Ladies and gentlemen, thank you for standing by and welcome to Charles River Laboratories International Fourth Quarter Earnings Conference Call and 2021 Guidance Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised today's conference is being recorded.

Thank you, Mary. Good morning and welcome to Charles River Laboratories fourth quarter 2020 earnings and 2021 guidance 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 fourth quarter and full year 2020 and our guidance for 2021 as well as our planned acquisition of Cognate BioServices. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks which will be posted on the Investor Relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately two hours after today's call can also be accessed on our Investor Relations website. The replay will be available through next quarter's conference call. I'd like to remind you of our Safe Harbor. All remarks that we make about future 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 from 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. In addition today's remarks will also include estimates of the COVID impact on the company. Certain methodologies and assumptions related to how we develop these estimates can be found on slide three. I will now turn the call over to Jim Foster.

Thanks Todd. Good morning. I'm very pleased to speak with you today about the conclusion of another extraordinary year for Charles River, our expectations for 2021, and the expansion of our early-stage research and manufacturing support portfolio into a complementary high-growth sector. 2020 was an unprecedented year. The COVID-19 pandemic challenged us in many ways. But to date we've navigated it successfully and reinforced our position as the leading nonclinical CRO. Our success in 2020 was due to the resilience of our business model, a comprehensive business continuity plan that enabled us to keep our worldwide operating sites open and adequately staffed.

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. My discussion this morning will focus primarily on our financial guidance for 2021, which principally excludes the impact of Cognate BioServices. We expect 2021 reported revenue growth of 12% to 14% excluding Cognate and organic revenue growth of 9% to 11%, which includes a benefit of the favorable year-over-year comparison to last year's COVID-19 revenue impact. Sustained client demand, including record fourth quarter bookings and proposal volume in our Safety Assessment business and a robust biotech funding environment support our growth outlook for 2021. Based on this strong revenue growth and with modest operating margin expansion in 2021, we believe we are well positioned this year to deliver non-GAAP earnings per share between $9 and $9.25. This equates to year-over-year earnings per share growth of approximately 11% to 14%, which is similar to our top line growth outlook, as higher revenue and margin improvement will be partially offset by a higher tax rate. Foreign exchange is expected to provide a 200 to 250 basis points benefit to our reported revenue growth guidance for 2021, as a result of the weakening U.S. dollar. Our FX rate estimates are based on the bank forecast for the year, which are currently very close to spot rates. We have provided information on our 2020 revenue by currency and the foreign exchange rates that we are assuming for 2021 on slide 40 and we'll continue to monitor fluctuations in the currency market as we progress through the year. From a segment perspective, our revenue outlook reflects the strong business environment and the fact that most of our businesses have recovered from COVID-19-related disruptions in 2020. The RMS segment is expected to achieve high teens organic revenue growth in 2021, as client order activity for research models rebounds from COVID-19 and the growth rate of HemaCare and Cellero cell supply businesses accelerates to targeted levels. We expect the DSA segment to deliver organic revenue growth approaching 10% in 2021 and Manufacturing to grow slightly below 10% on an organic basis as Robust Biologics demand is partially offset by the continuing impact of COVID on Microbial Solutions. We were very pleased that the operating margin improved by 100 basis points to 20% in 2020 and that we achieved our target of a 20% full year operating margin one year ahead of plan. Building upon this performance, we believe that we are well positioned to drive additional margin improvement for the full year 2021, despite modest pressures on Manufacturing due to Cognate, as we continue to leverage strong revenue growth and maintain our focus on operational excellence.

On a segment basis, RMS is expected to be a primary contributor to margin improvement in 2021, increasing from the COVID-suppressed levels of 2020 to well above 25% this year. The DSA operating margin is expected to continue to make progress toward the mid-20s target and the Manufacturing operating margin is expected to be similar to the 2020 level before Cognate. We expect unallocated corporate expense in 2021 to be in the mid-5% range as a percentage of revenue, or similar to 5.6% of revenue last year. Our scalable infrastructure enables us to drive greater efficiency even as we periodically reinvest to meet our goals and the needs of our clients. Total adjusted net interest expense is expected to decrease to a range of $66 million to $68 million in 2021 excluding Cognate, compared to approximately $74 million last year. We expect the decrease driven by lower average debt balances, as well as lower variable interest rates. The non-GAAP tax rate for 2021 is expected to be in the low 20% range, an increase from 18.9% in 2020. The increase in the tax rate is principally an issue of comparison to 2020, because last year's tax rate was reduced mainly by discrete tax benefits associated with state tax returns and foreign tax credits. As a reminder, the first quarter tax rate has been meaningfully lower in recent years, due primarily to the excess tax benefit related to stock compensation. Given our current stock price, we expect this to be true in 2021, resulting in a non-GAAP tax rate in the mid-teens in the first quarter.

We remain intently focused on driving strong free cash flow growth as a key measure of our financial performance. In 2020, free cash flow was $380 million, an increase of 12% from 2019, but below our prior guidance. The decrease in the fourth quarter resulted primarily from higher capital expenditures, which totaled $166.6 million. This was above our prior outlook of $130 million due to two factors: paying capital invoices ahead of schedule in order to give a discount, as well as the timing of capital projects. Some projects that were slow due to COVID-related challenges in the second quarter resumed in response to the reacceleration of growth and business activity.

At the end of the fourth quarter, our total debt balance was essentially unchanged sequentially at $1.9 million, but our gross leverage ratio decreased to 2.3 times, primarily because of the strong fourth quarter performance. With our leverage ratio below 2.5 times, we will benefit from interest savings on our variable rate debt, reducing the rate by 12.5 basis points to LIBOR plus 112.5 basis points. For 2021, we expect free cash flow to be in the range of $415 million to $435 million based on the anticipated strong operating performance of our business and our continued focus on working capital management. Capital expenditures this year are expected to total approximately $180 million excluding Cognate. Currently, we do not intend to repurchase any shares in 2021 and expect to exit the year with a diluted share count slightly more than 51 million shares. The FX benefit is expected to largely offset the earnings per share dilution from the higher share count.

A summary of our 2021 financial guidance, excluding Cognate can be found on slide 49. Looking ahead to the first quarter of 2021, we expect year-over-year revenue growth will be in the low double-digit range on a reported basis and approaching 10% on an organic basis. We expect earnings per share to increase at a high-teens rate year-over-year from $1.84 in the first quarter of last year. As I mentioned earlier, the first quarter tax rate is expected to be in the mid-teens, primarily due to the excess tax benefit from stock-based compensation. Before I conclude, I'll provide some details on our financial outlook including the acquisition of Cognate. Assuming the acquisition closes by the end of the first quarter, Cognate is expected to add approximately $110 million to revenue for the partial year resulting in a revenue growth outlook of 16% to 18%. We expect Cognate to be neutral to non-GAAP earnings per share in 2021, so do not expect the acquisition to have a meaningful impact on our current guidance.

The acquisition is not expected to have a meaningful impact on Charles River's consolidated operating margin this year, so we continue to expect to generate modest margin improvement with Cognate. We believe there will be opportunities to improve Cognate's operating margin over the next few years as we deliver acquisition synergies, enhance the scale of the business, and drive operating efficiency. We intend to update our full guidance and other financial metrics to reflect Cognate next quarter, once the acquisition closes. From both strategic and financial perspective, we believe the acquisition will deliver a compelling benefit that will generate value for shareholders. As a premier cell and gene therapy CDMO, we expect Cognate to boost the growth potential of our business and be increasingly accretive to non-GAAP earnings after the first year. Due to the high growth nature of the emerging cell and gene therapy sector, we expect to pay 23 times adjusted EBITDA for the next 12 months after the close. We expect the transaction will achieve our return on invested capital hurdle rate, which is to meet or exceed our cost of capital by year three or four. We plan to finance the Cognate acquisition through our current revolving credit facility and we will also evaluate opportunities to further optimize our capital structure given the attractive interest rate environment. Our pro forma gross leverage ratio at closing is expected to increase into the low three times range, which is consistent with the levels after other recent transactions. Also consistent with prior deals, we will focus on repaying debt in a timely manner following the acquisition and reducing leverage to our targeted level below three times. In conclusion, we are very pleased with our 2020 financial performance and believe that we are positioned to have another strong year in 2021. Over the past five years, we have achieved compound annual growth of 15% for revenue, 16% for earnings per share, 15% for operating cash flow and 10% for free cash flow. With Cognate and future acquisitions as well as continuation of the robust underlying demand environment, we believe that we will be able to achieve similar growth metrics over the next five years. We intend to provide a business update and more details on our longer-term outlook including our updated financial targets at a virtual Investor Day in the spring. Thank you.

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

Thank you. Our first question is from Eric Coldwell with Baird. Your line is open.

Hey thanks very much. Good morning. Just two quick ones here. First off and I think we could probably triangulate based on those last comments. But David could you tell us what the cost of capital you're using for the Cognate deal? It looks like you might be exploring some options on your debt structure related to this. And then secondarily, there were some comments on mix and safety being slightly dis-favorable in the short term. I'm curious if we could get a little more detail on what the driver of that was and what the outlook is for the mix going into 2021? Thanks very much.

Yes. Regarding the cost of capital for our return on invested capital calculations, we use our WACC, which is around 7%. I believe your question also pertains to potential funding options. Currently, interest rates are very low, and if this trend continues, we will explore ways to structure our long-term debt to finance Cognate. We will provide more details in the coming weeks or months. It makes sense to take advantage of the low-interest rate environment. While we can initially fund the investment through our revolver, we will monitor the market for longer-term interest rates for our bonds. As for the DSA margin, there were two factors that influenced it. To give some context, we've been aiming for a 20% overall margin for Charles River and are pleased to have achieved that this year, a year ahead of schedule. DSA significantly contributed to this achievement, with the margin growing by 140 basis points over the year. However, we did see a slight decline in Q4, mainly due to higher performance-based compensation. With a 9.4% organic revenue growth and the aforementioned margin improvement, the DSA team certainly deserves their compensation. Regarding the mix, we've previously discussed how an imbalance in studies with larger models can lead to increased initial costs. However, if profitability improves throughout the study, we often see similar margins overall. Mix can fluctuate, and sometimes it balances out, but occasionally, as we experienced in Q4, we may have a heavier load from studies that incur larger upfront costs. Overall, we are optimistic about DSA's potential and are still working towards the 25% goal mentioned by Jim in his prepared remarks. The impact from Q4 is mostly temporary.

Your next question comes from Dave Windley with Jefferies. Your line is open.

Hi, good morning. Thank you for taking my question. I want to ask about cell and gene therapy in relation to your acquisition of Cognate. For the first part of my question, I’d like you to elaborate on why the CDMO opportunity in cell and gene therapy is more appealing for Charles River compared to the small CDMO that was part of the WIL acquisition, which you chose to sell. The second part of my question is to provide more details on the components you've assembled, including your cell supply and complementary biologics testing capabilities. Is this collection fairly complete, or are there additional capabilities you think are necessary to enhance your cell and gene therapy business? Thank you.

Yes, thank you, Dave. Many years ago, we acquired a small molecule CDMO, which was a solid business. We communicated to analysts and shareholders that we had conducted a thorough analysis of the industry and concluded that there were some large competitors, making it challenging for us to achieve the necessary scale. Since we aim to be the premier player in our sectors, we believed it was best to exit, which we did. At that time, I may have exaggerated my desire to stay away from this sector. However, in recent years, several developments have occurred. First, cell and gene therapy have gained significant momentum. This presents us with the chance to carve out a niche in the CDMO market, positioning us as a leader in this area with the asset we are acquiring, and potentially the top player over time. This aligns with our earlier statements. There is about $20 billion invested in cell and gene therapy, and in 2020 alone, around 2,000 drugs were filed, with most being in preclinical and Phase I stages. The demand has surged. We are receiving many inquiries, and our M&A activity stems from client requests for products and services that they expect us to provide, either due to their trust in us or their inability to obtain these elsewhere. Thus, this acquisition fills a vital gap in our portfolio. While it wouldn't be disastrous if we hadn't pursued this opportunity, it would have forced clients to seek drug manufacturing elsewhere. Continuing on with your second question, we now have an extensive portfolio that starts with cells through research and development. We will be capable of process development for drugs, testing them in our Discovery and Safety business, producing them for clinical use, and eventually for commercial purposes. Our Biologics business will test these drugs prior to their introduction in clinics or the marketplace, creating a comprehensive offering. As mentioned, our involvement in cell and gene therapy is set to increase from about 5% of our consolidated revenues in fiscal 2021 to 10%. This represents a significant strategic shift for us, entirely in response to our clients’ needs, enabling them to work with us throughout the development of cell and gene therapy products, especially in cell therapy, where most of this business will concentrate, offering the potential to become a leading provider in this segment.

Very good, sounds good. Thank you.

Sure.

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

Thank you. Jim, just a quick follow-on on what you just said, I assume, the work that Cognate is doing is clinical at this point, but are you set up for commercial scale production? And can you maybe comment on the kind of the capital footprint and investment needs that you think you're going to need to make in the business over the next few years? Thanks.

They have a strong presence in the US and Europe and definitely have additional capacity, some of which has been added recently. This will enable them to handle larger clinical trial batches. As those drugs transition to commercial use, they will need to support that work as well, which clients will expect. Currently, there are very few commercial products in cell and gene therapy, although many are in development. This will be our aim and strategy moving forward. We possess the technical skills and regulatory knowledge required for CGMP production in cellular therapy, thanks to our experienced management team. Similar to our other growing businesses, having the right capacity in place will be crucial as we prepare for anticipated demand. I believe clients of Cognate will feel assured working with us, given the uncertainties associated with private equity ownership and future investments. Clients currently developing drugs with us will have a strong degree of confidence that if their drug progresses, we could be their commercial producers. We see this as a strong entry point for expanding business through our relationships with clients and integrating this into our overall portfolio.

Great. Thank you.

Sure.

Your next question is from Ricky Goldwasser with Morgan Stanley. Your line is open.

Yeah. Hi, good morning, and congrats Jim on completing the acquisition. I know you talked about it I think over a year at our conference and your intent to enter the area. So congratulations. My question is around the margin profile. Clearly, you exceeded your margin expectations by a year. But from everything I'm hearing, it sounds like there's a real nice opportunity for long-term margin expansion, right? You talked about the complexity of the projects that you are working on. And even when I think about sort of the strategic outsourcing it seems that we're starting to hear from some companies that they're looking to downsize their own facilities and their own sort of workspace, which I equate to kind of like five, ten years ago what we saw in the talks were kind of like capacity was coming down which gave you an opportunity. So how should we think about that margin expansion and opportunity? And when you give us those long-term goals is it going to be kind of like a 2-year goal, or are we thinking longer-term here, especially given kind of like the Cognate acquisition that really opens this new and growing market opportunity?

I'll provide a general comment. David might offer a more specific insight. We will hold off on a comprehensive exploration of this vital topic until we share our long-term guidance. To summarize, we are structured to enhance efficiency across all our operations while keeping our general and administrative expenses as low as possible as the business grows, a trend we have shown over the past few years. We have also showcased our capacity to improve efficiency. We will be focusing more on digital initiatives, which will enhance connectivity among our sites both internally and externally, thereby streamlining processes and potentially boosting returns. Our pricing power remains strong across all sectors, which ties into the outsourcing demand you mentioned. Biotech remains our primary growth driver, supported by a robust pharma presence. The biotech sector is well-funded and typically does not prefer to develop internal capabilities. Our largest business segment, DSA, presents substantial margin opportunities moving forward. We have pursued significant acquisitions in that sector that have performed well, although there is still margin potential to realize. The recent acquisition will continue to offer enhanced margin opportunities. We expect RMS to return to its pre-2021 performance levels, and its appealing cell product aspect should promote improvement. While the Manufacturing segment has potential for enhancement, we will assess how to approach that. With margins currently at 37%, they are indeed impressive, yet we believe there is still room for growth in the Biologics sector. Therefore, you can anticipate modest growth improvements in 2021 as mentioned in our prepared comments, with further advancements in the future. We will provide a detailed analysis on this before long.

I think you've covered all the main bases there, Jim. And the only thing I would add is that we constantly give some deep thoughts about where to invest versus the margin expansion. And it's always a balancing act to look for the medium term. But despite that comment as Jim said, we do feel we can get margin expansion this year. And we'll say more when we have the virtual Investor Day in the spring.

Thank you.

Your next question is from Juan Avendano with Bank of America. Your line is open.

Hi. Thank you. I have a few questions on RMS. I guess, the first one is the pent-up demand in research models, do you foresee that to be a multiple quarter event? And related to that, it seems like the supply of non-human primates has been severely impacted by COVID-19 and export bans from China. Are you seeing a benefit in your Research Model volumes as clients might need to migrate towards smaller volumes in the absence of the bigger models? This is a dynamic that I've been sort of tracking. And then the last thing is on HemaCare and Cellero it seems like the revenue that came in the quarter was a little bit lighter than expected. And so just curious, if you're seeing a lingering impact from the pandemic on the donation centers? I'll leave it there. Thank you.

Yes. There's probably a slight lingering impact as you put it on the government side through the fourth quarter. We had shutters down and then we opened it in May. It's been improving steadily. There's still some – obviously, some social distancing going on and we're always looking for new donors. So probably some slight drag coming out of the year. As we said in our prepared remarks, we anticipate that we'll continue to improve both as COVID becomes less severe hopefully. But even if it doesn't, we feel we have the operational knowledge to structure this in a way that we should achieve the goal. So we had next year's targets, which is north of 30%. So that will continue to participate – to grow nicely. In fact, you're going to ask another question on nonhuman primate. So I'll answer the one, I thought you were going to ask and answer the one that you did ask, why is that the supply is definitely constrained around the world? I think we've done an exceptional job in adding ensuring tightening up expanding our supply sources so that we have multiple supply sources for multiple countries, such that we can support the demand, which is quite significant. The sort of changing out of species and moving to smaller species, maybe we should have an offline conversation on that. I just don't think that's – I don't think that's happening. Work on large molecules really has to be done on larger species to get the sort of quality results that we're looking for. So I think NHPs will continue to play a critical role. In terms of pent-up demand for RMS, I think we've seen much of that play through the academic medical centers that were totally or partially shut in – basically in all three geographic locals. Asia, Europe and the US have essentially all opened. We don't believe regardless of the level of infection with COVID that they're going to go down – go back in the lockdown. The research is too important. They're sorry that they shut them down and they definitely now had to work with other agents around and given that their laboratories are usually all gone down. So we think that we're back in kind of a normal cadence in RMS for the products which is principally what you're talking about the services obviously we're not only unaffected but I think benefited from some of the COVID disruption that our competitors saw. But in terms of production sale of research models, I think we're back to normal cadence both in volume and price enhanced by the cellular products of business that continues to grow.

Thank you.

Your next question is from Robert Jones with Goldman Sachs. Your line is open.

Great. Good morning. Thanks for the question. Jim, I wanted to go back to the comments around the delayed instrument installations in Microbial. It seems like you're expecting that I think the language you used was to affect revenue growth well into 2021, but it seems like you saw some improvement towards the end of 2020. So just wanted to understand a little bit better what needs to kind of change at the client front in your mind to see a reacceleration of these installations? And then relatedly, I think you gave some commentary on margins by segment, but overall it looks like 20 basis points to 30 basis points improved EBIT margins. How could that look if in fact these installations start to come back in faster in 2021 just to the overall enterprise margin?

Yes, it’s challenging to predict, but we are confident in our assessment. We have faced difficulties accessing clients to install our most complex systems. In some instances, we managed to implement larger systems virtually because clients recognized the necessity and were willing to invest the required time and personnel. We had to innovate to make virtual setups work. Throughout 2020, we endured virtual audits from the FDA and other regulatory bodies, and clients participated as well. We also conducted virtual audits on various aspects of the company we are acquiring. This virtual environment makes it hard to foresee how comfortable people will become with virtual operations or if they will prefer to wait. We expect to maintain a similar pace to what we have experienced. The virus situation is challenging right now, with significant restrictions in many countries where we operate and in several states in the US. For example, we are not allowing outsiders into our facilities. This situation impacts our ability to deploy our large systems, which typically have high average selling prices and are quite profitable. Furthermore, each of these major systems contributes considerable revenue from cartridges, reagents, and, to some extent, our Accugenix ID business. Thus, we are missing out on all the additional revenue that comes from the systems that have not been installed, especially in fiscal 2020. The confusion regarding the end of 2020 is due to not just the reopening of sites but also a significant increase in demand for cartridges, primarily from our extensive installed base of smaller systems. This serves as a reminder that, while large systems may not be readily available, smaller ones are being utilized more frequently. Importantly, there is a strong demand for our business, possibly greater than ever. We will strive to install these systems as effectively as we can, but without their installation, we miss out on the extra revenue. This is why we expect to be slightly under 10% growth.

Got it. Thanks.

Sure.

Your next question is from Tycho Peterson with JPMorgan. Your line is open.

Thank you. I have a few follow-up questions. Jim, starting with Cognate, I want to revisit John Kreger's question regarding CapEx. When looking at other CDMOs like Catalent with Paragon, MaSTherCell, or Thermo with Brammer, the cost to build facilities is significant, typically in the range of $150 million to $250 million for commercial cell and gene therapy facilities. Given your CapEx guidance of $180 million, how should we view your willingness to consider more substantial investments? Additionally, I have two questions for David regarding guidance. Can you provide any details on the contribution from COVID? I know there was $60 million in 2020, so what are we expecting for 2021? Regarding margins, it seems there are a few potential positive drivers, such as the DSA price increase you mentioned, RMS recovering from COVID-suppressed levels, and the Manufacturing installation headwinds easing. All of these factors could lead to more than just modest improvement, but are there any significant offsets we should be aware of? Thank you.

So the CapEx will not be insignificant in this business. It will be meaningful, but I don't think we'll be disproportionate to the growth potential of this business. This will be amongst if not the highest growth aspect of our business. So we'll have to invest ahead of it as we've said earlier. Obviously, there's a substantial installed base already that we're buying. This business is principally GMP cell therapy manufacturing. And secondarily, the production of plasmid DNAs. And while the CapEx is substantial it's less substantial in some aspects of contract manufacturing. So we're not really going head-to-head for instance with Thermo and Catalent that are more gene therapy manufacturing businesses. It's challenging to determine their spending compared to ours. While it won't be insignificant, it will be at a lower level, and we're fairly confident we'll see significant returns. We've already incorporated this into our model, and we'll provide more details once we finalize the deal. David, you can address the second question.

Yes, certainly. Regarding COVID and its impact, we have taken a thoughtful approach in our guidance, which incorporates our expectations about COVID. While there are uncertainties, we had substantial losses related to COVID, particularly in RMS, but we believe that we will be moving past COVID by the end of the year as we mentioned in our last earnings call. In the academic sector, clients appear to be receptive, and we don't foresee a reversal of this trend, although we will monitor the situation closely. We generated $60 million in revenue related to COVID through DSA, some vaccines, and other areas, and we expect some of that revenue to persist into 2021. This is also included in our guidance. Overall, we feel we're moving forward with COVID largely behind us, aside from a few specific challenges we've identified, such as those related to Microbial, which present a slight headwind.

Okay. Thank you.

Your next question is from Patrick Donnelly with Citi. Your line is open.

Hey, thanks for taking the questions. Jim maybe a follow-up for you on the RMS business. It certainly proved more resilient even while the pandemic has lingered here. Can you just talk through what changes you've seen in customer behavior there? And then I know in recent quarters this one included you talked about some academic share gains. How much of that is increased penetration versus taking share from competition?

Yes. We definitely have seen a change in demand, outsourcing demand on the service side of our RMS business, almost entirely from the academic sector, who really were up against it with COVID with facilities that literally were shutting prematurely and a significant amount of research was at risk. And the fact that we were open that we were capable of doing this and have been able to do it so well for them for this amount of period of time, I think it demonstrated sort of the frailties of them continuing to do this internally. We've observed that some tasks previously handled internally have now been outsourced, and we are confident that a substantial portion of this shift is here to stay. In the second quarter, we noticed similar trends with clients in Discovery and Safety, particularly those who used other providers that failed to support them during the early outbreaks of COVID, or their own facilities faced closures for extended periods. This led clients to consider outsourcing for the first time or to increase their previous outsourcing efforts. Feedback indicates that our clients are quite satisfied with our services, our response time, and our pricing. Clearly, we've gained additional market share that was previously managed by clients in-house, as well as some business that was lost to competitors in RMS and DSA due to their inability to deliver. This increase in market share and our expectations for continued growth in specific areas of our business are reflected in our projections for 2021.

Great. Thanks, Jim.

Your next question is from Sandy Draper with Truist Securities. Your line is open.

Thanks so much. Most of my questions have been asked and answered, but I have one quick follow-up on the microbial testing. Instead of focusing on how it affects margins, are there any capacity constraints, Jim or David, when things clear up? I'm trying to understand if this could lead to a spike in revenue over four quarters before normalizing, or do you think it will simply return to a normal level? I'm considering what needs to happen here. Is it just a matter of starting to ship it out and deploying people, or is there a limit to how fast you can go, making it inevitable that things will revert to a normal level? Thanks.

Yes. I don't think there'll be a bolus of activity. The machines will have to be installed virtually or for real, probably most real. And then the clients will have to start to utilize them. Obviously, that installed base of whatever X number of machines that have either been delivered and not hooked up or waiting to be delivered by us to the clients who are not letting us in. As I said earlier sort of every day, every week, every month they don't have those systems. They're not buying the associated disposables. It's unlikely we're going to install all those systems at once and then they're going to suddenly expect to use them at once. It will be beneficial once we install the larger machines, as they will lead to increased usage of disposables. However, I believe this will happen gradually over time. Our inventory should be well-prepared to meet the demand for those disposables. While there may be slight benefits during certain quarters, I do not expect a sudden spike in demand.

Great. Thanks so much, Jim.

Sure.

Your next question is from Dan Brennan with UBS. Your line is open.

Great, thanks. Thanks for taking the questions. Congrats on the quarter. I've had two questions and a margin follow-up and then one more on Cognate. On the margins, I was hoping you could just help us on some of the segment margins. I know for Manufacturing, obviously exited the year at a great level, but I'm just wondering what is the guidance on Manufacturing margins for 2021? It's a little unclear from the deck and from the comments. And similarly on RMS, I know you talked about well above 25%. Are we talking 27%, 29%? Any help on those two numbers?

In Manufacturing, excluding Cognate, we expect the margins to be similar to what we had at the end of 2020. However, Cognate will have a slight negative impact. For Cognate this year, we anticipate being close to the long-term guidance we previously provided, which is in the mid-30s. We will share more details on this at the Investor Day. Regarding RMS, we expect it to be well above 25%, and based on last year, which was slightly above 25% to 26%, a range in the mid to high 20s seems appropriate.

Thank you, David. I have another question about Cognate. Can you provide any insights on the competitive landscape concerning Paragon and MaSTherCell? I assume that WuXi Advanced and other major players are also focusing on this area. Any information regarding the number of clients or other relevant details would be helpful. Additionally, are the senior executives at Cognate committed long-term, considering how vital talent and expertise are for managing these complex contract manufacturing organizations? What were the specifics of their agreements? Thank you.

So you should think of our principal competitors in this space being Lonza and WuXi and not Thermo and Catalent. And number one, you should consider that the size of our business, the business that we're buying, is comparable to those two. So, in the same ZIP code. Specifically, with regard to the sort of manufacturing capabilities that we're acquiring, if you look at the totality of our portfolio in cell and gene therapy, from the cellular product businesses, we bought last year with this business that we're teeing up now across our whole portfolio that cell and gene therapy capabilities are vastly more significant than those two players, and across the continuum where they can continue to use our services. We feel very confident about our competitive position. As I mentioned earlier, we are entering as a leader in the CGMP sector, and I believe there is a high likelihood that we can maintain that leadership within Charles River's broader portfolio, supported by our reputation and client relationships. In terms of management, we have consistently succeeded in retaining key personnel. With the recent deal we've signed, we are optimistic about securing contracts and retaining our key management team.

Great, thanks Jim.

Your next question is from Donald Hooker with KeyBanc. Your line is open.

Hey, great. I guess a lot of questions have been asked here, but maybe the big picture. Jim would love your broader perspective kind of with your leadership position in the space kind of on the topic of using artificial intelligence and machine learning and drug discovery. I know you had one partnership there with a company called Atomwise. You have a bunch of other partnerships. I'm not sure if you're dabbling in that area in other ways. What are your evolving views there? I know you've mentioned in the past, but just curious if your viewpoint on that topic has evolved?

We believe that artificial intelligence and machine learning will play an increasingly important role in drug development, particularly in predicting the success of preclinical and clinical trials. These technologies will also influence the design of trials and linkages between animal studies and human trials. Analyzing the data we have on numerous molecules, some successful and many unsuccessful, can be very significant and predictive. However, it is difficult to determine how robust this technology will be, how quickly regulators will adopt it, and how swiftly our clients will embrace it. What technology do we use as we make these small investments in technology deals? We will definitely have various ways to utilize that data, either in combination or through a single approach that stands out. We have conducted extensive internal work alongside several world-class experts. While we believe there is a continuing role for this, we want to be very careful about investing shareholders' money and making assumptions regarding user adoption, avoiding investments in the wrong technology or being overly aggressive too soon. Therefore, we will proceed in a very measured and thoughtful manner. I wouldn’t say we’re just dabbling; we are seriously exploring the best methods to leverage our capabilities alongside powerful AI tools. I anticipate that we will form additional AI technology partnerships in the future.

Thank you.

Your next question is from Dan Leonard with Wells Fargo. Your line is open.

Thank you. So quickly, anything to be mindful of from a phasing perspective in your 2021 guide, given your comments on the first half outlook for DSA? Is first half a larger than typical proportion of your full year outlook, given the visibility you're messaging on the DSA side? Thank you.

We don't normally see big gating differences in DSA throughout the year. We see that case in Biologics sometimes in RMS, but nothing particular to call out on DSA. We try to give you quite a lot of the pieces and give you a little bit of a hint for Q1 as well. But other than that, no, we don't look at DSA and feel that there are types of incidents that happen that would make that funky other than things like we can often have a mix issue. And that's not to do with the calendar. That could be at any point in the year.

And your last question is from Jack Meehan with Nephron Research. Your line is open.

Thank you. Good morning. Just to conclude, I was hoping you could give a little more color on DSA margins. I was wondering, obviously, the full year was strong, but fourth quarter underperformed a little bit. Are you seeing any inflationary pressures just given the amount of demand out there, either on wages or on some of the supply constraints around the large models? And what's embedded for 2021 in terms of those points?

We haven't specifically mentioned any wage pressures, which is unusual for those regions. There’s nothing major to report regarding wage inflation at Charles River. We monitor the situation closely country by country to remain competitive. In mid-2018, we aimed to transition Charles River to a living wage organization, which we acknowledged at the time. Currently, we don’t see any surprises related to wage inflation or supply costs that need further discussion, other than what we indicated earlier about Q4 being affected by timing issues. We continue to work towards our goal of achieving a mid-25% margin that we have been aiming for. We don’t have much more to add.

Great. Thank you for joining us on the conference call this morning. We look forward to speaking with you during upcoming investor conferences. This concludes the conference call.

Ladies and gentlemen, that concludes today's conference call. Thank you everyone for joining. You may now disconnect.