Charles River Laboratories International Inc

NYSE:CRL

Earnings Call Transcript 2020-Q4

[Operator]

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

I'd like to hand the conference over to your speaker today Mr. Todd Spencer, Corporate Vice President of Investor Relations with Charles River. Please go ahead.

[Todd Spencer, Corporate Vice President, Investor Relations]

Thank you, Mary. Good morning and welcome to Charles River Laboratories fourth quarter 2020 earnings and 2021 guidance conference call and webcast. This morning Jim Foster, Chairman, President and Chief Executive Officer; and David Smith, Executive Vice President and Chief Financial Officer will comment on our results for the fourth quarter and full year 2020 and our guidance for 2021 as well as our planned acquisition of Cognate BioServices.

Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks which will be posted on the Investor Relations section of our website at ir.criver.com. A webcast replay of this call will be available beginning approximately two hours after today's call can also be accessed on our Investor Relations website. The replay will be available through next quarter's conference call.

I'd like to remind you of our Safe Harbor. All remarks that we make about future expectations, plans, and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated.

During this call, we will primarily discuss non-GAAP financial measures which we believe help investors gain a meaningful understanding of our core operating results and guidance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results from operations prepared in accordance with GAAP.

In accordance with Regulation G you can find the comparable GAAP measures and reconciliations on the Investor Relations section of our website. In addition today's remarks will also include estimates of the COVID impact on the company. Certain methodologies and assumptions related to how we develop these estimates can be found on slide three.

I will now turn the call over to Jim Foster.

[Jim Foster, Chairman, President & Chief Executive Officer]

Thanks Todd. Good morning. I'm very pleased to speak with you today about the conclusion of another extraordinary year for Charles River our expectations for 2021 and the expansion of our early-stage research and manufacturing support portfolio into a complementary high-growth sector.

2020 was an unprecedented year. COVID-19 pandemic challenged us in many ways. But to date we've navigated it successfully and reinforced our position as the leading nonclinical CRO. Our success in 2020 was due to the resilience of our business model, a comprehensive business continuity plan that enabled us to keep our worldwide operating sites open and adequately staffed.

Our broad scientific capabilities and flexible outsourcing solutions that support our clients' needs and our employees around the world who met client needs through their commitment and dedication. As a result, we have now become even more integral to our value clients and more differentiated from the competition.

Despite the short-term impact of COVID-related client disruptions, we benefited from robust underlying client demand across most of our businesses. This was largely driven by clients' intensified use of strategic outsourcing to overcome challenges at their own sites as they partnered with us to move their early-stage research programs forward during the pandemic.

In addition, the record biotech funding environment which eclipsed $130 billion last year is allowing our clients to place greater emphasis on R&D investments particularly in the early stage pipelines.

We believe these factors drove our exceptional financial results in the fourth quarter and for the full year. We are extremely pleased to report organic revenue growth above 10% in the fourth quarter and 7% for the year. Both metrics are in line with or above our high single-digit organic growth target despite the short-term challenges associated with COVID-19 last year.

We also achieved our two-year operating margin target of 20% for the full year, one year ahead of schedule. We are continuing to closely monitor COVID-19, but believe our strong performance in 2020 and a continuation of robust demand trends including record booking and proposal activity in the Safety Assessment business position us well to get off to a strong start in 2021.

COVID-19 pandemic has also enhanced the global focus on scientific innovation which is generating biomedical breakthroughs across multiple therapeutic areas including through COVID-19 vaccines. This innovation has fueled continued investment in and the proliferation of more complex research techniques involving advanced drug modalities such as cell and gene therapies.

The complexity of these new modalities is increasing our clients' reliance on a high-science outsourcing partner like Charles River. To enhance our ability to meet our clients' needs in these emerging areas of scientific innovation and to take advantage of the significant growth opportunity that these advanced drug modalities present we are expanding our portfolio and scientific expertise through a combination of acquisitions strategic partnerships and internal investments.

This morning we announced our intent to acquire Cognate BioServices, a premier CDMO partner for clients comprehensive cell and gene therapy development and manufacturing needs. We believe Cognate which will become part of our manufacturing segment is an excellent opportunity to enter the CDMO market because it will allow us to participate in a niche value-added sector with a high-growth profile that adds to our existing nonclinical development and manufacturing support capabilities.

Let me start by highlighting three key aspects of the strategic rationale. Cognate has solutions across the major CDMO platforms for cell and gene therapies. Integrating manufacturing and required analytical testing is critical to drive efficiency and the cell and gene therapy sector offers exceptional growth potential. Cognate's scientific expertise makes this particularly attractive transaction.

It provides CDMO services across both cell and gene therapies with its primary area of expertise in the CGMP cell therapy manufacturing. Cognate also has capabilities in the production of plasmid DNA which is a foundational tool for the development of gene-modified cell therapies and gene therapies, as well as other inputs in the CDMO value chain.

Cell and gene therapies are emerging drug modalities. And as such the science will continue to evolve. However Cognate's broad capability should enable it to better adapt to shifts in the marketplace. Cognate has a track record of producing various cell types and technologies used in cellular immunotherapy and immuno-oncology regenerative medicine and advanced cell therapy.

The synergistic fit is the second pillar of the rationale. Cognate will be highly complementary to our existing nonclinical capabilities, establishing a premier scientific partner for cell and gene therapy development, testing and manufacturing and providing clients with an integrated solution from basic research through GMP production.

Biopharmaceutical clients are seeking to drive greater efficiency and leverage scientific benefits by working with fewer trusted partners who have broad integrated capabilities. As we are already a provider of extensive non-clinical services for cell and gene therapies the acquisition of Cognate will enable us to produce drugs in these advanced modalities.

We believe the strategic expansion of our portfolio is particularly synergistic with our Biologics Testing Solutions business. It will be ideal for clients to be able to seamlessly conduct analytical testing, process development and manufacturing for advanced modalities with the same scientific partner enabling them to achieve their goal of driving greater efficiency.

Our Biologics business is a premier provider of quality control testing, the cell and gene therapies including assay development, analytical testing and cell banking which are all critical steps in the manufacturing scale-up and commercial production processes. Clients will also have access to our cellular products as the starting point for their cell therapy program and will be able to work with Charles River through every step of the research and early-stage development process before moving into CGMP production with Cognate accelerating our clients' speed to market for advanced drug modalities.

With Charles River and Cognate combined, we expect to effectively double the revenue base of our comprehensive cell and gene therapy capabilities to approximately 10% of our total revenue. We believe Cognate will also immediately enhance our growth potential by expanding our capabilities and scale into this complementary high-growth cell and gene therapy sector.

The addressable market for Cognate's CDMO services principally cell therapy and plasmid production is currently estimated at approximately $1.5 billion and expected to grow at least 25% annually over the next five years. Growth is being fueled by the robust biotech funding environment. Approximately $20 billion was invested in cell and gene therapy companies in 2020, fueling the rapid rise of cell and gene therapies in the R&D pipeline, which now total over 2,000 programs. We believe the demand for Cognate services will intensify, as more of these programs progress into late-stage development and commercialization.

The companies that are successful in the market will be able to provide the science, the space and the integrated solutions to broadly support clients cell and gene therapy programs. We intend to be one of these successful companies.

The purchase price for Cognate is expected to be approximately $875 million in cash and the valuation will be consistent with comparable high-growth, high-science transactions in the cell and gene therapy CDMO sector. Cognate is expected to generate annual revenue of approximately $140 million in 2021, which we project to grow at or above the estimated market rate of at least 25% annually over the next five years. Because of the market growth potential and the emerging role of cell and gene therapies as treatments for oncology and rare diseases in particular, we believe Cognate will meaningfully enhance our revenue and earnings growth potential and the transaction will achieve our hurdle rates for investment returns. David will provide additional financial details on the transaction including the estimated 2021 financial impact.

We look forward to welcoming Cognate's dedicated employees to the Charles River family. Now let me give you the highlights of our fourth quarter and full year performance. We reported revenue of $791 million in the fourth quarter of 2020, an increase of 14.4% on a reported basis. Robust client demand across all three business segments drove organic revenue growth of 10.3%. The DSA and Manufacturing segments reported low double-digit organic growth. The RMS segment's organic growth rate rebounded to a mid-single-digit rate, recovering from COVID-related client disruptions, principally in the second quarter.

For 2020, revenue was $2.92 billion with a reported growth rate of 11.5% and an organic growth rate of 7%. We're very pleased with this high single-digit organic growth rate, particularly in light of the revenue headwind from COVID-19. The operating margin was 20.8% in the fourth quarter, a decrease of 60 basis points year-over-year.

Margin improvement in both RMS and Manufacturing segments was offset by DSA operating margin decline. For the full year the operating margin increased by 100 basis points to 20%, achieving our target one year ahead of schedule. This was an exceptional performance resulting primarily from the inherent operating leverage in our business, our continued efforts to drive operating efficiency and build a more scalable infrastructure and the benefits from the temporary cost reduction initiatives related to COVID-19.

Despite achieving our 20% target, we believe we are well positioned to achieve modest operating margin improvement in 2021. Earnings per share were $2.39 in the fourth quarter, an increase of 18.9% from $2.01 in the fourth quarter of 2019. For the full year earnings per share were $8.13, a 20.8% increase over the prior year. We exceeded our prior guidance range of $7.75 to $7.85, due primarily to robust low double-digit organic revenue growth and favorable below-the-line items for the fourth quarter including a lower tax rate.

We are very enthusiastic about the outlook for 2021. We believe our exceptional market position, the strategic expansion of our unique portfolio and our focus on operational excellence, combined with continuing robust client demand position us extremely well for the year ahead. Excluding Cognate, we expect organic revenue growth of 9% to 11% and non-GAAP earnings per share in the range of $9 to $9.25 or an increase of 11% to 14% year-over-year.

The acquisition of Cognate is expected to be neutral to non-GAAP earnings per share in 2021 and add approximately 400 basis points to the reported revenue growth rate, which equates to a reported revenue growth outlook of 16% to 18% in 2021.

I'd like to provide you with additional details on our fourth quarter segment performance and our expectations for 2021, beginning with the DSA segment's results. DSA revenue in the fourth quarter was $495 million, an 11.3% increase on an organic basis, driven by robust demand from global biopharmaceutical and biotechnology clients in both Discovery and Safety Assessment.

For the full year, DSA organic revenue growth was 9.4%. We expect organic revenue growth will be approaching 10% in the DSA segment in 2021 because clients both large and small are increasingly choosing to partner with a large reliable CRO like Charles River. Clients know that utilizing our science, our broad early-stage portfolio and our flexible outsourcing solutions will propel their research efforts faster and more efficiently than they could do it alone. This was amply demonstrated during the pandemic when they face challenges at their own sites. Robust biotech funding also continues to fuel a healthy demand environment.

Our Safety Assessment business continued to perform extremely well, driven by higher study volume and price increases in the fourth quarter. Bookings and proposal volume reached record levels in the fourth quarter across all regions and major service areas, which we believe positions the Safety Assessment business favorably for a strong first half of 2021. We're pleased with the extensive depth and breadth of our Safety Assessment portfolio and remain intently focused on continuing to enhance the value we provide to our clients.

We're also seeing greater opportunities to conduct safety and efficacy testing on cell and gene therapies. We believe there is meaningful growth potential inherent in the more than 2000 programs currently in the cell and gene therapy pipeline approximately two-thirds, of which are in the preclinical phase. The testing requirements of cell and gene therapies vary by molecule from complex combination pharmacology safety studies to certain cell therapies to safety programs that are similar to traditional large molecules for gene therapies.

We've already built one of the largest early-stage testing platforms to support this emerging high-growth sector and intend to continue to adapt and enhance our capabilities to meet the specific needs of these emerging drug modalities. We are continuing to add new capabilities across many of our businesses, including through strategic partnerships.

Our partnership strategy has proven to be very successful to stay current with cutting-edge technologies and add innovative capabilities with limited upfront risk. In the last several months, we have added new partnerships or expanded existing ones across several businesses, including with Cypre for 3D tumor modeling and screening immuno-oncological compounds in our Discovery business, and with PathoQuest and JADE Biomedical in our biologics business.

In addition, last month we announced the acquisition of Distributed Bio formerly a strategic partner through, which we established our integrated large molecule discovery platform. This platform filled the gap in our portfolio and expanded our early discovery expertise in the complex drug modality that few CROs can successfully offer. We believe our clients' willingness to outsource more of their discovery programs will be predicated on our ability to continue to add innovative capabilities to meet their critical research needs.

We believe the combination of the strategic outsourcing trend, deep scientific expertise, and our willingness to forge flexible relationships with clients led to the tremendous performance of the Discovery business, which had another exceptional quarter and year. Broad-based demand for our suite of early discovery, oncology and CNS services drove the fourth quarter performance.

To achieve our goals in 2021 and beyond, we will continue to strengthen our portfolio by expanding our scale, our science and our innovative technologies. By doing so, we are enabling our clients to remain with one scientific partner from target identification through IND filing and solidifying our position as the leading early-stage CRO.

The DSA operating margin was 23.2% in the fourth quarter, a decrease of 240 basis points for the fourth quarter of 2019. The decrease was driven by increased costs due in part to performance based bonuses and a slightly less favorable study mix in the Safety Assessment business.

For 2020, the DSA operating margin improved by 140 basis points to 23.4%. We are pleased with the full year margin expansion in the DSA segment and believe there will be incremental opportunities for improvement.

RMS revenue in the fourth quarter was $156.7 million, an increase of 5.2% on an organic basis. For the year, RMS organic revenue declined by 3.3%, reflecting an impact of approximately 7% from COVID-19, principally in the second quarter.

Our outlook for RMS organic revenue growth will be in the high teens for 2021, as a result of the recovery from last year's COVID-19 headwinds and the incremental benefit from adding the high-growth cell supply businesses to the organic revenue base, following the respective anniversaries of the HemaCare and Cellero acquisitions.

As anticipated, global demand for research models improved in the fourth quarter, both on a year-over-year and sequential basis, as clients returned to normalized order activity in all geographic regions, following COVID-related disruptions earlier in the year. Demand accelerated nicely in the fourth quarter, particularly in China.

We believe that we benefited from market share gains in 2020, especially with academic clients, as research sites reopened and not all suppliers could meet the clients' needs. We will continue to monitor the evolving COVID-19 situation globally, but at this point, it appears that most academic and biopharmaceutical clients have adapted their protocols to continue working during the pandemic.

The Research Model Services also continue to perform well. GEMS is benefiting from renewed outsourcing demand, due in part to COVID-19 challenges at our client sites earlier in the year, as well as scientists' use of more complex research models.

We're the natural partner for our GEMS clients, since we have extensive animal husbandry expertise, which enables us to manage their proprietary model safely and efficiently.

We're also continuing to generate client interest for Insourcing Solutions through both our CRADL initiative, where we provide turnkey research capacity to our clients, as well as through more traditional in-sourced staffing arrangements.

Revenue for our cell supply businesses HemaCare and Cellero increased in the fourth quarter on a comparative basis, but remained at a growth rate below the targeted 30% level. We anticipate that this growth rate will accelerate, as COVID-19 constraints ease and we expect to achieve our growth rate for these businesses in 2021.

We continue to work diligently to expand our donor base in the U.S. and add more comprehensive capabilities at all our sites, to accommodate the robust demand in the cell therapy market.

The acquisition of Cognate also positions Charles River as a trusted partner that can move cell therapy program forward, using the same cellular product through each step of the research and early-stage development phases and into CGMP production at Cognate.

The RMS operating margin was 25.1% in the fourth quarter, an increase of 50 basis points from the fourth quarter of 2019. The increase was driven by operating leverage from higher sales volumes in the Research Model Business, as well as the benefit from operating efficiency initiatives.

For 2020, the RMS operating margin declined by 420 basis points to 22%, due almost entirely to the impact of COVID-19. With the financial impact of COVID-19 believed to be largely behind us, we expect the RMS operating margin will rebound well above the 25% level in 2021.

Manufacturing revenue was $139.3 million for the fourth quarter, a growth rate of 12.4% on an organic basis, driven primarily by the Biologics businesses. The Microbial Solutions and Avian Vaccine businesses were also meaningful contributors to the fourth quarter revenue growth. Organic revenue growth for the year was 10.4%.

Microbial Solutions revenue growth rate improved again in the fourth quarter, due in part to year-end ordering trends for Endosafe testing cartridges. We continue to have delayed instrument installations resulting from COVID-19 restrictions at certain client sites.

We expect this will constrain the Microbial Solutions revenue growth rate well into 2021, primarily because the incremental revenue stream associated with corresponding sale of consumables, including cartridges, reagents and Accugenix microbial identification services, that generally follow the installation of our high-throughput systems will be delayed. This is the primary factor that is expected to cause the segment's organic growth rate to be slightly below 10% in 2021.

Beyond the COVID-19-related impact, we continue to firmly believe that our ability to provide clients with a comprehensive rapid and efficient microbial testing solution, as well as a high-quality and accurate testing platform, are key differentiators from the competition and will lead clients to continue to choose Charles River for the critical quality control testing requirements.

The Biologics business reported an exceptional quarter in the year with strong double-digit revenue growth. We believe that robust market demand will continue to support Biologics revenue growth in 2021 due largely to demand for testing of cell and gene therapies.

We've developed a comprehensive suite of new assays required to support the unique needs of cell and gene therapies and will continue to add assays in 2021 to accommodate the robust demand. The acquisition of Cognate is also expected to be highly synergistic to our Biologics business, as clients will now be able to outsource GMP cell and gene therapy production and required analytical testing to one scientific partner reducing the bottlenecks and inefficiencies of utilizing multiple outsourced providers. We also expect to derive a benefit from COVID-19 testing.

We believe our Biologics business will be providing required reduction testing as many of the vaccines move into the commercial production phase and some of the early-stage testing activity subsides. Given the strength of the demand environment, we are continuing to build upon our extensive portfolio of services to support the safe manufacture of biologics and ensure we have available capacity to accommodate client demand.

As part of this strategy, we were pleased to recently announce that we have expanded our partnership with PathoQuest to build a next-generation sequencing lab at our Pennsylvania site and partnered with JADE Biomedical to enhance our biologic testing capabilities and geographic reach in China.

Due to the leverage from strong revenue growth the Manufacturing Support segment's operating margin was 37.3% in the fourth quarter, an increase of 10 basis points. For the year the operating margin was 37.4% above our mid-30% target and consistent with our expectations for 2021, excluding Cognate.

As I mentioned earlier, we believe that the COVID-19 pandemic has demonstrated that we are even more integral to our clients now. We have been intently focused on accommodating their evolving needs during these challenging times and many clients have told us that they couldn't move their research forward without us.

Clients have outsourced incremental work to us across multiple therapeutic areas because of our deep scientific expertise and the ease and flexibility of working with an integrated early-stage CRO like Charles River. As a result, we generated approximately $60 million of revenue last year from our work on COVID-19 vaccines and related therapeutics.

We're proud to have worked on all of the COVID-19 vaccines that have been approved for emergency use by the FDA and in the UK to-date including; the AstraZeneca and Moderna Vaccines. AstraZeneca and Moderna are two leading biopharmaceutical companies that we have worked closely with under our respective strategic relationships for many years as they have embraced the benefits of outsourcing and driving efficiency through their R&D organizations.

Our relationships with Moderna and AstraZeneca demonstrate how we can work together towards a common mission to bring breakthrough treatments to market to save lives which has been particularly critical now as we strive to find a solution to the pandemic. As 2020 has demonstrated, we are operating in a robust business environment with excellent growth potential.

To continue to successfully execute our strategy to maintain and enhance Charles River's position as the leading early-stage CRO and expand our manufacturing support to CDMO capabilities, we will continue to make investments in our scientific capabilities through M&A, strategic partnerships and internal development, expand capacity and staff to accommodate demand and exploit our digital enterprise to provide critical data for internal use and to enhance connectivity with our clients.

We will continue to evaluate acquisition opportunities across our businesses and across a number of drug modalities and scientific capabilities. We will invest in a disciplined manner strengthening our portfolio and focusing on speed and responsiveness as we meet our clients' individual needs and promote a more efficient drug development model.

Our goal is to enhance our position as a trusted scientific partner for pharmaceutical and biotechnology companies, academic institutions and government and non-governmental organizations worldwide. By providing exceptional value to our clients, we believe we will continue to deliver greater value to our shareholders.

In conclusion, I want to thank our employees for their exceptional work and commitment, especially, during the COVID-19 pandemic, and our shareholders for their support.

Now I'd like David Smith to give you additional details on our financial performance and 2021 guidance as well as additional details on the acquisition of Cognate.

[David Smith]

Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results, which exclude amortization and other acquisition-related charges, costs related primarily to our global efficiency initiatives, our venture capital and other strategic investment performance and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation.

My discussion this morning will focus primarily on our financial guidance for 2021, which principally excludes the impact of Cognate BioServices. We expect 2021 reported revenue growth of 12% to 14% excluding Cognate and organic revenue growth of 9% to 11% which includes a benefit of the favorable year-over-year comparison to last year's COVID-19 revenue impact.

Sustained client demand, including record fourth quarter bookings and proposal volume in our Safety Assessment business and a robust biotech funding environment support our growth outlook for 2021.

Based on this strong revenue growth and with modest operating margin expansion in 2021, we believe we are well positioned this year to deliver non-GAAP earnings per share between $9 and $9.25. This equates to year-over-year earnings per share growth of approximately 11% to 14%, which is similar to our top line growth outlook, as higher revenue and margin improvement will be partially offset by a higher tax rate.

Foreign exchange is expected to provide a 200 to 250 basis points benefit to our reported revenue growth guidance for 2021, as a result of the weakening U.S. dollar. Our FX rate estimates are based on the bank forecast for the year, which are currently very close to spot rates. We have provided information on our 2020 revenue by currency and the foreign exchange rates that we are assuming for 2021 on slide 40 and we'll continue to monitor fluctuations in the currency market as we progress through the year.

From a segment perspective, our revenue outlook reflects the strong business environment and the fact that most of our businesses have recovered from COVID-19-related disruptions in 2020.

The RMS segment is expected to achieve high teens organic revenue growth in 2021, as client order activity for research models rebounds from COVID-19 and the growth rate of HemaCare and Cellero cell supply businesses accelerates to targeted levels.

We expect the DSA segment to deliver organic revenue growth approaching 10% in 2021 and Manufacturing to grow slightly below 10% on an organic basis as Robust Biologics demand is partially offset by the continuing impact of COVID on Microbial Solutions.

We were very pleased that the operating margin improved by 100 basis points to 20% in 2020 and that we achieved our target of a 20% full year operating margin one year ahead of plan. Building upon this performance, we believe that we are well positioned to drive additional margin improvement for the full year 2021, despite modest pressures on Manufacturing due to Cognate, as we continue to leverage strong revenue growth and maintain our focus on operational excellence.

On a segment basis, RMS is expected to be a primary contributor to margin improvement in 2021, increasing from the COVID-suppressed levels of 2020, to well above 25% this year. The DSA operating margin is expected to continue to make progress toward the mid-20s target and the Manufacturing operating margin is expected to be similar to the 2020 level before Cognate.

We expect unallocated corporate expense in 2021 to be in the mid-5% range as a percentage of revenue, or similar to 5.6% of revenue last year. Our scalable infrastructure enables us to drive greater efficiency even as we periodically reinvest to meet our goals and the needs of our clients.

Total adjusted net interest expense is expected to decrease to a range of $66 million to $68 million in 2021 excluding Cognate, compared to approximately $74 million last year. We expect the decrease driven by lower average debt balances, as well as lower variable interest rates.

The non-GAAP tax rate for 2021 is expected to be in the low 20% range an increase from 18.9% in 2020. The increase in the tax rate is principally an issue of comparison to 2020, because last year's tax rate was reduced mainly by discrete tax benefits associated with state tax returns and foreign tax credits.

As a reminder, the first quarter tax rate has been meaningfully lower in recent years, due primarily to the excess tax benefit related to stock compensation. Given our current stock price, we expect this to be true in 2021, resulting in a non-GAAP tax rate in the mid-teens in the first quarter.

We remain intently focused on driving strong free cash flow growth as a key measure of our financial performance. In 2020, free cash flow was $380 million, an increase of 12% from 2019, but below our prior guidance. The decrease in the fourth quarter resulted primarily from higher capital expenditures, which totaled $166.6 million.

This was above our prior outlook of $130 million due to two factors: paying capital invoices ahead of schedule in order to give a discount as well as the timing of capital projects. Some projects that were slow due to the COVID-related challenges in the second quarter resumed in response to the reacceleration of growth and business activity.

At the end of the fourth quarter, our total debt balance was essentially unchanged sequentially at $1.9 million, but our gross leverage ratio decreased to 2.3 times, primarily because of the strong fourth quarter performance. With our leverage ratio below 2.5 times, we will benefit from interest savings on our variable rate debt reducing the rate by 12.5 basis points to LIBOR plus 112.5 basis points.

For 2021, we expect free cash flow to be in the range of $415 million to $435 million based on the anticipated strong operating performance of our business and our continued focus on working capital management. Capital expenditures this year are expected to total approximately $180 million excluding Cognate.

Currently, we do not intend to repurchase any shares in 2021 and expect to exit the year with a diluted share count slightly more than 51 million shares. The FX benefit is expected to largely offset the earnings per share dilution from the higher share count.

A summary of our 2021 financial guidance, excluding Cognate can be found on slide 49. Looking ahead to the first quarter of 2021, we expect year-over-year revenue growth will be in the low double-digit range on a reported basis and approaching 10% on an organic basis.

We expect earnings per share to increase at a high-teens rate year-over-year from $1.84 in the first quarter of last year. As I mentioned earlier, the first quarter tax rate is expected to be in the mid-teens, primarily due to the excess tax benefit from stock-based compensation.

Before I conclude, I'll provide some details on our financial outlook including the acquisition of Cognate. Assuming the acquisition closes by the end of the first quarter, Cognate is expected to add approximately $110 million to revenue for the partial year resulting in a revenue growth outlook of 16% to 18%.

We expect Cognate to be neutral to non-GAAP earnings per share in 2021, so do not expect the acquisition to have a meaningful impact on our current guidance. The acquisition is not expected to have a meaningful impact to Charles River's consolidated operating margin this year, so we continue to expect to generate modest margin improvement with Cognate.

We believe there will be opportunities to improve Cognate's operating margin over the next few years as we deliver acquisition synergies, enhance the scale of the business and drive operating efficiency. We intend to update our full guidance and other financial metrics to reflect Cognate next quarter, once the acquisition closes.

From both strategic and financial perspective, we believe the acquisition will deliver a compelling benefit that will generate value for shareholders. As a premier, cell and gene therapy CDMO, we expect Cognate to boost the growth potential of our business and be increasingly accretive to non-GAAP earnings after the first year.

Due to the high growth nature of the emerging cell and gene therapy sector, we expect to pay 23 times adjusted EBITDA for the next 12 months after the close. We expect the transaction will achieve our return on invested capital hurdle rate, which is to meet or exceed our cost of capital by year three or four.

We plan to finance the Cognate acquisition through our current revolving credit facility and we will also evaluate opportunities to further optimize our capital structure given the attractive interest rate environment.

Our pro forma gross leverage ratio at closing is expected to increase into the low three times range, which is consistent with the levels after other recent transactions. Also consistent with prior deals, we will focus on repaying debt in a timely manner following the acquisition and reducing leverage to our targeted level below three times.

In conclusion, we are very pleased with our 2020 financial performance and believe that we are positioned to have another strong year in 2021. Over the past five years, we have achieved compound annual growth of 15% for revenue, 16% for earnings per share, 15% for operating cash flow and 10% for free cash flow.

With Cognate and future acquisitions as well as continuation of the robust underlying demand environment, we believe that we will be able to achieve similar growth metrics over the next five years. We intend to provide a business update and more details on our longer-term outlook including our updated financial targets at a virtual Investor Day in the spring. Thank you.

[Todd Spencer, Corporate Vice President, Investor Relations]

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

[Operator]

Thank you. [Operator Instructions] Our first question is from Eric Coldwell with Baird. Your line is open.

[Eric Coldwell, Baird]

Hey thanks very much. Good morning. Just two quick ones here. First off and I think we could probably triangulate based on those last comments. But David could you tell us what the cost of capital you're using for the Cognate deal? It looks like you might be exploring some options on your debt structure related to this.

And then secondarily, there were some comments on mix and safety being slightly dis-favorable in the short term. I'm curious if we could get a little more detail on what the driver of that was and what the outlook is for the mix going into 2021? Thanks very much.

[David Smith]

Yes. So, Eric in terms of the cost of capital for our return on invested capital calculations, we use our WACC, which is around 7%. But I think your question is also about how we might fund it. So, we know the interest rates are very low at the moment. If that holds, then we will be looking to see how we might structure our long-term debt to finance Cognate. So, we'll say more of course in a few weeks or a months' time when we come to do that.

But yes, I think it's definitely on the cards that with a low interest rate environment we ought to take advantage of that. And so although we can fund the investment initially through our revolver and we'll do that we will be keeping a close eye on actually what markets might do in terms of longer term interest rates for our bonds.

In terms of the DSA margin, there were two aspects that drove that. But if I just step back a moment you -- as everybody knows, we've been trying to get to the 20% overall margin for Charles River for some time now, really pleased that we've achieved it this year, really pleased that we did it one year ahead of schedule. And DSA was a meaningful contributor to that.

So, the margin grew 140 basis points over the full year. But we did have a slight decline in Q4. And that's partly to do with higher performance-based compensation. I mean we had the 9.4% organic revenue growth. I just mentioned the 140 basis point margin improvement so the wider DSA team absolutely deserve the compensation that they've got there.

Secondly, to your question on the steady mix and we've had this conversation a few years ago where we have a situation where we've got a disproportion amount of studies that have large models and so did additional costs initially when those studies kick off. But if profitability improves over the course of the study and overall you end up with similar sorts of margins.

So, mix is to tend to fluctuate. Sometimes it balances off to get the portfolio occasionally you get like we have in Q4 like we had a few years ago where we've got a particular heavy load and the like on studies that have larger costs at the beginning.

So, overall, yes, we're very pleased with the potential for DSA. Still striving to move that towards the 25%, which I think Jim mentioned in his prepared remarks as well. So, this Q4 impact is mostly transitory.

[Operator]

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

[Dave Windley, Jefferies]

Hi, thanks. Good morning. Thanks for taking my question. I wanted to focus on cell and gene therapy with my question in your Cognate acquisition I guess a two-parter. Jim in the WIL acquisition, there was a small CDMO that came along with it and you decided to sell that kind of decided that you didn't want to be at least in that CDMO business.

So, Part A of the question here is elaborate a little bit on why the CDMO opportunity in cell and gene therapy is more attractive to you for Charles River to get into. And then Part B, the question is to flesh out a little bit more of the pieces that you've now assembled, with your cell supply, your complementary biologics testing capabilities et cetera, a little bit more of the continuum?

And are there -- is that fairly complete at this point, or are there other additional capabilities that you feel like, you need to fill into white space in your C> business? Thanks.

[Jim Foster, Chairman, President & Chief Executive Officer]

Yes. Thanks for that Dave. Yeah. So, many years ago we did acquire a small molecule CDMO. And it was a perfectly good business. And you'll recall, kind of we told that we -- we told you and other analysts and shareholders, that we had done an exhaustive analysis of the industry.

And we had decided that, it was -- there were some very, very big players. And it would be difficult for us to achieve scale. And since we like to be, if possible the premier player in the spaces in which we work. We just -- we thought it was best to exit, which we did.

And at that time, perhaps overstated, I desired to remain out of it. But as you know, over the last couple of years in conversations with us, I think several things have happened. Number one, cell and gene therapy has heated up dramatically.

Number two that brings with us both, an opportunity to make a niche play, in the CDMO space. And be minimally a leader which we're entering with this asset, as a leader in the space and potentially the leader overtime. So we -- so that sort of dovetails with the original comments that we made.

You've got this $20 billion of investment in cell and gene therapy. Just in 2020, you've got 2,000 drugs that have been filed. The vast majority over two-thirds or three quarters I think are in preclinical and Phase I. So the demand has heated up dramatically. We have a lot of inbound.

Our M&A is derived from requests from clients, for products and services that they need that they'd like us to have, either because they trust us more or they're unable or incapable of getting these, elsewhere.

So, this feels like, -- it fills a very important gap in the portfolio. I don't think it would be lethal had we not done this, but it would cause clients to have to go outside to get their drugs manufactured. So just to, continue to comment and answer your second question.

We now have an extremely broad portfolio. So you're starting with us literally with the cells, via research and development. We're going to be able to do process development for you, of your drug. We're all obviously going to be able to test that drug, in our Discovery and Safety business.

We're going to be able to manufacture that drug, for the clinic and hopefully the commercial purposes. And our Biologics business is going to test those drugs, before they're going to the clinic or into the marketplace. So it's a very, very comprehensive suite.

As you heard us say, cell and gene therapy is going to move with this deal from, about 5% of our consolidated revenues in fiscal 2021 to 10%. So, it's a major move for us strategically, but we're doing that entirely in response to our clients.

So clients can stay with us through the development of the cell and gene therapy products, particularly cell therapy products, where the preponderance of this business, is focused and an opportunity to be a leading player in this segment.

[Dave Windley, Jefferies]

Very good, sounds good. Thank you.

[Jim Foster, Chairman, President & Chief Executive Officer]

Sure.

[Operator]

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

[John Kreger, William Blair]

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

[Jim Foster, Chairman, President & Chief Executive Officer]

Yeah. They've got a good geographic footprint. It's US and Europe. They have -- definitely have incremental capacity, some of which has been, added relatively recently, which will provide the capacity both, to do larger clinical trial lots. And if and as those drugs move into commercial, into a commercial domain, obviously to do that work as well, which the clients will want to do that also.

Obviously, there's, very few commercial products that exist in cell and gene therapy period, although so many being worked on right now. So that certainly would be the goal and the strategy we anticipate. We certainly have the technical ability, regulatory ability knowledge of CGMP production in cellular therapy from people that have come from a host of different company backgrounds to form a very strong management team there.

Capacity like all of our businesses that are growing will be important as we built out somewhat in advance of having the demand and anticipating the demand. I do think the clients of Cognate's will be very pleased to see it in our hands, because there's the uncertainty of being private equity owned and what's the future and what's the investment portfolio. So I do think that clients who are working with this company now in the clinic whose drugs are progressing nicely will have a high degree of confidence, if the drug makes it that we could and perhaps should be their commercial producers. So we like that sort of entry point here with a bunch of increased business with our access to clients with their footprint and with this being part of our overall portfolio.

[John Kreger, William Blair]

Great. Thank you.

[Jim Foster, Chairman, President & Chief Executive Officer]

Sure.

[Operator]

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

[Ricky Goldwasser, Morgan Stanley]

Yeah. Hi, good morning, and congrats Jim on completing the acquisition. I know you talked about it I think over a year at our conference and your intent to enter the area. So congratulations. My question is around the margin profile. Clearly, you exceeded your margin expectations by a year. But from everything I'm hearing, it sounds like there's a real nice opportunity for long-term margin expansion, right? You talked about the complexity of the projects that you are working on. And even when I think about sort of the strategic outsourcing it seems that we're starting to hear from some companies that they're looking to downsize their own facilities and their own sort of workspace, which I equate to kind of like 5, 10 years ago what we saw in the talks were kind of like capacity was coming down which gave you an opportunity. So how should we think about that margin expansion and opportunity? And when you give us those long-term goals is it going to be kind of like a 2-year goal, or are we thinking longer-term here, especially given kind of like the Cognate acquisition that really opens this new and growing market opportunity?

[Jim Foster, Chairman, President & Chief Executive Officer]

I'll give you a general comment. David may want to give you a slightly more specific comment. And I think we'll leave sort of the overall deep dive on this important subject with you entirely until we give longer-term guidance. But I think as a bottom line proposition, we are organized to drive efficiency throughout all of our businesses. We are organized to keep our G&A load as flat as possible as the business continues to grow and could -- we've demonstrated that over the last few years. We've also demonstrated our ability to drive efficiency. We're going to be doing some more work on the digital front, which will provide greater connectivity amongst our sites internally and externally, and we'll certainly take time out of the process that should generate better returns also.

We certainly will continue to have pricing power across all of our businesses, which I think you are alluding to with the outsourcing demand. There's basically biotech. We have a big pharma footprint. Biotech is the principal driver of our growth. Biotech is extraordinarily well funded and biotech has no internal capacity and doesn't want to have it. So I would say first and foremost, our biggest business segment which is DSA definitely has meaningful margin opportunity going forward.

We still have some major acquisitions in that business that have improved nicely, but still have more margin to contribute. And I think efficiency across all of those businesses will be significant. The company that we just bought will continue to have improved margin opportunity. You've got to see RMS get back to kind of historical levels to 2021. And then I think it should improve particularly since it has that attractive cell product aspect to it. I think the Manufacturing segment can always get better. We'll see how we decide to say about that. The margins being at 37% are obviously quite extraordinary. Having said that, I think there's probably still opportunity in the Biologics business to drive growth. So you should see some modest improvement in 2021 as we said in our prepared remarks and certainly more on a forward going basis, and we'll give you a deep definitive dive on that in the not-too-distant future.

[David Smith]

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

[Ricky Goldwasser, Morgan Stanley]

Thank you.

[Operator]

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

[Juan Avendano, Bank of America]

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

[Jim Foster, Chairman, President & Chief Executive Officer]

Yes. There's probably a slight lingering impact as you put it on the government side through the fourth quarter. We had shutters down and then we opened it in May. It's been improving steadily. There's still some – obviously, some social distancing going on and we're always looking for new donors. So probably some slight drag coming out of the year. As we said in our prepared remarks, we anticipate that we'll continue to improve both as COVID becomes less severe hopefully. But even, if it doesn't, we feel we have the operational knowledge to structure this in a way that we should achieve the goal. So we had next year's targets, which is north of 30%.

So that will continue to participate – to grow nicely. In fact, you're going to ask another question on nonhuman primate. So I'll answer the one, I thought you were going to ask and answer the one that you did ask, why is that the supply is definitely constrained around the world? I think we've done an exceptional job in adding ensuring tightening up expanding our supply sources so that we have multiple supply sources for multiple countries, such that we can support the demand, which is quite significant.

The sort of changing out of species and moving to smaller species, maybe we should have an offline conversation on that. I just don't think that's – I don't think that's happening. Work on large molecules really has to be done on larger species to get the sort of quality results that we're looking for. So I think NHPs will continue to play a critical role.

In terms of pent-up demand for RMS, I think we've seen much of that play through the academic medical centers that were totally or partially shut in – basically in all three geographic locals. Asia, Europe and the US have essentially all opened. We don't believe regardless of the level of infection with COVID that they're going to go down – go back in the lockdown. The research is too important. They're sorry that they shut them down and they definitely now had to work with other agents around and given that their laboratories are usually all gone down.

So we think that, we're back in kind of a normal cadence in RMS for the products which is principally what you're talking about the services obviously we're not only unaffected but I think benefited from some of the COVID disruption that our competitors saw. But in terms of production sale of research models, I think we're back to normal cadence both in volume and price enhanced by the cellular products of business that continues to grow.

[Juan Avendano, Bank of America]

Thank you.

[Operator]

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

[Robert Jones, Goldman Sachs]

Great. Good morning. Thanks for the question. Jim, I wanted to go back to the comments around the delayed instrument installations in Microbial. It seems like you're expecting that I think the language you used was to affect revenue growth well into 2021, but it seems like you saw some improvement towards the end of 2020.

So just wanted to understand a little bit better what needs to kind of change at the client front in your mind to see a reacceleration of these installations? And then relatedly, I think, you gave some commentary on margins by segment, but overall it looks like 20 basis points to 30 basis points improved EBIT margins. How could that look if in fact these installations start to come back in faster in 2021 just to the overall enterprise margin?

[Jim Foster, Chairman, President & Chief Executive Officer]

Yes. So it's an imperfect world to predict this, but we feel pretty confident in what we've told you which is that for sure we have had difficulty accessing clients to install our largest and most complex systems. And in a few cases we have been able to do this with some of our larger systems on a virtual basis. So the clients really were -- really needed these systems and were willing to dedicate the people and the time to do with us. And of course, we had to be creative and facile to do things virtually.

Now having said that, we've had the FDA and other regulatory agencies auditing us virtually all year all of 2020 and clients have done that. And we've done virtual audits of lots of things ourselves including some aspects of the company that we're in the process of buying. So we're in a virtual world.

So it's hard to predict how comfortable people will get doing things virtually or whether they're just going to want to wait. We think it will be a similar cadence to what we're on. The virus is pretty rough right now obviously. So limitations in many of the countries in which we work and we place these systems in many of the states in the US are severe. We're not letting outsiders into our facilities, for instance.

So the impact of that is as follows that we don't place the systems, which are large systems. They got large ASPs and they're quite profitable. But even more importantly than that every one of these big systems generate substantial amount of revenue of cartridges, reagents and to some extent and in some instances our Accugenix ID business. So we're losing all of that associated incremental revenue on all of these systems that weren't placed and still haven't been placed in fiscal 2020.

What you saw in the end of 2020, which is I think confusing you and I understand why is less that the sites opened up and more that there was just a surge of demand for cartridges at the end of the year pretty much with people that have -- we have a large installed base of thousands and thousands of systems most of which are relatively small. And those -- that's probably a commentary probably to a small extent that people who couldn't get large systems that they're going to use their smaller ones more readily.

But more importantly than out of commentary on just how much work is out there on testing all of these drugs before they get into the market enhanced slightly by COVID and somewhat by cell and gene therapy. So the business -- the demand for the business frustratingly has probably never been as good as it is now. We'll do the best we can being created in installing those systems. But as they are not installed, we don't get the incremental revenue and that's why we're projected to be slightly below the 10% growth.

Part of the answer -- to the second part of your question margins are exceptional in that business both in the Microbial business and the whole Manufacturing segment. Having said that, they have steadily improved. We think there's a lot of improvement in Biologics. And there has been some improvement in our manufacturing capability in Microbial, which has improved the margins as well. So stay tuned.

[Robert Jones, Goldman Sachs]

Got it. Thanks.

[Jim Foster, Chairman, President & Chief Executive Officer]

Sure.

[Operator]

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

[Tycho Peterson, JPMorgan]

Hey. Thanks. A couple of follow-ups here. Jim starting with Cognate. I want to go back to John Kreger's question on CapEx. If we look at some of the other CDMOs whether it's Catalent with Paragon and MaSTherCell or Thermo with Brammer. The cost of building out facilities here are not insignificant in the kind of $150 million to $250 million range for commercial cell and gene therapy facilities.

So in the context of your CapEx guidance being $180 million, I'm just curious how we should be thinking about your willingness to take on maybe more -- much more significant investments?

And then two quick follow-ups for David on guidance. I'm curious if you can break out any COVID contribution. I know it was $60 million in 2020. So what's baked in for 2021?

And then on the margins, it does seem like there's a couple of potential drivers to the upside here. You did have the DSA price increase you flagged. RMS recovering from COVID suppressed levels and then the Manufacturing installation tailwinds -- sorry headwinds wearing off. So all of those seem like they could get you above modest improvement, but I'm just curious if there are more meaningful offsets that would continue that? Thanks.

[Jim Foster, Chairman, President & Chief Executive Officer]

So the CapEx will not be insignificant in this business. It will be meaningful, but I don't think we'll be disproportionate to the growth potential of this business. This will be amongst if not the highest growth aspect of our business. So we'll have to invest ahead of it as we've said earlier. Obviously, there's a substantial installed base already that we're buying. This business is principally GMP cell therapy manufacturing. And secondarily, the production of plasmid DNAs.

And while the CapEx is substantial it's less substantial in some aspects of contract manufacturing. So we're not really going head-to-head for instance with Thermo and Catalent that are more gene therapy manufacturing businesses. So it's difficult to get sort of what there spend is versus what ours will be? They won't be -- it won't be insignificant, but it will be a lower order of magnitude one that we're pretty confident we'll get substantial returns on and that we've already obviously baked through our model and we'll give you clarity on it as soon as we close this deal.

David, you can take the second question.

[David Smith]

Yes. Yes sure. So short -- in terms of COVID and the sort of headwind tailwind here, the short answer is we've contemplated a sensible approach, at least we believe a sensible approach to what COVID will do in our guidance. So that's baked in. Of course, we don't know what we don't know. Just to unpack that a little bit. So we obviously, we had some significant losses because of COVID particularly in RMS. And we did say at the last earnings call that we expected RMS to be broadly exiting the year with COVID behind us and we still believe that to be true.

In academics, clients seem to be open and we're not expecting that do a U-turn, but we'll keep an eye out for that. We generated $60 million of revenue that was COVID related both in DSA some vaccines and some other aspects. Not all of that will go away. We expect to see some of that continue into 2021. And that's also baked into the guidance. So there are puts there are takes. Broadly, we feel the way we're looking at it, we've broadly got COVID behind us other than the things that's already been called out late. We've just been talking about Microbial for instance that's a lit bit of a headwind.

Moving ahead with your margin question. Just want to call out a few potential opportunities. I just want to make sure that you're cognizant of the unallocated corporate costs. So historically, we've seen a 50 basis point improvement as a percentage of revenue. This year we're guiding towards pretty much flat 2020. And the reason for that is that we have got some investments that we are contemplating or in the process of putting in.

In fact when Jim talked at the JPMorgan conference, we talked about five different strategic imperatives and one of those strategic imperatives was to champion technology. And indeed, I think Jim's just mentioned a few moments ago, the desire to put in best-in-class technology should help our clients essentially access scientific data in real time. So there is some set-up costs associated with that, which means that the unallocated COVID cost is not giving that 50% basis points that we've historically had, but we would expect to have that behind us this year.

[Tycho Peterson, JPMorgan]

Okay. Thank you.

[Operator]

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

[Patrick Donnelly, Citi]

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

[Jim Foster, Chairman, President & Chief Executive Officer]

Yes. We definitely have seen a change in demand, outsourcing demand on the service side of our RMS business, almost entirely from the academic sector, who really were up against it with COVID with facilities that literally were shutting prematurely and a significant amount of research was at risk. And the fact that we were open that we were capable of doing this and have been able to do it so well for them for this amount of period of time, I think it demonstrated sort of the frailties of them continuing to do this internally. So there's no question that we've seen incremental work that was done internally be outsourced. And we're highly confident that a meaningful amount of that has stuck.

And just a quick side. Similarly you asked the question about RMS, we saw some of this in Discovery and Safety in the second quarter with clients who either they were using another provider who was incapable of supporting them during the sort of -- kind of initial outbreaks of COVID and/or their own facilities were shut for some meaningful period of time and that caused them to either contemplate outsourcing for the first time and contemplate more outsourcing that they had done historically. And definitely based upon the feedback we've gotten from these clients really pleased with the services that we provide and the speed with which we're doing it and the price points as well.

So there's no question that we've got. It's an incremental share that was perhaps not available to anybody that was being done by the clients themselves. And for sure some work that was outsourced to competition both in RMS and in DSA where they were unable to do that. And that incremental share gain and expectation of continuing to gain share in certain aspects of our business is certainly baked into our 2021 numbers.

[Patrick Donnelly, Citi]

Great. Thanks, Jim.

[Operator]

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

[Sandy Draper, Truist Securities]

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

[Jim Foster, Chairman, President & Chief Executive Officer]

Yes. I don't think there'll be a bolus of activity. The machines will have to be installed virtually or for real probably most real. And then the clients will have to start to utilize them. Obviously that installed base of whatever X number of machines that have either been delivered and not hooked up or waiting to be delivered by us to the clients who's not letting us in. As I said earlier sort of every day, every week, every month they don't have those systems. They're not buying the associated disposables.

It's unlikely we're going to install all those systems at once and then they're going to suddenly expect to use them at once. Obviously, it's beneficial once we install them, because they are larger and they use a disproportionately large amount of disposables that will be beneficial, but I think it will be gradual. It will be persistent.

We're continuing to build -- our inventory will be in enough shape. I think you're inferring is that going to be a problem or an opportunity? I think our inventory will be appropriate shape to accommodate demands in those associated disposables. But I think it would be steady, maybe it's slightly beneficial in a particular quarter or two, but I don't think there's going to be a surge in demand.

[Sandy Draper, Truist Securities]

Great. Thanks so much, Jim.

[Jim Foster, Chairman, President & Chief Executive Officer]

Sure.

[Operator]

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

[Dan Brennan, UBS]

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

[David Smith]

Great. So in the Manufacturing, if you exclude Cognate, we would expect the margins to be similar to the way we exited in 2020. However, Cognate will be a little bit of a drag. So we are expecting with Cognate for just this year to be somewhere in the ZIP code of the long-term guidance that we've particularly given out, which will be in the mid-30s. We'll say more about where we think that's going to go at the Investor Day.

In terms of RMS, okay, so well above 25%, that's a fair call out. Where's the ceiling on that? I think last -- if you look at last year, we were a little bit above the 25% to 26%. So I would say somewhere in the mid-high teens would be about -- sorry, mid-high 20s would be about right.

[Dan Brennan, UBS]

Okay. Thanks, David. And then, just maybe one more on Cognate. I'm just wondering, could you give us any color on -- obviously, it's still a nascent market, any color on the competitive positioning Paragon and MaSTherCell. I'm sure WuXi Advanced and the big players are all focused here as well. So just any color whether it’d be number of clients, or just any color you can give on that front?

And then, I'm just wondering, in terms of the senior executives of Cognate are they locked up given how critical talent and expertise is to run these complex CMOs. I'm just wondering what the deal terms were on that front? Thank you.

[Jim Foster, Chairman, President & Chief Executive Officer]

So you should think of our principal competitors in this space being Lonza and WuXi and not Thermo and Catalent. And number one, you should consider that the size of our business, the business that we're buying is comparable to those two. So, in the same ZIP code.

Specifically, with regard to the sort of manufacturing capabilities that we're acquiring, if you look at the totality of our portfolio in cell and gene therapy, from the cellular product businesses, we bought last year with this business that we're teeing up now across our whole portfolio that cell and gene therapy capabilities are vastly more significant than those two players, and across the continuum where they can continue to use our services.

So, we feel really good about our competitive position. I said earlier in answer to someone's question, we're entering as a leader specifically the CGMP part, and I think our aspirations and I think high probability that we could be the leader with this in the midst of Charles River's larger portfolio our reputation our client contact.

And with regard to the management, we've always been successful in keeping key management. And obviously, we'll be proceeding to get contracts in place as -- now that we just signed a deal. So, we're quite confident that we'll keep the key management team in place.

[Dan Brennan, UBS]

Great, thanks, Jim.

[Jim Foster, Chairman, President & Chief Executive Officer]

Sure.

[Operator]

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

[Donald Hooker, KeyBanc]

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

[Jim Foster, Chairman, President & Chief Executive Officer]

Yeah. We think that artificial intelligence and machine learning will increasingly have a role in drug development, both in predictability of successful preclinical trials and predictability of success in clinical trials. And then obviously, have a role in the design of those trials and some linkage between the animal work and the human work.

Theoretically and practically utilizing, if you take a look at the data that we have on thousands and thousands and thousands of molecules, some of which have succeeded and many of which have failed is -- can be highly important and predictive. How robust that technology is, how quickly regulators adopt it, how quickly our clients embrace it, is really hard to tell. What technology do we utilize as we make these small investments in these technology deals we're going to definitely get access to multiple different ways of utilizing that data? And we may use them in combination or we may just have one that prevails. We've done a lot of work on this internally and with a bunch of world-class experts.

And while we think there's an ongoing role, we want to be very careful in terms of how we invest the shareholders' money and the assumptions that we make on sort of adoption by the users and not either invest in a wrong technology or invest too aggressively prematurely. So, on a very measured, but very thoughtful basis, we're going to continue to play in it. And I would say that, it's more than use the word dabble. I don't really feel that we're dabbling in. I think that we're -- we're seriously investigating the best way to utilize our capabilities in concert with some powerful AI tools. I suspect we will have additional AI technology partnerships going forward.

[Donald Hooker, KeyBanc]

Thank you.

[Operator]

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

[Dan Leonard, Wells Fargo]

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

[David Smith]

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

[Dan Leonard, Wells Fargo]

Okay. Thanks.

[Operator]

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

[Jack Meehan, Nephron Research]

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

[David Smith]

So, we've never really called out that we've had like wage pressure. That is atypical from what takes place in those countries. So there's nothing specific to call out for Charles River vis-à-vis wage inflation et cetera. And believe we take a very close look to what's going on country-by-country and try to stay competitive there. And there was an exception in 2018 midyear, when we felt that we wanted to bring Charles River to a living wage type organization, which we called out. But there are no real surprises in terms of wage inflation or in terms of supply costs, that we feel that we should be calling out other than what we've already said in terms of Q4 was really to do with the timing issue. Other than that, we feel that we will get -- start working -- will continue to work towards the mid 25% that we've been striving for some time. And we don't have much more to say.

[Jack Meehan, Nephron Research]

Thank you.

[Todd Spencer, Corporate Vice President, Investor Relations]

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

[Operator]

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