Good day. Thank you for standing by and welcome to the Charles River Laboratories International Q2 2021 Earnings Call. At this time, all participants are in a listen-only mode. After this speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded.

I would now like to hand the call over to your host, Todd Spencer, Corporate Vice President of Investor Relations. Please go ahead..

Thank you. Good morning and welcome to Charles River Laboratories' second 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 second quarter of 2021.

Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is posted on the Investor Relations' section of our website at ir.criver.com.

A webcast replay of this call will be available beginning approximately two hours after the call today and can be accessed on our Investor Relations' website. The replay will be available through next quarters' conference call. I'd like to remind you of our Safe Harbor.

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

During this call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP.

In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the Investor Relations' section of our website. I will now turn the call over to Jim Foster..

Thanks, Todd. Good morning. The strength of our leading non-clinical portfolio was clearly demonstrated in our second quarter financial performance. Robust industry fundamentals are leading to unprecedented client demand across most of our businesses and we're extremely well positioned to succeed in this environment.

Second quarter organic growth - revenue growth was in the mid-teens, even after normalizing for last year's COVID-19 impact and exceeded the long-term low double-digit target that we recently provided at our Investor Day in May.

Clients are increasingly choosing to partner with us for a flexible and efficient outsourcing solutions, the scientific depth and breadth of our portfolio, and our unwavering focus on flawlessly serving their diverse needs.

Utilizing our capabilities enables them to drive greater efficiency and accelerate the speed of their research, non-clinical development and manufacturing programs.

We believe that the efforts we have made and continue to make to differentiate ourselves from the competition are critical as clients choose to work with a smaller number of CROs, who offer broader scientific capabilities. Due to this sustained demand, we are keenly focused on the execution of our strategy.

We are strengthening our portfolio as we did through the acquisition of gene therapy CDMO, Vigene Biosciences in late June. Strategically adding staff and capacity to accommodate the robust demand and support our clients and enhancing our digital enterprise to provide greater connectivity and exceptional service to them.

We believe we will make these investments and remain well positioned to achieve our operating margin target of 22.5% in 2024. We believe the success of our strategy is reflected in our second quarter performance. So let me provide some of the highlights.

Quarterly revenues surpassed $900 million for the first time and a $914.6 million in the second quarter of '21, represented a 34% increase over last year.

Organic revenue growth of 24.1% was increased by approximately 8% when compared to last year's COVID-19 impact in the second quarter of 2020, with the greatest impact in the Research Models and Services segment.

Even after normalizing for the COVID impact, we reported mid-teens organic growth with double-digit increases across all three business segments. The operating margin was 20.8% an increase of 350 basis points year-over-year.

The improvement was principally driven by the RMS segment, reflecting operating leverage from significantly higher sales volume for research models, due in part to the comparison to last year's COVID-19 impact.

Notwithstanding this favorable year-over-year comparison, we were pleased with the margin progression in the first half of the year and are on track to achieve a full year operating margin of approximately 21% or a 100 basis points higher than last year.

Earnings per share were $2.61 in the second quarter, an increase of 65.2% from $1.58 in the second quarter of last year. This result widely exceeded our prior outlook of more than 50% in earnings growth for the quarter, primarily as a result of the exceptional demand environment.

Based on the second quarter performance and our expectation for sustained demand through the remainder of the year, we are increasing our revenue growth and non-GAAP earnings per share guidance for 2021. We now expect organic revenue growth in a range of 13% to 15%, a 100 basis point increase from our prior range.

Non-GAAP earnings per share are expected to be in a range from $10.10 to $10.35, which represents 24% to 27% year-over-year growth and an increase of $0.35 at midpoint from our prior outlook.

We attribute this exceptional performance and outlook to the success of our ongoing efforts to enhance our position as the leading non-clinical contract research and manufacturing organization, as well as the pace of scientific innovation that's fueling a significant increase in biotech funding and FDA approvals, both of which are tracking to near record levels through the first half of the year.

I'd like to provide you with details on the second quarter segment performance beginning with the DSA segment. Revenue is $540.1 million in the second quarter, an 18.1% increase on an organic basis over the second quarter of '20, driven by broad-based demand for both Discovery and Safety Assessment services.

COVID only had a small impact on the DSA segment last year, so it wasn't a meaningful driver of the year-over-year growth. Safety Assessment business continued to perform exceptionally well, reflecting robust demand from both biotech and global biopharma clients and price increases.

Bookings and proposal volume continued to achieve record highs in the second quarter, with strength across all regions and major service areas. The strength of biotech funding is enabling clients to meaningfully invest in early-stage programs and due to the unprecedented demand, we are now booking work into next year.

As I mentioned last quarter, clients are expanding their preclinical pipelines and intensifying their focus on complex biologics. To ensure they do not delay their research, we believe clients are securing space with us further in advance, which in turn provides us with greater visibility.

To support our clients, we are continuing to add staff, capacity and the resources necessary to effectively manage the current demand environment and provide our clients with a timely, efficient and high quality service that they have come to expect from Charles River.

We believe these investments position Safety Assessment business well and will support low double-digit organic revenue growth in the DSA segment this year.

We believe the combination of the robust funding environment as well as our deep scientific expertise, and willingness to forge flexible relationships with our clients, led to another exceptional quarter for the Discovery business.

Our comprehensive portfolio of oncology, CNS, early discovery and antibody discovery capabilities, which we recently enhanced with Distributed Bio and Retrogenix acquisitions is resonating with clients and clients are increasingly choosing to outsource to integrated discovery partners like Charles River.

Despite the robust funding, biotech clients continue to maintain limited or no internal infrastructure, opting instead to invest in their pipelines and utilize our services to move their programs forward.

To support the robust demand from biotech and global biopharmaceutical clients, we will continue to strengthen our portfolio by expanding our scale, our science and our innovative technologies through a combination of internal investment, M&A and our strategic partnership strategy.

By doing so, we are enabling our clients to remain with one scientific partner from target ID through IND filing and beyond and solidifying our position as the leading, non-clinical CRO. The DSA operating margin increased by 30 basis points to 23.5% in the second quarter.

Leverage from the robust DSA revenue growth was the primary driver of the margin improvement. Foreign exchange reduced the DSA operating margin by 150 basis points in the quarter, as revenue and costs are not naturally hedged at certain DSA sites, including our Safety Assessment operations in Canada.

We continue to expect the DSA margin will be in the mid-20% range for the year.

RMS revenue was $176.7 million, an increase of 44.5% on an organic basis over the second quarter of '20, approximately 33.4% of this growth was attributable to the comparison to last year's COVID related revenue impact from clients site closures and disruptions, which reduced research model order activity.

Adjusted for the COVID impact, the RMS growth rate was above 10%, as strong research activity across biopharmaceutical, academic and government clients led most RMS businesses to grow above the targeted growth rates. Robust demand for research models in China continued to be the primary driver of RMS revenue growth.

There has been a resurgence in research activity this year and model volumes far exceed pre-COVID levels. Similar to Western markets, the client base in China has transitioned from one dominated by academic and government clients, to a vibrant mid-tier biotech and CRO client base, which now represents the majority of our clients in China.

We believe the expansion of our client base is fueling increased demand and to accommodate the growth, we are continuing to expand our model and services offering and our geographic footprint in Western and Southern China. We are currently experiencing strong double-digit revenue growth in China.

Demand for research models outside of China was also quite strong. We believe this correlates with the increased level of non-clinical research that's being conducted by biopharmaceutical and academic clients in Western markets.

Research investments have led to biomedical breakthroughs and new drug modalities, and we believe the global focus on scientific innovation is sustainable.

We also continued to win new academic clients in the second quarter, resulting from the COVID-19 related clients shutdowns last year and more recently from digital engagements targeting the academic client base. Research Model services also performed very well.

GEMS is benefiting from strong outsourcing demand, as our clients seek for greater flexibility and efficiency they gain when we manage their proprietary model colonies. The greater complexity of scientific research and the proprietary models that our clients are creating further reinforce the value proposition for the GEMS business.

Clients need for greater flexibility and efficiency is also driving demand for our Insourcing Solutions or IS business, particularly for our CRADL initiative, which provides both small and large biopharmaceutical clients with turnkey research capacity at Charles River sites.

In addition to expanding our existing CRADL presence and adding clients in the Boston, Cambridge and South San Francisco biohubs, we're also looking to expand into other regions to provide a flexible capacity solution for our clients in emerging biohubs.

Utilizing CRADL also provides clients with collaborative opportunities to seamlessly access other Charles River services, which further enhances the speed and efficiency of their research programs.

The revenue growth rate for our cell supply businesses, HemaCare and Cellero improved in the second quarter, but remained below the target level due to continued limitations on donor access. We believe cell supply revenue will increase during the second half of the year as donor availability and capacity improves.

We have expanded capabilities, including donor capacity at our cell supply sites in Massachusetts and Washington State, which we believe will enable us to further expand our donor base in the US and accommodate the robust demand in the broader cell therapy market.

We expect HemaCare and Cellero will provide the critical tools for our new Cell & Gene Therapy CDMO business, Cognate and Vigene. We believe this will be highly synergistic for both Charles River and our clients, because it will enable us to move clients' cell therapy programs forward using the same cellular products from research to CGMP production.

The RMS operating margin increased to 27.4% from - 9.1% in the second quarter of last year. This significant improvement was primarily due to the comparison to last year's depressed margin associated with COVID-related client disruptions and the corresponding reduction in research model order activity.

Revenue from the manufacturing segment was $197.8 million, a 26.6% increase on an organic basis over the second quarter of last year. The increase was driven by strong double-digit revenue growth in both the Biologics Testing Solutions and Microbial Solutions businesses. COVID-19 did not have a meaningful impact on the segments' revenue last year.

But testing on COVID vaccine - COVID-19 vaccines has helped accelerate Biologics' revenue growth rate this year.

Consistent with the first quarter, Microbial Solutions' growth rate in the second quarter was well above the 10% level, reflecting strong demand for our Endosafe endotoxin testing systems, cartridges and core reagents in all geographic regions, as well as Accugenix microbial identification services.

With COVID-related client access restrictions effectively behind us, we were pleased with the strength of the underlying demand for our endotoxin testing platform, which performs FDA-mandated, lot release testing for our clients' critical quality-control testing needs. The advantages of our comprehensive portfolio continue to resonate with clients.

And we believe that our ability to provide a total microbial testing solution will enable Microbial Solutions to deliver at least low double-digit organic revenue growth this year and beyond, which is consistent with the historical trend pre-COVID.

The Biologics Testing business reported another exceptional quarter of strong revenue growth that was well above the 20% growth target for this business. Robust demand to Cell & Gene Therapy Testing Services continue to be the primary growth driver.

There has been a rapid increase in the number of Cell & Gene Therapy programs in development to approximately 3,000 programs now in the pipeline, with approximately two-thirds in the preclinical phase which is expected to continue to fuel the strong growth.

COVID-19 vaccine work was also a meaningful driver for Biologics' second quarter growth, but the underlying Biologics' growth trends remained above the 20% level even without the incremental COVID-19 testing revenue.

We believe Cell & Gene Therapies will continue to be significant growth drivers over the long-term and demand for COVID-19 vaccine testing is showing no signs of abating. We believe the commercial production of COVID vaccines will continue for many years to come, supporting the demand for our services.

These factors are contributing to the strength of the demand environment and we continue to build our extensive portfolio of manufacturing services to ensure we have available capacity to accommodate client demand. The Manufacturing segments' second quarter operating margin declined by 420 basis points to 33.2%.

The primary driver of the decline was the addition of Cognate CDMO business, as well as higher production costs in the Microbial Business. Cognate is a profitable business with a solid operating margin, but its margin is below the Manufacturing segment.

Coupled with the addition of Vigene in the third quarter, we expect a full year Manufacturing margins slightly below the mid-30% range. However, beyond 2021, we expect this headwind to gradually dissipate as we drive efficiency, and as the significant growth we anticipate generates greater economies of scale and optimizes throughout our CDMO sites.

Early in the second quarter, Cognate BioServices officially joined Charles River, followed by Vigene Biosciences in late June, we were very pleased to welcome both teams to the company.

Aligned with HemaCare and Cellero, these businesses form the core of our Cell & Gene Therapy offering and we believe they will be highly complementary to our Biologics business and our portfolio as a whole.

We are pleased with the initial progress on the integrations and the addition of the Cell & Gene Therapy CDMO services to our comprehensive portfolio which is resonating with clients. Our clients are beginning to explore opportunities to streamline their Biologics development workflows, by using Cognate's and Vigene's services.

And their legacy clients are already looking to utilize other products and services within the Charles River portfolio to drive greater efficiency in their development and manufacturing activities.

We believe the acquisition of Vigene Biosciences, with its viral vector-based gene delivery solutions fulfills our objective to create a comprehensive Cell & Gene Therapy portfolio which spans each of the major CDMO platforms. Gene-modified cell therapy, viral vector and plasmid DNA production.

In combination with Cognate's Memphis-based operations, we have established an end-to-end, gene-modified cell therapy solution in the US, which we believe is critical to support our clients more seamlessly.

Our goal is to enable clients to conduct the analytical testing, process development and manufacturing for these advanced modalities with the same scientific partner, enabling them to achieve their goal of driving greater efficiency and accelerating the speed to market.

As a result of the successful execution of our strategy to-date, we believe that our portfolio is the strongest it has ever been. Our efforts to enhance our scientific capabilities, deliver flexible outsourcing solutions and provide greater value to our clients have made Charles River an important partner for our clients.

With the biopharmaceutical industry benefiting from record funding levels, we are experiencing robust demand for our essential products and services. To support this demand and to continue to enhance the value we provide to clients, we will continue to move our growth strategy forward.

Our acquisitions and strategic partnerships remain vital components of our strategy, as we endeavor to expand the scientific expertise, global reach and innovative technologies that we can offer clients across all three are of our business segments.

Investing in our scientific capabilities, as well as internally on the necessary staff, resources and our digital enterprise, will help us ensure that we can meet the needs of our clients.

The successful execution of our strategy will not only enable us to enhance our position as our clients' partner of choice from concept to non-clinical development to the safe manufacture of their life-saving therapeutics.

It will also allow us to achieve our longer-term financial targets of low double-digit organic revenue growth, and an average of approximately 50 basis points of operating margin improvement beyond 2021. In conclusion, I'd like to thank our clients and shareholders for their support and our employees for their exceptional work and commitment.

And now, I'll ask David to give you additional details on our second quarter results and updated 2021 guidance..

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. Once again, we are very pleased with another strong performance in the second quarter. Robust revenue and earnings per share growth outperformed our prior outlook.

Organic revenue growth of 24.1%, including 8% related to last year's COVID-19 impact, and operating margin expansion of 350 basis points were the primary drivers behind earnings per share growth of 65.2% to $2.61.

These results also reflect a favorable comparison to the second quarter of last year, in which, we experienced the peak of the COVID-related impact and client disruptions.

Based on our strong second quarter results and expectations for the underlying strength of demand to continue, we have increased our full year financial guidance and now expect to deliver organic revenue growth in a range of 13% to 15% for the full year.

Primarily as a result of the enhanced growth prospects this year, and to a lesser extent, favorable tax rate, we raised our earnings per share guidance by $0.35 to a range of $10.10 to $10.35, which represents a year-over-year growth of 24% to 27%. By segment, our updated outlook for 2021 reflects the strong business environment.

For RMS, we continue to expect organic revenue growth in the high-teens, driven by the recovery in Research Model order activity from the impact of the COVID-19 pandemic last year, as well as exceptional growth in China.

Our outlook for DSA is unchanged, with low double-digit organic revenue growth for the full year, reflecting continued strength in early-stage research activity. For the Manufacturing segment, we now expect to achieve high-teens organic revenue growth.

Our revised outlook is based on exceptionally strong demand in Biologics, driven primarily by Cell & Gene Therapy programs, and an increase in contribution from the Microbial Solutions business, which is expected to return to at least low double-digit growth for the full year.

Including the acquisitions of Cognate and more recently, Vigene Biosciences, Manufacturing's reported revenue growth rate is expected to be in the low to mid-40% range.

With regard to operating margin, our expectations for segment contributions remain mostly unchanged from our prior outlook, with the RMS operating margin meaningfully above 25% for the full year. DSA in the mid-20% range and Manufacturing slightly below the prior mid-30% outlook, principally reflecting the addition of Vigene in late June.

Lower unallocated corporate costs contributed to the second quarter margin expansion, totaling 5.6% of revenue or $51.2 million in the second quarter, compared to 6.1% of revenue last year.

Our scalable infrastructure enables us to drive greater efficiencies, even as we continue to make investments to support the growth of our businesses and meet the needs of our clients. We continue to expect unallocated corporate costs to be in the mid-5% range as a percentage of revenue for the full year.

The second quarter non-GAAP tax rate was 20.4%, representing a 60 basis point decline from 21% in the second quarter of last year. The decrease was due to a favorable excess tax benefit associated with stock-based compensation, which resulted from increased equity exercise and award activity at higher stock price levels during the quarter.

This benefit was partially offset by higher tax expense associated with the UK tax will change. For the full year, we are reducing our tax rate outlook to a range of 19.5% to 20.5% from our prior outlook of a tax rate in the low-20% range, principally driven by a higher benefit on stock-based compensation.

Total adjusted net interest expense for the second quarter was $20.8 million, an increase of $3.7 million sequentially and $1.7 million year-over-year due to higher debt balances primarily to fund the Cognate acquisition.

At the end of the second quarter, we have an outstanding debt balance of $2.7 billion, representing gross and net leverage ratios of about 2.5 times. Subsequent to the end of the second quarter, we completed the acquisition of Vigene on June 28th.

On a pro forma basis, including Vigene, our gross leverage ratio remained below 3 times which we attribute to our robust free cash flow generation that has enabled us to repeat that ahead of our expectations.

For the full year, we now expect total adjusted net interest expense to be slightly below our prior outlook in a range of $82 million to $85 million, primarily reflecting the accelerated debt repayment. Free cash flow was $140.2 million in the second quarter, an increase of 3.5% over the $135.5 million for the same period last year.

The primary drivers of the increase were our strong second quarter operating performance and distributions from our VC investments, partially offset by higher capital expenditures.

In view of our robust results in the first half of the year, we have increased our free cash flow outlook by $65 million, and now expect free cash flow of approximately $500 million for the full year. CapEx was $46.4 million in the second quarter, compared to $26.8 million last year. The increase was due primarily to the timing of projects.

Some investments which were slowed or deferred during the COVID-19 disruptions last year and are back on track. We continue to expect CapEx to be approximately $220 million for the full year. A summary of our revised financial guidance for the full year, including all recent acquisitions can be found on Slide 39.

For the third quarter, our outlook reflects the continuation of a strong demand environment. We do expect that growth rates will normalize from the second quarter levels, because we have anniversaried the peak of the COVID-19 related revenue loss last year.

Accordingly, we expect organic revenue growth in the low to mid-teens range and reported revenue growth in the low-20% range.

You should note that we are not forecasting a meaningful difference between the first half and second half organic growth rates after normalizing last year's COVID impact, which is not surprising, as we believe the robust demand environment is showing no signs of abating.

We expect low double-digit earnings per share growth when compared to last year's third quarter level of $2.33. I will remind you that the DSA operating margin in the third quarter of last year included a 50 basis point benefit from the Discovery milestone payments, which will impact the year-over-year comparison.

In closing, we are very pleased with our second quarter results, which included another quarter of robust revenue, earnings and free cash flow growth. We continue to be focused on the continued execution of our strategy and achieving our financial and operational targets, which will move us forward to what our longer-term targets for 2024. Thank you..

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

And your first question come from the line of Eric Coldwell with Baird..

Thank you. Good morning. Main question is on preclinical safety assessment. We are hearing in our various channel checks that sites are booked well into 2022. I know you made a comment on that in your call. We're hearing that more broadly.

We're also hearing that some of your competitors have been placing massive long-term model purchase commitments, multiyear commitments very large, which I think is a sign of the strength of the industry.

But, it really comes down to the question of capacity, and you know, where you stand, what kind of investments you're making? How do you balance this supply-demand imbalance, so your clients don't try to seek other solutions in the marketplace? Just any thoughts on that would be helpful..

Yeah, Eric. We're investing capacity thoughtfully, aggressively, geographically multiple sites at once, not dissimilar to what we've done historically. We're continually reviewing where we think the demand will be for the next few years and ensuring that our capacity meets our - because that capacity is sufficient to accommodate that.

I don't think it's a bad thing that clients are reserving space earlier, which allows us to plan better, and obviously gets us greater visibility from a staffing and expense point of view.

It also provides a more orderly business model, frankly, and it's not all that dissimilar to the way it was years ago, where we had similar types of demand even other client base was quite different.

So, where, you know I'd say the principal conversations around here are ensuring - working hard and ensuring that we have sufficient headcount and physical capacity to accommodate the demand, not just in safety by the way, obviously, safety is our biggest business.

So principally, the conversation goes there, but certainly across Biologics and Discovery and other business and certainly China as well where it's relatively focusing on - and ensuring sufficient capacity, it's what we put this portfolio together for to service the clients that they outsource more work. So, we are very much on top of that, Eric..

Okay, Jim if I could squeeze one more in. I noticed in the press release a comment about higher production costs in Microbials. I was hoping to get a little more color on that..

Yeah, nothing really significant, just certain raw material costs are kind of higher at the moment. So supply chain issues that, you know, lots of businesses are having I think that's quite transitory. Mic that is still quite good within that business and the growth rate really was terrific. So just kind of kind of short-term blip..

Okay, thanks very much. Good job with the quarter..

Sure. Thanks, Eric..

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

Hey, good morning. I'll start with question on Manufacturing. You know, on the back of the Vigene deal, you noted, you know, clients are beginning to explore opportunities to streamline you know development with you.

I guess, as you look at your Cell & Gene Therapy portfolio today, you know are there any existing gaps? And can you talk a little bit more about how Vigene fits in with the rest of that business?.

Yeah, I think it's a pretty solid portfolio, Tycho. You know, we have the cells, which it's a Cell Therapy, obviously, there is no Cell Therapy R&D, will scale up without that. So we'd like that we started first with that, we now have significant capability in Cell Therapy, Manufacturing, particularly modified cell therapies.

And you know we have this viral vector and plasmid DNA capability on both sides of the pond now in the US and Europe, which give us a substantial capability as well. There may be some nuances. And of course, we're always looking at M&A opportunity.

So I want to get too specific stuff, just to say that I think that M&A will be principally around in just increased scale and enhanced geographic dispersion and diversity and growth. I do think that not unlike other businesses, geographic proximity, you know, when you're dealing with live cells is not unimportant and would be beneficial.

And clients still like the ability to be relatively close to their external providers of services, if possible. So there still a fair number of assets out there that we're quite interested in, there are a variety of sizes, I'd say most of them are on a smaller side, several hundred ones, we may have one of course and those are no longer available.

If we are unable, for whatever reason or unwilling because of the price point, to buy and meet the targets we currently have, I think we do have a very - we have a terrific installed base and the growth rates will be such that will become a big business.

And of course, just want to remind you that we look at the Cell & Gene Therapy assets, which are whatever it is now 18 months to 24 months old, we look at those very much in combination with our Biologics business, which is very high growth right now, you heard us talk about north of 20%, terrific capacity here, those businesses that join that they have to the testing of those Cell & Gene Therapy products before they go into the clinic, and hopefully, after they're approved, before they go into patients will be just as essential as the contract manufacturing pieces of it.

So, we're thrilled to be able to piece those together. Pretty big portfolio now. I think that - we didn't update it on this call, but we said you know it's Cell & Gene Therapy revenues are greater than 10% of the total Charles River, is a big number and it's going to grow disproportionately fast. So, very pleased with the portfolio..

All right, and then a follow-up on RMS, you know, obviously a number of those businesses, you know, benefited over the past year from the challenges around the pandemic.

If you look at the you know the GEMS outsourcing and also, you know, the CRADL and insourcing initiatives, I guess, as we're kind of, you know, past the halfway point part of this year and working through, you know getting back to labs up and running, you know, how do you feel about the durability of some of those trends? You know, in particular, around GEMS and then CRADL insourcing?.

Really good. While we certainly got, and are enjoying enhanced outsourcing from clients that did work themselves or didn't use us or used us partially, and we really proved the value proposition that we have by staying open and doing this great work.

The mark - by putting aside that COVID pop, as it were, this significant demand - increasing demand for GEMS models and specialty models and more complex models and more translational models, for sure. This IS businesses increasingly more interesting.

The CRADL you know, these CRADL locations and principally in Cambridge, Mass and South San Francisco and eventually other important parts of the world, above high revenue generators, high margin businesses and significant feeders to other parts of our business, particularly service enterprises.

So being in those environments, but you know, being part of that Cambridge, cameo - sort of Kendall Square universe has been critically important to ourselves.

I think the growth rates and margin contributions are absolutely sustainable in those businesses, and we will continue to expand capacity growth in the current places that we are located, but also we're going to add new sites as well..

Okay, thank you..

Sure..

Next, you have a question from the line of Dave Windley with Jefferies..

Close enough, I guess. Good morning. Thanks. Thanks for taking my question. I wanted to Jim ask about China tie a couple things together there. You mentioned that the demand in China has kind of rotated from the academic and government sector to more private sector client base.

I'd be curious your comments about how that influences your price points and margins for your business in China? And then the second part of my question would be, you know, given the success there in models and the evolution and you know strengthen the investment in biopharma in China in general, is it time just to rethink or start thinking about planting other business lines in China to leverage off of your existing base?.

Yeah. So huge investments by the Chinese government in the life sciences, venture capital firms are aplenty and so we're seeing significant investment in sort of classic and new pharma companies and mostly biotech companies.

So but while I don't personally think the market will overtake the US, I think it's going to be the second largest market for sure. Yeah, I mean, provides enormous demand for us. You know, I think look, we'll always try to get more price to general proposition, including in China. So, I wouldn't say, otherwise.

You know, that the cost structure is significantly lower than other parts of the world as to the price points, but the margins are comparable.

We have to be careful, given the fact that we have lower - you know, we have a lot of local Chinese competitors, who I think in part or in whole financed by the government, and so they have the ability to really go after us always on price, just like we've seen in the US and Europe.

I mean, our RMS competitors worldwide principally compete with us on price and not so much of quality or service. But having said that, you know, we'll continue to drive price as much as we can, because of course, costs go up in China as well. And of course, we've - we're growing at least the RMS franchise very nicely.

So lots of investments and services, IS, GEMS, et cetera, lab testing in China, and significant investments in new production facilities. Your second question is a tough one to answer. So, I just remind you, we have a large and growing RMS business, we have - we actually have a large Microbial business.

It's just that since the testing isn't regulated over there, the total revenue contribution is relatively modest. And we have recently within the last 12 months, done sort of a joint venture in our Biologics business which we're pretty excited about, because we have many of our major competitors over there.

I think as a general proposition we would like to do everything that we do in China. And we certainly would like to do Discovery and Safety. And as we've said countless times, M&A multiples are a real deterrent for us. I mean, there's no way we can rationally buy companies over there to build out our portfolio without crushing our return.

So we're not going to do that. So the issue for us is, when do we want to enter? And how do we do that thoughtfully and fiscally responsibly with sort of a JV type thing like we've done with Biologics that's always a possibility and/or greenfield, our activities there, which is, you know, it's slower which we wouldn't like that.

It's obviously the less money than buying a company. But it's not insignificant.

We're just going to have to keep continue to evaluate the market demand, I would tell you that we are so busy, as you know, from our numbers in the US and Europe that we have lots of work and great growth rates and escalating operating margins without the complexity and some of the challenges of doing work in China.

So we're not particularly frustrated with it right now. I would say it's a longer-term strategic conversation that we're having all the time within Charles River..

Very helpful. Thank you, Jim..

Sure. Sure, Dave..

The next question comes from the line of John Kreger with William Blair..

Hi, thanks very much. Jim, my question relates to the capacity availability for Cognate and Vigene.

Can you just remind us where those programs are in terms of their capacity build out? Should we be assuming a necessary step up in CapEx in the next couple of years? Or is that already sort of in the long-term plan?.

Definitely in our guidance. So what we've told you about the accretion of those businesses to our top line to our EPS and improving operating margin, is real. Both of those businesses have a significant amount of available capacity, by that, I mean, you know, they were in that process of expanding capacity when we bought both of them more actually.

So that will continue. It's a significant amount of space.

It's - you know it's an interesting one, John, the business is so potentially so explosive, the ability to take clients, particularly in the Manufacturing pieces in the pure CDMO piece for modified cell therapies to take those from clinical production to commercial, which we can see with a couple of the clients, at least, depending on how impactful those new drugs are, will lead up a lot of capacity.

So we're just going to have to live through, we're going to always have to have incremental capacity available, by that, I mean, you know, rent space have a plan to finish it either all at once or in slices sort of, you know, chunk that's out there and stay very close to the clients, how the drugs are doing, what phase they're in, how well financed, are they - what's the competitive scenario and you know we're doing that really well.

So, I think we're in a very good place right now, as we see capacity for the next I don't know, a couple of years. But we're going to have to stay ahead of it.

You know, the guidance that we gave recently about, we anticipate that CapEx will be you know around 7% of our revenue that incorporates and accommodates for significant growth, certainly in Safety, certainly in Discovery and certainly in the CDMO business, which is obviously a new business for us.

I don't think it's particularly more capital-intensive in lots of other things that we do, and I know that. But - and particularly that, that the Cell Therapy type of work that we're doing is, I'm not saying it's not capital-intensive, but it's not as intensive as some other aspects of the CDMO space.

So, we think we have our arms around for the scale, growth and cost..

Sounds great. Thank you..

Sure..

Next question come from the line of Elizabeth Anderson with Evercore..

Hi, guys. Thanks so much for the question.

I was wondering if you could expand on Tycho's question a little bit and sort of talk more about the cross-sell opportunity in Cell & Gene Therapy between RMS and the CDO - CDMO business so far, sort of where are you in terms of the interest of clients to sort of do the whole spectrum with you, and then sort of how do you see that progressing over the next few years? Thanks..

Yeah, I mean, you know, we see it progressing well. If you look at - just if you look certainly at most of our large clients, I would say that they buy most and some buy everything that we sell, all our products and all of our services.

So, you know, we are an increasingly - increasingly more important provider, significant spend with those companies we're dealing with very senior people there, and they look at us as an essential provider of a whole bunch of things that they need.

The smaller the clients get, particularly our biotech clients while many of them are pre-revenue, lots of them are public and they've got $10 billion or $15 billion or $20 billion market caps. So they're not smaller companies.

And they have - while they may have the money, they have no, as I said in my prepared remarks, zero desire to build these things out internally. And I think that's going to get increasingly more nuanced, that they're going to have less of a desire, particularly in things like Cell & Gene Therapy or Biologics Testing or for sure, Safety.

So, the broader the portfolio, I think, the more client capture that we have. We're already seeing almost immediately, as I commented on briefly in my remarks, clients who are working with Cognate and Vigene interested in the broader range of services that Charles River has.

And conversely, clients that we're working with Charles River very interested that we now have the Cell & Gene Therapy capabilities.

So you know, everything is about speed to market with all of these companies, regardless of their size, and the ability to work with a - as much - to as much as possible with a single source to kind of get the pricing behind you. And I have to renegotiate every step of the way, definitely accelerates the whole process.

Also as some of these small companies, our regulatory capabilities really helpful to them to kind of guide them for their FDA filings or filings with other regulatory agencies around the world.

So, given the fact that there were 3,000 Cell & Gene Therapy drugs in development, two-thirds of which are in preclinical, a lot of how - hopefully a large number of which we are already working with that we'll to work with, having these capabilities was really essential for us to participate in a really large portion of the marketplace..

Got it. That's really helpful. Thanks..

Your next question comes from the line of Juan with Bank of America..

Hi, thank you for the question.

Regarding your margin targets in 2021 and 2024, what would you say is the likelihood or a risk the Manufacturing support margins could remain in the low-30s given the investments that need to take place in this area? And how do you see the negative impact of foreign exchange on DSA margins playing out for the rest of this year and in relation to your 2024 margin target?.

Okay, I'll take that, Jim. So I'll take the FX one on DSA data. So you've seen a 150 basis point headwind in DSA for Q2, and basically averages out just roundabout 100 basis points for the first half of the year. And actually, we actually think the second half of the year would be somewhat similar.

That said, in respect to your question about how the FX might turn out in the longer-term, as we've seen through history, we should see that reverse. I can't predict when that FX will reverse. But at some point, we should see some benefits coming in certainly over the period of 2024.

In respect to the question around, you know, the CDMO drag on the margins, and in particular, you know, Cognate, we - well, to start, we're not expecting to see a meaningful impact on the consolidated operating margin. But to your question, yes, there is a drag on the Manufacturing segments' margin.

And as we said before, you know, we expect to see modest margin improvement over the next few years you know as we deliver the acquisition synergies, you know, there's, we've got a great procurement department, we've got good back office functions that can bring some synergies to those businesses.

We will continue to enhance the scale of the business and like we do with every operating unit, we know we're looking to drive operating efficiency.

And with the high revenue growth, where we're expecting north of 25% for the foreseeable future, we would get economies as those you feel like the fixed costs become less prevalent respect to the whole of business.

So, in terms of margin progression, we would expect to see with time, the Manufacturing business improve, certainly from today's position. And in terms of long-term guidance that we gave just two months ago, we did say that we were expecting to get into the mid-30% range. Clearly, we will do what we can to improve that further.

But at this stage, we're posting over the next few years mid-30s from Manufacturing..

Thank you..

Your next question is from the line of Donald Hooker with KeyBanc..

Great, good morning, I was curious if you all could elaborate a bit on any potential inflationary pressures, obviously tremendous demand for what you're doing.

I'm wondering if, you know, it might be more expensive to hire the scientific talent now than it was before - have you see any trends there? How do you manage that?.

Want to take that, David?.

Yeah, I'll take that. So while we take - I'll take the broader question, first on just wage and inflation pressures. I mean, you know I'd like, many people who picked up that many companies, you know, it's a global issue, pressures across most industries. I can't say every industry, but certainly most industries and regions.

And certainly wage pressure and recruitment, for Charles River has been and always in terms of, you know, we're continually growing and we got to keep up with that.

We've spoken about this at many of our earnings calls, you know, we've discussed some of the investments that we've made and initiatives to address that in the past like the live and wage, you know, work-life balance initiatives that's form. And yet, we're seeing our revenue growth is ahead of our initial expectations.

So as you can imagine, we're working very hard in multiple geographies to actually make sure we're hiring and meeting that real most event. So really, the - to your question about looking that between workgroups, it's more about bringing in the staff of the sort of the wider growth that we're seeing as opposed to specific category.

Of course, with, you know, 19,000 people, there's going to be some departments where we may feel that there are some needs to pay more to make sure that we can, you know, get that type of resource in.

But we're not seeing a blanket issue with respect to scientific staff or with other staff, it's more about just managing the sheer growth within Charles River vis-a-vis the wider churn that we're seeing in the wider economy, because of COVID people, many people are looking for change.

So we continue to drive some of these work-life balance type issues, because that will go a long way to helping with retention as well. But notwithstanding all of that, that I've described, you know, we've factored that into the guidance for this year, we still feel that that's still relevant in respect of the longer-term guidance that we've given.

So we should still see that 150 basis points increase over the next three years, not for this year, how that will pan out within the years too early to call. But certainly we feel with the extra growth that we're benefiting from that helps pay for some of these global issues that we're all facing..

Great, thank you..

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

Hey, thanks for taking the questions, guys.

Jim, maybe just on kind of an increased demand in the backlog going out for next year? Can you just talk a little bit about the pricing environment? You know are you seeing clients book on things like pay basis just to reserve space when they need it? And what kind of pricing are you guys kind of talking about in some of these you know bookings to the out years?.

No, take a pay yet. Frankly surprises me if I was in the client's shoes, I would do that. Just to protect myself, so I could go to the front of the line and not have to get in line. But that's their business and their call. So yeah every once in a while we get quite a serious question about that.

So what would that look like? And we give them a quote and I guess it's too expensive. We're really pleased with the price. You know, we're not going to disclose the prices we haven't for years, but we're really pleased with the pricing you know we're getting in Safety.

You know, with the studies continued to be incredibly complex, more complex than it used to be oftentimes, end points are added as the drug progresses and looks more promising those days get more expensive.

And, you know, we continue to have a nice mix between what we call, general toxicology and special toxicology which provides sort of an enhancement to the overall price paradigm.

You know, we have to be conscious cognizant and professional about the pricing, because not unlike so many of our other businesses, like RMS for instance, we have competitors, particularly smaller ones that compete with us principally on price, allegedly on speed and flexibility, which is not true, I like to play the card that Charles River must be too slow, because it's so big that's just not true.

So and when we have new opportunities to get on new work, unless we're trying to take work from our competitor, we're pretty much always driving the price out. So I would say that pricing is increasingly, it's certainly an important focus of our clients.

But I would say as demand has intensified and as capacity continues to fill, even with new capacity being built, that price is not the first thing that clients talk about, and I think that provide some opportunities for us.

We've been pretty pleased with that pricing yield for the last, I'd say three years anyway, and I wouldn't anticipate any change in that going forward..

Great. Thanks, Jim..

Sure..

There are no other questions at this time..

Great. Well, thank you for joining us on the conference call this morning. We look forward to speaking with you during an upcoming investor conference. This concludes the call..

This concludes today's conference call. You may now disconnect..