expected to drive better-than-expected earnings per share in a range of $9.25 to $10, which represents year-over-year growth above 20%. By segment, our outlook for 2021 continues to reflect the strong business environment and the differentiated capabilities we provide to support our clients' needs.

RMS organic revenue growth guidance for the year is unchanged from our initial high-teens outlook, reflecting recovery from the impact of the COVID-19 pandemic last year, exceptional growth in China and the expectation of our cell supply revenue growth will improve during the year.

The DSA segment is now expected to deliver low double-digit growth for the full year, reflecting the strong first quarter performance and intensified early stage research activity. For the Manufacturing segment, we now expect to achieve mid-teens organic revenue growth, with both the Biologics and Microbial Solution businesses contributing.

Including the acquisition of Cognate, Manufacturing's reported revenue growth rate is expected to be in the high-30% range. With regard to operating margin, RMS will continue to be a primary contributor to the overall improvement for the year, with the segment margin meaningfully above 25%.

We also expect the DSA segment operating margin to increase over the prior year into the mid-20% range. When factoring in Cognite, the Manufacturing segment's operating margin is expected to be in the mid-30% range this year or moderately below its 2020 level.

Unallocated corporate costs was slightly higher than our expectations, totaling 6.2% of total revenue or $51.2 million in the first quarter compared to 5.6% of revenue in the first quarter of last year.

The increase was primarily the result of continued investments to support the growth of our businesses and higher performance-based compensation costs due in part to the first quarter operating outperformance.

Despite the higher expenses in the first quarter, we continue to expect unallocated corporate costs to be in the mid-5% range as a percentage of revenue for the full year.

The first quarter tax rate was 14.5%, a 20 basis point increase year-over-year and consistent with our outlook in February, which calls for a tax rate in the mid-teens due to the gating of the excess tax benefit from stock-based compensation.

We continue to expect our full year tax rate will be in the low-20% range on a non-GAAP basis, which is unchanged from our outlook provided in February.

Total adjusted net interest expense for the first quarter was $17.1 million, which was essentially flat sequentially and a decrease of nearly $2 million year-over-year due to lower average debt levels, which resulted in interest rate savings based on our leverage ratio.

At the end of the first quarter, we had $2.2 billion of outstanding debt, representing a gross leverage ratio of 2.3 times and a net leverage ratio of 1.9 times. In March, we issued $1 billion of senior notes to further optimize our capital structure and take advantage of the attractive interest rate environment.

The proceeds of this bond offering we used to redeem a previously issued higher-rate $500 million bond to pay down the existing term loan and a portion of the revolving credit facility and to finance a portion of the Cognate acquisition.

In April, we also amended our existing credit agreement to establish a new revolver with borrowing capacity of up to $3 billion. The net result of these actions will reduce our average interest rate on debt by approximately 50 basis points to 2.65%. An overview of our current capital structure is provided on slide 36.

On a pro forma basis, including the Cognate and Retrogenix acquisitions, our gross leverage ratio was just under three times, and we had total debt outstanding of slightly below $3 billion.

For the year, the higher debt balances due primarily to Cognate acquisition will be partially offset by the lower average interest rate from these refinancing activities, which is expected to result in total adjusted net interest expense of $83 million to $86 million.

Free cash flow was $142.2 million in the first quarter, a significant increase compared to $42.9 million last year. The primary reason for the improvement was the strong first quarter operating performance, along with our continued focus on working capital management.

Capital expenditures were $28 million in the first quarter compared to $25.7 million last year. Looking ahead, we are increasing our capex guidance for 2021 by $40 million to approximately $220 million. The increase primarily reflects the investments we are making in Cognate to support its high-growth business.

Even with the additional capital, we expect capex will remain below 7% of our total revenue this year, which is consistent with the target that we provided at our last Investor Day in 2019.

For the full year, we are updating our free cash flow guidance to the upper end of the prior range and now expect free cash flow of approximately $435 million for the full year.

We are pleased to be able to increase free cash flow due primarily to the strong first quarter operating performance, even after incorporating the transaction costs and capital needs of Cognate. A summary of our revised financial guidance for the full year, including Cognate, can be found on slide 38.

For the second quarter, our updated outlook reflects a continuation of the strong demand environment. We now expect second quarter reported revenue growth at or near the 30% level, including the contribution of Cognate. On an organic basis, we expect second quarter growth rate to be at or near 20%.

This reflects the prior year comparison to the COVID-related revenue impact, which will contribute approximately 700 basis points to the second quarter revenue growth.

As a result of the impact of COVID-19 on the second quarter of last year, we expect this year's second quarter non-GAAP operating margin and earnings per share to increase significantly versus the prior year. Our expectation for non-GAAP earnings per share is a growth rate of more than 50% year-over-year.

In conclusion, we are very pleased with our strong first quarter performance, which included robust revenue aims and free cash flow growth.

We remain confident about our prospects for the year and our ability to consistently grow the top line, bottom line and cash generation, and as such, believe this is reflected in the substantial improvement in our outlook. We look forward to hosting our upcoming virtual Investor Day in a few weeks.

At that time, we plan to update our longer-term financial targets, which we believe will reflect the strong demand environment. Thank you..

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

Our first question comes from John Kreger of William Blair. Your question please..

Hi. Thanks very much. Jim, given all the Cognate commentary you gave us, can you just step back and help us understand what part of the CDMO industry are you interested in playing in kind of over time, longer term? Development, drug product, drug supply? If you could just elaborate on that, that would be helpful..

Sure, John. So Cognate gives us the ability, and particularly in combination with HemaCare and Cellero, to provide -- to actually provide the cells to do the process development, to do the clinical trial scale up, and ultimately, to provide commercial quantities specifically of cell therapy products.

And secondarily, we have some of the capabilities that are involved in and facilitate gene therapy manufacturing as well. But I'd say that the CDMO business will be primarily cell therapy-related..

Great. And then last month, you guys talked about Valence strategic relationships, which had some references to AI and machine learning.

Can you just talk a little bit more about how you see machine learning having applicability within, I assume, DS&A mainly?.

Sure. Look, there's a huge amount of focus on utilizing data to inform the design of preclinical trials to achieve better outcomes. And I think, ultimately, the proof to design better clinical trials to achieve better outcomes and then to provide some correlation between the two of them.

And so there's a rich amount of data, and I think Valence is a particularly strong AI company. We're going to see attributes or aspects of this, I think, all around our portfolio.

We don't see this as a replacement for things that we do, but we see them as augmentative and/or earlier -- provide earlier indications of how a drug is likely to perform before we get into, let's say, nonregulated and certainly regulated safety trials.

So the advent of AI should both enhance speed, and hopefully, outcomes in terms of the numbers of drugs that get to market. And between the rich data sets that we have and their facility with AI, it should be a very interesting combination, albeit very early days..

Very helpful. Thank you..

Sure..

Our next question comes from Eric Coldwell of Baird. Your question please..

Thank you very much. Impressive quarter. I'm focused on Safety Assessment, DSA segment. You cited record RFPs, record demand in Q1. That obviously follows the 2020 DSA segment-ending backlog of $1.4 billion, which was up 40% year-over-year, yet you're only forecasting low double-digit organic revenue growth in the segment this year.

When we look at prior year's beginning backlog and how that compared to the resulting revenue growth, the math would, frankly, suggest multiples of what you're guiding to.

I'm just curious what explains this disconnect from past backlog growth to your outlook for low double-digit growth this year?.

Want to take a shot at that David?.

David, are you still connected? If so, you might be on mute. I think we lost David. He might have to come back in..

Okay. Okay. That's OK. So the way we look at this, Eric, is that we've got -- we're thrilled with the demand. We're thrilled with the backlog. We're delighted with the way the year has started. We're really optimistic about the guidance that we provided, the fact that, that segment will be organic double-digit growth rate.

It's still early in the year, so we want to see how more of the year unfolds. But we're quite confident and comfortable with our guidance for the year. And again, as we discussed quarter after quarter, there is nonlinearity in our business.

So things sort of move identically quarter-to-quarter, increase literally, not necessarily at the same rate quarter-to-quarter. So we think this will be a very strong year that we've guided to..

Well, Jim, it certainly doesn't look like you're going to miss that target. I'm just curious, I mean, pricing, I mean, can't be bad in this environment.

And it just leads me to wonder if there's a big mix shift in the nature of the work, if there's capacity constraints happening, it makes me wonder if there's something in that backlog report from last year that you changed how you look at backlog or the reporting of the figure because it just historic trend, if I go back, even stripping out acquisitions the last five years, it just the growth rates would be if history repeated itself, the growth rates would be materially higher than what you're talking about.

And it just seems these are awesome numbers. I'm not complaining obviously, but it seems like a bit of a disconnect..

So maybe we'll take it off-line. But just to provide some comfort, Eric, and I understand the nature of your question. Pricing sign, capacity is well utilized, but we have sufficient capacity.

And as I said in my prepared remarks, we actually have clients booking more work earlier, I don't know, because they have more work because they're better funded in. Maybe there's an underlying concern that none of us or our competitors will have the capacity that they want when we need it, although we work really hard to do that.

The mix is solid, and we're getting a significant amount of work from big drug companies, a little bit instigated by COVID, but also just a plethora of new biotech companies. So nothing but good things are happening. We're pleased with our articulation of good things happening and what that reflects in terms of financial guidance.

But maybe we should just talk to you off-line and get you more comfortable with the ebb and flows..

Yes. That sounds great. And again, congrats on overall performance. Really good..

Yes. And I'm back on. I'm sorry, I hit speaker button instead of the mute button. Was happily chatting away to myself. And then when I saw that it's mute, I realized that I hadn't heard what Jim was saying, but I get the impression that you were discussing about how the backlog has been built up because people are booking out further afield.

And one of the reasons why we've been able to increase our outlook this year is because we can see much more of the year. So if that was discussed, I won't repeat it..

Eric is pleased with what we're doing, but thinks that the guidance for the back half of the year should be materially higher given how we ended the year, given where we are now and given the ebbs and flows of the business, with pricing, and I explained that we were pleased with the year-over-year guidance, that things weren't linear, that nothing but good things was going on from a demand and pricing and mix point of view.

And that's when you came in there..

Good..

Our next question comes from Dave Windley of Jefferies.

Your question please?.

Hi. Thanks for taking my questions. I won't exactly follow on Eric's question. I think you addressed that well enough. But you have pointed out, Jim, Discovery's stronger performance for a couple, maybe three quarters.

And you also commented, in general, in your prepared remarks about continuing to seek ways to add value for clients in DSA, which is a general comment, but I wonder if maybe it's not related to the growing Discovery business and potentially pull-through there, which we've asked about for years.

So I wondered if you could kind of elaborate on the adding value to clients and DSA part of your comments..

Yes. Yes, the Discovery business, as we've been talking about for at least a couple of years now, has really come into its own just in terms of client utilization, understanding of the depth and strength of the scientific portfolio. We've been adding additional businesses like D Bio and Retrogenix. And we have scale now.

So we've got terrific organic growth, even though we don't break that out, and meaningfully improving operating margins in that segment as well as a pull-through into Safety. And of course, we're seeing high growth rates and nice margins in the Safety business as well. And I think we have a very strong capacity situation in both of our businesses.

So we're really pleased with the demand. We're really pleased with the client uptake. It's largely driven by biotech clients. Having said that, we have a lot of big pharma clients who are sourcing more of their work to us, for sure, in Safety, and they have been for a while, but increasingly in Discovery.

And as we keep adding these assets either through direct straight-up acquisition or the strategic initiatives that we've been pursuing vigorously, I think that will only intensify..

When you think about -- to follow up, when you think about your capital deployment appetite, I guess there are some deals discussed in the public markets regarding monetization spin-off of potential assets. You've now dipped your toe into contract manufacturing, to John's question, that's a relatively capital-intense area.

I wonder if you could kind of give us a rank order or a priority list of where your capital deployment appetite primarily resides..

Sure. The sites continuing to invest appropriately in our businesses, all of which are growing. So most of our capex is growth-related. But as we reiterated in our prepared remarks, we're going to keep capex is going to stay below 7% of revenue even with the addition of Cognate and the capacity that's required there.

But all of our businesses require additional capacity, certainly. Certainly, Safety does as well. So putting that aside, we're going to continue to do these technology deals in which we have about a dozen that are signed and another dozen in conversation. Distributed Bio was one of those that turned into an acquisition.

Retrogenix began to be one of those and just pivoted immediately into an acquisition.

And we have other deals in AI and bioinformatics and digital pathology, next-generation sequencing, environment traumatic and 3D tumor modeling that are cutting-edge technologies, and we're going to invest small amounts in those businesses or loan them some money and some of those, for sure, will be acquisitions.

And they won't be particularly large companies and particularly expensive acquisitions, but they will grow rapidly. They'll enhance the portfolio, and they will distinguish us from the competition, not entirely, but particularly in the discovery.

And I would say, besides those deals, which I don't know what the cadence will be, but I think we'll have a couple of dozen things that we're kind of participating in, and we'll buy some of them. We're going to do some straight up M&A in the discovery space.

We're going to hopefully do some more straight-up M&A, sort of in the general ambit of cell and gene therapy. We'll do some more straight-up M&A sort of lab sciences area. We'll do more work in sort of aspects of biologics and microbial. And we actually have a couple of things that would fall into RMS. So the conversations, as always, are several.

They're almost all private equity-owned businesses, which means that they're all for sale at the right time and in the right price. Nothing would take us off the reservation. They would be continued additions of what we're doing.

If you have the underlying thesis of the question is, what additionally might you do in the CDMO space, specifically? I can't say that categorically, except to say that our focus for the foreseeable future is primarily in cell therapy and secondarily in aspects of gene therapy.

And I think that we are currently a meaningful player in the cell therapy space and could be the most meaningful player in that space, where we just continue to grow the business in and add additional parts and pieces.

And I think you understand fully that surrounding this surrounding the CDMO activities and cell and gene therapy is the cell product businesses and buttressed by the Biologics business. So that's a powerful portfolio, and then that's added further with the combination trials for pharmacology and toxicology.

So it's a broad suite of offerings in cell and gene therapy, which is the largest and potentially the most exciting modality. And we'll see where it all goes. There's a couple of thousand drugs that are being worked on right now. We're probably working on a significant number of those. Yes.

So that's the nature of our focus in M&A, and particularly, in cell and gene therapy..

Great, very helpful. Thank you..

Sure..

Our next question comes from Robert Jones of Goldman Sachs. Your question please..

Great. Thanks for the question. Jim, I just had two related to capacity on the Safety Assessment side and then the newer CDMO capabilities. I know on Safety Assessment, just wanted to get a little bit of a better sense on your comments around clients booking further in advance of actual work.

And just related to that, how you're thinking about capacity? Do you think, as what you're seeing trend, that you might need to be adding capacity? I know it's always a tricky dynamic to match supply and demand within Safety Assessment. And then just the second question around CDMO.

I know last quarter, you said you were going to assess if you needed to add more capacity there. Just -- I know it's not too far from when you made that comment, but just curious if there's any updated thoughts on the CDMO footprint..

Sure. So we have been adding incremental amounts of capacity every year. I'm going to say five or six years, but I think it's longer because the Safety Assessment business began to come back strong -- began to sort of flatten out in 2012 and began to come back strong in 2013. So it's probably seven or eight years.

And since proximity is important and since we have a dozen Safety Assessment sites, we can't and won't just add space at one locale nor would we add all the space in the U.S. or all the space in Europe. So I don't know.

We added at least half a dozen sites incremental amounts of space, depending on client demand, depending on capabilities, depending on how the space is currently utilized and depending on where we see the market going. So we have always done that. So we did in 2020 for this year. We're doing it now for next year and probably for '23.

We're obviously realtime as we -- as the demand is exceeding our plan and our original guidance, which is a high-class problem, thinking very carefully about do we have to add more incremental capacity for this year. And I don't think we have an answer to that. If we do, it will be subtle.

So those of you who are concerned about our capex spend, for whatever reason that might be, shouldn't be concerned. We have a high-growth business, and we have to provide the capacity we won't have the business. We love the fact, by the way, that clients are booking earlier. That's so good for us. It's so much more orderly.

I think there's a conduit there with pricing. So I think that the pricing is still an issue with them. Don't get me wrong, but I think they're less concerned about price and more concerned about science and getting a slot.

So keeping capacity relatively tight, so our margins are good, and so clients are desirous of getting in the queue early is a really good thing, subject to the caveat that you don't want to run out of space and turn clients away. So as you indicated in your question, we're always walking that tight rope. I think we're really good at it.

It's not a perfect science. But we will add additional space. We're adding it right now, and we'll continue to add through the year. We probably will crank it up a little more than we would have as long as we feel that this demand will continue certainly through the back half of this year, which I think we've guided to and for next year.

On the CDMO space, particularly on the Cognate space, particularly with cell therapy manufacturing aspects of it, there is -- we bought incremental capacity. That's in place. So we're fine. We obviously have to finish -- add and finish additional space for next year and beyond based upon both, not only the client demand but the nature of the demand.

So is it some, the clients in Phase II? Are they in Phase III? And are they hinting about and wanting us to gear up for commercial launch or not? So we have to roll all of those things up. We have certainly sufficient capacity to accommodate the demand for this year and probably the beginning of next year, and we'll add more space there.

So capacity and head count, the rate-limiting factors in the business, not demand. Demand is not a right limiting factor right now, which is a beautiful thing. Having the space is I don't mean to be flip about it, but it's relatively straightforward. It's just planning and cash.

And you've got to get the planning really early because it takes a while to build space. And tox is probably 18 months or so, maybe two years to get the space we built and validated its greenfield, maybe 12 to 18 months of an addition. And maybe it's a little bit shorter in the CDMO space. It's probably nine to 12 months.

So getting the space built ahead of when we need it and getting people hired and trained ahead of when they need it accommodates the -- there's a sufficient capacity to accommodate to the demand and allows us not to be short. And by the same token, we don't want to have too much space or too many people sitting around, nothing to do.

So it's a constant balancing act..

Appreciate your thoughts. Thanks, Jim..

Sure..

Our next question comes from Tycho Peterson of JPMorgan. Your question please..

Hey, thanks. Jim, on manufacturing, you talked about COVID vaccine testing intensifying. I'm curious how we should think about that dynamic. Curious if you can quantify what's actually baked into the outlook on COVID. I think last year, you said it was about $60 million across the portfolio.

And then as we think about Cognate, one question that comes to mind is why people would work with you versus Catalent that has Paragon and MaSTherCell, Thermo that has Brammer.

So can you just talk a little bit about how you think about competitive positioning for Cognate?.

Sure. The numbers that we called out last year that were clearly COVID-related, I think, fall into a different category than what we're going to see this year, what we're seeing this year. Plus I don't think it's a useful piece about it.

I mean we teased out last year because we had a tough second quarter, where revenue was down in RMS and a little bit in Microbial and a few other things that we were watching accost tightly and etc, etc. We were trying to make sense of it for our investors.

I think on a forward-going basis, while there's going to be some meaningful but modest, because it was modest last year, going to be some amount of continued work on COVID-related therapeutics, monoclonal antibodies and antivirals. Drugs to treat people who get the disease, perhaps if they have been vaccinated or not.

On an ongoing basis, though, our Biologics business is going to do a lot of testing of COVID-related vaccines. And I think we're probably going to move into a genre of it being flu-like. And there'll be booster shots next year and new variants every year, and they will always make it. I don't know who give will be.

At least the four companies who already have vaccines and perhaps others and companies like that will continue to test it. So I don't think it's all that useful to break it out or try to break it out going forward because I think it will just be an ongoing business.

And so Biologics, while a really strong business for us and there's lots of large molecule products besides what I'm about to say, like monoclonal antibodies and others and there's no question that cell and gene therapy COVID-related work will be really, really critical.

Why someone would work with us? Well, I think the two companies that you mentioned are principally in the gene therapy manufacturing space. So cell therapy manufacturing space, we have smaller clients -- sorry, smaller competitors who are around the same size as we are in cell therapy manufacturing but don't have the large suite of services.

So the ability to work with us from very, very early research to process development through the clinic to end-use work, I think it's a distinguishing feature of our portfolio. And by the way, we continue -- hope to continue to add to that. So hopefully, more of a holistic approach.

The competition helps clients with speed to market, and they don't have to pause at each step and work with somebody else..

Okay. That's helpful. And then follow-up, just curious about the sustainability of some of the trends you called out. At RMS, you talked about GEMS, this resurgence around outsourcing, managing proprietary colonies.

How much of that came from the pandemic? And how much of that do you think is sustainable? And then separately for DSA, you've called out the pricing increases and client securing space ahead of time a number of times on this call. I'm just curious how you think about the sustainability of those trends as well..

I feel really good about the sustainability of both of them. So GEMS has been a nice growth business for us for at least a decade. Those models are critically and increasingly important for basic drug research. There's a whole bunch of services associated with producing those models, and they're complicated to produce and providing them to the clients.

I think we got a little pop because of COVID, which we will keep. And I think the demand for these models, which continue to be more sophisticated, made more easily through CRISPR and other technologies, is a really strong demand for us. We're doing that pretty much across the globe at all of our sites.

We're pleased with DSA pricing, even though we're not going to break that out. And we're really pleased with the growth in the dome and demand there.

I don't see any rationale given the funding environment, given the new modalities like cell and gene therapy and immunotherapies that -- and yes, we got a little bit of incremental work there, to your question. Specifically in Discovery, I would say, that caused some clients to take a look at us that hadn't. So I think they're quite happy.

So we will retain that work. And as we add new services like D-Bio and like Retrogenix, I think we'll get incremental work. So I would think that the pricing paradigm would hold up.

I would think that clients -- as long as the demand remains strong, there's no reason or indications that it will soften; that we'll see more clients booking slots earlier, which is great for them; and as I said earlier, way better for us in terms of visibility planning; and getting our calendar straight in terms of how our space is utilized because maximizing that capacity is really powerful for the bottom line..

Okay. Thank you..

Okay..

Our next question comes from Ricky Goldwasser of Morgan Stanley. Your question please..

Yes. Hi. Good morning and congrats on the quarter. Jim, I wanted to go back to the comments around clients securing room on the tox side earlier on. I mean this is something that we've been talking about for a long time.

So are you starting to have any conversations with your customers around sort of pay or play time, type of deals and securing capacity for longer periods of time given -- considering that it takes about 18 months, right, to build capacity?.

Yes. That would be nice. I think that would logically follows from the market situation. I'm a bit -- we had this over a decade ago. We had a couple of clients that would book just book capacity on a take-or-pay basis and pay for it to be empty until they needed it so they never had to get in line.

I think I've said to you and others countless times, but if I was running R&D for one of the big drug companies, I for sure would commit to space like that so I didn't have to worry about it.

It's a relatively trivial enough of the cost of developing a drug, and the hopeful clinical cost is about 20% of the cost of development and drug and being on tox as some percentage of that. And mostly money is spent in the clinic. So we've had a few passing questions and thoughts about that as some vibrations with some clients thinking about it.

I wouldn't want to project or predict whether that will happen or not. I just seem reluctant to do that. Although increasingly, we're not seeing people book slots earlier. I think if they book slots earlier and they're for whatever reason, I'm happy with the slot. Let's say it may -- let's say they want to start a study in June.

And we say to them, "Yes, we can't start until September," then that requires them to back it out further or do something about taking the space on a take-or-pay basis. So anything is possible. I do think the market dynamics are such that it would support the basis for your question.

I just think that the big drug companies, in particular, have been reluctant to do those sorts of deals. And I would say that we don't have any concrete evidence that that's on the horizon..

And then as a follow-up question, I mean, you've been consistently beating and raising organic growth goals in your sort of forecast for the different segments.

Considering sort of mix of business and your performance, why -- what's kind of like still holding you back from upping long-term guide?.

Nothing -- we're going to give new long-term numbers in our investor conference in a couple of weeks. So I think we'll wait to do that then. So nothing is holding us back. I think we have a good understanding of the market and a good assessment of the funding paradigm and the new modalities and what clients are telling us.

And obviously, we have a big footprint to work with virtually all the big drug companies and most of the biotech companies. So we have a really good installed base. So now we have a clear view of it, and we'll be putting out our new numbers shortly..

Great. Thank you..

Our next question comes from Juan Avendano of Bank of America.

Your question please?.

Hi, good morning. Thank you for the question.

I guess building up on the backlog question on DSA and how strong it is, can you give us an update on the mix of studies that you're seeing in Safety Assessment in toxicology? How is the mix from general toxicology and specialty toxicology trends? How has that trend been? And how does that compare to prior years?.

We don't have any control over that. You don't get long-term studies unless you do short-term studies. And you don't get -- you usually -- I wouldn't say never, but you usually don't get specialty work unless you've done a general toxicology work. So they come in tandem. We like both.

Action profiles are kind of not all that dissimilar, although the pricing is a bit easier on the specialty work side. So it's probably around the 50-50 range. We like it that way. As I said, we can't control it. So every once in a while, you'll hear us say that we have an abundance of long-term stays and not enough short-term ones or vice versa.

Typically, that balances out over time, and it feels like we're in balance right now..

Got it. And a follow-up on DSA as well.

Can you give us an update on the pull-through or the revenue synergies across -- that you're seeing right now between Discovery and Safety Assessment? And how is that tracking against your long-term goal?.

Yes. I mean without processing it too finely because I don't think that's useful or productive to kind of do this on a quarterly basis, there's no question that we have an increasing number of clients.

They could have been Safety clients who never did Discovery with us or Discovery clients on never did Safety or new clients who never did anything with us that work with us to help discover and develop a compound.

And then are thrilled because we have a really deep understanding of the molecule to work with us because a, they trust us, b, because they like our science, and c, because it's faster. So I think over time, we will continue to have a significant amount of our clients be doing both with us. We don't contract with them that way.

In other words, we don't say we won't do the discovery work with us much. It just Safety or vice versa, that would be overreaching and I think dangerous.

But I think increasingly, particularly as the Discovery portfolio has grown so significantly and with great scientific depth and with great cutting-edge technologies that we have much more clients open to and are utilizing us for discovery, some of whom use us a safety before that are really comfortable just continuing to have us develop the drug..

Okay. Thank you..

Our next question comes from Dan Brennan of UBS. Your question please..

Great. Thanks for taking the question. Maybe the first one just on margins. I know you called out, obviously, with the strong top line operating leverage and efficiencies.

Could you just maybe break out a little bit maybe some of the components there? Just what was the impact from acquisitions? What would the impact from efficiencies, if you will, and just operating leverage just in terms of the new guidance that you're providing?.

Yes. That's right. And well, we've given the pieces for the different deals we've done. And broadly, this year, Cognate is pretty neutral on the margin and earnings per share, so is Retrogenix given its size.

So for this year, the majority -- well, all of the increase that you're seeing is, if I put it to way around is not to do with Cognate and Retrogenix. It had to do with the operational businesses itself.

And of course, With the top line improvements that we posted today, we'll get some fall-through that will also help with the margin because, of course, we've got a lot of fixed costs embedded in there.

Once upon a time, we used to break out our efficiency program and what that was doing to Charles River as a whole, but we stopped doing that for a while now. But broadly, yes, I mean, we've got good top line growth. The efficiencies, they're kicking in, as we described. It's all working very well together at the moment.

But I -- there isn't really the M&A that's causing sort of an upside or a drag, with the exception of Cognate on the Manufacturing margin, which is a drag. But given the overall performance of the business, we were covering that, as you've seen, by posting the increase toward a 21% margin this year..

Got it. Maybe second one would just be on HemaCare. I know I think it grew below -- I think last quarter, you had talked about some of the drag there given the pandemic and you expected the recovery.

Just where do we stand in terms of the guidance for '21 now? What's baked in for HemaCare for the remainder of the year?.

Well, we haven't broken out HemaCare in precise numbers. What we have said in the preprepared remarks that HemaCare had a slower start than we had hoped, but we do see that improving as we go through the year. I just would like to point out, it is a relatively small business.

And the fact that it's had some issues at the beginning of the year because of COVID and donor access to sites, etc, we see that improving as we go through the year. And of course, it's still a strong business for the future. So this year, it's a small impact on the business..

Got it. And then I know Microbial rebounded this quarter, excuse me. Similarly, you had an impact last quarter from the pandemic or actually in the prior quarter.

Just how do we think about the ability for that business to -- like is there further catch-up to go given what you saw this quarter versus what the normalized expectation for that segment?.

Yes. So again, as we called out, while we've seen a nice improvement in Microbial, it's got the double-digit growth earlier than we expected. So we're pleased with that. But we've not got full access to install new equipment with all of our clients. We're making headway in there. But of course, as we continue to do that, that would be an upside.

And of course, that's been factored into the revised guidance this morning..

Great. And then maybe last one, just on Cognate, Jim. Sorry, if I missed it. I know you gave a lot of details in the deck and the presentation. But what specifically is baked in for Cognate this year? And I think at the time you did the deal, I think you were anticipating what a 15% revenue tag or is this correct? Just wondering on both of those fronts.

And if it's 15%, why couldn't it be higher than that given the overall growth rate of that end market?.

So we added $110 million in revenue. That helps..

And in terms of the -- when you did the deal, I think you talked about -- correct me if I'm wrong, was it a three year CAGR 15%? Just wondering kind of what the opportunity is, given the end market, I think, is certainly growing at that rate, if not stronger..

Oh, The total growth rate was 25% on an annual basis going forward..

Got it. Thanks, David..

Our next question comes from Elizabeth Anderson of Evercore. Your question, please..

Hi, guys. I just had to ask a little bit more about how customers are moving through the like post-pandemic era.

Are you seeing sort of people sort of taking a time sort of think through like what they're outsourcing, what they're keeping in or sort of think through changes to their discovery program? Or is it just kind of - "oh, let's like get moving because we had all these projects that were delayed".

Or sort of how would you characterize the tone of your conversations?.

I mean they're quite positive, except in the second quarter in our research model business when academic clients were closed, and we had difficulty placing some of our Microbial Solutions systems. All of our sites remained open. And virtually all of our clients, except a handful, were open. So our clients have been busy. They're well financed.

The vast majority of our clients have no internal capability to do anything to have discovered drugs and then all the rest of the development that comes to us. So I wouldn't say that there's been a dramatic change.

We just have increasingly intense demand across the board for what we do, based upon really robust portfolios, early stage portfolios that most of our clients have and enough money to prosecute them broadly as opposed to sort of chunk it.

And we don't see any indications that those elements would soften or that the demand would soften as -- certainly as we move through this year. And as we said earlier, we gave a longer-term guidance and our thoughts on where our business is going and demand is going at our investor conference..

Okay. That's helpful. And then as a follow-up, you talked about some of the capacity constraints in terms -- and expanding capacity in terms of the physical infrastructure. Are you seeing any change in terms of like the availability of employees or any cost pressures on wages or anything of that sense out of -- versus a couple of months ago? Or it....

We're hiring a lot of people. We're actually hiring more people than we had planned to hire because the demand for everything we do is exceeding that. So as I said earlier, it's a high-class challenge. It depends on the geographic locale. And some term geographic locale, it's easier to hire people; some, there's greater competition.

I do think we are an attractive place that lots of people like to work or want to work at. We worked on over 80% of the drugs for the last three years. People like that. It's probably our best recruiting tool. We're always trying to -- we have 110 locations now, so lots of different countries.

So the competition for head count, as I said, it's different and different places than the kind of wage levels are fluid. So we're always trying -- we're working hard to stay up to or ahead of it so that pay is never an issue.

So I'd say it's the ultimate rate-limiting factor in our business is availability, not just of anybody, but are really strong people who understand that we're working for patients and the criticality of their work. So I'd say we're doing a very good job. I think we did a really good job in the first quarter with our recruitment.

We anticipate significant improvement through the back half of the year pretty much across the board around the world. And so we're working hard to stay ahead of it..

Great. Thank you very much..

Our next question comes from Patrick Donnelly of Citi. Your question please..

Great. Thanks guys. Maybe another one on the cell and gene therapy piece.

I understand it's still early days, but can you just talk about some of your customer conversations around cell and gene therapy business now that you've closed Cognate? Have you seen any increased interest in areas like HemaCare and Cellero now that you're more kind of an end-to-end cell and gene therapy player? Or should we expect those benefits to be a little more long term?.

I mean it is early. So we have the combination of -- revenues up more slowly in the first quarter in HemaCare and Cellero because of lack of access to donors, coupled with the fact that Cognate's relatively new. It's a month or two old. So I think it's early to tell.

We have no doubt that the thesis is a very strong one, but clients who can use us starting very, very early in the process through process development and scale up through the clinic out to commercial quantities is powerful. No client's going to build -- virtually, no clients going to build this stuff themselves.

I think the competitive marketplace is attractive for us.

I think we have a unique portfolio that clients are definitely resonating to based upon conversations and based upon the uptake in business and our ability to sell a whole suite of cell and gene therapy services, including pharmacology and safety testing, including biologic testing, including some microbial testing, including some -- across our research model business, it's becoming a very big business for us.

Look, it's no different than everything else we do.

We provide a comprehensive, holistic portfolio of products and services so it's more of a solution for clients because -- particularly small biotech companies -- everyone, but particularly them, they don't have the time or the ability or the desire to work with half a dozen different providers across those different streams of business.

And so our whole thesis is about being the largest nonclinical CRO so that we can do more for our clients. And a, they don't have to do it themselves because they don't want to and b, they don't have to work with multiple players..

Got you. Thanks Dave, Todd and Jim..

Our final question comes from George Hill of Deutsche Bank.

Your question please?.

Hi. It's Maxi on for George.

Could you talk about your thoughts on the change in dynamics -- competitive dynamics in the industry following there is some vertical innovation trend and if recent deals in this space create opportunities to move upstream into later-stage research services?.

one is CDMO space, one is the clinical space. So we dipped that toe into the CDMO space and like it, at least on the cell therapy side. On the clinical side, we could do that, I guess. It doesn't seem that there's a client need, and I don't think we should make -- even contemplate a move like that unless the clients are requesting it.

So the only company that has a clinical and preclinical capabilities is Covance, I think it's a failed experiment. I don't think clients buy from them on that basis nor have contracts to do preclinical work all the way through the clinic that's years. Nobody buys that way.

So we haven't had a conversation in the last decade with the clinical CRO about paying together. No one's ever called me a clinical CRO that came together with them. And I don't think any of us would even contemplate that move, although it would provide a bigger share of the client's wallet. So that would be attractive.

But since the clients aren't buying that way or thinking that way and not desirous of any of us doing that, until that changes, I don't see any logical rationale for us in the preclinical side and other people have clinical site to get together. Having said that, I learned a long time ago never to say never about anything.

So I don't know at what point the demand quotient will change and clients would want one company or multiple companies to do both. If and when that happens, we'll explore..

Well, that concludes the call today. Thank you for joining us on the conference call. We look forward to speaking with you during our upcoming investor events, including our virtual Investor Day on May 27. This concludes the conference call. Thank you..

.