Charles River Laboratories International, Inc.

Ladies and gentlemen, thank you for standing by. And welcome to the Charles River Laboratories third quarter 2021 earnings conference call. At this time, all participants on a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during this session, you will need to press star then one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then zero. I would now like to turn the conference over to your speaker for today, Todd Spencer, Vice President, Investor Relations. You may begin.

Thank you. Good morning and welcome to Charles River Laboratories' third 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 third quarter of 2021. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is posted on the investor relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately two hours after the call today and can 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 the call, we will primarily discuss non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the investor relations section of our website. I will now turn the call over to Jim Foster.

Good morning. Our strong third quarter results demonstrate the effectiveness of our strategy and the progress we've made on its execution. as well as the sustained strength of the industry fundamentals. As anticipated, third quarter revenue increased at a low teens rate organically, and we reported mid-teens earnings per share growth. We believe that Charles River is a stronger company today than it has ever been. We are seeing unprecedented demand across most of our businesses, and we believe that this, coupled with the strength of our leading non-clinical portfolio, will enable us to achieve our low double-digit organic revenue growth target over the longer term, as well as in 2022. As a result, we are continuing to invest to add people and capacity to accommodate growing client demand and to build a scalable operating model to enhance our scientifically distinguished portfolio, to strengthen our relationship with clients, and to work with them to devise outsourcing solutions which enable them to increase productivity and speed to market. We have maintained our focus on non-clinical drug research and manufacturing solutions, strategically expanding our portfolio to provide clients with the critical capabilities they require to discover, develop, and safely manufacture new drugs. Last month, we divested our RMS operations in Japan and our CDMO site in Sweden for a total of approximately $115 million plus potential contingent payments of up to an additional $25 million. We routinely evaluate the strategic fit and fundamental performance of our global infrastructure for acquisitions and legacy sites alike and have sold or closed operations that didn't meet our key business criteria but may have been underperforming financially. The decision to divest these two operations was consistent with our evaluation process, and we intend to redeploy the capital in other growth areas of our business. Moving to the third quarter, highlights of our financial performance are as follows. We reported revenue of $895.9 million in the third quarter of 21, a 20.5% increase over last year. Organic revenue growth was 13.6%, with each of our business segments contributing a strong performance. Last year's COVID impact resulted in a modest 170 basis point increase to organic revenue growth. From a client perspective, biotechs continue to drive revenue growth, with global biopharmaceutical clients also making solid contributions to the quarter. Third quarter reported revenue growth was affected by a $10 million foreign exchange headwind compared to our prior outlook. Notwithstanding the FX impact, we continue to see strong, sustained client demand across most of our businesses, with trends largely consistent with the first two quarters of this year. The operating margin was 21.4%, a decrease of 130 basis points year over year. As anticipated, the decline was primarily driven by the comparison to the strong third quarter of last year, which benefited from COVID cost controls. as well as the impact of the cognate and bi-gene acquisitions on the manufacturing segment's operating margin. With an operating margin of 21% for the first nine months of the year, we are squarely on track to achieve our goal of approximately 21% for 2021, which represents a 100 basis point increase over the prior year. This also demonstrates our commitment to driving efficiency and achieving our longer-term margin target of 22.5 percent in 2024. Earnings per share were $2.40 in the third quarter, an increase of 15.9 percent from $2.33 in the third quarter of last year. This result was favorable to our prior outlook due in large part to a lower than expected tax rate. David will provide some additional details on the tax rate shortly. With a sustained strength of the demand environment, our revised financial guidance for 21 reflects three primary factors, unfavorable movements in foreign exchange, a lower tax rate, and the divestitures. Reported revenue growth was lowered by approximately 150 basis points at midpoint to a range of 19.5 to 20.5 percent to primarily reflect current FX rates as well as the impact of the RMS Japan and CDMO Sweden divestitures. We have narrowed our organic revenue growth outlook to 13.5 to 14.5 percent with approximately 275 basis points of this increase generated by the comparison to last year's COVID-19 impact. Normalized organic growth is expected to be squarely in the low double-digit range this year, and that is consistent with our targeted growth rate next year as well. We also narrowed non-GAAP earnings per share guidance to a range of $10.20 to $10.30, which represents just over 25% year-over-year growth. We are pleased to have maintained our EPS growth within the previous range, even after absorbing the impact of the divestitures. I'd like to provide you with details on the third quarter segment performance, beginning with the DSA segment. DSA revenue in the third quarter was $531.8 million, a 13% increase on an organic basis with strength and safety assessment, including lab sciences and bioanalytical services and discovery services. Demand for our services and price increases are driving low double-digit organic growth in the DSA segment, which is a trend that we expect to continue into next year. Biotech clients are leveraging our expertise rather than investing in internal capabilities, and global biopharmaceutical clients are choosing to partner with us because it's more efficient to leverage our flexible infrastructure instead of maintaining or expanding their own. We believe we have become the principal partner of choice for biotech clients of all sizes. Demand for our services is high because the sustained level of biotech funding is enabling clients to meaningfully invest in early stage research at an accelerated pace, and because they don't have the internal capabilities to do the type of work that we perform for them. To meet our clients' growing needs, we have focused our business on unmatched scientific expertise, rapid turnaround times, flexible, creative solutions, and the ability to accommodate the increasing complexity of our clients' research programs. The safety assessment business continued to perform very well in the third quarter, and bookings and proposal volume continued to track at record levels. As we have mentioned throughout the year, clients are choosing to book their safety assessment studies further in advance, which enhances their ability to start working with us as soon as their molecules are ready. These early bookings, which now extend well into 2022, translate into greater visibility and a stronger book of business for us. The strong demand for our services requires us to closely manage the current workload by adding staff, capacity, and other necessary resources while managing the continual shifts in client timelines and study protocols that are associated with booking work further out. Because of our client-focused business approach, we believe we can balance their priorities and our capabilities effectively, making Shell's River an even more indispensable research partner to clients, both large and small. We are also making progress on our goals to continually improve our connectivity with clients, including through digital enhancements as we strive to take an additional year out of our clients' drug development timelines. The discovery business had a strong year driven by our comprehensive portfolio of oncology, CNS, early discovery, and antibody discovery capabilities. Biotech clients continue to choose to invest in their pipelines instead of infrastructure and utilize our integrated services to move their programs forward. Global biopharmaceutical companies are continuing to increase their reliance on outsourcing strategies for the discovery programs because they prefer to leverage our cutting edge and industrialized discovery capabilities and flexible solutions to create a more efficient R&D model. We are pleased to be working with both biotech and global biopharma clients, partnering with them to discover, develop, and bring critical therapies to patients who need them. To support the robust demand from these clients, we will continue to strengthen our portfolio by expanding our scale, our science, and our innovative technologies through a combination of internal investment, M&A, and our strategic partnership strategy. By doing so, we are enabling our clients to remain with one scientific partner from target identification through IND filing and beyond, and solidifying our position as the leading non-clinical CRO. The DSA operating margin decreased by 90 basis points to 24.3% in the third quarter, but increased sequentially. The year-over-year decline was due to foreign exchange, which reduced the DSA operating margin by approximately 70 basis points, and a discovery milestone payment, which contributed 50 basis points to last year's DSA operating margin. RMS revenue was $171.3 million, an increase of 10.7% on an organic basis over the third quarter of 2020, with approximately 200 basis points of the increase attributable to the comparison to last year's COVID-related revenue impact. The RMS performance largely reflects the trends that we have experienced all year. Robust demand for research models, particularly in China, broad-based growth across research model services, partially offset by continued headwinds for the cell supply business. The research model business continued to experience strong double-digit growth in China, as well as solid performance in North America, which we believe correlates with the increased level of non-clinical research activity that's being conducted by biopharmaceutical and academic clients. We believe the global focus on scientific innovation is sustainable and will continue to drive client demand. However, the biopharmaceutical market in Japan has not participated in this trend. As a result, we chose to divest our RMS operations in Japan with an opportunistic sale to the Jackson Laboratory. We have established a licensing agreement under which Jax will produce and distribute our models in Japan. Research model services perform very well. GEMS is benefiting from strong outsourcing demand as our clients seek the greater flexibility and efficiency they gain when we manage their proprietary model colonies. The greater complexity of scientific research and the proprietary models that our clients are creating further reinforce the value proposition for the GEMS business. Our clients' need for greater flexibility and efficiency is also driving demand for our insourcing solutions or IS business, particularly our cradle initiative, which provides both small and large biopharmaceutical clients with turnkey research capacity at Charles River sites. Last month, we announced the expansion of our cradle footprint in the Boston Cambridge Biohub. and will continue to expand in other regions, including in South San Francisco, to provide a flexible capacity solution for our clients globally. Utilizing Cradle also provides clients with collaborative opportunities to seamlessly access other child service services, which further enhances the speed and efficiency of the research programs. The self-supply business, which consists of HemaCare and Solero, continues to be affected by limitations on donor availability, as it has not fully recovered from last year's COVID-related restrictions. We have implemented several improvement initiatives, including expansion of donor capacity across multiple sites, productivity initiatives, and enhancing the digital engagement with donors. We anticipate that revenue will improve in the coming quarters because the robust demand in the cell therapy market sector remains firmly intact. The RMS operating margin decreased by 160 basis points year-over-year to 26.1 percent, primarily due to the cell supply business. Like many of our businesses, cell supply is leveraged to sales volume, so we expect profitability will meaningfully improve once donor availability and the growth rate rebound. Revenue for the manufacturing segment was $192.9 million, a 19.1% increase on an organic basis over the third quarter of last year. The increase was primarily driven by continued strong double-digit revenue growth in both the biologics testing solutions and microbial solutions businesses, as well as approximately 350 basis points attributable to the comparison to last year's COVID-related revenue impact. Microbial solutions growth rate in the third quarter remained well above 10%, reflecting strong demand across our portfolio of critical quality control testing solutions. We were pleased with the strength of the underlying demand for our endotoxin testing systems and cartridges, which perform FDA-mandated law release testing on injectable drugs and medical devices. The advantages of our comprehensive portfolio continue to resonate with our clients. And we believe that our ability to provide a total microbial testing solution will enable microbial solutions to deliver at least low double-digit organic revenue growth this year and beyond. The biologics testing business reported another exceptional quarter of strong double-digit revenue growth. Robust demands for cell and gene therapy testing services continue to be the primary growth drivers. with COVID-19 vaccines and traditional biologics also being meaningful contributors. We believe cell and gene therapies will continue to be significant growth drivers over the longer term to support our 20% growth target for this business. The strength of the demand for these services necessitates that we continue to build our extensive portfolio of manufacturing services to ensure we have available capacity to accommodate client demand. The third quarter marked the first full quarter that Cognate and BiGene were part of Charles River. As anticipated when we acquired Cognate, a large COVID-related project was completed in the second quarter, and we are actively adding new projects in its place. We continue to make great progress on the integrations and believe our cell and gene therapy CBMO business will be highly complementary to our biologics business and our portfolio as a whole. We also believe that we now have a comprehensive cell and gene therapy portfolio, which spans each of the major CDMO platforms, gene modified cell therapy, viral vector, and plasma DNA production. Our goal is to enable clients to conduct analytical testing, process development, and manufacturing for these advanced drug modalities with the same scientific partner, allowing them to achieve their goal of driving greater efficiency and accelerating their speed to market. As mentioned earlier, the decision to divest our CDMO site in Sweden was based on several factors. First, its capabilities, including plasmid DNA, were already duplicated at other CDMO sites in the UK and US. Second, we determined it would be advantageous to invest in and expand capacity at our other CDMO hubs that are more centrally located and proximate to clients, And finally, this was our smallest and least profitable CDMO site. This divestiture does not reflect any changes in client demand or the cell and gene therapy CDMO sector, as we firmly believe the growth profile for this business remains at or above 25% over the longer term. The manufacturing segment third quarter operating margin declined by 640 basis points to 32.7%. The primary driver of the decline was the inclusion of both Cognate and Vigene for the full quarter. These businesses are profitable, but their margin is below the overall manufacturing segment. As noted last quarter, we continue to expect the full-year manufacturing margin will be slightly below the mid-30% range, reflecting the addition of the CDMO business. However, beyond 2021, we expect this headwind to gradually dissipate. as we drive efficiency and as the significant growth we anticipate generates greater economies of scale and optimizes throughput at our CDMO sites. We are operating in a robust business environment with excellent growth potential. Biotech funding in 2021 is continuing to track at or above the robust pre-COVID levels. The sustained funding environment, both from the capital markets and the biopharmaceutical industry, and the biotech industry's cash reserves are enabling an accelerated pace of scientific innovation. Clients, both large and small, view us as their partner of choice, from concept to non-clinical development to the safe manufacture of their life-saving therapeutics. To continue to successfully execute our strategy to maintain and enhance Charles Rivers' position as the leading non-clinical CRO and accommodate our clients' growth needs, It's essential that we continue to make investments in our scientific capabilities through M&A, technology partnerships, and internal development, enhance our digital enterprise to provide real-time access to critical data for both internal and client use, and also to expand our capacity and staff. Demand for our services in the current market environment has outpaced our expectations. and we have been hiring ahead of our initial plan this year to accommodate this growth. We have hired 4,000 talented people this year to both support growth and offset attrition and plan to hire an additional 1,000 people in the fourth quarter. We believe we attract qualified employees because our mission and the critical work that we do to help our clients develop life-saving therapies distinguishes us from other companies. For a business like Charles River, staffing is a consistent challenge on which we have placed a disproportionate focus. We believe we are effectively managing staffing levels, including increased cost, and we will continue to be thoughtful with respect to compensation heading into 2022 as we strive to maintain or reduce turnover and remain competitive in the marketplace. It will be a headwind, but one that will help us to support the robust client demands and achieve our low double-digit organic growth target that we expect in 2022. By focusing intently on our strategy, we have become a trusted scientific partner for pharmaceutical and biotechnology companies, academic institutions, and government and non-government organizations worldwide. We have demonstrated the value we can provide to clients and believe that is why they have trusted us to work on more than 80% of the drugs approved by the FDA over the last three years. We believe that our steady focus on our strategy to continue to enhance our portfolio will enable us to continue to achieve our long-term financial targets and deliver greater value to shareholders. In conclusion, I'd like to thank our clients and shareholders for their support and our employees for their exceptional work and commitment. I'll now ask David to give you additional details on our third quarter results and updated 2021 guidance.

Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results which exclude amortization and other transaction-related charges, costs related primarily to our global efficiency initiative, 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, divestitures, and foreign currency translation. We are pleased with our strong results for the third quarter, which included 13.6% organic revenue growth and a 15.9% increase in earnings per share. Operating margin for the third quarter was 21.4%, while lower than the prior year as anticipated, it represented a 60 basis point sequential increase and was in line with our full year target of approximately 21%. In addition to the COVID cost controls last year and the CDMO acquisitions this year that Jim mentioned, the third quarter operating margin was also lower than last year's robust 22.7% level because of a foreign exchange headwind and last year's discovery milestone payment. Although cost inflation and supply chain pressures have made headlines recently, we believe we are effectively managing the tighter labor market in our supply chain, and higher costs in these areas have been reflected in our updated guidance. Lower unallocated corporate costs contributed to the third quarter operating margin, summing in at 5% of revenue, or $45 million, compared to 5.5% of revenue last year. Corporate costs are nonlinear, fluctuating from quarter to quarter due to several factors, including health and fringe-related costs and performance-based compensation. Despite the third quarter favorability, we continue to expect unallocated corporate costs in the mid-5% range as a percentage of revenue for the full year. The third quarter non-GAAP tax rate was 17%, representing a 490 basis point decrease from 21.9% in the third quarter of last year. The lower tax rate was due primarily to two factors, discreet tax benefits associated with R&D tax credits and a favorable excess tax benefit related to stock-based compensation associated with a higher stock price. These benefits will also result in a reduction of our full-year non-GAAP tax rate to a range of 18 to 19 percent from our prior outlook of 19.5 to 20.5 percent. Total adjusted net interest expense for the third quarter was $20.7 million, an increase of $2 million year-over-year, reflecting higher debt balances to fund the Cognate and Viagene acquisitions, but was essentially flat sequentially. At the end of the third quarter, we had an outstanding debt balance of $2.9 billion, representing a gross leverage ratio of 2.7 times and a net leverage ratio of 2.6 times. For the full year, we now expect total adjusted net interest expense to be slightly lower than our prior outlook in a range of $80 to $82 million, reflecting debt repayment and continued low variable interest rates. Free cash flow was $119.2 million in the third quarter, representing a decrease of 21% over $151.1 million for the same period last year. The lower free cash flow was primarily due to higher capital expenditures, which increased by nearly $30 million to $55.5 million. There were two reasons for the increase in capital expenditures. We continued to invest in capacity additions and other growth projects to meet client demand, and last year's level was still constrained by COVID-related project delays. For the year, our free cash flow and CapEx guidance remained unchanged. at approximately $500 million and $220 million, respectively. CapEx is expected to total over 6% of total revenue in 2021. With the robust demand environment exceeding our expectations this year and expected to continue across our portfolio, we now believe CapEx will be about 9% of total revenue next year as we continue to add capacity to support our growth, particularly in our legacy businesses, including safety assessment. With respect to 2021 guidance, we are updating our full year revenue growth outlook to a range of 19.5 to 20.5% on a reported basis, reflecting the impact of the divestitures and foreign exchange and organic revenue growth to 13.5 to 14.5%. Foreign exchange is now expected to be less of a benefit than previously anticipated due to the strengthening of the US dollar over the last three months, particularly when compared to the British pound and euro. We now expect 150 to 200 basis points benefit from FX for the year compared to our prior outlook of approximately 250 basis points. As Jim mentioned, the strength of the dollar resulted in a headwind that reduced third quarter reported revenue by approximately $10 million compared to our prior outlook. We have narrowed our earnings per share guidance to a range of $10.20 to $10.30, primarily due to the lower tax rate outlook, partially offset by the divestitures. Please keep in mind that the divestitures are expected to reduce revenue by nearly $20 million and non-GAAP earnings per share by less than 10 cents in the fourth quarter, which is reflected in the four-year 2021 financial guidance. By segment, our updated outlook for 2021 continues to reflect a sustained and healthy business environment. With our organic revenue growth outlook narrowed within our previous range, we have maintained our segment growth expectations including organic revenue growth in the high-teens for the RMS segment, low double digits for the DSA segment, and high-teens for the manufacturing segment. On a reported basis, we moderated the segment outlook to reflect updated FX rates in the divestitures. We now expect revenue growth for the RMS segment in the high-teens range, manufacturing in the low 40% range, and DSA unchanged in the mid-teens. With regard to operating margins, our segment outlook remains effectively unchanged from our prior outlook. A detailed summary of our updated financial guidance for the full year can be found on slide 39. With one quarter remaining in the year, our fourth quarter outlook is effectively embedded in our guidance for the full year. The RMS demand divestiture will affect the year-over-year comparison in the fourth quarter. On a year-over-year basis, we expect organic revenue growth will be in the high single digits and reported revenue growth in the low double-digit range. When normalized for the COVID impact, we expect our organic revenue growth for the full year will be squarely in the low double-digit range, which is also consistent with the growth that we foresee next year. Non-GAAP earnings per share is expected to be flat to a low single-digit increase in the fourth quarter when compared to last year's level of $2.39. The fourth quarter tax rate is expected to return to the low 20% range, which along with the diversities will meaningfully constrain the earnings per share growth rate. I would like to provide one model in comment with regard to next year. We will add a 53rd week at the end of the fourth quarter of 2022, which is periodically required to true up our fiscal year to a December 31st come the year end. The 53rd week has historically been characterized as a partial week of revenue, since it occurs during the holidays, but a full week of costs. To conclude, and before we turn the page to next year, we intend to finish the fourth quarter on a strong note and achieve our updated financial guidance for this year. Our expected 2021 performance demonstrates the progress that we are making, as well as the investments that are necessary to achieve the 2020 financial targets that we provided at our investor day in May, which include low double-digit organic revenue growth, an operating margin of approximately 22.5%, and long-gap earnings per share growth at a faster rate than revenue. Thank you.

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

Thank you. Ladies and gentlemen, as a reminder to ask the question, you will need to press star then 1 on your telephone. We ask that you limit yourself to one question only. Again, that's one question per caller. To withdraw your question, press the pound key. That's star one to ask the question. Please stand by while we compile the Q&A roster. Our first question comes from the line of John Crager with William Blair. Your line is open.

Hey, thanks very much. Jim and David, I heard you guys make a few comments about 22. Just wanted to make sure we heard that right. I think you said low double-digit organic growth expected and CapEx spending of around 9%. Anything else you can add to that sort of early 22 look? And maybe where should we expect the higher CapEx investing to be targeted? Thanks.

So we did say that, John, and We're enjoying really extraordinary demand pretty much across the whole portfolio. And we anticipate, given the spending paradigm, given the strength of new scientific modalities, given cell and gene therapy, given the nature of our portfolio, that the demand will continue through next year at least. So giving sort of early indications of that. What we're experiencing this year is... It's quite interesting and unique. We had a pretty thoughtful and positive plan for this year. We are well in excess of our operating plan as evidenced by a couple of guidance raises and just the changes in the top line guidance. And so we have been working really hard to plan for additional capacity and hire enough people to do the work. And I think we're doing well. But as we look at next year and beyond, we do think that the capacity needs will continue to be significant. And it's not something you can do sort of at the 11th hour. And the scale and size of the business is just getting to the point where not only did we think it was appropriate, but sort of our early roll-up is showing that a CapEx on a percentage basis will be meaningfully higher than last time we had spoken to you folks. I would say it's the nature of the portfolio as a whole, probably more legacy portions of the portfolio and more probably safety assessment than anything else. So, you know, sort of as safety assessment goes, so does the company these days. So we have terrific growth rates in the safety assessment business. We, you know, we're by far the market leader. A lot of clients are depending on us. We have all these new biotech companies created and minted and have no internal capability to do their work. We thought that both that 9% and a double digit would be a good early glimpse of what we anticipate for next year.

Great. Thank you.

I'll add a bit more color on the puts and takes as well, because I think that's clearly of interest to a number of people. And while we're not going to talk about the 2022 full sort of guidance, there are a number of things that we have kind of called out, but there's a lot of material this morning to go through. So Jim talked about the strong demand environment, so I won't repeat about that. But that low double-digit organic growth does help fuel some of the headwinds that we're seeing. And by the way, you're aware of microbial access headwinds that we've had this year, which is behind us. Self-supply, we would hope that'd be fully behind us when we get into 2022 as well. So that's another tailwind. And of course, that buoyant double-digit growth helps with our margin expansion goals. You know that we're trying to get to 150 basis points over the next three years. That won't be linear. For instance, the investments that we're making in digital, we won't see the returns really kick in until the outer year. And next year, we have this modest headwind from the 53rd week, which I called out in my remarks. And then there are other known headwinds that we've got. We'll continue to invest in people, capacity, digital. You're all familiar with the global pressures that we're seeing on hiring and inflation. You know, it's impacting many sectors and regions, so I won't labour that point, but we'll have our share of that. However, we are fortunate to be in the industry that we're in. We're not as buffeted by those issues as some, but neither are we immune. So that said, we believe we're effectively managing those tighter labour markets and supply chains, but it will take effort and it will take investment. And then there are things which we can't call out today, simple ones like FX. That's one of the last pieces we put in the Jigsaw piece. Um, we've got that unique item around potential for us tax reform. Should it be enacted? But I am hearing that there's a good chance that we punted into 2023. Um, and then we've got the open questions around inflation. Is it short term as some people would have it believe, or is it more sustained? And I think that's too early to call. And finally, great recognition as it's being called, you know, it has to come to an end, but at what point. So we're working on finalizing the plan in February. We'll put those pieces together. and share that with you. But as I said, strong demand that we're seeing, that should help us progress towards these long-term targets, and we should have appropriate numbers for you in 22.

Very helpful. Thanks.

Thank you. Our next question comes from the line of Derek DeBruin with Bank of America. Your line is open.

Hey, good morning, everyone. Hey, Jim, can you talk a little bit about the the cell and gene therapy business and sort of like in the demands in that area. Um, and you know, sort of how that is flowing through on particularly how that was flowing through on the margin profile and, uh, just, you know, sort of how should we think about the growth in that segment in 22 and the rest of this year and next year?

Yeah. Um, hi Derek. Uh, you know, we, we put together relatively swiftly through MNA, um, several cell and gene therapy assets for the cell product businesses and the CDMO assets. And of course, they show up in two different segments. They're working really hard to integrate and connect those businesses. I think we're doing really well at that. We're also working really hard to connect those businesses, particularly the CDMO piece, to our biologics business. because being able to manufacture the drug and test it are a really important capability that distinguishes us from most of our competitors. The cell supply business, as we call that, its growth rate is being hampered right now by sort of COVID-related donor restrictions for donors, but that should ameliorate over time, and Growth rate there should be 25 or 30% on an ongoing basis. And we haven't said that much about the margins. The margins should not be dilutive to RMS, let's put it that way. On the CDMO piece, we've been really clear that that manufacturing segment has had mid to high 30% operating margins. Not a lot of businesses that would be accretive to that. So it's a bit of a headwind, although that will improve meaningfully and systematically over time as we increase volume, as hopefully a few clients go from clinical stage to commercial, as we have more digital capability. So it should be less of a drag. It's tough to say. what CDMO will look like from a margin profile out a few years, particularly if we're doing multiple commercial runs for clients. So, you'd obviously have just greater efficiency and throughput and consistency of supply. And, you know, I think that could invigorate the margins. So, pleased with the growth rates. Directionally pleased with the margin rates. We think we put together a a nice portfolio sort of on its own and are connecting it thoughtfully and carefully with our legacy businesses, particularly biologics.

Do you need to invest more heavily in technologies in this area, particularly in discovery? I mean, it's still sort of like the Wild West. I'm just wondering if it's an extra heavy technology investment relative to what you're typically used to.

I wouldn't say that. You know, I think that we're going to continue to have to invest in technology across the portfolio, particularly in areas like AI and machine learning and next generation sequencing and certain aspects of pathology and antibody discovery. You know, and AI is a bit of a wild card. You know, there's so many shots on goal that we could take and so much impact that this could have on the portfolio, but it's still relatively early days. So, you know, I think that we will have meaningful investments, particularly in AI and machine learning. I do think they can be beneficial to the whole portfolio, maybe particularly cell and gene therapy. You know, look, per your question, the whole discovery platform is obviously much heavier science, much more cutting edge science. And I'd say the majority of our strategic deals are discovery related. So I guess from that vantage point, yes, we're very much focused on it. I don't think the price points will be necessarily higher though.

Thank you.

Thank you. Our next question comes from the line of Tycho Peterson with JP Morgan. Your line is open.

Hey, thanks. I want to revisit the 2022 discussion for a minute because I think you also talked about earnings leverage. And, David, as you talked about, obviously, you know, you've got some headwinds here with the extra week and wage inflation and, you know, I think three-quarters of the divestiture headwinds. Can you help us think about the leverage you can pull to drive that earnings leverage next year? The street has you up about 11.5% on earnings in line, you know, effectively with revenues. But, you know, if you're actually going to have the earnings leverage, you mentioned digital. I'm just curious what other leverage you have to pull to drive margin expansion and earnings leverage next year? And how should we think about tax rate at this point for next year?

So look, we've got really strong revenue demand. This year, the demand has increased more than we expected, which is great. It's setting us nicely for the future. And we've made meaningful investments this year. So we can continue to make meaningful investments in the business with that revenue forfeit. And that's one of the benefits of having high revenue and double-digit growth. But we do need to invest some of that additional profit, if you like, into the business, not just for the short term in terms of headcount, but also into the medium term in terms of digital. So we will continue to do that. And I don't see next year different in that respect, except we might not see we're not going to see 100 basis point margin improvement in 2022 like we've seen in the last two years, and particularly this year, where we've got 100 basis point improvement despite the investments that we have made in the business. So that's helpful. That's a helpful headwind, if you like. That helps cover some of these tailwinds. In terms of tax, we are, well, it depends where we end up with Biden. We did call out on our investor call back in May that while we're low 20s traditionally at the moment, okay, this year we've had a few discrete items, but without those discrete items, we would have expected the 2022 to be the low 20s. With Biden, that would have moved us up to the, we expected to move up to the mid-20s. And as I said a few moments ago, you know, I'm hearing that subject to a vote in the House, we should see the Biden reforms pushed out at 22 into 23. So, ergo, if that happens, tax rate would be back to where we've traditionally been at the low 20s. Actually, while I have the call, again, people are talking about puts and takes. In terms of the divestitures that we've called out, we've called out what that impact is for this year. But I'll share with you that broadly, we would expect that to be a 20 to 25 cent headwind for 2022 as well.

Okay, that's helpful. And then if I could ask just one clarification for Jim on the DSA capacity expansion. You know, you've talked about the price increases on prior calls. Are we at a point now where customers are pushing back on price and you're, you know, having to expand capacity? How do you think about that trade-off?

Pricing is – we're very pleased with the price that we're getting. We continue to be pleased. And now I would say that – Generally speaking, clients are the most interested right now in when they can start a study, available study slots, sometimes or many times the geography of where they'll start that study. So do you have room for me? Do you have the scientific capability for me? Can you meet my turnaround times? And oh, by the way, what's the price? I'm not saying they're not interested in price. I would say it's significantly de-emphasized as an important issue. So if you think of the client base with hundreds of new biotech companies being created every year with literally no internal capacity and big pharma continuing to rapidly reduce their internal capacity, our role has just become increasingly more significant. That's what we're trying to say about this year. I mean, this is a high-class problem, right, high-class challenge that we are working really hard to have enough people and to build enough space to accommodate the demand, which is right now significantly ahead of where we thought our business plan would be. So as we put the final touches on next year's operating plan, we just have to be very thoughtful and make sure that we have capacity and then some. And of course, by the way, anything we build even now is probably not available until 23 anyway. So we have to get ahead of that. So it's a very, it's the most attractive supply demand paradigm that we've ever seen across most of our businesses, but particularly nuanced and safety, just given our scale and scientific depth. And so it's incumbent upon us if this marketplace is going to depend on us to make the necessary investments and capacity and people to accommodate them.

Okay. Thank you.

Thank you. Our next question comes from the line of Elizabeth Anderson with Evercore. Your line is open.

Hi, guys. Thanks so much for the question. Maybe just to follow up on that one clearly. So if we think about sort of the free cash, sorry, the CapEx expenditures next year, how do you sort of see that? I mean, broadly trending, you said you obviously increase capacity across a variety of facilities, but do you see that kind of 9% maybe tapering back down, or is that kind of the new run rate to go with? Thank you.

I think it would be – I'm not sure it's the right adjective. I think it would be difficult – to predict that, but I think if we had to call it today, we think the demand will continue. We look at the world in five-year chunks. We have a five-year strategic plan. We've been public about being able to double the size of the company, et cetera, et cetera. We certainly don't think this growth rate is going to slow, given the biotech funding, given all the new modalities, our competitive prowess given the fact that we'll probably do additional M&A to make our portfolio stronger. So given the scale of our business and the demand on our business, you know, I think we would anticipate that that's the new normal, you know, that we'll have CapEx's percentage of sales around that level going forward. There's no logical demand reason that that should slow. But from where we are now, that looks like the right rate to accommodate client demand.

Thank you. Our next question comes from the line of Eric Coldwell with Baird. Your line is open.

Thanks, good morning. David, a second ago you mentioned another 22 factor, which was the impact of the divestitures at 20 to 25 cents. We were curious if that was a full year impact or if that was the incremental impact after adjusting for the fourth quarter here this year.

Yes, that's a full year impact.

So full year 20 to 25, so incremental, would be roughly something less than 10 to 15?

Correct. It's the impact on the 22-year, correct. If we were taking it out of 22, it would be the 20 to 25 cents. And the reason why it's not the Q4 multiplied by 4 is, broadly, the work that we've divested on the Swedish side can actually be done elsewhere within our organization. So We're making an assumption as to how much of that load we can pick up.

Got it. And then I had a follow-up on the self-supply business, and I know those units have been impacted by the pandemic and donor access in particular. But, look, I'm an applicable advocate. We cover the healthcare supply chain broadly. We look at a lot of healthcare sectors. Just about every category I could think of is near or above pre-pandemic levels, and some healthcare sectors are actually growing fairly nicely at the moment, it just seems like the world has opened up more than these numbers are representing. And I'm curious if there isn't something more going on in the cell supply business that's holding it back.

Yeah, there really is nothing more going on, Eric. It's a function of donor access. The demand is still quite significant. The good news is that we had a better October. We opened additional donor rooms, given that we did two acquisitions in that space. So in addition to the California facility, we have capabilities in Massachusetts and Washington State. That obviously is and will continue to improve donor access. As we said, that business should continue to improve, hopefully sequentially. as we move through the back half of this year and into next year and get to the growth levels that we anticipated when we did these deals and announced them, which was around 30% top line. So we're confident we'll get back to that.

Jim, last one for me. Thank you for that. Your largest competitor in the research model animal supply side of the business is In the midst of a combination with another company in the space, is there any knock-on impact from that to you? I don't suspect that there is, but I'm just curious. You know, we often talk about clinical CRO mergers and the impact across clinical CROs. It's much less common to talk about larger competitors and research models coming together, and I know that's more of a vertical deal than a horizontal one, but I am curious if you see any potential impact from that. the, uh, the changes over at Envigo?

Um, yeah, you know, we really don't, that that's been an enterprise that we've competed with for a long period of time. Uh, I would say principally and always on price, uh, as opposed to quality. So we've always been a sort of scientific partner with a broader geographic footprint and, uh, sort of a different level of service with our clients and our portfolio. And that company has been less of an impactful competitor, I would say, over the years than they were historically. So I would expect that that situation, that fact pattern really doesn't change at all as a result of this. Thanks very much.

Thank you. Our next question comes from the line of Teja Savant with Morgan Stanley. Your line is open.

Hey, guys. Good morning. Just one follow-up there, also related to RMS, Jim. Are you seeing any pickup and disruptions in China from some of the COVID-related shutdown there, or are customers generally in better shape to handle the surge this time around? and one for Dave on the guide. To what extent in 22 can you push through pricing increases to your customers to absorb some of the headwinds you've outlined on the call here?

Yeah, we're not seeing any new or additional COVID-related dislocations in China. Obviously, the first place we saw it back when it all hit and the first place that it improved I'd say that that marketplace, for us at least, is back minimally to pre-COVID levels and probably stronger than that, both in the academic part and the biopharmaceutical part. We continue to make significant investments in capacity, and we're growing that business nicely and nicely geographically, both in the core research model piece and the related services. No, the business is going really well.

And in terms of pricing for 2022, that's part of our low double-digit growth assumption. And as you know, we don't break out price anymore anyway, and we're still sharpening our pencil as to what exactly the 2022 plan will look like in terms of price. But yeah, it's part of the low double-digit growth that I mentioned before.

Got it. Thanks, guys.

Thank you. Our next question comes from the line of David Windley with Jefferies. Your line is open.

Hi, good morning. Thanks for taking my questions. Jim, is it possible to quantify in some way the benefit to your visibility, particularly in safety assessment, but the benefit to your visibility in 22 from clients booking out further, like, you know, how much more percent of revenue do you think you have visibility to in 22 versus what would be normal?

Yeah. It's probably quantifiable, Dave, but... But not for us, right? No, probably a dangerous thing to quantify. I would say that, you know, it continues to be more pronounced, but that's a very good thing for us in terms of Some of the things I've talked about, hiring and capacity and timing and scheduling and utilization of our various facilities. It gives us several things. It gives us a better look to the future. It also gives us a much closer working relationship with the clients who now have to really do a better job planning, a better job nuancing their priorities and portfolio, and a better job messaging to us what's really essential to be done quickly, whatever that means for them, and what could wait. So it feels like while it's pretty feverish and the demand is great, it's a more rational planning paradigm. So I think that it's actually enhancing our relationship with the clients. It feels like this sort of leverage that we have and they have is sort of on an equal playing field now and that we're much more communicative. So, you know, we like it from a planning point of view and a visibility point of view.

And then a related follow-up question is around the mix in that business. You know, I'm thinking broadly about a pipeline that's moving toward large molecule in general, but also maybe, you know, at the bleeding edge moving toward cell and gene therapy, and you've highlighted, you know, that part of your business. And so the shifting mix, but also in that the supply chain for that shifting mix, how does that change the type of animal models that you need to use in those studies, and do you have access to all of those?

Yeah, we work really hard at making sure we have sufficient supply of all of our animal models, particularly some of the larger models. And we've had to identify and validate multiple new sources of supply in multiple countries to accommodate just the increase in demand and the pace of demand and just to ensure that the supply is there. It's an ongoing complex challenge, one that I think we're managing well, and we feel that we are, you know, directly managing it quite well in terms of having sufficient numbers for 22. So, yeah, I mean, I think the animal models will become increasingly more complex, particularly some of the larger ones for the biologics in particular. I think that's been the case for some period of time.

But just to be clear, the implication in your response to that, that the shift or you are seeing a shift toward large large animal, or I'm sorry, like non-human primate and large animal within the mix. Is that the right way to think about it with large molecules?

Yeah, and I think that's a continuation of the shift that started some time ago, and I think it's more intensified these days just given the nature of the drugs.

Sure. Thank you. Appreciate it.

Thank you. Our next question comes from the line of Patrick Donnelly with Citi. Your line is open.

Thanks for taking the question, guys. David, maybe one more on the margin side. Just trying to figure out, again, the moving pieces for 22 versus kind of the long-term guide you gave. I mean, does 22 have potential to be a bit more of a muted year, given, again, some of the increasing costs on the labor side, obviously significant investments in manufacturing? Just trying to think of kind of that bridge in terms of 22. It seems like there's some pressures. So maybe just talk through that one more time. It would be appreciated.

Yeah, you broke a little bit. You said... I missed the middle part of the question, which I think was key to the question.

Yeah, it was around the 22 margins and then just the cadence in terms of the long-term guide. Does 22 have potential to be a bit more muted given, you know, labor pressure, investments in manufacturing, all the other moving pieces?

Yeah, I mean, as I said, you know, earlier, you know, anybody that's expecting us to get 100 basis points next year, reconsider that, please. And equally, even if you take 150 basis points and you say that's going to be linear, I think you need to consider that as well, given the commentary that we've made about some of the pressures this year in terms of wage in particular and inflation. But we've made some meaningful investments this year in 2021. So I wouldn't want you to feel that we have draconian pressures on us. We have a portion of that pressure, as everybody else in the world does. We think we can cope with that well. But I wouldn't want to leave you with the impression that the last two years' worth of margin appreciation is going to continue. And indeed, we did try to signal that at the investor day, that we would be looking at 150 over two years. And we've also got that headwind from the 53rd week in 2022. Digital investments that we've been making, which has been quite sizable in amounts, will be kicking in in the outer years. And then, of course, we've got on top of that some of the compensation pressures that we've mentioned. So our key here is to make sure that we can supply the needs of our clients, continue to get that growth, continue to win new share, make sure that we're in a great position that we become the first call in terms of doing the work for any drug research.

Understood. Thanks. I'll leave it there.

Thank you. Our next question comes from the line of John Sawbeer with UBS. Your line is open.

Thanks for taking my question. I guess just in the cell and gene therapy manufacturing portfolio, are there any areas there that you see gaps or areas that could be complementary to invest with the existing portfolio? And any thoughts on where to maybe deploy the divestiture proceeds from the recently announced transactions?

We would hope to deploy the divestitures in further M&A, but, you know, money's fungible, so I'd say generally we're just going to deploy it to grow our business generally. Obviously, if we have a deal... Sooner than later, we can directly apply it. The cell and gene therapy portfolio is pretty robust right now. I think there's some subtle, I don't want to list them off because we're looking at additional M&A there, but there's some subtle areas that we can improve and enhance just to have a broader connectivity so we never have to outsource anything ourselves. Having said that, I think it's more about the scale of the current portfolio and the geographic footprint of the current portfolio that I think we'll primarily do organically, although it's possible we'll do some M&A. If you take the businesses that we bought, which are five, maybe six, depending on what you think retrogenics is, And then you add our biologics business and some of our safety and discovery capabilities. It's a very broad portfolio now, and certainly from a service point of view, it's the broadest of anyone in the industry. So we have a good base right now and can accommodate a lot of demand from a diverse client base. We'll invest in it aggressively organically if we can get some of these niche deals done that we're looking at from an M&A point of view, then some of the subtle gaps that wouldn't actually be that obvious will be filled.

Thanks for taking my question.

Thank you. I'm not showing any further questions in the queue. I will now turn the call back over to Todd for closing remarks.

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