Charles River Laboratories International, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Charles Weaver Laboratories International Fourth Quarter Earnings Conference Call and 2021 Guidance Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question, you will need to press star 1 on your telephone. Please be advised, today's conference is being recorded. If you require any further assistance, please press star zero. I'd like to hand the conference over to your speaker today, Mr. Todd Spencer, Corporate Vice President of Investor Relations with Charles River. Please go ahead.

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 and 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 non-clinical CRO. Our success in 2020 was due to the resilience of our business model our comprehensive business continuity plans that enabled us to keep our worldwide operating sites open and adequately staffed, our broad scientific capabilities and flexible outsourcing solutions that supported clients' needs, and our employees around the world who met client needs through their commitment and dedication. As a result, we have now become even more integral to our valued clients and more differentiated from the competition. Despite the short-term impact of COVID-related client disruptions, we benefited from robust underlying client demands across most of our businesses. This was largely driven by clients' intensified use of strategic outsourcing to overcome challenges at their own sites as they partnered with us to move their early-stage research programs forward during the pandemic. In addition, the record biotech funding environment, which eclipsed $130 billion last year, is allowing our clients to place greater emphasis on R&D investments particularly in the early stage pipelines. We believe these factors drove our exceptional financial results in the fourth quarter and for the full year. We are extremely pleased to report organic revenue growth above 10% in the fourth quarter and 7% for the year. Both metrics are in line with or above our high single-digit organic growth target, despite the short-term challenges associated with COVID-19 last year. We also achieved our two-year operating margin target of 20% for the full year, one year ahead of schedule. We are continuing to closely monitor COVID-19, but believe our strong performance in 2020 and a continuation of robust demand trends, including record booking and proposal activity in the safety assessment business, position us well to get off to a strong start in 2021. COVID-19 pandemic has also enhanced the global focus on scientific innovation, which is generating biomedical breakthroughs across multiple therapeutic areas, including for COVID-19 vaccines. This innovation has fueled continued investment in, and the proliferation of, more complex research techniques involving advanced drug modalities, such as cell and gene therapies. The complexity of these new modalities is increasing our clients' reliance on a high science outsourcing partner like Shell's River. To enhance our ability to meet our clients' needs in these emerging areas of scientific innovation and to take advantage of the significant growth opportunity that these advanced drug modalities present, we are expanding our portfolio and scientific expertise through a combination of acquisitions, strategic partnerships, and internal investments. This morning, we announced our intent to acquire Cognate Bioservices, a premier CDMO partner for clients' comprehensive cell and gene therapy development and manufacturing needs. We believe Cognate, which will become part of our manufacturing segment, is an excellent opportunity to enter the CDMO market because it will allow us to participate in a niche value-added sector with a high growth profile that adds to our existing non-clinical development and manufacturing support capabilities. Let me start by highlighting three key aspects of the strategic rationale. Cognate has solutions across the major CDMO platforms for cell and gene therapies. Integrating manufacturing and required analytical testing is critical to drive efficiency, and the cell and gene therapy sector offers exceptional growth potential. Cognate's scientific expertise expertise makes this a particularly attractive transaction. It provides CDMO services across both cell and gene therapies with its primary area of expertise in the CGMP cell therapy manufacturing. Cognate also has capabilities in the production of plasma DNA, which is a foundational tool for the development of gene-modified cell therapies and gene therapies, as well as other inputs in the CDMO value chain. Cell and gene therapies are emerging drug modalities, and as such, the science will continue to evolve. However, Cognate's broad capabilities should enable it to better adapt to shifts in the marketplace. Cognate has a track record of producing various cell types and technologies, use in cellular immunotherapy and immuno-oncology, regenerative medicine, and advanced cell therapy. The synergistic fit is the second pillar of the rationale. Cognate will be highly complementary to our existing non-clinical capabilities, establishing a premier scientific partner for cell and gene therapy development, testing, and manufacturing, and providing clients with an integrated solution from basic research through GMP production. Biopharmaceutical clients are seeking to drive greater efficiency and leverage scientific benefits by working with fewer trusted partners who have broad integrated capabilities. As we are already a provider of extensive non-clinical services for cell and gene therapies, the acquisition of Cognate will enable us to produce drugs in these advanced modalities. We believe the strategic expansion of our portfolio is particularly synergistic with our biologics testing solutions business. It will be ideal for clients to be able to seamlessly conduct analytical testing, process development, and manufacturing for advanced modalities with the same scientific partners. enabling them to achieve their goal of driving greater efficiency. Our biologics business is a premier provider of quality control testing for cell and gene therapies, including assay development, analytical testing, and cell banking, which are all critical steps in the manufacturing scale-up and commercial production processes. Clients will also have access to our cellular products as the starting point for the cell therapy programs. and we'll be able to work with Charles River through every step of the research and early stage development process before moving into CGMP production with Cognate, accelerating our clients' speed to market for advanced drug modalities. With Charles River and Cognate combined, we expect to effectively double the revenue base of our comprehensive cell and gene therapy capabilities to approximately 10% of our total revenue. We believe Cognate will also immediately enhance our growth potential by expanding our capabilities and scale into this complementary high-growth cell and gene therapy sector. The addressable market for Cognate CDMO services, principally cell therapy and plasmid production, is currently estimated at approximately $1.5 billion and expected to grow at least 25% annually over the next five years. Growth is being fueled by the robust biotech funding environment Approximately $20 billion was invested in cell and gene therapy companies in 2020, fueling the rapid rise of cell and gene therapies in the R&D pipeline, which now total over 2,000 programs. We believe the demand for cognate services will intensify as more of these programs progress into late-stage development and commercialization. The companies that are successful in the market will be able to provide the science, the space, and the integrated solutions to broadly support clients' cell and gene therapy programs. We intend to be one of these successful companies. The purchase price for Cognate is expected to be approximately $875 million in cash, and the valuation will be consistent with comparable high growth, high science transactions in the cell and gene therapy CDMO sector. Cognate is expected to generate annual revenue of approximately $140 million in 2021, which we project to grow at or above the estimated market rate of at least 25% annually over the next five years. Because of the market growth potential and the emerging role of cell and gene therapies as treatments for oncology and rare diseases in particular, we believe Cognate will meaningfully enhance our revenue and earnings growth potential, and the transaction will achieve our hurdle rates for investment returns. David will provide additional financial details on the transaction, including the estimated 2021 financial impact. We look forward to welcoming Cognate's dedicated employees to the Charles River family. Now let me give you the highlights of our fourth quarter and full year performance. We reported revenue of $791 million in the fourth quarter of 2020, an increase of 14.4% on a reported basis. Robust client demand across all three business segments drove organic revenue growth of 10.3%, The DSA and manufacturing segments reported low double-digit organic growth. The RMS segments' organic growth rate rebounded to a mid-single-digit rate, recovering from COVID-related client disruptions principally in the second quarter. For 2020, revenue was $2.92 billion, with a reported growth rate of 11.5% and an organic growth rate of 7%. We're very pleased with this high single-digit organic growth rate, particularly in light of the revenue headwind from COVID-19. The operating margin was 20.8% in the fourth quarter, a decrease of 60 basis points year-over-year. Margin improvement in both R&S and manufacturing segments was offset by DSA operating margin decline. For the full year, the operating margin increased by 100 basis points to 20%, achieving our target one year ahead of schedule. This was an exceptional performance, resulting primarily from the inherent operating leverage in our business, our continued efforts to drive operating efficiency and build a more scalable infrastructure, and the benefits from the temporary cost reduction initiatives related to COVID-19. Despite achieving our 20% target, we believe we are well positioned to achieve modest operating margin improvement in 2021. Earnings per share were $2.39 in the fourth quarter, an increase of 18.9% from $2.01 in the fourth quarter of 2019. For the full year, earnings per share were $8.13, a 20.8% increase over the prior year. We exceeded our prior guidance range of $7.75 to $7.85 due primarily to robust low double-digit organic revenue growth and favorable below-the-line items for the fourth quarter, including a lower tax rate. We are very enthusiastic about the outlook for 2021. We believe our exceptional market position, the strategic expansion of our unique portfolio, and our focus on operational excellence, combined with continuing robust client demand, position us extremely well for the year ahead. Excluding Cognate, we expect organic revenue growth of 9% to 11%, and non-GAAP earnings per share in a range of $9 to $9.25, or an increase of 11% to 14% year-over-year. The acquisition of cognates expected to be neutral to non-GAAP earnings per share in 2021 and add approximately 400 basis points to the reported revenue growth rate, which equates to a reported revenue growth outlook of 16% to 18% in 2021. I'd like to provide you with additional details on our fourth quarter segment performance and our expectations for 2021, beginning with the DSA segment's results. DSA revenue in the fourth quarter was $495 million, an 11.3% increase on an organic basis, driven by robust demand from global biopharmaceutical and biotechnology clients in both discovery and safety assessments. For the full year, DSA organic revenue growth was 9.4%. We expect organic revenue growth will be approaching 10% in the DSA segment in 2021 because clients, both large and small, are increasingly choosing to partner with a large, reliable CRO like Charles River. Clients know that utilizing our science, our broad early-stage portfolio, and our flexible outsourcing solutions will propel their research efforts faster and more efficiently than they could do it alone. This was amply demonstrated during the pandemic when they faced challenges at their own sites. Robust biotech funding also continues to fuel a healthy demand environment. Our safety assessment business continued to perform extremely well, driven by higher study volume and price increases in the fourth quarter. Bookings and proposal volume reached record levels in the fourth quarter across all regions and major service areas, which we believe positions the safety assessment business favorably for a strong first half of 2021. We're pleased with the extensive depth and breadth of our safety assessment portfolio and remain intently focused on continuing to enhance the value we provide to our clients. We're also seeing greater opportunities to conduct safety and efficacy testing on cell and gene therapies. We believe there is meaningful growth potential inherent in the more than 2,000 programs currently in the cell and gene therapy pipeline, approximately two-thirds of which are in the preclinical phase. The testing requirements for cell and gene therapies vary by molecule, from complex combination pharmacology safety studies to certain cell therapies to safety programs that are similar to a traditional large molecule for gene therapies. We've already built one of the largest early-stage testing platforms to support this emerging high-growth sector and intend to continue to adapt and enhance our capabilities to meet the specific needs of these emerging drug modalities. We are continuing to add new capabilities across many of our businesses, including through strategic partnerships. Our partnership strategy has proven to be very successful to stay current with cutting-edge technologies and add innovative capabilities with limited upfront risk. In the last several months, we've added new partnerships and expanded existing ones across several businesses, including with Cypray, for 3D tumor modeling and screening immuno-oncological compounds in our discovery business, and with PathoQuest and Jade Biomedical in our biologics business. In addition, last month, we announced the acquisition of Distributed Bio, formerly a strategic partner, through which we established our integrated large molecule discovery platform. This platform filled a gap in our portfolio and expanded our early discovery expertise in the complex drug modality that few CROs can successfully offer. We believe our clients' willingness to outsource more of their discovery programs will be predicated on our ability to continue to add innovative capabilities to meet their critical research needs. We believe the combination of the strategic outsourcing trend, deep scientific expertise, and our willingness to forge flexible relationships with clients led to the tremendous performance of the discovery business, which had another exceptional quarter and year Broad-based demand for our suite of early discovery oncology and CNS services drove the fourth quarter performance. To achieve our goals in 2021 and beyond, we will continue to strengthen our portfolio by expanding our scale, our science, and our innovative technologies. By doing so, we are enabling our clients to remain with one scientific partner from target identification through IND filing and solidifying our position as the leading early-stage CRO. The DSA operating margin was 23.2% in the fourth quarter, a decrease of 240 basis points for the fourth quarter of 2019. The decrease was driven by increased costs due in part to performance-based bonuses and a slightly less favorable study mix in the safety assessment business. For 2020, the DSA operating margin improved by 140 basis points to 23.4%. We are pleased with the full-year margin expansion in the DSA segment. and believe there will be incremental opportunities for improvement. RMS revenue in the fourth quarter was $156.7 million, an increase of 5.2% on an organic basis. For the year, RMS organic revenue declined by 3.3%, reflecting an impact of approximately 7% from COVID-19, principally in the second quarter. Our outlook for RMS organic revenue growth will be in the high teens for 2021 as a result of the recovery from last year's COVID-19 headwinds and the incremental benefit from adding the high-growth self-supply businesses to the organic revenue base following the respective anniversaries of the Hemacare and Solero acquisitions. As anticipated, global demand for research models improved in the fourth quarter, both on a year-over-year and sequential basis as clients returned to normalize order activity in all geographic regions following COVID-related disruptions earlier in the year. Demand accelerated nicely in the fourth quarter, particularly in China. We believe that we benefited from market share gains in 2020, especially with academic clients. As research sites reopened and not all suppliers could meet the client's needs, we will continue to monitor the evolving COVID-19 situation globally, but at this point, It appears that most academic and biopharmaceutical clients have adapted their protocols to continue working during the pandemic. Research model services also continue to perform well. GEMS is benefiting from renewed outsourcing demand due in part to COVID-19 challenges at our client sites earlier in the year, as well as scientists' use of more complex research models. We're the natural partner for our GEMS clients since we have extensive animal husbandry expertise which enables us to manage their proprietary models safely and efficiently. We're also continuing to generate client interest for insourcing solutions through both our cradle initiative, where we provide turnkey research capacity to our clients, as well as through more traditional insourced staffing arrangements. Revenue for our self-supplied businesses, Hemacare and Solero, increased in the fourth quarter on a comparative basis, but remained at a growth rate below the targeted 30% level. We anticipate that this growth rate will accelerate as COVID-19 constraints ease, and we expect to achieve our growth rate for these businesses in 2021. We continue to work diligently to expand our donor base in the U.S. and add more comprehensive capabilities at all our sites to accommodate the robust demand in the cell therapy market. The acquisition of Cognate also positions Charles River as a trusted partner that can move cell therapy programs forward using the same cellular products through each step of the research and early stage development phases and into CGMP production at Cognate. The RMS operating margin was 25.1% in the fourth quarter, an increase of 50 basis points from the fourth quarter of 19. The increase was driven by operating leverage from higher sales volumes in the research model business, as well as the benefit from operating efficiency initiatives. For 2020, the RMS operating margin declined by 420 basis points to 22%, due almost entirely to the impact of COVID-19. With the financial impact of COVID-19 believed to be largely behind us, we expect the RMS operating margin will rebound well above the 25% level in 2021. Manufacturing revenue was $139.3 million For the fourth quarter, a growth rate of 12.4% on an organic basis, driven primarily by the biologics businesses. The microbial solutions and avian vaccines businesses were also meaningful contributors to the fourth quarter revenue growth. Organic revenue growth for the year was 10.4%. Microbial solutions revenue growth rate improved again in the fourth quarter, due in part to year-end ordering trends for EndoSafe testing cartridges. We continue to have delayed instrument installations resulting from COVID-19 restrictions at certain client sites. We expect this will constrain the microbial solutions revenue growth rate well into 2021, primarily because the incremental revenue stream associated with corresponding sale of consumables, including cartridges, reagents, and actigenics microbial identification services that generally follow the installation of our high throughput systems will be delayed. This is the primary factor that is expected to cause the segment's organic growth rate to be slightly below 10% in 2021. Beyond the COVID-19-related impact, we continue to firmly believe that our ability to provide clients with a comprehensive, rapid, and efficient microbial testing solution, as well as a high-quality and accurate testing platform, are key differentiators from the competition and will lead clients to continue to choose Charles River for the critical quality control testing requirements. The biologics business reported an exceptional quarter in a year with strong double-digit revenue growth. We believe that robust market demand will continue to support biologics revenue growth in 2021 due largely to demand for testing of cell and gene therapies. We've developed a comprehensive suite of new assays required to support the unique needs of cell and gene therapies and will continue to add assays in 2021 to accommodate the robust demand. The acquisition of Cognate is also expected to be highly synergistic to our biologics business. Its clients will now be able to outsource GMP cell and gene therapy production and the required analytical testing to one scientific partner, reducing the bottlenecks and inefficiencies of utilizing multiple outsource providers. We also expect to derive a benefit from COVID-19 testing. We believe our biologic business will be providing required production testing as many of the vaccines move into the commercial production phase and some of the early stage testing activities subside. Given the strength of the demand environment, we are continuing to build upon our extensive portfolio of services to support the safe manufacture of biologics and ensure we have available capacity to accommodate client demand. As part of this strategy, we were pleased to recently announce that we have expanded our partnership with PathQuest to build a next-generation sequencing lab at our Pennsylvania site and partnered with Jade Biomedical to enhance our biologic testing capabilities and geographic reach in China. Due to the leverage from strong revenue growth, the manufacturing support segment's operating margin was 37.3% in the fourth quarter, an increase of 10 basis points. For the year, the operating margin was 37.4% above our mid-30% target and consistent with our expectations for 2021, excluding cognate. As I mentioned earlier, we believe that the COVID-19 pandemic has demonstrated that we are even more integral to our clients now. We have been intently focused on accommodating their evolving needs during these challenging times, and many clients have told us that they couldn't move They couldn't move their research forward without us. Clients have outsourced incremental work to us across multiple therapeutic areas because of our deep scientific expertise and the ease and flexibility of working with an integrated early-stage CRO like Charles Ferber. As a result, we generated approximately $60 million in revenue last year from our work on COVID-19 vaccines and related therapeutics. We're proud to have worked on all of the COVID-19 vaccines that have been approved for emergency use by the FDA and and in the UK to date, including the AstraZeneca and Moderna vaccines. AstraZeneca and Moderna are two leading biopharmaceutical companies that we have worked closely with under our respective strategic relationships for many years, as they have embraced the benefits of outsourcing and driving efficiency through their R&D organizations. Our relationships with Moderna and AstraZeneca demonstrate how we can work together towards a common mission, to bring breakthrough treatments to market to save lives, which has been particularly critical now as we strive to find a solution to the pandemic. As 2020 has demonstrated, we are operating in a robust business environment with excellent growth potential. To continue to successfully execute our strategy to maintain and enhance Charles River's position as a leading early-stage CRO, to expand our manufacturing support to CDMO capabilities, We will continue to make investments in our scientific capabilities through M&A, strategic partnerships, and internal development, expand capacity and staff to accommodate demand, and exploit our digital enterprise to provide critical data for internal use and to enhance connectivity with our clients. We will continue to evaluate acquisition opportunities across our businesses and across a number of drug modalities and scientific capabilities. We will invest in a disciplined manner, strengthening our portfolio and focusing on speed and responsiveness as we meet our clients' individual needs and promote a more efficient drug development model. Our goal is to enhance our position as a trusted scientific partner for pharmaceutical and biotechnology companies, academic institutions, and government and non-governmental organizations worldwide. By providing exceptional value to our clients, we believe we will continue to deliver greater value to our shareholders. Conclusion, I want to thank our employees for their exceptional work and commitment, especially during the COVID-19 pandemic, and our shareholders for their support. Now, I'd like David Smith to give you additional details on our financial performance and 2021 guidance, as well as additional details on the acquisition of Cognate.

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 buy-in services. 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 the 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 US dollar. Our FX rate estimates are based on the bank forecast for the year, which are currently very close to the 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 will 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 the HemaCare and Solera 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 biologic 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 carbonate, 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 toward the mid 20% 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 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 to $68 million in 2021, excluding COVID, compared to approximately $74 million last year. We expect a 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 and increase from 18.9% in 2020. 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 do a discount, as well as the timing of capital projects. Some projects that were slow due to the COVID-related challenges in the second quarter resumed in response to the re-acceleration 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 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-teamed 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 to 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 compelling benefits 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 coordinate 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. 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, 15% for earnings per share, 15% for operating cash flow, and 10% for pre-cash flow. With Cognate and future acquisitions, as well as a 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. Ladies and gentlemen, at this time, if you would like to ask a question, simply press the star followed by the number 1 on your telephone keypad. Again, if you would like to ask a question, press the star 1 on your telephone. We will limit one question per participant only. Thank you. Our first question is from Eric Caldwell 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 in safety being slightly disfavorable 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.

Yeah, so Eric, in terms of the cost of cattle for our return on invested cattle calculations, we use our WAC, which is around 7%. But I think your question is also about how we might fund it. So we know the interest rates are very low at the moment. If that holds, then we will be looking to see how we might structure our long-term debt to finance Cognate. So we'll say more, of course, in a few weeks or months' time when we come to do that. But yes, I think it's definitely on the cards that with a low interest rate environment, we ought to take advantage of that. So although we can fund the investment initially through our revolver, and we'll do that, We will be keeping a close eye to what markets might do in terms of longer-term interest rates for our bonds. In terms of the DFA margin, there were two aspects that drove that. If I just step back a moment, as everybody knows, we've been trying to get to the 20% overall margin for child welfare for some time now. Really pleased that we've achieved it this year. Really pleased that we did it one year ahead of schedule. And DSA was a meaningful contributor to that. So the margin grew 140 basis points over the full year, but we did have a slight decline in Q4. And that's partly to do with higher performance-based compensation. I mean, we had the 9.4 organic revenue growth. I've just mentioned 140 basis point margin improvement. So the wider DSA team absolutely deserve the compensation they've got there. Secondly, to your question on the the study mix and we've had this conversation a few years ago where we have a situation where we've got a disproportionate amount of studies that have large models and so there's additional costs initially when those studies kick off but the profitability improves over the course of the study and overall you end up with similar sorts of margins so mixes you know tend to fluctuate Sometimes it balances off to get the portfolio occasionally. You get, like we have in Q4, like we had a few years ago, where we've got a particular heavy load, like on studies that have larger costs at the beginning. So overall, yeah, we're very pleased with the potential for DSA, still striving to move that towards the 25%, which I think Jim mentioned in his pre-promote remarks as well. So this Q4 impact, is mostly transplant history.

Your next question comes from Dave Lindley with Jeffrey. See why it's open.

Hi, thanks. Good morning. Thanks for taking my question. I wanted to focus on cell and gene therapy with my question and your cognate acquisition I guess a two-parter. Jim, in the will acquisition, there was a small CDMO that came along with it and you decided to sell that, kind of decided that you didn't want to be at least in that CDMO business. So part A of the question here is elaborate a little bit on why the CDMO opportunity in cell and gene therapy is more attractive to you for Charles River to get into and And then part B of the question is to flesh out a little bit more of the pieces that you've now assembled with your cell supply, your complementary biologics testing capabilities, et cetera, a little bit more of the continuum. And is that fairly complete at this point, or are there other additional capabilities that you feel like you need to fill into white space in your CGT business? Thanks.

Yes, thanks for that, Dave. Yeah, so many years ago, we did acquire a small molecule CDMO, and it was a perfectly good business. And you'll recall from the time that we sold it that we told you and other analysts and shareholders that we had done an exhaustive analysis of the industry, and we had decided that it was – There were some very, very big players, and it would be difficult for us to achieve scale. And since we'd like to be, if possible, the premier player in the spaces in which we work, we thought it was best to exit, which we did. And at the time, perhaps overstated our desire to remain out of it. But as you know, for the last couple of years in conversations with us, I think several things have happened. Number one, cell and gene therapy has heated up dramatically. Number two, that brings with us both an opportunity to make a niche play in the CDMO space and be minimally a leader, which we're entering with this asset as a leader in the space, and potentially the leader over time. So we... So that sort of dovetails with the original comments that we made. You've got this $20 billion investment in cell and gene therapy just in 2020. You've got 2,000 drugs that have been filed. The vast majority, over two-thirds or three-quarters, I think, are in preclinical and phase one. So the demand has heated up dramatically. We have a lot of inbound. You know, our M&A... is derived from requests from clients for products and services that they need that they'd like us to have, either because they trust us more or they're unable or incapable of getting these elsewhere. So this feels like it fills a very important gap in the portfolio. I don't think it would be lethal had we not done this, but it would cause clients to have to go outside to get their drugs manufactured. So just to continue to comment and answer your second question, We now have an extremely broad portfolio. So you're starting with us literally with the cells for your research and development. We're going to be able to do process development for you of your drug. We're all obviously going to be able to test that drug in our discovery and safety business. We're going to be able to manufacture that drug for the clinic and hopefully for commercial purposes. And then our biologics business is going to test those drugs before they are going to the clinic or into the marketplace. So it's a very, very comprehensive suite. As you heard us say, cell and gene therapy is going to move with this deal from about 5% of our consolidated revenues in fiscal 21 to 10. So it's a major move for us strategically, but we're doing that entirely in response to our clients. So clients can stay with us through the development of the cell and gene therapy program. products, particularly cell therapy products, where the preponderance of this business is focused, and an opportunity to be a leading player in this segment.

Very good. Sounds good. Thank you. Sure.

Your next question is from John Krieger with William Bear. Your line is open.

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

Yeah, they've got a, uh, they've got a good geographic footprint. It's, you know, it's, it's, uh, U S and Europe. Um, They definitely have incremental capacity, some of which has been added relatively recently, which will provide the capacity both to do larger clinical trial lots and if and as those drugs move into a commercial domain, obviously to do that work as well, which the clients will want to do that also. Obviously, there's very few commercial products that exist in cell and gene therapy, period. Although so many are being worked on right now. So that certainly would be the goal and the strategy anticipated. We certainly have the technical ability, regulatory ability, knowledge of CGMP production in cellular therapy from people that have come from a host of different company backgrounds. to form this really strong management team there. You know, capacity like all of our businesses that are growing will be important, have to be built out somewhat in advance of having the demand and anticipating the demand. I do think the clients of Cognates will be very pleased to see it in our hands because, you know, the there's the uncertainty of being private equity owned and what's the future and what's the investment portfolio. So I do think that clients who are working with this company now in the clinic, whose drugs are progressing nicely, we'll have a high degree of confidence that the drug makes it that, that we could, and perhaps should be their commercial, uh, producers. So, you know, we'd like that sort of entry point here, um, with a bunch of increased business with our access to clients with their footprint. and with this being part of our overall portfolio.

Great. Thank you.

Sure.

Your next question is from Richie 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 on 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. You talk about the complexity of the projects that you are working on. Even when I think about 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, 10 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's going to be kind of like a two-year goal? or are we thinking longer term here, especially given kind of like the cognitive acquisition that really opens this new and growing market opportunity?

I'll give you a general comment. David may want to give you a slightly more specific comment, and I think we'll leave sort of the overall deep dive on this important subject until we give longer-term guidance. But I think the bottom-line proposition is We are organized to drive efficiency throughout all of our businesses. We're organized to keep our GNA load as flat as possible as the business continues to grow, and I think we've demonstrated that over the last few years. We've also demonstrated our ability to drive efficiency. We're gonna be doing some more work on the digital front, which will provide greater connectivity amongst our sites internally and externally, and will certainly take time out of the process that should generate better returns also. We certainly will continue to have pricing power across all of our businesses, which I think you were alluding to with the outsourcing demand. Basically, biotech, while we have a big pharma footprint, biotech is the principal driver of our growth. Biotech is extraordinarily well-funded, and biotech has no internal capacity and doesn't want to have it. So I would say first and foremost, our biggest business segment, which is DSA, definitely has meaningful margin opportunity going forward. We still have some major acquisitions in that business that have improved nicely, but still have more margin to contribute. And I think efficiency across all of those businesses will be significant. The company that we just bought will continue to have improved margin opportunity you're going to see RMS get back to kind of historical levels to 21, and then I think it should improve, particularly since it has that attractive cell product aspect to it. I think the manufacturing segment can always get better. We'll see what we decide to say about that. The margins being at 37% are obviously quite extraordinary. Having said that, I think there's probably still opportunity in the biologics business to drive growth. So you should see some modest improvement in 21, as we said in our prepared remarks, and certainly more on a forward-going basis. And we'll give you a deep, definitive dive on that in the not-too-distant future.

I think you've covered all the main bases there, Jim. The only thing I would add is that we constantly give some deep thought 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. Juan 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 Hemoker and Solero, it seems like the revenue that came in 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.

yeah, it's probably a slight, um, lingering impact as you put it on the, on the, on the donor sites through the fourth quarter. Uh, it, you know, we had shut ours down and then reopened it in May. It's been improving steadily. You know, there's still some, obviously some social distancing going on and we're always looking for new donors. And, um, so, uh, probably some slight drag coming out of the year. Uh, 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 goals that we had initially established, which is north of 30%. So that will continue to grow nicely. I thought you were going to ask another question on non-human primates, so I'll answer the one I thought you were going to ask and answer the one that you did ask. One 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 from 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 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 do it. uh, played a, a, a critical, uh, role. Um, in terms of pent up demand for RMS, um, you know, I think we've seen much of that play through the academic medical centers that were, uh, totally or partially shut in basically an all three geographical locales, Asia, Europe, and the U S have essentially all opened. Uh, we don't believe regardless of, of, uh, the level of infection with COVID that they're going to go down and go back into lockdown. The research is too important. They, they're sorry that they shut them down and they definitely know how to work with hot agents around them given that they're in laboratories and usually all ground up. 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 service is obviously were not only unaffected, but I think benefited from some of the COVID disruption that our competitors saw. But in terms of production and sale of research models, I think we're back to normal cadence, both of volume and price, enhanced by the cellular products of businesses 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 21, 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 know, you gave some, some commentary on, on margins by segment, but overall it looks like, you know, 20 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?

Yeah. So it's a, it's an imperfect world to predict this, but we feel pretty confident in what we've told you all, which is that for sure, we have had difficulty accessing clients to install our largest and most complex systems. And in a few cases, we have been able to do this with some of our larger systems on a virtual basis. So the clients really were really needed these systems and were willing to dedicate the people and the time to do it with us. And, of course, we had to be creative and facile to do things virtually. Now, having said that, we've had the FDA and other regulatory agencies auditing us virtually all year, all of 2020, and clients have done that. And we've done virtual audits of lots of things ourselves, including some aspects of the company that we're in the process of buying. So we're in a virtual world. So trying to predict how comfortable people will get doing things virtually or whether they're just going to want to wait. We think it will be a similar cadence to what we're on. The virus is pretty rough right now, obviously. So limitations in many of the countries in which we work and we place these systems, and in many other states in the U.S., are severe. We're not letting outsiders into our facilities, for instance. So the impact of that is as follows, that we don't place the systems, which are large systems, they've got large ASPs and they're quite profitable, but even more importantly than that, every one of these big systems generate substantial amounts of revenue of cartridges, reagents, and to some extent, and in some instances, our Acugenics ID business. So we're losing all of that associated and incremental revenue on all of these systems that weren't placed and still haven't been placed in fiscal 20. What you saw in the end of 20, which is, I think, confusing you, and I understand why, is less that that the sites opened up and more that there was just a surge of demand for cartridges at the end of the year, pretty much with people that have, you know, we have a large install base of thousands and thousands of systems, most of which are relatively small. And those, that's probably a commentary, probably to a small extent of people who couldn't get large systems that they're going to use their smaller ones more readily. But more importantly than that, a commentary on just how much work is out there on testing all of these drugs before they get into the market, enhanced slightly by COVID and somewhat by cell and gene therapy. So the demand for the business, frustratingly, has probably never been as good as it is now. We'll do the best we can being creative in installing those systems, but as they're not installed, we don't get the incremental revenue, and that's why we're projecting to be slightly below the 10% growth. I'd like to answer the second part of your question. You know, margins are exceptional in that business, both in the microbial business and the whole manufacturing segment. Having said that, they have steadily improved. We think there's a lot of improvement in biologics. And there has been some improvement in our manufacturing capability in microbial, which has improved the margins as well. So, you know, stay tuned.

Got it. Thank you.

Your next question is from Tycho Peterson with JP Morgan. Your line is open.

Hey, thanks. A couple follow-ups here. Jim, starting with Cognate, I want to go back to John Krieger's question on CapEx. You know, if we look at some of the other CDMOs, whether it's Catalan with Paragon and MasterCell or Thermo with Brommer, you know, the cost of building out facilities here are not insignificant in the kind of $150 million to $250 million range for commercial, you know, cell and gene therapy facilities. In the context of your CapEx guidance being $180 million, I'm just curious how we should be thinking about your willingness to take on maybe much more significant investments. And then two quick follow-ups for David on guidance. I'm curious if you can break out any COVID contribution. I know it was $60 million in 2020, so what's baked in for 2021? And then on the margins, it does seem like there's a couple potential drivers to the upside here. You did have the DSA price increase you flagged, RMS recovering from COVID. COVID suppressed levels, and then the manufacturing, you know, installation table and sorry, headwinds, you know, wearing off. So all of those seem like they could get you above modest improvement. Um, but you know, I'm just curious if there are more meaningful offsets that, that would contain that. Thanks.

So the, uh, the CapEx will not be insignificant, uh, in this business. Uh, you know, it will, it will be meaningful, but, um, I don't think we'll be disproportionate, um, to the growth potential of this business. This will, this will be, uh, amongst, if not the highest growth aspect of our business. So we'll have to invest ahead of it, as we said earlier. Obviously, there's a substantial installed base already that we're buying. You know, this business is principally GMP cell therapy manufacturing and secondarily the production of plasma 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 Catalan that are more gene therapy manufacturing businesses. And so it's difficult to vet sort of what this spend is versus what ours will be. It won't be insignificant, but it'll be a lower order of magnitude, one that we've we're quite confident we'll get substantial returns on and that we've already obviously baked through our model and we'll give you clarity on it as soon as we close this deal.

David, you can take the second part. Yeah, sure. So in terms of COVID and the sort of headwind tails in there, the short answer is we've contemplated a sensible approach, at least we believe a sensible approach to what COVID will do in our guidance. So that's baked in. Of course, we don't know what we don't know. Just to unpack that a little bit, so obviously we had some significant losses because of COVID, particularly in RMS, and we did say at the last earnings call that we expected RMS to be broadly exiting the year with COVID behind us, and we still believe that to be true. Academics, clients seem to be open, and we're not expecting that to do a U-turn, but we'll keep an eye out for that. Um, we generated, um, 60 million of revenue that was COVID related, um, both in DSA, some vaccines and some other aspects. Not all of that will go away. Um, we expect to see some of that, um, continuing to 21 and that's also baked into the guidance. So there are, there are take broadly. We feel the way we're looking at it, we broadly got COVID behind us other than the things that have already been called out. Like we just been talking about microbial for instance. that's still a bit of a headwind. Moving over to your margin question, just want to call out a few potential opportunities. I just want to make sure that you're cognizant of the unallocated corporate costs. So historically, we've seen a 50 basis points improvement as a percentage of revenue. This year, we're guiding towards pretty much flat to 2020. And the reason for that is that we have got some investments that we are contemplating or in the process of putting in. In fact, when Jim talked at the JPMorgan conference, we talked about five different strategic imperatives, and one of those strategic imperatives was to champion technology. And indeed, I think Jim's just mentioned a few moments ago, the desire to put in best-in-class technology to help our clients essentially access scientific data in real time. So there is some set of costs associated with that, which means that the unallocated corporate cost is not giving that 50% basis points that we've historically had, but we would expect to have that behind us this year.

Okay, thank you.

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

Hey, thanks for taking the questions. Um, Jim, maybe, maybe we follow up for you on the RMS business. You know, it's certainly proved more resilient, you know, 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've talked about some academic share gains. Um, you know, how much of that is increased penetration versus taking share from competition?

Yeah, we, um, definitely have seen a, uh, 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, um, you know, our, the fact that we were open, that we were capable of doing this and, and having able to do it so well for them for this long period of time, I think it's demonstrated, um, sort of the frailties of them continuing to do this internally. So there's, there's no question that we've seen incremental work that was done internally be outsourced. And, uh, we're, you know, we're highly confident that the meaningful amount of that has stuck, um, Just a quick aside, similarly, even though you asked the question about RMS, we saw some of this in discovery and safety in the second quarter with clients who either they were using another provider who was incapable of supporting them during the initial outbreaks of COVID and or their own facilities were shut for some meaningful period of time and that caused them to either contemplate outsourcing for the first time or contemplate more outsourcing than they had done. historically and definitely based upon the feedback we've gotten from these clients, really pleased with the services that we provide and the speed with which we're doing it and the price points as well. So there's no question that we've garnered some incremental share that was perhaps not available to anybody that was being done by the clients themselves and for sure some work that was outsourced to competition both in RMSM and DSA. where they were unable to do that. And that incremental share gain and expectation of continuing to gain share in certain aspects of our business is certainly baked into our 2021 numbers. Great. Thanks, Jim.

Your next question is from Sandy Draper with Tourist Security. C-line is open.

Thanks so much. Most of my questions have been asked and answered, but maybe just one quick follow-up on the microbial testing. Maybe looking at it the other way, less about what's getting pulled forward in margin impact, but are there any capacity constraints, Jim or David, when things clear up? I'm just trying to think, could this be a bolus of revenue that then for four quarters is higher and then normalizes, or do you think it would just sort of return to a normal level? I'm just trying to think through you know, what would have to happen? Is this just, you know, you start to ship it out and put people out, or is there a point where you can only go so fast, and so it's just going to get back to a normal level?

Thanks. Yeah, 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 install base of, you know, whatever X number of machines that have either been delivered and not hooked up or waiting to be delivered by us to the client who's not letting us in. As I said earlier, sort of every day, every week, every month that 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 start to use them at once. Obviously, it's beneficial once we install them because they are larger and they use a disproportionately larger amount of disposables. That will be beneficial, but I think it will be gradual. It will be persistent. We're continuing to build. Our inventory will be in enough shape. I think you were inferring is that going to be a problem or an opportunity. I think our inventory will be in appropriate shape to accommodate and those associated disposables. But I think it would be steady. Maybe it's slightly beneficial in a particular quarter or two, but I don't think it's going to be a surge in demand.

Great. Thanks so much, Jim.

Sure.

Our next question is from Dan Brennan with UBS. The line is open.

Great. Thanks for bringing the questions. Congrats on the quarter. I said two questions, 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, I give it a year at a great level. But I'm just wondering, what is the guidance on manufacturing margins for 21? It's a little unclear from the deck and from the comments. And similarly, on RMS, I know you talked about well above 25%. We're talking 27, 29. Any help on those two numbers? And then I have a follow-up.

Right. So the manufacturing, if you exclude Cognate, we would expect the margins to be similar to the way we exited in 2020. However, Cognate will be a little bit of a drag. So we are expecting with Cognate for just this year to be somewhere in the zip code of the long-term guidance that we've given out, which would be the mid-30s. We'll say more about where we think that's going to go at the investor day. In terms of RMS, okay, so well above 25%. That's a fair call out. Where's the ceiling on that? I think if you look at last year, we were a little bit above the 25% at 26%. So I would say somewhere in the mid-high 20s would be about right. Okay.

Thanks, David. And then just maybe one more on Cognate. I'm just wondering, could you give us any color on, while this is still a nascent market, any color on the competitive positioning? You know, Paragon has MasterCell. I'm sure, you know, Wuxi and Lonzen, the big players are all focus here as well. So just any color, whether it be number of clients or just any color you can get on that front. And then I'm just wondering, in terms of the senior executives of Cognate, are they locked up given how critical talent and expertise is to run these complex CMOs? I'm just wondering what the deal terms were on that front. Thank you.

So you should think of our principal competitors in this space being WANZA and WUSHI and not Thermo and Catalan Number one, you should consider that the size of our business, the business that we're buying, is comparable to those two, sort of 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, And across our whole portfolio, our 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. So we feel really good about our competitive position. As I said earlier, in answer to someone's question, we're entering as a leader, specifically the CGMP part. I think our aspirations and I think a high probability performance that we could be the leader with this in the midst of Charles River's larger portfolio, our reputation, our client contact. And with regard to the management, we've always been successful in keeping key management, and obviously we'll be proceeding to get contracts in place now that we just signed the deal. So we're quite confident that we'll keep the key management team in place.

Great, thanks, Jim.

Sure.

Your next question is from Donald Hooker with KeyBank. 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, you know, 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.

Yeah, we think that artificial intelligence and machine learning will – increasingly have a role in drug development, both in predictability of successful preclinical trials and predictability of successful clinical trials, and then obviously have a role in the design of those trials and some linkage between the animal work and the human work, theoretically and practically. If you take a look at the data that we have on thousands and thousands and thousands of molecules, some of which have succeeded and many of which have failed, can be highly important and predictive. How robust that technology is, how quickly regulators adopt it, how quickly our clients embrace it is really hard to tell. What technology do we utilize as we make these small investments in these technology deals? We're going to definitely get access to multiple different ways of utilizing our data. We may use them in combination or we may just have one that prevails. We've done a lot of work on this internally and with a bunch of world-class experts. And while we think there's an ongoing role we want to be very careful in terms of how we invest the shareholders' money and the assumptions that we make on sort of adoption by the users and not either invest in the wrong technology or invest too aggressively prematurely. So on a very measured but very thoughtful basis, we're going to continue to play in it. And I would say that it's more that you used the word dabble. I don't really feel that we're dabbling, and I think we're seriously investigating the best way to utilize our capabilities in concert with some powerful AI tools. I suspect we will have additional AI technology partnerships going forward. Thank you.

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

Thank you. So just 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 of your messaging on the DSA side? Thank you.

We don't normally see big gating differences in DSA throughout the year. We see it occasionally 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.

Okay, thanks.

And your last question is from Jack Meehan with Neftal 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?

So we've never really called out that we've had a wage pressure that is atypical from what takes place in those countries. So there's nothing specific to call out for Charles River vis-a-vis wage inflation, et cetera. We take a very close look to what's going on country by country and try to stay competitive there. And there was an exception in 2000 and I think 18, mid-year, when we felt that we wanted to bring Java to a living wage type organization, which we called out, but there are no real surprises in terms of wage inflation or in terms of supply costs that we feel that we should be calling out other than what we've already said in terms of Q4 was really to do with the timing issue. Other than that, we feel that we will get, you know, continue to walk towards the mid-25% that we've been striving for for some time. We've got not much more to say.

Thank you.

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.