Q3 2021 Charles River Laboratories International Inc Earnings Call
Okay.
Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories third quarter 2021 earnings Conference call.
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I would now like to turn the conference over to your Speaker for today, Todd Spencer Vice President Investor Relations you may begin.
It's 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.
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.
<unk> 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 CD ammo side 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. When they have been underperforming financially the decision to divest. These two operations was consistent with <unk>.
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 'twenty, one and 25% 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 biotech continued 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-19 cost controls.
As well as the impact of the cognate and by gene acquisitions on the manufacturing segment's operating margin.
With an operating margin of 21% through 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.
Also demonstrates our commitment to driving efficiency and achieving our longer term margin target of 22, 5% in 2024.
Earnings per share were $2 40 in the third quarter, an increase of 15, 9% 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 rates shortly.
With the sustained strength of the demand environment, our revised financial guidance for 'twenty. One reflects three primary factors.
And favorable movements in foreign exchange.
The 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.
25% to primarily reflect current FX rates as well as the impact of the RMS Japan in <unk>, Sweden divestitures.
We have narrowed our organic revenue growth outlook to 13, 5% to 14, 5%.
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 our 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 our 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 in safety assessment, including lab Sciences in bio analytical services and discovery services.
And for our services and price increases that 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.
A 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 too.
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.
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 already.
These early bookings, which now extend well into 2020 to 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.
<unk> and other necessary resources, while managing the continual shifts in client timelines in 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 Charles River and even more indispensable research part of the 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.
S early discovery and antibody discovery capabilities biotech clients continue to choose to invest in their pipeline 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 and by doing so we are enabling our clients to remain with <unk>.
<unk> scientific partner from target identification through IND filing and beyond and solidifying our position as the leading non clinical CRO the.
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 the 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 we 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 operation to Japan with an opportunistic sale to the Jackson Laboratory.
We have established a licensing agreement under which JAKKS will produce and distribute our models in Japan.
Which model services performed very well.
<unk> is benefiting from strong outsourcing demand as our clients seek the greater flexibility and efficiency gain when we manage their proprietary model colonies.
Greater complexity of scientific research and our 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 Bio hub.
And we will continue to expand in other regions, including South San Francisco and South San Francisco to provide a flexible capacity solution for our clients globally.
Rising Cradle also provides clients with collaborative opportunities to seamlessly access other Charles River services, which further enhances the speed and efficiency of their research programs.
Our self supply business, which consists of heme occur in <unk> continues to be affected by limitations on donor availability.
As it has not fully recovered from last year's Covid related restrictions.
We implemented several improvement initiatives, including expansion of donor capacity across multiple sites.
Productivity initiatives and enhancing the digital engagement with Donuts, we anticipate that revenue will improve in the coming quarters, because the robust demand in the cell therapy market sector remains firmly intact.
Operating margin decreased by 160 basis points year over year to 26, 1%, primarily due to the cell supply business like many of our businesses sell suppliers leveraged the sales volume.
So we expect profitability will meaningfully improve once donor availability in the growth rate rebound.
Revenue for the manufacturing segment was $192 9 million and 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.
<unk> 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 lot release testing.
And 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 Rover.
Robust demand for cell and gene therapy testing services continued 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.
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.
Third quarter marks the first full quarter that cognitive by Jean where part of Charles River as anticipated when we acquired cognate.
Large COVID-19 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 integration and believe our cell and gene therapy, <unk> business will be highly complementary to our biologics business and our portfolio as a whole.
I also believe that we now have a comprehensive cell and gene therapy portfolio, which spans each of the major <unk> 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 that goal of driving greater efficiency and accelerating their speed to market.
As mentioned earlier the decision to divest our CMO site in Sweden was based on several factors first as capabilities, including plasma DNA, we're already duplicated at other <unk> sites in the U K and U S. Secondly, determined it would be advantageous to invest in and expand.
Capacity at our other CMO hubs that are more centrally located in proximate to clients and finally, this was our smallest and least profitable CMO site.
This divestiture does not reflect any changes in client demand or the cell and gene therapy CMO sector. As we firmly believe the growth profile for this business remains at or above 25% over the longer term.
The manufacturing segment's 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 <unk> 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 CMO business. However, beyond 2021, and we expect this headwind to gradually dissipate as we drive efficiency and has significant growth we anticipate generates.
Greater economies of scale and Optimizes throughput at our CMO 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-19 levels.
The sustained funding environment, both from capital the capital markets in the biopharmaceutical industry.
And the biotech industry as 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 river's position as the leading non clinical CRO and accommodated 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.
Enhanced 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 4000 talented people this year to both support growth and offset attrition and plan to hire an additional 1000 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 lifesaving 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 demand and achieve our low double digit organic growth target that we expected 2022 by.
By focusing intently on our strategy, we have become a trusted scientific partner for pharmaceutical and biotechnology companies academic institutions and government and nongovernment 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.
Percent 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.
It will enable us to continue to achieve our long term financial targets and deliver greater value to shareholders.
Conclusion, I would like to thank our clients and shareholders for their support and our employees for their exceptional work and commitment.
Now I'll ask David to give you additional details on our third.
Third quarter results and updated 2021 guidance.
Thank you Jim and good morning.
Before I begin may I remind you.
Yes.
Primarily to non-GAAP results, which exclude amortization.
Action related challenges.
Costs related primarily to our global efficiency initiatives.
<unk> capital and other strategic investment performance.
Right.
Many of my comments will also refer to organic revenue growth, which excludes acquisition and divestiture.
Translation.
We are pleased with our strong results will take quarter, which included 14, 6% organic revenue growth.
<unk> seen 9% increasing earnings per share.
Operating margin for the third quarter with 21, 4%.
While lower than the prior year as anticipated.
Presented a 60 basis point sequential increase.
In line with our full year target.
Target of approximately 21%.
In addition to the Covid cost controls last year.
The <unk> acquisition this year, Jim mentioned third quarter operating margin.
Also lower than last year's robust 22, 7%.
That level because of the.
Foreign exchange headwinds and last year's scheduled milestone payments.
Although cost inflation and supply chain pressures have made headlines recently, we believe we are effectively managing the tungsten labor marketing supply chain and high cost areas.
Got it.
Lower unallocated corporate costs contributed to the third quarter operating margin.
Revenue of $45 million compared to $5.
You bet you last year.
Corporate cost on non linear fluctuating from quarter to quarter in Q2.
Including health and fringe related costs.
Based compensation.
Despite the third quarter capability, we continue to expect.
In the mid 5% range as a percentage of revenue for full year.
Third quarter non-GAAP tax rate.
M 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.
Discrete tax benefits associated with R&D tax credits and a favorable exit.
Related to stock based compensation associated with couponing.
These benefits will also result in a reduction of our full year non-GAAP tax rate to a range of 18% to 19% from our prior outlook.
Of 19, 5% to 28%.
Total adjusted net interest expense in the third quarter was $20 $7 million, an increase of $2 million year over year.
Reflecting higher debt balances to fund Courtney and Biogen acquisitions, but was essentially flat sequentially.
At the end of the quarter, we had an outstanding debt balance of $2 $9 billion, representing a gross leverage ratio of two times and a net leverage ratio of two six times for.
For the full year, we now expect total adjusted net interest expense to be slightly lower than our prior outlook.
In the range of $80 million to $82 million, reflecting debt repayments and continued low interest rates.
Free cash flow was $119 2 million.
Quarter, representing a decrease of 21%.
$151 1 million tons for the same period last year.
The lower free cash flow was primary.
Only due to higher capital expenditures, which increased by nearly $30 million to 55 million.
Julien.
There were two reasons for the increase in capital expenditures, we continued to invest in capacity additions and other groups.
Projects to meet demand.
Last year's level was still constrained.
Related contract right.
For the year, our free cash flow.
Guidance remains unchanged at approximately $5 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.
In our legacy.
Okay.
With respect to 2021 guidance.
Updating our full year revenue outlook to a range of 19 to 20.
On a reported basis.
Putting the impact of the divestitures.
Change and organic revenue growth to 13, five to 14, 5%.
Foreign exchange is now expected to be less of a benefit.
Previously anticipated due to the strengthening of U S III.
Everyone, particularly when compared to the British pound and euro.
We now expect 150 to 200 basis points.
Compared to our plan.
<unk> 250 basis points as Jim mentioned, the strength of the dollar resulted in a headwind reduced third quarter reported revenue by approximately $10 million compared to all right. Okay.
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.
Yes.
Divestitures.
Keep in mind, thanks to are expected to reduce revenue by nearly $20 million and non-GAAP earnings per share.
10 full quarter, which is reflected in the full year 2021 financial guidance.
By segment.
Updated outlook for 2021 continues to reflect the sustained and healthy business environment.
Our organic revenue growth narrowed our previous range, we have maintained our segment expectation, including organic revenue growth in the high teens for the RMS segment.
Low double digits for the DSA segment.
High teens for the manufacturing segment on a reported basis.
Moderated the segment outlook to reflect updated FX rates and the divestitures. We now expect revenue growth for the ultimate segments in the high teens range.
Factoring in the low 40% range and DSA unchanged in the mid teens.
With regard to operating margin.
Segment profit remains effectively unchanged from our prior outlook.
A detailed summary of our updated.
Updated financial guidance for the full year can be found on slide 39.
With one quarter in EMEA fourth quarter outlook.
I did in our guidance for the full year.
Hello, Mr Bond divestiture will.
The year over year comparisons in the fourth quarter on a year over year basis, we expect organic revenue will be in the high single digits and reported revenue growth.
What gives you a range.
When normalized.
We expect organic growth for the full year.
Again, we'll be squarely in the low double digit range, which is also consistent with the growth that we should see 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.
Okay.
The fourth quarter tax rate is expected to return to the low 20% range, which along with the divestitures will be a strong earnings per share growth rate.
I would like to provide one modeling comment with regard to next year, we will add 50 <unk> week at the end of the fourth quarter of 2022.
Periodically the client to true up our fiscal year to December 31st come to year end.
Third week has historically been characterized partially because revenue.
Cause dream holiday for a full week of costs.
To conclude.
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 are expected to 2021 performance.
Constricts the progress we are making as well as the investments that are necessary to achieve the 2020 financial targets that we provided at our Investor day, ne which include low single digit organic revenue growth and operating margin of approximately 22, 5% non-GAAP and at a faster rate.
Okay.
That concludes our comments operator, we will now take questions.
Thank you, ladies and gentlemen, as a reminder to ask a question you will need to press Star then one on your telephone.
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Our first question comes from the line of John Kreger with William Blair. Your line is open.
Hey, thanks very much.
Jim and David I heard you guys make a few comments about 'twenty two just wanted to make sure.
You heard that right I think you said low double digit organic growth expected and capex spending of around 9%.
Alex you can add to that sort of early 'twenty, two look and maybe where should we expect the higher capex investing to be targeted thanks.
So where we did say that John.
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 challenging therapy.
The nature of our portfolio, it's a demand will continue.
Through next year at least so given giving should early indications of that.
What we're experiencing this year is.
It's quite interesting and unique we have.
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.
As we.
Look at next year and beyond.
We do think that the capacity needs, we 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 businesses just getting to the point where.
Not only did we think was appropriate.
Early rollout for showing that our capex on a percentage basis will be.
<unk> <unk> 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 or anything else.
<unk> safety assessment goes so does the company these days.
So we have terrific growth rates in the safety assessment business, we were by far the market leader lot of clients depending on as you have all these new biotech companies created committed and have no internal capability to do that work. So.
We thought that both at 9% and a double digit would be a good early collapsed.
We anticipate for next year.
Great. Thank you.
Hello.
A bit more color on the puts and takes as well because I think thats clearly of interest from a number of people and while we're not going to talk about the 2022 full.
The guidance there are a number of things that we have kind of called out but there is a lot of material.
Morning to go through so.
Jim talked about the strong demand environment.
But that low double digit organic growth does help fuel some of the headwinds that we're seeing and by the way Youre aware of microbial access headwinds that we've had this year, which is behind us now.
Supply, we would hope that would be fully behind us when we get into 2022 as well so that's another tailwind.
And of course that buoyant double digit growth.
With our margin expansion goals.
We're trying to get to 150 basis points over the next three years that wont be linear.
For instance, the investments that we're making in digital we wont see the return to really kick in until the outer year and next year. We have this modest headwind from the 50, <unk> week, which I called out in my remarks, and then there are other known headwinds that we've got we will continue to invest in people capacity digital <unk>.
It will familiar.
With the global pressures that we're sharing on hiring and inflation.
And many thanks to the region, so I won't belabor that point, but we will have our share.
However, we are fortunate to be in the industry that we're in we're not as affected by those issues as some but neither are we immune.
That said, we believe for effectively managing those tighter labor market supply chain, but it will take care of it and it will take investment.
And then there are things, which we call on today simple ones like FX.
That's one of the last piece is we put in the jigsaw piece.
We've got that unique item around potential for U S tax reform.
Would it be enacted but I am hearing that there's a good chance that with consequent to 2023.
And then we've got very complex things around inflation is it short term as some people would have at the length or is it more sustained and I think that's too early to call.
Finally, great recognition of this being cold.
It has to come to an end, but at what point.
So we're working on finalizing the plan in February we will 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 'twenty two.
Very helpful. Thanks.
Thank you.
Our next question comes from the line of Derik de Bruin with Bank of America. Your line is open.
Hey, good morning, everyone.
Hey, Jim can you talk a little bit about.
The cell and gene therapy business, and certain white and the demands in that area.
And sort of how that is flowing through on particularly how that is flowing through on the margin profile.
And.
Just how should we think about the growth in that segment in 'twenty, two and the rest of this year and into next year.
Yes.
We've put together.
Relatively swiftly through M&A.
Several cell and gene therapy assets.
The cell product businesses in the CMO assets and of course.
Ralph in two different segments.
They're working really hard on it.
Integrate and connect those businesses I think we're doing really well. It's that we're also working really hard to connect those businesses.
Particularly the CMO piece to add to our biologics business.
Because being able to manufacture the drug and tested our.
Really important capability that distinguishes us from most of our.
Competitive we.
The cell supply business as we called out as its growth rate is being hampered right now by sort of covered related toner.
<unk>.
Restrictions for Domino's.
That should ameliorate over time and growth rates, there should be 25%, 30% kind of ongoing basis.
We haven't said that much about the margin Joe the margins should be.
Should not be dilutive to our a assets per tower.
See the ammo piece.
Really clear that.
The manufacturing segment has had lowered has had mid to high 30% operating margin not a lot of businesses that would be accretive to that so it's a bit of a headwind although that will improve.
Italy.
Excuse me.
Meaningfully at 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 <unk> will look like from a margin profile out of few years, particularly if we're doing multiple commercial runs for clients. So obviously.
Just greater efficiency through throughput and consistency.
Of supply I think that could could invigorate the margin itself.
Pleased with the growth rates Directionally pleased with our margin rates.
Together, a nice portfolio.
Sort of on its own and 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.
Still a sort of like the wild west. So I'm just wondering if its an extra heavy technology investment relative to what you are typically used to.
I wouldn't I wouldn't say that.
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.
Certain aspects of <unk> and <unk>.
The antibody discovery.
AI is a bit of a wildcard.
There's so many shots on goal that we could take them so much.
Impact of this could have on our portfolio, but it's still relatively early days so.
I think that we will have meaningful investments, particularly in AI and machine learning I do think it can be beneficial to the whole portfolio, maybe particularly.
And gene therapy.
Look the hull.
Part of your question the whole discovery platform and its 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 romance that advantage point and yes, we're very much focused on it and I think that.
Price points will be necessarily higher though.
Okay.
Thank you.
Our next question comes from the line of Tycho Peterson with Jpmorgan. Your line is open.
Hey, thanks.
Wanted to revisit the 2020.
For a minute because I think you also talked about earnings leverage and David as you talked about obviously, you've got some some headwinds here with the extra week in wage inflation I think three quarters of the divestiture headwinds can you help us think about the levers you can pull to drive that earnings leverage next next year. The Street has you up about 11, 5% on earnings in line effectively.
Revenue split, yes, you're actually going to have the earnings leverage you mentioned digital I'm. Just curious what are the levers you have to call 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.
Our revenue this year the demand has increased more than we expected which is great it's setting up nicely.
Future and we've made meaningful investments this year.
So we can continue to make.
And with meaningful investments in the business with that corporate and Thats one of the benefits of having high.
High revenue and double digit growth.
But we do need to invest some of that additional property line.
Into the business not just for the short term in terms of head count, 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.
Not going to see a 100 basis point margin improvement in 2022 that we've seen in the last few years.
Particularly this year, where we've got a 100 basis point improvement despite the investments that we've made in the business.
So so that's helpful. That's helpful.
Headwind you feel like that helps cover some of the.
Tell me.
In terms of tax.
We are.
Well it depends where we end up with Biogen, we did call out on our investor call back in May.
While were low 20 traditionally at the moment okay. Good. So we've had two discrete items.
But without those discrete items, we would have expected for 2022 to be the low twenty's with by then that would have moved.
We expect it to move up to the mid <unk> and as I said a few times.
Hearing that.
So both of the house, we should see the Biogen reforms pushed out to 'twenty two into 'twenty three.
Okay with that happen. Thanks.
Tax rate would be back to where we have traditionally been at the low <unk>.
As you all I have for the call again people are talking about puts and takes.
In terms of the divestitures that we called out we called out what that impact is.
This year, but I will share with you that broadly we would expect that to be at 20 to 25 headwind for.
For 2022 as well.
Okay. That's helpful. And then if I could ask you just one clarification for Jim on the DSA capacity expansion you talked about price increases on prior calls we at a point now where customers are pushing back on pricing and you're having to expand capacity.
Actually 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.
Now I would say that.
Generally speaking clients.
Are the most interested right now in <unk>.
When they can start a study available slightly studies slots.
Sometimes.
Many times, the geography of where those status study so.
Do you have room for me do you have the scientific capability for me can you read my turnaround times and Oh by the way, what's the price I'm, not saying that I am interested in price I would say it's.
Significantly deemphasize has as an important issue.
If you think of the client base with hundreds of new biotech companies being created every year with literally no internal capacity and.
And big pharma continuing to rapidly reduce their internal capacity.
Our role is just because it has become increasingly more significant.
So we're trying to say about this year I mean this is this is a.
This is a high class problem right high class challenge that we are working really hard to have enough people in to build enough space to accommodate the demand which is right now.
Okay.
Significantly and.
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.
Of course by the way.
We build.
Even now is probably not available until 'twenty three 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.
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 in capacity and people to accommodate.
Okay. Thank you.
Yeah.
Thank you.
Our next question comes from the line of Elizabeth Anderson with Evercore. Your line is open.
Hi, guys. Thanks. So much further question, maybe just to follow up on that one clearly so if we think about sort of the free cash I'm sorry, the capex expenditures next year, how do you see as sort of see that I mean broadly trending you said 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 I think it will be difficult.
To predict that.
But.
I think if we had to call. It today, we think that demand will continue and we look at the world in five year chunks or even five year strategic plan.
<unk> 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 given our competitive prowess given the fact that we'll probably do additional M&A to make our portfolio stronger.
Given the scale of our business and the demand on our business I think we would anticipate that.
The new normal.
We'll have.
Capex as a percentage of sales around that level going forward and there's no logical demand reason that that should slow.
But from where we are now that looks like that looks like the right the right rates 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 you a second ago, you mentioned, another 22 factor, which was the impact of the divestitures at 20% to 25%.
We were curious if that was a full year impact of that was the incremental impact after adjusting for the fourth quarter here this year.
Yes, its simple thats, a full year impact.
So.
So so full year 'twenty to 'twenty, five so incremental would be roughly.
Less than 10 to 15.
Correct.
Thanks on the 22, yet correct, if we were taking it out to 'twenty two.
20% to 25, and the reason why not.
The Q4 multiplied by four is broadly.
The work the work that we divested in the Swedish side can actually be done elsewhere within our organization. So we're making we're making an assumption as to how much of that will be complete.
Got it and then I had a follow up on.
This whole supply business and I know those.
Thats have been impacted by the pandemic and donor access in particular, but.
Look I'm going to advocate, we cover the health care supply chain broadly we look at a lot of health care sectors. Just about every category I can think of is <unk>.
Near or above pre pandemic levels in some some health care 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 am curious if there is something more going on in the sole supply business that's holding it back.
Yes, there really is nothing more going on Eric.
Don or access the demand is still quite significant.
The good news is that we had a better October we've opened additional donor rums given that we did two acquisitions in that space are in addition to the California.
We are keeping growth in Massachusetts in Washington State that obviously.
Is and will continue to improve garner access.
You said that that business should continue to improve hopefully sequentially.
Move to the back half of this year and into next year to get to the growth levels that.
We anticipated when we did these PFS an amount which was around 30% top line. So we're confident we'll get 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 businesses.
In the midst of.
The 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 some we often talk about clinical CRO mergers and the impact across clinical CRO is it's much less common to talk about larger competitors in research models coming together and I know Thats a.
More of a vertical deal than a horizontal one but I am curious if you see any potential impact from.
The changes over at <unk>.
Yes.
We really that's been an enterprise that we've competed with for a long period of time.
I would say principally an always on price.
As opposed to quality so.
We've always been sort of scientific partner with a broader geographic footprint.
So the different level of service.
And our clients.
On a broader portfolio.
So.
And that company has been less.
Less of an impactful competitor I would say over over the years.
Then they were historically so.
I would expect that situation that fact pattern really doesn't change at all as a result of this.
Thanks very much.
Sure. Thank you.
Our next question comes from the line of Tejas Savant with Morgan Stanley. Your line is open.
Hey, guys. Good morning, just one follow up also related to RMS Jim are you seeing any pick up in disruptions in China from some of the COVID-19 related shutdown that or our customers generally in better shape to handle the surge this time around.
And one for Dave on the guide to what extent in 'twenty two can you.
Push through pricing increases to your customers to absorb some of the headwinds you outlined on the call here.
Yes, we're not seeing any new or additional COVID-19 related dislocations.
Dislocations in China.
Obviously, the first place we saw.
Back when it all hit in the first place that approved.
I would say that marketplace for us at least is back minimally to pre COVID-19 levels and probably stronger than that apart from the academic part of bio <unk>.
Pharmaceutical part.
We make continue to make significant investments in capacity and we're growing that business nicely and nicely geographically both in our core research model.
The related services so.
No that business is going really well.
Yes.
And in terms of pricing of 22.
Pos about low double digit growth assumptions.
So.
No we don't we don't breakout price.
Any more anyway, and we're still sharpening our pencils to what exactly the 2022 plan will look like in terms of price.
So, but yes part of the low double digit growth.
As 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 'twenty two from.
Clients booking out further like.
How much more percent of revenue do you think you have visibility to in 'twenty two versus what would be normal.
Yes.
It's probably quantify of OPEC.
But not for us right now.
It will probably be a dangerous thing to quantify I would say that.
It continues to be more pronounced.
That's a very good thing for us in terms of some of the things I've talked about hiring and capacity.
Timing and scheduling.
And utilization.
Various fulfilling suggests it gives us it gives us.
I think that 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 nuances their priorities and portfolio and a better job messaging to us.
What's really essential to be done.
Quickly whatever that means.
For them.
Mark could wait so feels like while it's a pretty feverish and the demand is great.
More rational planning paradigm so.
Thanks.
I actually enhancing our relationship with our clients it feels like the sort of leverage that we have and they have is sort of on an equal playing field now.
As <unk> communicated so.
We like it from a planning point of view and if theres ability point of view.
And then a related follow up question.
Is around the mix in that business.
Im thinking broadly about.
Our pipeline that's moving towards large molecule in general, but also maybe what the bleeding edge moving towards cell and gene therapy, and you've highlighted that.
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.
Yes.
<unk>.
<unk>.
We work really hard at making sure we have sufficient.
Supply of all of our animal models, particularly some of the larger models.
We've had two <unk>.
<unk>.
Validate multiple new sources of supply in multiple countries.
To accommodate just the increase in demand and the pace of demand than 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.
Directionally managing it quite well in terms of having sufficient numbers for 'twenty two so yes.
The animal models will become increasingly more complex, particularly some of the larger ones.
Yes.
For the biologics in particular I think that's been the case for some period of time.
But just to be clear the.
The implication in your response to that the shift or you are seeing a shift towards large large animal or I'm, sorry, like nonhuman primate and large animal within the mix is that the right way to think about it with Florida.
Yes.
It's a continuation of the shift.
Some time ago, and I think that shift.
It's more intensified these days just given the nature of the drugs.
Sure. Thank you I 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 on the margin side, just trying to figure out again, the moving pieces for 'twenty two versus kind of a long term guide you gave.
Two.
Potentially be a bit more of a muted year given again some of the increasing costs in the labor side, obviously significant investments in manufacturing.
Just trying to think of kind of that bridge in terms of in 'twenty. Two it seems like there's some pressures. So maybe just talk to that one more time that would be appreciated.
Broker that you said.
You said I missed the middle part of the collection, which I think was key to the question.
Yes. It was around the 22 margins and then just the cadence in terms of the long term guide was 22, a potentially be a bit more muted given the labor crush, yes investments in manufacturing and all the other moving pieces.
Yes.
As I said.
Earlier.
Anybody that expecting it to get 100 basis points next week.
We consider that please.
And equally even if you take 150 basis points, and you said thats going to be linear.
Continue to consider that as well given the commentary that we've made about some of the pressures this year in terms of wages, particularly in inflation.
But we.
We've made some meaningful investments this year in 2021, so I wouldn't want you to feel that we have.
Tony and pressures on us we have a portion of that pressure as anybody else in the wrong dose.
We think we can cope with that well.
But I wouldn't want to leave you with impression that in the last two years, what sort of margin accretion is going to continue.
And indeed, we did try to take a lot at the Investor day.
That we would be looking at 150 of the two years.
And we've also got the headwinds from the 50 <unk> week.
In 2022 digital investments that we've been making which has been quite sizable and amounts will be kicking in in the out years.
So.
And then of course that we got on top of that some of the compensation pressures that we've mentioned so all of our key here is to make sure that we can supply the needs of our clients continue to get that growth continue to win share.
Make sure that we're in a great position that some.
The first call in terms of doing the work.
And the drug research.
Understood. Thanks, I'll leave it there.
Thank you.
Our next question comes from the line of Jon <unk> 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.
The recently announced transaction.
We would hope to deploy the divestitures.
Further M&A.
My name is fungible, so I would say generally we're just kind of deploy them to.
To grow our business generally if obviously if we if we have a deal.
And why.
We can directly.
You can directly apply the cell and gene.
Therapy portfolio is pretty robust right now.
There's some subtle.
Lithomarge because we're looking at additional M&A.
This is a subtle areas that we can improve and enhance just to have just have a broader connectivity. So we never have.
Finishing 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 will bucket.
Primarily due 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 Petrogenesis and then you add our biologics business and some of our safety and discovery capabilities, It's a very broad portfolio now.
Certainly from a service point of view, it's the broadest of anyone.
And the industry. So we.
We have a good base right now.
Can accommodate.
A lot of low demand.
A diverse client base and so we will invest in aggressively organically if we can get some of these.
Niche deals done that were looking at from an M&A point of view then.
Some of the gaps that would actually be that obvious will be 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.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation you may now disconnect.
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