CRL — Q2 2016 Earnings Call Transcript

Thank you. Good morning, and welcome to Charles River Laboratories' second quarter 2016 earnings conference call and webcast. This morning, Jim Foster, Chairman, President, and Chief Executive Officer; and David Smith, Executive Vice President, and Chief Financial Officer will comment on our second quarter results and update guidance for 2016. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our website. A replay of this call will be available, beginning at noon today and can be accessed by calling 800-475-6701. The international access number is 320-365-3844. The access code in either case is 397220. The replay will be available through August 17th, and you may also access an archived version of the webcast on our website. I would also like to note that we will be holding our meeting with Management in New York on Thursday, August 11th, at 8:30 AM. If you haven't registered yet or need information, please call or email me. You can find my contact information on today's press release. I'd like to remind you of our Safe Harbor. Any remarks that we may make about future expectations, plans, and prospects for the Company constitute forward-looking statements for purposes of the Safe Harbor provisions, under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors, including, but not limited to those discussed in our annual report on Form 10-K, which was filed on February 12, 2016, as well as other filings we make with the Securities and Exchange Commission. During this call, we will be primarily discussing results from continuing operations and non-GAAP financial measures. We believe that these non-GAAP financial measures help investors to gain a meaningful understanding of our core operating results and future prospects, consistent with the manner in which Management measures and forecasts the Company's performance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations to those GAAP measures on our website through the financial information link. Jim, please go ahead.

Good morning. I am very pleased to say that the strong financial performance we experienced in the first quarter continues in the second quarter of 2016. All three business segments reported revenue gains which demonstrate continued solid execution of our business strategy, successful initial integration of WIL Research, and our ongoing focus on exceptional client service. As a result, clients continue to choose to partner with Charles River for our science, our support, and the increasing breadth of our portfolio, which provides wider opportunities for them to leverage our expertise to achieve their goals faster and more efficiently in their research. I would like to provide you with highlights of our second-quarter performance. We reported revenue of $434.1 million in the second quarter of 2016, a 27.8% increase over the second quarter of 2015. At 0.4%, the negative impact of foreign exchange was minimal. Acquisitions contributed 19.4% to second-quarter revenue growth, and our legacy businesses generated 8.7% organic growth, similar to the first quarter and in line with our long-term high single-digit target. Both the legacy microbial solutions and safety assessment businesses generated growth in excess of 10%, and we were also pleased to see 4% growth in RMS. From a client perspective, biotechnology clients were the primary driver of revenue growth. Sales to these clients increased at a double-digit rate as they continued to invest in their pipeline. The operating margin declined 50 basis points year over year to 19.5%. The decline was due primarily to the acquisition of WIL, which, as we have mentioned, has an operating margin below our DSA segment level. Our goal to achieve $17 million to $20 million of cost synergies over two years will improve WIL's operating efficiency. I am pleased to say we are making excellent progress on synergies and fully expect to achieve our goal in 2017. Earnings per share were $1.20 in the second quarter, an increase of 25% from $0.96 in the second quarter of 2015. The improvement was due primarily to a combination of higher revenue generated by our legacy operations and the benefit of our acquisitions, particularly WIL. Second-quarter earnings per share also benefited from our venture capital investments, which contributed a gain of $0.06. We were exceptionally pleased to see such robust performance across our portfolio in the second quarter. On the strength of our second-quarter results and our expectations for the second half of the year, we are raising our revenue guidance range by 100 basis points for both reported and constant currency. The increase reflects an organic growth rate of 7% to 9%, compared to our previous expectation of 6% to 8%. We are also increasing our 2016 non-GAAP earnings per share guidance to a range of $4.40 to $4.50, which is $0.065 higher at the midpoint of the range than our original guidance. We are confident that we will achieve our full-year revenue and earnings per share guidance. I would like to provide you additional details on our second-quarter segment performance, beginning with the RMS segment. Revenue was 125.1 million, an increase of 4% in constant currency over the second quarter of 2015. Growth was driven by higher sales and research models in China and research model services. Revenue from services was robust in the quarter with our GEMS, RADS, and insourcing solutions businesses all reporting revenue growth. The RMS operating margin declined slightly in the second quarter to 28.9% from 29.1%. The 20 basis point change was due primarily to a greater proportion of services in the revenue mix. Operating margins for the product businesses are higher, so increasing service revenue did impact the margin. However, higher revenue in our continuing efficiency initiatives are driving operating margin improvement for our service businesses. Revenue for the manufacturing support segment was $87.9 million, a 31.3% growth rate in constant currency over the second quarter of last year. The acquisition of WIL's CDMO businesses, Celsius and Sunrise, contributed 18.4% of growth. On an organic basis, growth was 12.9% driven primarily by the microbial solutions and biologics businesses. Microbial solutions reported an exceptional second quarter with the upgrades to our manufacturing plant completed and production capacity increased, the first quarter backlog was filled. Combined with robust sales of PTS products, core reagents, and microbial identification services, the legacy microbial solutions business generated revenue growth in the second quarter consistent with our target, which is greater than 10%. We are continuing to drive adoption of the PTS family of products, which is the only rapid endotoxin testing platform and at the same time, focusing on expanding our footprint in the market for rapid testing and microbial identification. As the only provider who can offer a comprehensive solution for rapid quality control testing of both sterile and nonsterile biopharmaceutical and consumer products, we are in a unique position to support our clients' rapid testing needs. We are investing in research and development for the microbial solutions business to enhance the functionality of our rapid testing platform, and drive greater adoption of our products in order to capitalize on this moment in time, when we have the opportunity to set the standard for rapid testing and identification. We are optimistic that our ability to provide a total microbial testing solution for our clients will be a driver for microbial solutions to continue to deliver at least low double-digit organic revenue growth for the long-term foreseeable future. The biologics business reported a very strong year-over-year performance in the second quarter, with robust revenue growth as a result of strong demand for our biosafety and cell banking services. As we mentioned previously, the biologics business supports the development of biologic drugs, which are representing an increasing proportion of drugs in development. Furthermore, the number of biosimilars in development is also increasing, adding to the demand for our services. In order to further strengthen our services portfolio, we recently acquired Blue Stream Laboratories, an analytical CRO supporting the development of complex biologics and biosimilars. Located proximate to both our headquarters and our safety assessment facility in Massachusetts, Blue Stream is recognized for its expertise in structural and functional protein characterization programs, and the development and validation of assays for current good manufacturing practice, law release, and stability programs. Although this is one of our smaller acquisitions, Blue Stream was a strategically important target because its capabilities fit so well with ours. As a result of the acquisition, we can now provide a comprehensive portfolio of both bioanalytical and biosafety testing services, with the ability to support biologic and biosimilar development from discovery through clinical phases and commercial manufacturing. The manufacturing segment second-quarter operating margin was 35.4%, a 190 basis-point increase year over year, and well above our low 30% target. The improvement was driven primarily by the microbial solutions and biologics businesses. In both cases, increased volume and the benefit of efficiency initiatives contributed. DSA segment revenue was 221.1 million in the second quarter, a 45.6% increase in constant currency over the second quarter of 2015. The acquisitions of WIL and Oncotest contributed 35% to the segment's second-quarter growth. The organic revenue growth of 10.6% was driven primarily by the safety assessment business, which reported a double-digit revenue increase over the same period last year. We were exceptionally pleased with this performance, which resulted primarily from improved client demand, especially from our biotech clients, and the successful execution of our targeted sales strategy. The DSA segment's operating margin was 21.2%, a decline of 40 basis points from 21.6% from the second quarter of 2015. Margins in both the legacy discovery and safety assessment businesses improved, but as expected, the addition of WIL slightly depressed the segment operating margin. We are making excellent progress on the cost synergies, and expect WIL's margin to improve, but it will continue to modestly reduce the DSA segment's operating margin at least through the end of 2016. The discovery services business performed well in the second quarter. We are beginning to gain meaningful traction on integrated discovery work, and have recently signed three new deals in different therapeutic areas: ocular, oncology, and ALS. We continue to make progress with our efforts to inform our client base about the breadth of our unique portfolio, and the value of working with a single partner through a larger portion of the early-stage drug research process. The decision process is lengthy, but there is great potential for growth and outsourcing of discovery. We have a reputation for the scope of our expertise, which is one of the critical factors in our clients' choice to partner with us. We are continuing to enhance that expertise through acquisitions and partnerships, particularly with academic institutions, which are often on the cutting edge of research. As a result, we believe that as outsourcing increases, we will be the partner of choice for discovery services. Our safety assessment business had a very strong quarter, with all of our facilities reporting higher revenue and WIL exceeding our expectations. As a result of our dedicated focus on portfolio expansion, enhancing our scientific expertise, improving our operating efficiency, and developing flexible and customized working relationships with clients, we are positioned exceptionally well to provide the support which our clients require in order to expedite the drug research efforts. And with the acquisition of WIL, our extensive capabilities and scale present an even more compelling value to our clients, whether they are global biopharma companies increasing their reliance on CROs, or small and midsize biotech companies, which have always relied on external resources. As clients have increasingly chosen to work with us, capacity at our safety assessment sites has continued to fill. We are operating near optimal capacity and our backlog is increasing. Opening Charles River Massachusetts provided some infrastructure to accommodate growth. Clients are especially interested in placing GLP studies in Charles River Massachusetts, and we expect to be able to accommodate them by early 2017. The strategic collaboration with Moderna Therapeutics, which we announced on June 6th, was based in part on the proximity of Charles River Massachusetts to Moderna's operations in Cambridge, which allows their scientists to work side-by-side with ours. The integration of WIL is progressing very well, and I am pleased to say we have accomplished the major goals we set for the first 120 days. Chief among those was the integration of WIL's workforce and its clients. We assured both constituencies that the combination of Charles River and WIL would not create disruption and, in fact, would provide expanded career opportunities for employees, and broader support for clients' drug research efforts. Initial feedback suggests that we were successful with both groups. Employees are working collaboratively and productively, and feedback from many clients has been positive. We have already seen the first few instances where a Charles River or WIL client has placed a study at an alternate location within our larger framework. We expect to see this happen more often, as clients take advantage of our broader portfolio, and leverage our global network. Biotech companies were the primary driver of revenue growth in the second quarter. We commented when we announced our planned acquisition of WIL that even if biotech funding from the capital markets were to slow, we believe that biotech companies had sufficient cash on hand to fund research for a minimum of three years, a point of view which has been supported by a number of analyst reports, the most recent of which was published last week. Cash positions are being reinforced by continued support from large pharma as those companies increasingly rely on biotech for new molecules. We continue to expect that biotech companies will be a significant source of revenue growth for us, which is one of the advantages of WIL's exposure to small and midsize biotech. The scientific strength and breadth of our unique portfolio is leading to enhanced dialogue with a wide range of clients. As we make progress on our goal to maintain and enhance our position as the premier nonclinical CRO, we are becoming the go-to partner for an expanding number of clients who recognize our expertise, scale, and deep commitment to them. We have increasingly become part of the solution to more efficient and productive drug research, where the clients utilize Charles River to augment their internal expertise, or because they have no in-house infrastructure and choose to partner with the most experienced scientific CRO. Working collaboratively with us to design studies and interpret the results expands our clients' bandwidth and capabilities, as they make critical go and no-go decisions relative to their early development pipelines. Our critical importance to our clients increases as we expand our broad portfolio. Therefore, they increasingly rely on our expertise. We believe that the continued expansion of our portfolio and our scientific expertise, superb execution, and our flexibility relative to decision-making speed and relationship structures are the basis for long-lasting relationships with our clients and our future growth. We are maintaining our intense focus on the initiatives that we view as critical to expanding the value we provide for clients. We are continuing to assess opportunities to broaden our early-stage portfolio with strategic acquisitions such as the recent acquisition of Blue Stream. We are partnering with Venture Capital funds to gain access to their portfolio companies, and, as in the case of BioMotiv, which we announced on April 13, to work with academic researchers in both the UK and the U.S. Our continuing investment in internal systems and technology is the basis for improved access to and analysis of information, which increases our decision-making capabilities and the availability of real-time data to our clients. And perhaps most important, we are creating an enhanced working environment, with greater opportunities for our employees. At the end of the day, our employees are the reason that we worked on more than 55% of the drugs approved by the FDA in 2014 and 2015. It is their commitment to Charles River and our clients that makes us the premier early-stage contract research organization, and enables us to achieve our long-term growth goals and enhance shareholder value. In conclusion, I would like to thank our employees for their exceptional work and commitment, and our shareholders for their support. Now I would like David to give you additional details on our second-quarter results.

Thank you, Jim, and good morning. I will be addressing primarily non-GAAP results from continuing operations, which exclude amortization and other acquisition-related charges, costs linked to our global efficiency initiatives, and certain other items. You can find the corresponding GAAP results and a reconciliation of the non-GAAP items in the associated slide presentation and on our website. Turning to our results, we are pleased to report a strong performance in the second quarter. Revenue and earnings per share surpassed our previous expectations, driven by our legacy safety assessment and microbial solutions businesses, along with WIL Research. The second quarter EPS was also supported by a $0.06 gain from Venture Capital investments. This strong performance has led us to raise our four-year revenue growth outlook to a range of 21% to 24.5% on a constant currency basis and to adjust our non-GAAP earnings-per-share guidance to a range of $4.40 to $4.50. I want to address foreign exchange and our tax rate, both of which will be moderate headwinds in the second half of the year. These have been factored into our updated guidance. Due to Brexit, foreign exchange rate impacts have gained attention in recent weeks. To clarify our exposure to the British pound, we are providing an updated revenue breakdown by currency. Approximately 10% of our revenue is generated in British pounds, down from the previous 15% discussed during our last full-year update in 2014. This decrease is due to a strengthening U.S. dollar and the currency mix from recent acquisitions. Changes in foreign exchange rates following the Brexit vote, notably the weaker British pound, are expected to have a minimal effect on our 2016 results, reducing revenue by under $10 million and having a negligible impact on our operating income and earnings per share. Our early discovery operations in the UK generate revenue in British pounds, U.S. dollars, and euros, mitigating much of the effect of the weakening pound on operating income. Our Edinburgh operations are more naturally hedged, primarily billing clients in British pounds. We will continue to monitor the UK situation closely from both operational and financial standpoints. Overall, we expect the foreign exchange impact this year to align with our previous estimate of roughly a 1% headwind to revenue and a slight benefit to earnings per share. Our tax rate will be higher than we initially anticipated in 2016 for two main reasons: higher taxes linked to certain actions taken to access cash outside the U.S. efficiently and the higher tax rate on Venture Capital investment gains. These factors, along with WIL's higher tax rate, resulted in a second-quarter tax rate of 29.9%, up 170 basis points sequentially. We now forecast the full-year non-GAAP tax rate to fall between 29% to 30%, which is 100 basis points higher than our earlier forecast of 28% to 29%. This increase will lead to around a $0.06 reduction in earnings per share for the year. The higher tax rate partially offsets our second-quarter outperformance and has been factored into the midpoint increase of $0.065 in our 2016 non-GAAP earnings per share guidance. Our outlook for other non-operating components remains basically the same for the year. I will briefly discuss the second quarter results and the full-year outlook for these items. Unallocated corporate costs decreased by $2 million sequentially to 6.8% of second-quarter revenue due mainly to the normal quarterly variations in health and fringe-related costs. For the year, we continue to expect unallocated corporate costs to be around 7% of revenue. Net interest expense reached $7.2 million in the second quarter, which is a $3.3 million sequential increase due to higher debt balances and interest rate spreads following the WIL acquisition. For the full year, we still expect net interest expense to be between $26 million and $28 million. Our diluted share count slightly increased to 47.9 million shares in the second quarter, as anticipated, since we focused our capital spending on debt repayment rather than share repurchases. We continue to expect an average diluted share count of around 48.5 million shares for the year. Following the WIL acquisition, we have made significant progress on our debt repayment. We reduced our debt by roughly $80 million from the end of April to $1.34 billion at the close of the second quarter. Our leverage ratio now stands at about 3.1 times pro forma EBITDA. Given our solid operating performance and plans for further debt repayment this year, we aim to reduce our leverage ratio below three times by year-end, which is quicker than the 18-month timeframe we estimated at the WIL acquisition's announcement in January, and we look forward to interest savings. Once we go below three times, our interest-rate spread will decrease by 25 basis points from LIBOR plus 150 basis points to LIBOR plus 125 basis points. Now, I will update our cash flow. In the first half, free cash flow rose by $23.4 million to $96.5 million, primarily driven by strong year-over-year earnings growth, including WIL's performance. However, in the second quarter, free cash flow dropped by $6.3 million to $66.2 million due to cash acquisition and integration costs related to WIL. For 2016, we still expect free cash flow to be between $235 million and $245 million. Capital expenditures, totaling $20 million year-to-date, are slightly better than our forecast of $80 million to $85 million, partly due to timing and a refined capital forecast for WIL's businesses after acquisition completion. Before discussing our third-quarter outlook, I would like to highlight two factors that led to a decrease in our GAAP earnings per share guidance for the year. The first was an increase in acquisition-related costs as we refined estimates for transaction and integration costs after closing the WIL acquisition over a quarter ago. To a lesser degree, we also anticipate incurring some costs from the recently announced Blue Stream acquisition. The second factor is higher costs tied to our global efficiency initiatives due to plans to close a small facility in Ireland, as we believe the long-term prospects for its niche services are limited. In the third quarter, we expect many of the strong trends from the first half of the year to continue. We aim to make further progress with the WIL integration and realize synergies. We expect third-quarter revenue to increase by more than 20% year over year, aligning with or slightly lower than second-quarter levels due to a greater foreign exchange headwind post-Brexit and seasonal trends in the RMS segments. This seasonality is also the main reason we expect the consolidated non-GAAP operating margin to be slightly lower than in the second quarter. Non-GAAP earnings per share is anticipated to grow at a high single to low double-digit rate year-over-year, comparable to the second quarter, excluding the $0.06 from Venture Capital gains. We have not included Venture Capital investment gains in our third or fourth-quarter forecasts since we achieved our expected annual return on those investments in the first quarter and do not project their performance beyond our expected return. I also want to remind you about the 53rd week, which will impact the fourth quarter this year. This week is occasionally necessary to align with a December 31 year-end due to our quarterly reporting structure. The 53rd week typically sees low sales due to holidays, but standard costs remain. In 2016, it is expected to contribute roughly 1% to revenue growth or about 4% to fourth-quarter revenue, providing a nominal benefit to earnings per share and having minimal impact on the operating margin. In closing, we are pleased with our strong performance in the first half of the year, which has allowed us to increase our revenue and non-GAAP earnings per share guidance. Our updated earnings per share range of $4.40 to $4.50 for the year shows a $0.115 increase in our guidance since February. This reflects strong demand for our essential products and services and Venture Capital investment gains of $0.10, partially offset by a $0.06 headwind from the higher than expected tax rate. We remain committed to continued execution and believe our first half performance positions us well to meet our financial targets for the year.

That concludes our comments. The operator will take your questions now.

David, just a couple of pieces of information, maybe you could give us. Could you give us the employee headcount now that the WIL acquisition is closed, and I was also hoping, if you could comment on the tax rate. How much of that increase is structural, now that you have maybe a little bit of a different geographic footprint versus the part that may go away after this year?

So, quick answer to the headcount, we're about 10,000 employees now, with WIL. In terms of the tax increases, well clearly WIL had an impact, because as we previously outlined, that the 35% tax rate had some bearing. But the real tax implications I was talking about and the reasons for the 1% increase are more to do with how we bring cash from, particularly places like Canada and China, where we've got more cash than we need, in terms of the business capital needs and working capital requirements in those countries, and bring that back to enable us to pay down the debt. So we get, varies from country to country, but we could get either a 5% or 10% withholding tax implication there. What we're seeing is more cash is being generated there than we initially anticipated at the beginning of the year, and so that's one of the reasons why we have that driver. We're also seeing some thoughts on some other countries where we feel there may be opportunity to bring cash forward. And finally, it's not certain, and certainly not in our control, but we're aware there may be some tax changes in places like Germany and the UK, but that's more to a lesser extent. The main driver is bringing cash to be able to pay down our debt.

So once you get that leverage ratio down to where you want it to be, do you anticipate possibly not repatriating cash and leaving it permanently invested abroad?

Well I think the wise question there is, while we intend to bring our leverage ratio below three by the end of the year now, that basically enables us to free up the facility for further acquisitions. So I guess the question really would be, continuing to bring that cash forward to enable us to keep the leverage ratio down, to enable us to continue the rate of turn that we have in terms of our acquisition plan.

Hi, good morning, thanks for taking my question. I was hoping to make it a two-parter. The first part would be, interested in your retention efforts, success of your retention efforts of key management and particularly study directors at WIL. How is that going and what are you doing to keep those folks? And secondly, Jim, you talked about interest in GLP studies in Massachusetts. Could you talk about the utilization level in Massachusetts and how much growth that facility can support as you move into 2017? Thanks.

Sure. As I said, the integration efforts have gone extremely well at WIL, as well or better than we had anticipated culturally. Economically and in terms of structure of staff, so we have fabulous senior people all ex-WIL, all from WIL, running the sites. And I am not aware that we have lost anybody that we haven't intended to, or knew that we would lose. So I am not that we've lost any of our senior study directors. We know those are people critical to support our clients, and providing client stability by having access to similar, or the same people in the same sites, we know is important to some of our clients. We have a very stable and robust and collaborative organization, and very good synergies. Strong organization there, Charles River Massachusetts is developing towards the opening of the facility, has gone quite well, actually just had a board tour there last week. Headcount is way up. We moved a bunch of core people from other Charles River sites. As you know, Dave, we opened half of the rooms that we originally finished, so forty of the eighty rooms we originally finished. We are working hard to get those GLP ready. They will be ready by the end of the year. Clients will be working in the fourth-quarter to do their audits and be comfortable with it. We are quite confident that we will be ready, willing, and open for business in Q1 of FY17. We have a large cadre of clients both medium-sized and small biotechs, and very large pharma clients on the East Coast who are quite interested in utilizing the facility. So we are quite confident we will be able to fill that up, and I hope that sometime next year we're talking to you about opening the balance of those 80 rooms which would be another 40. It's not a huge amount of space, but it's meaningful and significant, both at a time when we need incremental capacity, and in the most, probably the most important geographic locale in the world.

Yes, hi, good morning. Couple of questions here, first of all on Brexit, obviously you've quantified for us the impact from an FX perspective. But are you seeing anything, or are you anticipating to see anything from a demand perspective? What are you hearing from your clients, especially given WIL's presence in Europe?

Given my nationality, maybe I will make a comment on the Brexit. And as you mentioned we gave you some of the immediate implications to Brexit being the impact on the foreign exchange. In terms of looking forward, it's still early stages in the UK. My personal belief is that as each week passes, I think it begins to stabilize a bit. I think, Prime Minister May has done the right thing in terms of not signing article 50 until she's got her ducks lined up. And I think it's becoming a much more thoughtful approach to the exit than I think it was looking like a few weeks ago. And while we're involved in a number of industry workshops in the UK, just to quote a couple, The Association of British Pharmaceutical Industry is one, the Bioindustry Association is another, and we have a seat at the table of these associations, and they have been formally asked to look into the implications of the EU, UK exit, and I think that the workshop called the Life-Sciences Transition Group, which is giving some advice to the British government. So, and of course we are keeping closely aligned with tax advisers, banks, and others to assess the impact on tax, trade, imports, and regulatory methods. I've got a caveat, of course it's early days, but from what we're picking up, for our industry the impact of Brexit should be a lot less than many other industries. That said, I do want to caveat that it's still early days and of course there's still plenty of room to go and get things wrong. But it looks good at the moment.

And then just one follow-up, on pricing. Obviously this is always an area of focus. Jim, can you just give us what, status out of what you're seeing in the marketplace from a pricing perspective?

I assume you are asking principally about safety. Let me just, so I'll comment on that first. We're continuing to get a 5% increase over prior year, which we are pleased with. We have a very healthy mix of general and specialty toxicology, which also benefits margins. And our efficiency initiatives have been quite powerful as well, so we're really pleased with how nicely we've continued to drive margin, and the space stays relatively full. When I say relative I'm talking about all of our competitors and clients as well. But space seems fuller than it has been in years. So, as space continues to be relatively full, we have some level of confidence we will be able to continue to get price. And, so, we're pleased with the value proposition given the level of our investment and the quality and complexity of the work that we are doing. So far prices are 5% over last year.

Just wanted to touch on the Manufacturing Support margin. Was hoping you could walk us through what drove, specifically the significant expansion there in the operating margin, and was any of the additional revenue more drop through than typical? And then as we look at a mid 30s margin range, how should we think about that, as being achievable going forward?

So, we'll start with the last part first. You should think that having an operating margin over 35% is extraordinary, and we would love to do that on a continual basis. It's not something we are ready to promise yet. Our longest term goals are to have operating margins in this segment in the low 30s which we have always done and are quite confident we can continue to do. Obviously we are very serious about driving efficiency, getting price when one can get it, and having new products and enhanced services. All I can say is our goal will be to continue to drive those higher, and further, but I would have to stop short of promising that 35 is here to stay, although that would be our goal. There's a lot of factors. We had very strong productivity enhancements with our new manufacturing in our Microbial Solutions and improved inventory status, so we just sold a lot of cartridges and a lot of handheld units. That business has three parts, all of which are performing really well. Our Celsis business is performing quite well, also at or ahead of where we had anticipated. Also, as we said in our prepared remarks, our biologics business, which is obviously driven by the increasing strength and availability and success of new biologic drugs, is really driving the demand for that sector so again our capacity utilization is good. There is some price in there, and we are utilizing, we've got a very good mix. We've made some investments in our facilities and I think those are bearing fruit. We are quite confident in that segment's ability to grow at least in low double digits and certainly to have operating margins remaining at least in low 30s. But as I said earlier, we are really pleased with the quarter, and while we aspire to, we are not ready to commit to it.

Thanks guys for taking the questions, and congrats on very nice results. I wanted to go back to RMS, Jim. And I was just going through the past couple of quarters and it kind of dawned on me that this is like the third quarter that you guys have really handedly beat us on RMS constant dollar revenue growth. I was just wondering, thinking about some of the steps you had taken back some time ago on Hollister, and shutting down some rooms. I know that was more of a cost-driven action, but as I think about just the supply versus demand, given that you guys control, obviously a very dominant share in this marketplace, what's the supply-demand scenario look like these days? Are you still getting some price there? How are you doing in academia? Are there still share gains there? I guess any other color would be helpful on RMS and just the outperformance there would be great. Thanks.

Sure, Greg. On the capacity side, we work really hard with all of our businesses, to have capacity in sync with demand. I should also say that we have some efficiency initiatives in place, and being further integrated into our operating modalities, such that I think we will be able to continue to use our facilities in a more efficient and more robust fashion, which should help to enhance our operating margins. We are not concerned that we're not going to have enough space if that's part of your question. So I'd say that the demand curve these days is driven by, we have price, we have a mix, with sales of inbred animals and immuno-compromised animals sort of higher value animals. We definitely continue to take share, I would say generally, but perhaps more focused on the academic sector given our shares are very large in pharma. We're getting significant increase in China, which is obviously a very large, very new and very large growth market for us, so we are going to continue to build space and service that locale from multiple geographies. Many of those small cities there of course are more than 10 million people. And we are getting some service revenue, which again, sometimes it's not as linear as we would like it to be, but some nice service revenue in our genetically engineered models business and our diagnostic business and our insourcing solutions business. The business has stabilized; it is affected by large reductions in pharmaceutical infrastructure. We saw a little bit of that in the second quarter; we saw virtually none of that in the first quarter, kind of hard to predict what we will see in the third quarter. But short of that, the business feels stable. We are really pleased with the operating margins, and obviously pleased to kind of be at our longest term growth goals for the first and second quarter.

Could we talk a little bit about the manufacturing business? You put together a rather diverse set of assets over the last few years. Can you talk about one, I guess, the competitive dynamic, in terms of who you are running into these days? Two, are you seeing the potential for revenue synergies with other parts of the business? And then three, you are guiding to sort of double-digit long-term organic revenue growth in this business. Can we, it does look like just from the Q1 results this year and sort of how we think about it, there is some lumpiness in of business, can we talk about the seasonality and the lumpiness and how we get to the double-digit?

So we are quite confident we can continue to grow the business low double digits. I would say that we had a little bit of a blip in the first quarter because we were changing over our manufacturing modality in the Microbial Solutions business. So that is unusual. And I would say that business is very unseasonal, if that's a word; it's quite consistent. The biologics business is hard to predict from history, but I would say it tends to have a slightly softer first quarter usually, and then a better back half of the year. But doesn't have the kind of seasonality related to holidays and summers that we typically see in the research model business, when people just don't buy animals because they won't be there to do research with and on them. And the other piece in that sector which we didn't call out this quarter is smallish but nicely operating egg business which has a couple of clients that buy more at certain points of the year, but I wouldn't say that from a portfolio point of view is very seasonal. I'd have to say that whole segment is not seasonally impacted much at all, and certainly not research models perhaps even the safety assessment business may or may not, so that’s a good thing. There's lots of competition. It's interesting, at the moment our most profitable segment and a very high-growth segment on an organic basis; it's quite competitive. We have lots of big competitors both in the biologics piece, companies our size or larger that are well-financed and do good work, and we have growing competition in the microbial space. The distinction though is that they tend to be siloed approaches for a lot of our competition. These businesses are in a larger context, for us, so when you talk about revenue synergies, we have lots of pharma clients who buy a whole bunch of products and services from us but also want us to help them with quality control aspects of the manufacturing facilities or testing drugs before they go into the clinic or after they go on the market. And of course in the egg business, the products are used to manufacture vaccines and a lot of our big pharma clients have veterinary pharmaceutical subsidiaries. Sales synergy is quite good, although the microbial and biologic sales forces tend to be more technical and a little bit more siloed than some of our other sales organizations. But there's still some connectivity. Very strong segment for us that is quite consistent and quite predictable, and we really do think that without additional M&A, and there may or may not be M&A in that space we can continue to grow it, at least at low double digits and we will obviously work hard to continue to drive the margins up. But as I said to an earlier question, while we strive to get to the mid-30s we can't promise that yet.

Hey, thanks, Jim, can you maybe just give us a sense of your mix on the biotech side? Obviously with the biogen stuff in the news, I'm just wondering about the risks of customer consolidation?

I don't think I know that off the top of my head. Our biotech revenue is pretty substantial, and there are thousands of clients that comprise that. Yes we have lots of sales with a lot of the big players. I won't mention any by name even though you did. But we have a lot of virtual biotech companies, and we have a lot of what I would call kind of second-tier biotech companies that are public that have substantial market caps that are in late phase 3 or have their first drug in the market and look like they'll have serial one. We called out Moderna in a press release recently which is a very hot technology that cuts across multiple therapeutic areas. And again, we don't have any clients, even our biggest pharma clients, that comprise more of the 5% of our revenue. Look, there's going to continue to be churn in our client base; there has been forever, Tycho, forever. And our biotech clients will merge with one another and get bought, and occasionally some will go out of business, and every year hundreds more will start up. Look, so all we can do is do the best quality work for them, and even if companies get bought, it's likely that the buyer is a Charles River client and it's likely that we will continue to have the work. Every once in a while we are going to have, whether those big biotech companies get bought by big pharma companies that may do less with us than others, that would be a good thing as well. While anything can be disruptive for a very short period of time, we think it all gets sort of meted out in the scale of the work that we do.

And then if I could ask one follow-up on pricing. Now that WIL is in-house and Envigo is integrated as well, are you able to push through more pricing discipline? And can you also separately comment on pricing and potential margin flow through for GLP work. Once you do start to ramp that at Charles River Massachusetts, will that be a decent price premium?

We are confident that we will continue to get appropriate levels of enhanced price in our safety assessment business, commensurate with the demand and available capacity, the complexity of the work that we do, and the synergies that we have with other lines of business. All of it is subject to the long and short term contracts that we have with clients. We have different pricing modalities with all of them. We have seen a classic and appropriate supply and demand curve here as our spaces fill over a number of years. You have been on this journey with us, and we are essentially full. Appropriately full now. We're using our facilities well. We acquired a little bit of incremental capacity with WIL, and of course we have opened a little bit of incremental capacity with Massachusetts and a couple of other sites, both last year and a little bit this year, that, I think as long as the demand is persistent, and we are able to accommodate it with the appropriate amount of increased capacity and we don't have large amounts of unused space we would be able to get, continue to get price. And then clients are very interested in, particularly the big ones as they shut down space and having access to us as the, particularly as the studies get more complex, access to us, helping them design the study and interpret it. Hard to phrase what I'm about to say but I would say that price continues to be important but I would say it's often less emphasized than it was in prior years. That everyone is really interested in quality of work in science, speed and responsiveness, I would say, and collaboration kind of second, third, and fourth, and while price is in the mix, we rarely start conversations that way. I'm sure we do sometimes. It's not the principal focus, and I think that's obviously a good thing, and it's an appropriate thing given the level of our investment and the fact the clients are increasingly relying on us.

Hi, this is Jon Kaufman on for John Krieger. For taking questions today. I just want to focus on the discovery piece. Can you talk a little bit more about the traction you have made in the discovery business? What are you seeing from pharma in terms of willingness to outsource the early discovery piece right now?

Yes, so we have a wide range of clients in our discovery business from the very biggest pharma companies to startup biotech and everything in between. I wouldn't say it's particularly focused upon or used more widely by any particular segment of clients. Our very, very early discovery assets are small molecule-based. So maybe there are less classic biotech companies in that segment. We are seeing enhanced interest in our discovery capabilities. We called out some integrated deals which we recently signed in three therapeutic areas. We are working really hard on those. We have lots of conversations like that ongoing with large and small clients. It's very complicated scientific fields that tend to be multi-year and multimillion dollar deals. Sometimes there are milestones, sometimes there aren't. And we are working hard to be able to sell across that whole discovery portfolio, not just the in vivo piece but in vitro and in vivo and we're also working hard to have pulled through from discovery into safety, which sometimes happens, eventually happens. We do the discovery work and then the drug is looking good and the client uses us for safety assessment. Our aspiration is to have those conversations up front. Some clients will contract that way and others won't. Some of the integrated work is a lot longer sell than we had originally anticipated. That's okay. And a lot of it just has to do with educating the client base that our services are available and the nature of them. They tend to be very highbrow scientific conversations between our scientists and the clients' scientists. So the sorting out how we can help them and what we can do for them that they can't do themselves. I would say the sale is among the most complex that we have, and to that point we have a very sophisticated sales organization. Most of those people are PhDs so we are going toe to toe with our clients. We are pleased with the trajectory and the potential and some of the recent wins that we have had.

Good morning guys, Jim, you've had this sort of vision of a fully integrated discovery organization for a while and obviously you continue to assemble the assets to create that. I would just be curious how the tone of the conversations, or the level of the conversations you have had with the customer base have changed. You are really the only one that has this suite of capabilities. How have you, if you get pushed back on why someone isn't using you more broadly, what is typically the reason, or what you have to do to convert them?

Yes, as I said to the last questioner, the sell takes a while, and we really have to have time to go in, so while I keep using the word sale, it's way more sophisticated than that. So you're really going in and saying, look, we have the scientific capabilities which we believe, if you need them, can be quite helpful to you. Sometimes the initial feedback is, yes, we do discovery, why on earth would we need you, thanks for coming. But often when we dig down and we tell them we've found 65 development candidates, a third of which have gotten proof of concept working through the clinic, their eyes open up and we talk about the therapeutic areas where we have had success. We have a lot of clients that some of our discovery capabilities are what I would call industrialized aspects of some of the things that they do, but we do on a more routine basis, and we do more efficiently, and I would say that we do actually better science because we do more of it. When you get the client to listen, I would say, look, increasingly clients are more collaborative and open-minded, and are looking for any edge they can get, with anyone, whether it's another pharma collaborator, an academic collaborator, or a CRO collaborator, who will help them either discover something or enhance something that they've discovered or help them develop it, either to elimination, or to move it through the clinic. So I would say that clients are increasingly more open and interested in hearing our story, and as the discovery portfolio gets larger, and we have greater therapeutic area coverage, and of course we start quite early in that process. There is more to talk to them about and I've always thought that a critical mass is important for us to get their attention and I think we are doing that, increasingly doing that well. Particularly for clients who are now working across our portfolio, starting with them and discovery, particularly for the smaller clients is really magic, because they tend to stay with us during the lifecycle of that drug and perhaps additional drugs coming down the pipeline.

One is a follow-up and then a broader question. First in RMS, following up on the prior question, could you break out or even just prioritize what was behind the 4% growth? How much was pure price increase versus maybe project expansion or new volume for example?

A little bit hard to do. The research model business, the research model. So the RM part of RMS, we're getting 2% to 3% price, and I would throw mix into the pricing comment as well. We have higher value animals. That's playing through there, you get a little bit of share gain. You've got pure, de novo available business in China, so you just have market availability which is increasing all the time. And then the service business, I would say, we have slightly less pricing activity in the service business, but the volume has increased nicely over the prior year so kind of all of those things in the aggregate give us that 4% increase.

That's helpful. The follow-up is just on capital deployment and M&A. You obviously made one recent tuck-in acquisition, but you're delevering more quickly than you initially expected and the market for M&A at least on the clinical side continues to be very active. Could you share your views on what you're seeing on the preclinical side? Willingness of private scholars versus historically, and I guess your appetite to do a greater volume of deals, as these opportunities do present themselves?

I think you asked a couple of questions. We continue to be interested in expanding our portfolio, strategically and scientifically. So we are both more important and more helpful to our clients. And as we said many times before, we are emphasizing discovery. We are interested in probably in vitro capabilities. There are some geographic areas of interest for us, and we would not foreclose expansion in any of our current businesses that are growing. I would also say that we have an extremely active and robust M&A operation and we have several deals in which we are in discussions at the moment. But that's sort of always the case with us. But we are very focused and there are a lot of things available at the moment. So as we delever, as we promised, and get below three turns, you should not be surprised if we do something meaningful. I would use the term meaningful to describe something not gigantic, but meaningful that it moves the top and bottom line and also gets us service capabilities that our clients like. Specifically on the safety assessment side, which you asked about, all I can say is that all of our competitors, including WIL, which we bought, but all of our competitors traded in the last two years, three of them traded in the last 12 months. Several of them have traded to private equity, which means that sometime in the future they will be available again. And I couldn't really comment, I wouldn't comment anyway but I really couldn't comment on what we may or may not do in that space. It will depend on if and when those markets, when those businesses come to market, and how strong the demand curve is then. I wouldn't rule anything out. If it could help us support our clients in a more holistic way.

Hey, good morning guys, and thanks for squeezing me in. Jim, you talked a lot about the visibility in discovery from big biotech but, I guess can you talk about what you are seeing out of the more mature drug development companies, the commercial stage companies? And, is that end market demand steady, or, and if it's not can you talk about how we've seen the mix shift away from more traditional pharma towards biotech, maybe from a personal revenue perspective?

You said discovery so I'm going to assume that you were talking about discovery and not safety. I would say that with big pharma companies, more of the activities that they periodically do, so good example would be in our oncology franchise, we do something called xenographs, which we put human tumors into immuno-compromised animals. So, in some of the big drug companies where they're doing cancer research, they will do that themselves, but they kind of do it periodically, and not the best use of their time or their people and while it's not trivial, and it's reasonably complex, it's much better in our hands where we do lots of that for lots of clients. That's an example of something that even the big drug companies say, well fine, why don't you do that for us because you do that better and more efficiently. I would say small clients, we can help them with target identification and enhancing their targets. We can help them with the medicinal chemistry, and we can certainly help them with the in vitro and in vivo aspects of our business. I would say that our discovery assets are appropriate for clients large and small. It really depends on their view on outsourcing. I would say that almost all of our big pharma clients are increasingly more open and interested in actively doing outsourcing. There are a few that remain reluctant to do that, but they're you can see they are beginning to think about it. So the client base, both large and small, will be significant and I continue to believe that the scale and depth and complexity of our portfolio and our ability to explain it to clients and sometimes link it with our safety assessment businesses or our Biologics business will be very increasingly more important to our clients.

Thank you for joining us this morning. We look forward to seeing you next week in New York at our meeting with Management. This concludes the conference call. Thank you.