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

Thank you. Good morning, and welcome to Charles River Laboratories First Quarter 2021 Earnings Conference Call and Webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer; and David Smith, Executive Vice President and Chief Financial Officer, will comment on our results for the first quarter of 2021. Following the presentation, they will respond to questions.

Thanks, Todd. Good morning. I'm very pleased to speak with you today about another exceptional quarter at Charles River. Our robust first quarter financial performance, highlighted by 13% organic revenue growth and 170 basis points of year-over-year operating margin improvement, demonstrates the strength of the biopharmaceutical market environment and the power of our unique portfolio, both of which we believe are as strong as they have ever been. We believe clients are increasingly choosing to partner with us for our flexible and efficient outsourcing solutions, with scientific depth and breadth of our portfolio and our unwavering focus on seamlessly serving their diverse needs. Clients are opting to work with a smaller number of CROs who offer broader scientific capabilities, which enable them to drive greater efficiency and accelerate the speed of the research, nonclinical development, and manufacturing programs. The complexity of scientific research is also increasing our clients' reliance on a high-science outsourcing partner like Charles River. To further differentiate ourselves from the competition, we are strategically expanding our portfolio in areas that deliver the greatest value to clients and offer significant growth potential. Already this year, we have enhanced our scientific capabilities for advanced drug modalities through the acquisitions of Distributed Bio, Cognate BioServices, and Retrogenix. Distributed Bio and Retrogenix strengthen our discovery portfolio.

Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition-related charges, costs related primarily to our global efficiency initiatives, our venture capital and other strategic investment performance, and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation. We're very pleased with our accomplishments in the first quarter, which widely outperformed our outlook. We delivered strong revenue growth, well above the 10% level on an organic basis and significant operating margin expansion of 170 basis points, which drove earnings-per-share growth of 37.5% to $2.53. The operating margin performance was particularly encouraging as the consistent margin improvement reflects our efforts to build a more scalable and efficient infrastructure and leverage the robust growth in our end market. As Jim mentioned, we have increased this year's financial guidance to reflect the enhanced growth profile for the full year, including the strong performance for the first quarter and the addition of Cognate and other acquisitions that we have completed. We now expect to deliver reported revenue growth of 19% to 21% and organic revenue growth in a range of 12% to 14% for the full year. Given the robust top-line performance, we expect to drive meaningful operating margin improvement this year, with the full-year margin approaching 21. This is expected to drive better-than-expected earnings per share in a range of $9.25 to $10, which represents year-over-year growth above 20%. By segment, our outlook for 2021 continues to reflect the strong business environment and the differentiated capabilities we provide to support our clients’ needs. RMS organic revenue growth guidance for the year is unchanged from our initial high-teens outlook, reflecting recovery from the impact of the COVID-19 pandemic last year, exceptional growth in China, and the expectation that our cell supply revenue growth will improve during the year. The DSA segment is now expected to deliver low double-digit growth for the full year, reflecting the strong first quarter performance and intensified early-stage research activity. For the Manufacturing segment, we now expect to achieve mid-teens organic revenue growth, with both the Biologics and Microbial Solution businesses contributing. Including the acquisition of Cognate, Manufacturing's reported revenue growth rate is expected to be in the high-30% range. With regard to operating margin, RMS will continue to be a primary contributor to the overall improvement for the year, with the segment margin meaningfully above 25%. We also expect the DSA segment's operating margin to increase over the prior year into the mid-20% range. When factoring in Cognate, the Manufacturing segment's operating margin is expected to be in the mid-30% range this year or moderately below its 2020 level. Unallocated corporate costs were slightly higher than our expectations, totaling 6.2% of total revenue or $51.2 million in the first quarter compared to 5.6% of revenue in the first quarter of last year. The increase was primarily the result of continued investments to support the growth of our businesses and higher performance-based compensation costs, due in part to first quarter operating outperformance. Despite the higher expenses in the first quarter, we continue to expect unallocated corporate costs to be in the mid-5% range as a percentage of revenue for the full year. The first quarter tax rate was 14.5%, a 20 basis point increase year-over-year and consistent with our outlook in February, which calls for a tax rate in the mid-teens due to the gating of the excess tax benefit from stock-based compensation. We continue to expect our full-year tax rate will be in the low-20% range on a non-GAAP basis, which is unchanged from our outlook provided in February. Total adjusted net interest expense for the first quarter was $17.1 million, which was essentially flat sequentially and a decrease of nearly $2 million year-over-year due to lower average debt levels, which resulted in interest rate savings based on our leverage ratio. At the end of the first quarter, we had $2.2 billion of outstanding debt, representing a gross leverage ratio of 2.3 times and a net leverage ratio of 1.9 times. In March, we issued $1 billion of senior notes to further optimize our capital structure and take advantage of the attractive interest rate environment. The proceeds of this bond offering were used to redeem a previously issued higher-rate $500 million bond to pay down the existing term loan and a portion of the revolving credit facility and to finance a portion of the Cognate acquisition. In April, we also amended our existing credit agreement to establish a new revolver with borrowing capacity of up to $3 billion. The net result of these actions will reduce our average interest rate on debt by approximately 50 basis points to 2.65%. An overview of our current capital structure is provided on slide 36. On a pro forma basis, including the Cognate and Retrogenix acquisitions, our gross leverage ratio was just under three times, and we had total debt outstanding of slightly below $3 billion. For the year, the higher debt balances due primarily to the Cognate acquisition will be partially offset by the lower average interest rate from these refinancing activities, which is expected to result in total adjusted net interest expense of $83 million to $86 million. Free cash flow was $142.2 million in the first quarter, a significant increase compared to $42.9 million last year. The primary reason for the improvement was the strong first quarter operating performance, along with our continued focus on working capital management. Capital expenditures were $28 million in the first quarter compared to $25.7 million last year. Looking ahead, we are increasing our capex guidance for 2021 by $40 million to approximately $220 million. The increase primarily reflects the investments we are making in Cognate to support its high-growth business. Even with the additional capital, we expect capex will remain below 7% of our total revenue this year, which is consistent with the target that we provided at our last Investor Day in 2019. For the full year, we are updating our free cash flow guidance to the upper end of the prior range and now expect free cash flow of approximately $435 million for the full year. We are pleased to be able to increase free cash flow due primarily to the strong first quarter operating performance, even after incorporating the transaction costs and capital needs of Cognate. A summary of our revised financial guidance for the full year, including Cognate, can be found on slide 38. For the second quarter, our updated outlook reflects a continuation of the strong demand environment. We now expect second quarter reported revenue growth at or near the 30% level, including the contribution of Cognate. On an organic basis, we expect the second quarter growth rate to be at or near 20%. This reflects the prior year comparison to the COVID-related revenue impact, which will contribute approximately 700 basis points to the second quarter revenue growth. As a result of the impact of COVID-19 on the second quarter of last year, we expect this year's second quarter non-GAAP operating margin and earnings per share to increase significantly versus the prior year. Our expectation for non-GAAP earnings per share is a growth rate of more than 50% year-over-year. In conclusion, we are very pleased with our strong first quarter performance, which included robust revenue aims and free cash flow growth. We remain confident about our prospects for the year and our ability to consistently grow the top line, bottom line, and cash generation, and as such, believe this is reflected in the substantial improvement in our outlook. We look forward to hosting our upcoming virtual Investor Day in a few weeks. At that time, we plan to update our longer-term financial targets, which we believe will reflect the strong demand environment. Thank you.

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

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

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

Sure, John. So Cognate gives us the ability, and particularly in combination with HemaCare and Cellero, to actually provide the cells to do the process development, to do the clinical trial scale-up, and ultimately, to provide commercial quantities specifically of cell therapy products. And secondarily, we have some of the capabilities that are involved in and facilitate gene therapy manufacturing as well. But I'd say that the CDMO business will be primarily cell therapy-related.

Great. And then last month, you guys talked about Valence strategic relationships, which had some references to AI and machine learning. Can you just talk a little bit more about how you see machine learning having applicability within, I assume, DS&A mainly?

There's a significant emphasis on using data to guide the design of preclinical trials for improved outcomes. Ultimately, we need to demonstrate how to create better clinical trials that yield favorable results and establish a connection between the two. We have access to a wealth of data, and Valence is a particularly strong AI company. This will manifest in various ways throughout our portfolio. We don't view this as a replacement for our existing efforts, but rather as a means to enhance them and provide earlier insights into how a drug might perform before entering non-regulated and regulated safety trials. The introduction of AI should improve both the speed of development and the outcomes regarding the number of drugs that reach the market. The combination of our extensive data sets and Valence's AI capabilities presents a promising opportunity, even though it’s still in the early stages.

Very helpful. Thank you.

Sure.

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

Thank you very much. Impressive quarter. I'm focused on Safety Assessment, DSA segment. You cited record RFPs, record demand in Q1. That obviously follows the 2020 DSA segment-ending backlog of $1.4 billion, which was up 40% year-over-year, yet you're only forecasting low double-digit organic revenue growth in the segment this year. When we look at prior year's beginning backlog and how that compared to the resulting revenue growth, the math would suggest multiples of what you're guiding to. I'm just curious what explains this disconnect from past backlog growth to your outlook for low double-digit growth this year?

Want to take a shot at that, David?

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

We are excited about the demand and our backlog. The year has started well, and we are optimistic about our guidance, expecting organic double-digit growth in that segment. It is still early in the year, and we want to see how things unfold, but we are confident in our guidance. As mentioned previously, our business shows nonlinearity, meaning things do not progress at the same rate quarter-to-quarter. We believe this will be a strong year based on our guidance.

Well, Jim, it certainly doesn't look like you're going to miss that target. I'm just curious, I mean, pricing, I mean, can't be bad in this environment. And it just leads me to wonder if there's a big mix shift in the nature of the work, if there are capacity constraints happening, which makes me wonder if there's something in that backlog report from last year that you changed how you look at backlog or the reporting of the figure because it just historic trend, if I go back, even stripping out acquisitions, the last five years, it just the growth rates would be, if history repeated itself, the growth rates would be materially higher than what you're talking about. And it just seems these are awesome numbers. I'm not complaining, obviously, but it seems like a bit of a disconnect.

So maybe we'll take it off-line. But just to provide some comfort, Eric, and I understand the nature of your question. Pricing signs, capacity is well utilized, but we have sufficient capacity. And as I said in my prepared remarks, we actually have clients booking more work earlier, I don't know, because they have more work because they're better funded in. Maybe there's an underlying concern that none of us or our competitors will have the capacity that they want when we need it, although we work really hard to do that. The mix is solid, and we're getting a significant amount of work from big drug companies, a little bit instigated by COVID, but also just a plethora of new biotech companies. So nothing but good things are happening. We're pleased with our articulation of good things happening and what that reflects in terms of financial guidance. But maybe we should just talk to you off-line and get you more comfortable with the ebb and flows.

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

Yes. And I'm back on. I'm sorry, I hit the speaker button instead of the mute button. I was happily chatting away to myself. And then when I saw that it's mute, I realized that I hadn't heard what Jim was saying, but I get the impression that you were discussing about how the backlog has been built up because people are booking out further afield. And one of the reasons why we've been able to increase our outlook this year is because we can see much more of the year. So if that was discussed, I won't repeat it.

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

Good.

Our next question comes from Dave Windley of Jefferies. Your question please?

Hi. Thanks for taking my questions. I won't exactly follow on Eric's question. I think you addressed that well enough. But you have pointed out, Jim, Discovery's stronger performance for a couple, maybe three quarters. And you also commented, in general, in your prepared remarks about continuing to seek ways to add value for clients in DSA, which is a general comment, but I wonder if maybe it's related to the growing Discovery business and potentially pull-through there, which we've asked about for years. So I wondered if you could elaborate on the adding value to clients and DSA part of your comments.

Yes. Yes, the Discovery business, as we've been talking about for at least a couple of years now, has really come into its own just in terms of client utilization, understanding of the depth and strength of the scientific portfolio. We've been adding additional businesses like D Bio and Retrogenix. And we have scale now. So we've got terrific organic growth, even though we don't break that out, and meaningfully improving operating margins in that segment, as well as a pull-through into Safety. And of course, we're seeing high growth rates and nice margins in the Safety business as well. And I think we have a very strong capacity situation in both of our businesses. So we're really pleased with the demand. We're really pleased with the client uptake. It's largely driven by biotech clients. Having said that, we have a lot of big pharma clients who are sourcing more of their work to us, for sure, in Safety, and they have been for a while, but increasingly in Discovery. And as we keep adding these assets either through direct straight-up acquisition or the strategic initiatives that we've been pursuing vigorously, I think that will only intensify.

When considering your capital deployment appetite, there have been discussions in the public markets about monetizing potential assets through spin-offs. You've recently entered the contract manufacturing space, which is quite capital-intensive. Could you provide a priority list or a ranking of where your capital deployment focus mainly lies?

Sure. The sites continuing to invest appropriately in our businesses, all of which are growing. So most of our capex is growth-related. But as we reiterated in our prepared remarks, we're going to keep capex is going to stay below 7% of revenue even with the addition of Cognate and the capacity that's required there. But all of our businesses require additional capacity, certainly. Certainly, Safety does as well. So putting that aside, we're going to continue to do these technology deals in which we have about a dozen that are signed and another dozen in conversation. Distributed Bio was one of those that turned into an acquisition. Retrogenix began to be one of those and just pivoted immediately into an acquisition. And we have other deals in AI and bioinformatics and digital pathology, next-generation sequencing, environmental traumatic, and 3D tumor modeling that are cutting-edge technologies, and we're going to invest small amounts in those businesses or loan them some money and some of those, for sure, will be acquisitions. And they won't be particularly large companies, nor particularly expensive acquisitions, but they will grow rapidly. They'll enhance the portfolio, and they will distinguish us from the competition, not entirely, but particularly in the discovery. And I would say, besides those deals, which I don't know what the cadence will be, but I think we'll have a couple of dozen things that we're kind of participating in, and we'll buy some of them. We're going to do some straight-up M&A in the discovery space. We're going to hopefully do some more straight-up M&A, sort of in the general ambit of cell and gene therapy. We'll do some more straight-up M&A in sort of lab sciences area. We'll do more work in sort of aspects of biologics and microbial. And we actually have a couple of things that would fall into RMS. So the conversations, as always, are several. They're almost all private equity-owned businesses, which means that they're all for sale at the right time and in the right price. Nothing would take us off the reservation. They would be continued additions of what we're doing. If you have the underlying thesis of the question is, what additionally might you do in the CDMO space, specifically? I can't say that categorically, except to say that our focus for the foreseeable future is primarily in cell therapy and secondarily in aspects of gene therapy. And I think that we are currently a meaningful player in the cell therapy space and could be the most meaningful player in that space, where we just continue to grow the business and add additional parts and pieces. And I think you understand fully that surrounding the CDMO activities and cell and gene therapy is the cell product businesses and buttressed by the Biologics business. So that's a powerful portfolio, and then that's added further with the combination trials for pharmacology and toxicology. So it's a broad suite of offerings in cell and gene therapy, which is the largest and potentially the most exciting modality. And we'll see where it all goes. There's a couple of thousand drugs that are being worked on right now. We're probably working on a significant number of those. Yes. So that's the nature of our focus in M&A, particularly in cell and gene therapy.

Great, very helpful. Thank you.

Sure.

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

Thank you for the question. Jim, I have two related inquiries regarding capacity in Safety Assessment and the newer CDMO capabilities. I'm interested in your comments about clients booking further in advance of actual work in Safety Assessment, and how you are assessing capacity. Based on current trends, do you anticipate needing to increase capacity? I understand that matching supply and demand in Safety Assessment can be challenging. As for the second question about CDMO, you mentioned last quarter that you would evaluate the need for additional capacity there. I'm curious if you have any updates on the CDMO footprint since that comment.

Sure. We have been gradually increasing our capacity each year for several years, likely seven or eight. The Safety Assessment business started recovering in 2013 after flattening out in 2012. Since we have multiple Safety Assessment sites, we can't simply add capacity in one location or concentrate it all in the U.S. or Europe. We have added at least half a dozen sites based on client demand and how the current space is utilized, along with market projections. We've always managed this, including adding capacity in 2020 and planning for next year and possibly 2023. We're monitoring demand closely, which is exceeding our original estimates, and we may need to make slight adjustments to our capacity this year. If that happens, it will be minimal. Those worried about our capital expenditures should not be concerned, as we have a high-growth business that requires sufficient capacity to manage this growth. We appreciate clients booking earlier, which makes the process more orderly. While pricing is still a factor for clients, they seem more focused on the science and securing their slots. Maintaining tight capacity helps our margins, but we must be careful not to run out of space and turn clients away, which is a balancing act we are skilled at. We are currently increasing capacity and plan to continue doing so throughout the year, potentially ramping it up more if we see sustained demand. In the CDMO area, specifically with Cognate and cell therapy manufacturing, we have already added capacity. We need to continue expanding for next year based on client demand and the specifics of that demand, such as whether clients are in Phase II or III and if they are preparing for commercial launch. We have enough capacity for this year and likely early next year, but we will add more as needed. Capacity and headcount are our constraints, not demand, which is a positive situation for us. Having sufficient space is a matter of careful planning and funding, and we need to start that planning early because building space takes time. Toxicology space can take around 18 months to two years, while CDMO space may take nine to twelve months. We need to build the required space and hire and train the workforce in advance to ensure we can meet demand without falling short. At the same time, we must avoid having excessive space or idle personnel. It's a continual balancing effort.

Appreciate your thoughts. Thanks, Jim.

Sure.

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

Hey, thanks. Jim, on manufacturing, you talked about COVID vaccine testing intensifying. I'm curious how we should think about that dynamic. Curious if you can quantify what's actually baked into the outlook on COVID. I think last year, you said it was about $60 million across the portfolio. And then as we think about Cognate, one question that comes to mind is why people would work with you versus Catalent that has Paragon and MaSTherCell, Thermo that has Brammer. So can you just talk a little bit about how you think about competitive positioning for Cognate?

The numbers we discussed last year that were related to COVID fall into a different category than what we're experiencing this year. I don’t think it's particularly useful to compare the two. Last year, we had a difficult second quarter with revenue declines in RMS and Microbial, among other areas we were closely monitoring. We aimed to clarify this for our investors. Moving forward, while there will be some continued work on COVID-related therapeutics, such as monoclonal antibodies and antivirals, it will be modest, similar to last year. These will be drugs for treating individuals who contract the virus, regardless of their vaccination status. Our Biologics business will also engage in extensive testing of COVID-related vaccines. I anticipate that the situation will evolve to resemble a flu-like scenario, with booster shots and new variants emerging annually. As for the companies involved, I expect at least four will continue testing the vaccines, along with possibly others. Therefore, I don’t think it’s particularly useful to separate this out moving forward, as I see it becoming a standard part of our ongoing operations. Our Biologics division remains strong, supported by a wide range of large molecule products, including monoclonal antibodies. Additionally, cell and gene therapy work related to COVID will remain crucial. Regarding why clients would choose to work with us over companies like Catalent or Thermo, I think both those firms primarily operate in gene therapy manufacturing, while we also focus on cell therapy manufacturing. We face smaller competitors in that space who don’t offer the comprehensive suite of services we provide. Our capability to support clients from initial research through process development and clinical applications to end-use is a key differentiator. Furthermore, we aim to enhance this holistic approach, as our competition accelerates clients’ speed to market without the need to switch service providers at each stage.

Okay. That's helpful. And then follow-up, just curious about the sustainability of some of the trends you called out. At RMS, you talked about GEMS, this resurgence around outsourcing, managing proprietary colonies. How much of that came from the pandemic? And how much of that do you think is sustainable? And then separately for DSA, you've called out the pricing increases and client securing space ahead of time a number of times on this call. I'm just curious how you think about the sustainability of those trends as well.

I feel very optimistic about the sustainability of both areas. GEMS has been a strong growth segment for us for at least ten years, and its models are increasingly essential for basic drug research. There are many services linked to producing these models, which are complex to create and deliver to clientele. We experienced a boost due to COVID, which we plan to maintain. The demand for these models is robust, especially as they become more advanced through CRISPR and other technologies, and we are operating on this front worldwide across all our locations. We are satisfied with DSA pricing, though we won’t provide specific details on that. The growth and demand in the dome are also encouraging. Given the funding landscape and the rise of new modalities like cell and gene therapy and immunotherapies, I believe we have secured additional work in Discovery, which has led some clients to reconsider us. They seem pleased, and we expect to retain that business. With the introduction of new services like D-Bio and Retrogenix, we anticipate further incremental work. I believe our pricing strategy will remain stable, and as long as demand stays strong, clients will likely book slots earlier, which benefits them and gives us better visibility for planning and space utilization, ultimately enhancing our bottom line.

Okay. Thank you.

Okay.

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

Yes. Hi. Good morning and congrats on the quarter. Jim, I wanted to go back to the comments around clients securing room on the tox side earlier on. I mean this is something that we've been talking about for a long time. So are you starting to have any conversations with your customers around sort of pay or play time, type of deals, and securing capacity for longer periods of time, considering that it takes about 18 months, right, to build capacity?

Yes, that would be beneficial and seems to align with the current market conditions. I have some reservations based on past experiences from over a decade ago when a few clients secured capacity on a take-or-pay basis, paying for it while it was unused to avoid waiting. I've mentioned multiple times that if I were leading R&D at a major pharmaceutical company, I would definitely commit to such space to eliminate concerns about availability. It's a relatively small portion of the overall cost of drug development, with the hopeful clinical cost roughly 20% of that, and most spending occurs during clinical trials. We've had a few inquiries and thoughts on this from clients. However, I am hesitant to make predictions about whether it will materialize. That said, we are seeing an increase in early slot bookings. For instance, if a client wants to initiate a study in June but we are not available until September, they would need to adjust their plans or consider taking the space on a take-or-pay basis. Anything is feasible, and the current market dynamics could support the concept you mentioned. Nevertheless, larger pharmaceutical companies have generally been cautious about entering into such agreements, and we currently lack firm evidence that this will change soon.

And then as a follow-up question, I mean, you've been consistently beating and raising organic growth goals in your forecast for the different segments. Considering the mix of business and your performance, what's kind of like still holding you back from upping long-term guidance?

Nothing, we're going to provide new long-term numbers at our investor conference in a couple of weeks, so we will wait until then. Nothing is holding us back. We believe we have a strong understanding of the market, a solid assessment of the funding paradigm, the new modalities, and what clients are telling us. We also have a significant presence with nearly all the major drug companies and most biotech firms. We have a well-established base, and now we have a clear view of the situation, with new numbers to be released soon.

Great. Thank you.

Our next question comes from Juan Avendano of Bank of America. Your question please?

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

We don't have control over that. Long-term studies require short-term studies, and specialty work typically follows general toxicology work. They are interrelated. We appreciate both types of work. The action profiles are somewhat similar, though specialty work tends to have a more straightforward pricing structure. It generally balances out around a 50-50 split, which we prefer. As I mentioned, we cannot control this entirely. Occasionally, we may report having either an excess of long-term studies without enough short-term ones or the other way around. Usually, this evens out over time, and it appears we are currently in balance.

Got it. Can you provide an update on the revenue synergies between Discovery and Safety Assessment? How is that aligning with your long-term goals?

Yes. I mean without processing it too finely because I don't think that's useful or productive to kind of do this on a quarterly basis, there's no question that we have an increasing number of clients. They could have been Safety clients who never did Discovery with us or Discovery clients on never did Safety, or new clients who never did anything with us that work with us to help discover and develop a compound. And then are thrilled because we have a really deep understanding of the molecule to work with us because a, they trust us, b, because they like our science, and c, because it's faster. So I think over time, we will continue to have a significant amount of our clients be doing both with us. We don't contract with them that way. In other words, we don't say we won't do the discovery work with us much. It just has to be Safety or vice versa, that would be overreaching and I think dangerous. But I think increasingly, particularly as the Discovery portfolio has grown so significantly and with great scientific depth and with great cutting-edge technologies, that we have much more clients open to and are utilizing us for discovery, some of whom use us in safety before that are really comfortable just continuing to have us develop the drug.

Okay. Thank you.

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

Great. Thanks for taking the question. Maybe the first one just on margins. I know you called out, obviously, with the strong top line operating leverage and efficiencies. Could you just maybe break out a little bit maybe some of the components there? Just what was the impact from acquisitions? What would the impact from efficiencies, if you will, and just operating leverage just in terms of the new guidance that you're providing?

Yes, that's correct. We've outlined the details of the various deals we've undertaken. Overall, this year, Cognate and Retrogenix are neutral in terms of margin and earnings per share due to their size. Thus, the majority of the increase you're seeing is not attributable to these entities but rather to the operational businesses themselves. With the top line improvements we've reported, there will be some favorable impact on margins due to the fixed costs we have. In the past, we used to outline the effects of our efficiency program on Charles River as a whole, but we've stopped doing that for some time. Nevertheless, we are experiencing strong top line growth, and the efficiencies we mentioned are coming into play effectively. However, apart from Cognate's impact on the Manufacturing margin, there isn't significant M&A activity affecting the results positively or negatively. Despite this drag from Cognate, we are still achieving a 21% margin this year due to the overall performance of the business.

Maybe we could discuss HemaCare next. I believe its growth was below expectations last quarter due to the pandemic, and you anticipated a recovery. Can you update us on the guidance for 2021? What considerations do we have for HemaCare for the rest of the year?

Well, we haven't broken out HemaCare in precise numbers. What we have said in the preprepared remarks is that HemaCare had a slower start than we had hoped, but we do see that improving as we go through the year. I just would like to point out, it is a relatively small business. And the fact that it's had some issues at the beginning of the year because of COVID and donor access to sites, etc, we see that improving as we go through the year. And of course, it's still a strong business for the future. So this year, it's a small impact on the business.

Got it. I know Microbial improved this quarter. Similarly, you were affected last quarter by the pandemic. How should we consider the potential for that business to catch up, based on what you experienced this quarter compared to the usual expectations for that segment?

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

Great. And then maybe last one, just on Cognate, Jim. Sorry, if I missed it. I know you gave a lot of details in the deck and the presentation. But what specifically is baked in for Cognate this year? And I think at the time you did the deal, I think you were anticipating what a 15% revenue tag or is this correct? Just wondering on both of those fronts. And if it's 15%, why couldn't it be higher than that given the overall growth rate of that end market?

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

In terms of the deal, I believe you mentioned a three-year CAGR of 15%. I'm curious about the opportunity, considering the end market is definitely growing at that rate, if not faster.

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

Got it. Thanks, David.

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

Hi, guys. I just had to ask a little bit more about how customers are moving through the post-pandemic era. Are you seeing people taking time to think through what they're outsourcing, what they're keeping in or sort of think through changes to their discovery programs? Or is it just kind of, 'Oh, let's get moving because we had all these projects that were delayed'? Or sort of how would you characterize the tone of your conversations?

I mean they're quite positive, except in the second quarter in our research model business when academic clients were closed, and we had difficulty placing some of our Microbial Solutions systems. All of our sites remained open. And virtually all of our clients, except a handful, were open. So our clients have been busy. They're well financed. The vast majority of our clients have no internal capability to do anything to have discovered drugs and then all the rest of the development that comes to us. So I wouldn't say that there's been a dramatic change. We just have increasingly intense demand across the board for what we do, based on really robust portfolios, early stage portfolios that most of our clients have and enough money to prosecute them broadly as opposed to sort of chunk it. And we don't see any indications that those elements would soften or that the demand would soften certainly as we move through this year. And as we said earlier, we gave a longer-term guidance and our thoughts on where our business is going and demand is going at our investor conference.

Okay. That's helpful. As a follow-up, you mentioned some capacity constraints related to physical infrastructure. Are you noticing any changes in the availability of employees or any wage cost pressures compared to a couple of months ago?

We are actively hiring a substantial number of employees, surpassing our initial hiring plans due to increased demand for our services. This situation poses a positive challenge, varying by geographic location. In some areas, hiring is more straightforward, while in others, competition is stiff. We believe we are an appealing employer, as evidenced by our involvement in over 80% of drug development over the past three years, which serves as a strong recruitment advantage. With 110 locations in various countries, the competition for talent varies by region, and wage levels are dynamic. We are focused on remaining competitive to ensure that salary is not a barrier to attracting talent. Ultimately, the biggest limitation we face in our business is not just any employees, but finding exceptional individuals who are committed to our mission of serving patients. I believe we have performed well in recruitment during the first quarter and expect significant improvements in hiring throughout the latter part of the year globally. We are diligently working to remain proactive in this area.

Great. Thank you very much.

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

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

It is still early days. We are seeing slower revenue growth in the first quarter for HemaCare and Cellero due to limited access to donors, combined with the fact that Cognate is relatively new, only a month or two old. Therefore, it is too soon to make definitive statements. We firmly believe in the strength of our business thesis; however, clients who can engage with us early in the process—through development, scaling, clinical applications, and into commercial quantities—represent a valuable opportunity. Virtually no client will build these capabilities independently. The competitive landscape is appealing for us, and we possess a unique portfolio that clients have responded positively to, based on our discussions and the increase in business. Our ability to provide a comprehensive suite of cell and gene therapy services—covering pharmacology, safety testing, biologic testing, and microbial testing—has significantly contributed to our growth in this area. Essentially, we offer a holistic portfolio of products and services, positioning us as a solution provider for clients. This is particularly beneficial for smaller biotech companies, as they typically lack the time, resources, or inclination to engage with multiple providers across various service areas. Our strategy is focused on becoming the largest nonclinical CRO, enabling us to deliver greater support to our clients, so they don't have to manage it themselves and can minimize interactions with numerous different players.

Got you. Thanks, Dave, Todd, and Jim.

Our final question comes from George Hill of Deutsche Bank. Your question please?

Hi, it's Maxi filling in for George. Could you share your thoughts on the shifting competitive dynamics in the industry due to recent innovations, and whether the latest deals in this area offer the chance to advance into later-stage research services?

Yes, I understood that. You mentioned it quickly, but the consolidation on the clinical side of the business is similar to what we've seen and actively participated in on the preclinical side. As you know, we have 12 different sites and about eight or nine acquisitions in the Safety business. That entire sector is closely linked with acquisitions and industry consolidation to enhance our scientific depth, capabilities, and geographic reach. You are observing and will continue to see the same trend in the clinical space. Now that it's started, I expect it to progress. I’m not sure where it will lead, but it could end up with two or three major players. Regarding what this means for us, we consistently monitor the clinical sector. We previously had a small clinical CDMO capability, which we divested due to its limited scale, but now we are re-entering through cell and gene therapy. So we have two major initiatives: one in the CDMO space and the other in the clinical space. We have tentatively stepped into the CDMO area and find it promising, particularly in cell therapy. On the clinical side, we could also pursue that, but it doesn't seem there is client demand at this time, and I don’t think we should consider such a move unless clients express interest. The only company with both clinical and preclinical capabilities is Covance, and I believe that has not proven successful; clients do not tend to engage with them based on that offering nor enter contracts for comprehensive preclinical to clinical work, which takes years. We haven’t discussed collaborating with clinical CROs about integrated services in the past decade, nor has anyone ever approached me for partnership. While collaborating could enhance our share of client spending, clients currently don't seek that from us. Until that changes, I don’t see a reason for us to join forces with others who have clinical capabilities. However, I’ve learned never to rule out any possibilities entirely. I don’t know at what point client demand will shift to prefer one company or multiple companies for both services. If that occurs, we will consider it.

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