CRL — Q2 2021 Earnings Call Transcript

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 the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated. During this call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the Investor Relations' section of our website. I will now turn the call over to Jim Foster.

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 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 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 that 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. 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 had only 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 client 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 client 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 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 reinforces 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 segment's revenue last year. But testing on 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 for Cell & Gene Therapy Testing Services continues 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 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 segment's 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 but 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, where some investments which were slowed or deferred during the COVID-19 disruptions last year 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.

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

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 and aggressively, geographically across 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 this demand. I don't think it's a bad thing that clients are reserving space earlier, as it allows us to plan better and gives us greater visibility from a staffing and expense standpoint. It also provides a more orderly business model, and it's not all that dissimilar to the way it was years ago, when we had similar types of demand. So, the principal conversations around here are ensuring we have sufficient headcount and physical capacity to accommodate the demand, not just in safety, but obviously, safety is our biggest business. The conversations go beyond that to Biologics and Discovery and other business segments, including China as well, focusing on ensuring sufficient capacity, as that is the goal we set this portfolio together for—to service the clients that 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, a lot of businesses are having. I think that's quite transitory. The metrics are still quite good within that business, and the growth rate was really terrific. So, it’s just kind of a short-term blip.

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

Sure. Thanks, Eric.

Hey, good morning. I'll start with a question on Manufacturing. On the back of the Vigene deal, you noted that clients are beginning to explore opportunities to streamline development with you. I guess, as you look at your Cell & Gene Therapy portfolio today, are there any existing gaps? 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. We have the cells, which is a Cell Therapy, and no Cell Therapy R&D or scale-up will occur without that. So we'd like that we started first with that, and now we have significant capability in Cell Therapy Manufacturing, particularly modified cell therapies. We also have viral vector and plasmid DNA capability on both sides of the Atlantic in the US and Europe, which gives us substantial capability. There may be some nuances. And of course, we're always looking at M&A opportunities. I don't want to get too specific, except to say that I think that M&A will be principally around increased scale and enhanced geographic dispersion and diversity of growth. Geographic proximity is also important to clients regarding live cells. So there are still a fair number of assets out there that we're quite interested in, various sizes. Most of them are on the smaller side, and several options are no longer available. If we are unable or unwilling due to price points to buy and meet our targets, I think we have a terrific installed base, and the growth rates will make it a big business. I want to remind you that we look at Cell & Gene Therapy assets in combination with our Biologics business, which is very high growth right now, as you heard us mention, above 20%. Those businesses will be essential for testing those Cell & Gene Therapy products before they go into the clinic and hopefully after they're approved before going into patients. We’re thrilled to piece those together, yielding a remarkable portfolio. I think that we didn't update it on this call, but the Cell & Gene Therapy revenues are greater than 10% of the total Charles River now, which is significant and it's going to grow disproportionately fast.

All right, and then a follow-up on RMS. Obviously, a number of those businesses benefited over the past year from the challenges around the pandemic. If you look at the GEMS outsourcing and CRADL insourcing initiatives, as we move past the halfway mark of this year, how do you feel about the durability of those trends, particularly around GEMS and CRADL insourcing?

Really good. While we certainly enjoyed enhanced outsourcing from clients that did work themselves or didn't use us or used us partially, we've proven the value proposition by staying open and doing great work. Putting aside the COVID boost, the significant demand for GEMS models and specialty models, as well as more complex and translational models, is for sure notable. The IS business, particularly in places like Cambridge and South San Francisco, has been very interesting; the CRADL locations are high revenue generators and high margin businesses and significant feeders to other parts of our business, particularly service enterprises. Being in those environments, particularly in the Cambridge and 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, plus we are looking to add new sites as well.

Okay, thank you.

Sure.

Close enough, I guess. Good morning, thanks for taking my question. I wanted to ask Jim about China. You mentioned that the demand in China has rotated from the academic and government sector to more private sector client base. I'd be curious about how that influences your price points and margins for your business in China? Additionally, given the success there in models and investments in biopharma in China in general, is it time to rethink or start thinking about planting other business lines in China to leverage off of your existing base?

Yeah. There's huge investments by the Chinese government in the life sciences; venture capital firms are aplenty, so we're seeing significant investment in sort of classic and new pharma companies, and mostly biotech companies. While I don't personally think the market will overtake the US, I do believe it will become the second largest market for sure. It provides enormous demand for us. We will always try to get better pricing; that's a general proposition, including in China. The cost structure is significantly lower than other parts of the world, but price points and margins remain comparable. We need to be cautious given the fact that there are many local Chinese competitors, mainly financed by the government, and they have the ability to competitively price. Our RMS competitors worldwide principally compete on price but not so much on quality or service. We’ll continue to drive prices as much as we can, especially as costs go up in China. Our RMS franchise is growing nicely, and we have made significant investments and services in China, including IS and GEMS. Regarding your second question, we have a large and growing RMS business, we also have a sizable Microbial business. Testing isn't regulated over there, so the total revenue contribution remains modest. We recently did a joint venture in our Biologics area, which we are quite excited about, considering our major competitors are present there. We would like to build everything that we do in China, and we are cautious about entering the market, given the challenges and complexities involved, to ensure we act thoughtfully and fiscally responsibly, either through a joint venture or greenfield activities. We continue to need to evaluate market demand; we have so much work and high growth in the US and Europe, so our focus is currently not in China. It's a longer-term strategic conversation within Charles River.

Very helpful. Thank you, Jim.

Sure. Sure, Dave.

Hi, thanks very much. Jim, my question relates to the capacity availability for Cognate and Vigene. Can you 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 part of the long-term plan?

Definitely in our guidance. What we've told you about the accretion of those businesses to our top line, our EPS, and improving operating margins is real. Both businesses have a significant amount of available capacity; they were in the process of expanding capacity when we bought them, and that will continue. They have a significant amount of space. It's an interesting one; the business is potentially explosive, the ability to take clients from clinical production to commercial, which we can see with a couple of clients depending on how impactful those new drugs are, will lead to needing a lot of capacity. So we're always going to have incremental capacity available, meaning preparing space to have plans to finish it all at once or in stages. We're focusing on staying very close to the clients—their drug phases, how well financed they are, and the competitive scenario—they're doing that really well. I think we're well positioned for the next couple of years. Our guidance indicates that CapEx will be around 7% of our revenue to accommodate for significant growth, particularly in Safety, Discovery, and the CDMO business. I don't think it's particularly more capital-intensive than several areas we work in, and the Cell Therapy work is not significantly more intensive than other aspects of the CDMO space. We have our arms around the scale, growth, and costs.

Sounds great. Thank you.

Sure.

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

Yeah, I mean, we see it progressing well. If you look at most of our large clients, I would say they buy most or everything that we sell. So we are becoming an increasingly important provider with significant spend from those companies, and we're dealing with senior people there who consider us an essential source for the services they need. Even smaller clients, while many are pre-revenue, or public with solid market caps, they have zero desire to build their capabilities internally. That trend will become even more linear down the road, particularly for Cell & Gene Therapy, Biologics Testing, and certainly Safety. The broader the portfolio, the more client capture we will have. We're already seeing clients who are working with Cognate and Vigene interested in the broader range of services that Charles River has. Client curiosity in their interest in Cell & Gene Therapy capabilities is high; the speed to market is critical for all these companies, regardless of size. The ability to work with a single source to alleviate the pricing negotiations at every step allows for acceleration of the entire process. Some of these companies find our regulatory capabilities incredibly helpful in guiding them through their FDA or other regulatory agency filings globally. As you know, there are 3,000 Cell & Gene Therapy drugs in development; two-thirds are in preclinical phases. Many of those companies we are already involved with, so having these capabilities is essential for our participation in a significant portion of the marketplace.

Got it. That's really helpful. Thanks.

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

Okay, I'll take that, Jim. Regarding FX, you've seen a 150 basis point headwind in DSA for Q2, and it averages out to about 100 basis points for the first half of the year. We actually think the second half of the year will be somewhat similar. That said, in respect to your question about how the FX might turn out longer-term, as we’ve seen historically, we should see some benefits coming in at some point during 2024. We're not expecting a meaningful impact on the consolidated operating margin but, yes, there is a drag on the Manufacturing segment's margin. As we said before, we expect to see modest margin improvement over the next few years as we deliver on acquisition synergies. We've got a great procurement department and back-office functions that can bring synergies to these businesses, we will continue to enhance the scale of the business. Like we do with every operating unit, we know we're looking to drive operating efficiency. Given the high revenue growth and expectations of north of 25% for the foreseeable future, we will get economies as fixed costs become less prevalent.

Thank you.

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 it might be more expensive to hire the scientific talent now than it was before. Have you seen any trends there? How do you manage that?

Want to take that, David?

Yeah, I'll take that. So while we take the broader question on wage pressures, like many companies, it's a global issue with pressure across most industries. I can't say every industry, but certainly most industries and regions experience wage pressure and recruitment issues for Charles River. We are continually growing and need to keep up with that. We've spoken about past investment initiatives to address that like live and wage initiatives and work-life balance initiatives. We're seeing our revenue growth ahead of initial expectations. We continue to work hard, across multiple geographies, to meet this talent demand. It's more about managing the sheer growth within Charles River versus a specific category. Of course, we have 19,000 people; therefore, there will be some departments where we might feel the need to pay more for certain resources. However, we aren't seeing a blanket issue regarding scientific staff; it’s more about balancing growth versus the wider economy turmoil, with many people looking for change due to COVID. We will continue driving work-life balance policies, as those measures help with retention throughout our workforce. We have factored that into our guidance for this year and still feel confident about delivering 150 basis points increase over the next three years. It's too early to call how that will pan out within those years, but we believe that with the extra growth benefiting us, it will offset these global challenges.

Great, thank you.

Hey, thanks for taking the questions, guys. Jim, maybe just on the increased demand for backlog going out for next year? Can you talk a little bit about the pricing environment? Are you seeing clients book on things like pay basis just to reserve space when they need it? What kind of pricing are you guys discussing in some of these bookings for the out years?

I wouldn't take a pay yet. It frankly surprises me; if I were in their shoes, I would do that just to protect myself to go to the front of the line. So that's their business. Now and again, we get serious questions about that. We provide quotes, but sometimes they find them too expensive. We're really pleased with the pricing, and I can say we’re not disclosing pricing. The pricing in Safety is good; studies have become incredibly complex with increasing endpoints as the drugs progress. We’ve been pleased with mixed services including general toxicology and special toxicology, which is driving overall pricing upward. We have to remain conscious regarding pricing, as some competitors price primarily on cost and not quality or service. However, as demand intensifies and capacity fills, pricing is not the first topic clients bring up. Our pricing has tended to yield well for the past three years, and I would not anticipate any changes going forward.

Great. Thanks, Jim.

Sure.

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.