CRL — Q4 2017 Earnings Call Transcript

Thank you. Good morning and welcome to Charles River Laboratories' fourth quarter 2017 earnings and 2018 guidance conference call and webcast. This morning, Jim Foster, Chairman and Chief Executive Officer, and David Smith, Executive Vice President and Chief Financial Officer, will comment on our results for the fourth quarter of 2017 and our guidance for 2018. 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 443328. The replay will be available through February 27 and you may also access an archived version of the webcast on our Investor Relations website. 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 14, 2017, 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 the Investor Relations section of our website through the financial information link. Now, I’m pleased to turn the call over to Jim Foster.

Good morning. I’m very pleased to speak with you today about the conclusion of another strong year for Charles River, our expectations for 2018 and beyond and some important developments that will contribute to our long-term growth. Let me begin with an overview of our industry and factors driving our performance. We are operating in a robust business environment that gives us excellent growth potential. Our total addressable market is in the range of $15 billion, growing at a mid-single digit rate. At revenue approaching $2 billion, that gives us a long runway. Biotech funding remains strong, in fact, 2017 was the second strongest year ever, with funding rising 37% from 2016 levels. The FDA approved 46 drugs last year, more than twice the number of drugs as in 2016 and because of our unique early stage portfolio and extensive scientific expertise, we worked on 74% of the approved drugs. We have demonstrated the value we can provide to clients and fully intend to continue to enhance our value proposition, both through internal initiatives and strategic acquisitions. With the strength of the market opportunities and our premier reputation with clients, Charles River is on a path to nearly double its size over the next five years. We are maintaining our long-term target for consolidated revenue growth at high single digits over the five-year life of our strategic plan and low double digits, including acquisitions. Our long-term target for the consolidated non-GAAP operating margin remains greater than 20%, even including acquisitions because profitable revenue growth is key to our long-term goals. Further to that point, we continue to target at least low double digit non-GAAP EPS growth, exceeding organic revenue growth by at least 200 basis points. Before discussing our fourth quarter results, I'm pleased to share two important events that will enhance our ability to achieve our growth goals. First, you will hopefully have seen that we announced a definitive agreement to acquire MPI Research, a leading non-clinical CRO providing comprehensive testing services to biopharmaceutical and medical device companies worldwide. Acquiring MPI will strengthen Charles River’s ability to partner with clients across the drug discovery and development continuum. As you know from the press release, we've entered into a definitive agreement to acquire the company for approximately $800 million in cash, subject to certain adjustments. Adding MPI’s capabilities enhances Charles River’s position as a leading early stage CRO and drives profitable revenue growth and immediate non-GAAP earnings per share accretion. Our commitment to growth, including through strategic acquisitions, requires an organizational infrastructure that is both broad and deep with highly experienced leadership at the top. The appointments of Davide Molho and Birgit Girshick are important steps in building out that necessary structure. Effective immediately, Davide becomes President and Chief Operating Officer of Charles River, responsible for our RMS, DSA, biologics and avian businesses and continues to report to me. Trained as a veterinarian, Davide has established a proven track record of outstanding performance, leading many of our businesses through important strategic initiatives during his nearly 20 years with the company. His extensive operations management experience in both the US and Europe uniquely qualifies Davide to oversee our global organization and provide leadership as it continues to grow. Davide has been a key contributor on our executive management team. The appointment of Birgit Girshick to corporate Executive Vice President, Discovery and Safety Assessment, enables us to manage the discovery and safety assessment businesses as one cohesive unit, leveraging the synergies between the two related businesses in order to enhance the extensive services we provide to clients. During her more than 25 years with the company, Birgit has established an exceptional record of operational management, most recently leading our global discovery business after successfully executing the WIL Research integration. Given her experience, there is no one more qualified to combine these two businesses into a seamless operating unit. This enhanced organizational structure will enable us to continue to advance our strategic objectives and support our continuing growth. I have complete confidence in Davide and Birgit’s capabilities and believe that Charles River will benefit greatly as a result of their new roles. I look forward to continuing to work side by side with Davide, Birgit and the entire team as we drive Charles River’s growth and development over the coming years. As I said at the outset, we plan to nearly double in size over the course of our five-year plan, generating significant earnings growth and delivering value to our stakeholders. Today's appointments give us the right leadership structure to support and advance that plan. Now, let me give you the highlights of our fourth quarter and full-year performance. We reported revenue of $478.5 million in the fourth quarter of 2017, an increase of 2.5% on a reported basis. Robust client demand in the manufacturing and DSA segments drove organic revenue growth of 5.6%. For 2017, revenue was $1.86 billion with a reported growth rate of 10.5% and an organic growth rate of 6.7%. From a client perspective, biotech clients were our fastest growing client segment in both the quarter and the year. The operating margin was 19.7% in the fourth quarter, an increase of 50 basis points year-over-year. We continue to be very pleased with the margin improvement in the manufacturing segment, which drove the fourth quarter increase. Lower corporate costs also contributed to the margin improvement. The full-year operating margin of 19.3% was slightly higher than 2016, primarily due to a 170 basis point improvement in the manufacturing operating margin offset in part by a lower RMS operating margin. Earnings per share were $1.40 in the fourth quarter, an increase of 15.7% from $1.21 in the fourth quarter of 2016, due primarily to venture capital investment gains as well as higher revenue and operating income. For the full year, earnings per share were $5.27, a 15.6% increase over the prior year. Earnings growth was driven by higher revenue and operating income as well as contributions from venture capital investments and the excess tax benefit from stock compensation. When adjusting both years for these items, the year-over-year growth rate was 7.2%. Our strong performance in 2017 reflects robust client demand across our broad portfolio of essential early stage drug research and manufacturing support products and services as well as the disciplined investments in staffing and infrastructure that we are making to support our continuing growth. These investments have positioned us extremely well to address the continued strong demand, which is the basis for our outlook for 2018. Not including the anticipated acquisition of MPI, we expect organic revenue growth of 5.7% to 6.7% and non-GAAP earnings per share in a range of $5.42 to $5.57. The EPS range includes $0.14 of gains on venture capital investments and $0.14 for the excess tax benefit associated with stock compensation. Adjusting both years to exclude these items, the 2018 EPS range represents growth between 8% and 11% and when including MPI, the non-GAAP earnings per share range is expected to increase to $5.67 to $5.82, a growth rate of 13.5% to 16.5% on the same adjusted basis. In either case, the projected non-GAAP EPS growth rate in 2018 is in line with our goal of an EPS growth rate more than 200 basis points higher than the organic revenue growth rate. I'd like to provide you with additional details on our fourth quarter segment performance and speak to our expectations for 2018 and longer term. I’ll begin with the RMS segment. RMS revenue in the fourth quarter was $120.4 million, a decrease of 1.4% on an organic basis. The RMS operating margin decreased by 130 basis points to 26% due primarily to lower sales volume. From a client perspective, Charles River’s DSA segment is and will continue to be the largest client of the research models business. Research models remain an essential regulatory required scientific tool for early stage research and a vital component of our portfolio. Researchers view our broad portfolio of high quality, scientifically defined research models and our exceptional client service as the foundation from which they derive precise scientific data about their molecules. In both the fourth quarter and full-year 2017, biotech clients increased their purchases of research models, but global biopharma clients continued to reduce theirs. This is likely the result of both increased use of CROs and biotech partnering and consolidation in the biopharma industry, but as the leading supplier of models to these clients, the impact largely offsets growth from biotech clients and China. Growth opportunities in China are significant and our business has been growing at double digit rates each year since we acquired it in 2013. The revenue growth rate moderated to low double digits in the second half of 2017 because of capacity constraints. Our new production facility in the Shanghai area was completed in the fourth quarter and we began commercial shipments early this year. This new production capacity as well as plans to continue to expand in China are among the factors that give us confidence in our long-term low single-digit growth targets for RMS. In addition to China, we believe that the benefit of modest price increases and growth in the service businesses will also support our long-term target for this segment. GEMS and insourcing solutions performed well in the fourth quarter and we expect that the revenue growth rate for RADS will improve in 2018 now that we have anniversaried the one-time single client project in 2016 that depressed the growth rate in 2017. We expect that these trends will continue: declining demand from large biopharma, increasing demand from biotechs, strong growth in China, modest price increases and demand for services. Therefore, we are reaffirming our long-term target of low single-digit revenue growth for RMS. Because of the importance of our research models to drug research and to our discovery and safety assessment businesses, we must continue to provide the high-quality research models for which Charles River is known and respected as efficiently as possible. Over the last five years, we have periodically taken actions to enhance the productivity and streamline capacity in the research models business. The goal of these actions, including the planned closure of our RMS site in Maryland before the end of the year and our continuing efficiency initiatives, is to sustain the robust RMS operating margin and our long-term target in the high-20% range. DSA revenue in the fourth quarter was $253.2 million, a 6.8% increase on an organic basis, driven by both the discovery and safety assessment businesses. DSA growth was slightly below the third quarter level, due primarily to a less favorable steady mix in safety assessment, which can fluctuate from quarter-to-quarter based on clients' priorities. For the full year, DSA organic revenue growth was 7.5%. Safety assessment growth was in the high single digits for the year, offset slightly by slower growth for the discovery business. We expect the discovery business to generate higher revenue growth in 2018 and beyond and we continue to expand our services and demand for outsourced services trends higher. We are continuing to enhance our position as the premier single source provider for a broad portfolio of discovery services. We have built exceptional capabilities in the area of oncology, which is the largest and fastest growing area of drug research. We strengthened these capabilities in January, with the acquisition of KWS BioTest, a leading discovery oncology CRO based in the UK. KWS specializes in immune-oncology, an area of significant scientific breakthroughs in which researchers are harnessing the human immune system to fight diseases such as cancer. We believe that adding KWS's capabilities to our portfolio enables us to increase the support we can provide to clients, as they increase their focus on oncology drugs, a belief that was reinforced by our clients’ immediate and positive reaction to the acquisition. Our early discovery business recently delivered its 78th development candidate to a client. Early discovery scientific reputation and innovative sales strategies are creating new opportunities for us to work with clients at the earliest stages of drug research. Three clients recently renewed existing agreements or selected us to provide integrated programs. These opportunities combined with increasing demand from small and mid-sized biotech clients position the business for improved revenue growth in 2018. Our assessment business continues to attract new business on the basis of our strong portfolio, scientific expertise and flexible and customized working relationships. Our capacity remained well utilized in 2017 and we opened a modest number of study rooms to accommodate growth. Pricing also continued to increase in 2017 at a rate of approximately 2%. As we noted last year, we will not provide future updates on safety assessment pricing. The safety assessment revenue increase in the fourth quarter reflected continued client demand and price increases, partially offset by steady mix. Proposal volume and bookings were very strong in the fourth quarter, increasing both year-over-year and sequentially, which positions us for continued safety assessment growth in 2018. In our view, there will continue to be significant demand for outsourced services from both biotech and pharma companies and we intend to maintain and expand our position as their partner of choice. As biotech companies proliferate and pharma companies increasingly rely on outsourced services to improve efficiency and access to expertise, they no longer maintain in-house. We need additional capacity to accommodate the demand. For that reason, the acquisition of MPI Research is particularly opportune. MPI will add ototoxicity and abuse liability capabilities and expand our existing capabilities in general toxicology and special toxicology, including ophthalmology, juvenile toxicity, molecular biology, and surgery, as well as medical device testing. In addition to its strong scientific capabilities, MPI provides a 1 million square foot single site with available capacity. Furthermore, biotech companies represent the largest portion of their diversified client base, which will expand our exposure to the most significant driver of demand for outsourced services. From a financial perspective, this acquisition delivers compelling benefits, which will generate value for shareholders and which we consider fundamental to any acquisition we do. MPI will be immediately accretive to non-GAAP EPS. It will meet or exceed our ROIC hurdle rate within three to four years and will enhance our opportunities for organic growth. Subject to regulatory approvals and customary closing conditions, we expect to close the acquisition early in the second quarter of 2018. On that basis, we expect the acquisition will contribute $170 million to $190 million to our consolidated revenue and add approximately $0.25 to non-GAAP earnings per share in 2018. We expect greater benefits in 2019 with MPI’s revenue contribution representing approximately $260 million to $280 million of consolidated revenue and non-GAAP earnings per share accretion of approximately $0.60. A $13 million to $16 million cost synergies will be somewhat less than we achieved with WIL, primarily because MPI’s operating margin is already slightly above 20%. As we did with the WIL acquisition, we have already initiated a comprehensive integration planning process. Andy Vic, Corporate Vice President, Safety Assessment Ohio who joined us with the WIL acquisition and has been instrumental in its successful integration, will manage the operational integration on a full-time basis. He will work side by side with both Charles River and MPI personnel to ensure that the integration process proceeds smoothly. The DSA operating margin was 22% in the fourth quarter, 180 basis points below the fourth quarter of 2016. The decline was a result of the safety assessment study mix and higher staffing cost to support current and future growth, particularly in the early discovery business. The operating factors accounted for 100 basis points of the decline, with an additional 80 basis points resulting from the negative impact from foreign exchange. For the year, the DSA operating margin was 22.3%, 40 basis points below the prior year. The slight decline is due primarily to lower than expected revenue and higher staffing costs. Given our long-term outlook for high single digit revenue growth for the DSA segment, we expect that higher revenue will result in improved operating margins. In addition, our continuing efficiency initiatives are expected to drive margin gains. Therefore, we are increasing our long term DSA operating margin target to the mid-20% range, above the more than 20% we've previously targeted. The manufacturing support segment concluded an exceptional year with a strong fourth quarter. Revenue for the quarter was $104.8 million, a growth rate of 11.8% on an organic basis, driven by the microbial solutions and biologics businesses. Organic revenue growth for the year was 12.9% due to robust market trends in both businesses, our continuing efforts to enhance our product and service offerings and our best-in-class client service. Because we believe that the market trends will continue and we will continue executing our successful go to market strategy, we are reaffirming our long term goal of organic revenue growth in the low double digits for the manufacturing segment. Combining robust sales of the PTS family of products, core reagents and microbial identification services, the microbial solutions business continued to generate low double digit organic revenue growth in the fourth quarter and for the year. Our installed base of rapid detection systems continued to expand and as a result, we are driving higher cartridge sales. Furthermore, as the only provider who can offer a comprehensive solution for rapid quality control testing above sterile and non-sterile biopharmaceutical and consumer products, we are leveraging our client relationships to market our microbial solutions. For clients who have historically used our testing products in only one area, we are introducing them to our comprehensive microbial testing solution and selling across a broader portion of the microbial portfolio. We are in a unique position to support our clients' rapid testing needs and win new business, which is why we believe that the microbial solutions business will be able to continue to deliver low double digit organic revenue growth for the foreseeable future. The biologics business reported another exceptional performance in the fourth quarter as well as for the year, delivering robust double digit organic revenue growth for both periods. We believe that the number of biologic and biosimilars drugs in development has led to a rapid increase in demand for our services over the last several years, especially in view of the fact that many of the biologic drugs are being developed by biotech companies that do not have the internal infrastructure to support the manufacturer. Because of the exceptional growth in 2017 and our belief in continued growth for the foreseeable future, we have plans to expand into a new facility near our existing Pennsylvania site, which is larger and provides significantly more capacity for growth in 2018 and beyond. The additional capacity as well as continued expansion of our biologics services portfolio will further enhance our ability to support our clients’ biologic and biosimilar development efforts from discovery through clinical phases and commercial manufacturing. Strong revenue growth and our focus on continuous improvement have resulted in greater operating efficiency in the manufacturing support segment. The fourth quarter operating margin was 37.6%, a 340 basis point improvement from the fourth quarter of 2016. And for the year, the operating margin was 35.5%, a 170 basis point improvement over the previous year. Based on our outlook for low double-digit revenue growth and continued efficiency initiatives, we are increasing our long-term operating margin target for the manufacturing segment to the mid-30% range from more than 30% previously. The increased margin expectation for this segment is one of the reasons that we believe we will achieve our consolidated margin of more than 20%. As I said earlier, we are operating in a robust business environment with excellent growth potential. We are realizing that potential because of four factors that distinguish us from the competition; our unique early stage portfolio, which we continue to expand both through internal development and strategic acquisition; our scientific expertise, which is unmatched in the CRO industry and enables our clients to rely on us instead of maintaining in-house capability; our focus on continuous improvement, which enables us to operate more efficiently and effectively even as we grow through acquisition; and our best-in-class client service through which we ensure that our products and services are precisely tailored to each client's individual needs. Our long term targets are based on our ability to execute our business strategy in this robust environment. We believe that we can generate consolidated revenue growth in the high single digits and an operating margin above 20%, including acquisitions. The revenue target is based on low single digit growth for RMS, high single digit growth for DSA and low double digit growth for manufacturing. The operating margin target is based on maintaining a high 20% margin for RMS and mid-20% target for DSA and a mid-30% target for manufacturing. The investments we have made have enhanced our position as a trusted scientific partner for pharmaceutical and biotechnology companies, academic institutions and government and non-government organizations worldwide. We have demonstrated the value we can provide to clients and believe that our long-term targets demonstrate our goal to deliver value to shareholders. In conclusion, I'd like to thank our employees for their exceptional work and commitment and our shareholders for their support. Now, I'd like David Smith to give you additional details on our financial performance and 2018 guidance.

Thank you, Jim and good morning. Before I begin, may I remind you that I’ll be speaking primarily to non-GAAP results from continuing operations, which exclude amortization and other acquisition related charges, costs related primarily to our global efficiency initiatives, the divestiture of the CDMO business in 2017 and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, the CDMO divestiture, the impact of foreign currency translation and the 53rd week in 2016. I will focus my discussion on our 2018 financial guidance. This guidance does not include the impact of MPI Research since the acquisition has yet to close. In 2018, we believe that we are well positioned to deliver earnings per share between $5.42 and $5.57. The 2018’s earnings growth rate appears compressed by the year-over-year comparison of venture capital investment gains and the excess tax benefit associated with stock compensation, which creates a combined headwind of $0.24 per share. Adjusting for these headwinds, the year-over-year earnings per share growth is expected to be approximately 8% to 11%, primarily driven by higher revenue and modest operating margin improvement. This year, we have forecast venture capital investment gains of $0.14 per share compared to a gain of $0.29 per share in 2017. Because of these strong historical returns, we increased our estimate for VC gains to $0.14 a share from a level of $0.04 in prior years. We believe the higher estimate for 2018 more closely aligned with historical performance because in each of the last five years, we have outperformed our initial $0.04 outlook with gains ranging from $0.05 in 2015 to $0.29 last year. Given the inherent difficulty of forecasting VC gains or potential losses, we will evaluate eliminating these gains from our guidance beginning in 2019. For the excess tax benefit, we are estimating a $0.14 per share contribution in 2018 compared to $0.23 per share in 2017. The $0.23 last year was nearly double our original estimate due to the stock price appreciation and subsequent option exercise activity. The VC gains and excess tax benefit created significant $0.24 headwind in 2018, and it is important to note that our earnings per share growth rate would be 8% to 11% on adjusting for this headwind. In 2018, we expect organic revenue growth on a consolidated basis to be in a range of 5.7% to 6.7%. From a segment perspective, the underlying trends in each of our business segments are expected to be similar to those of last year. We expect RMS growth to improve from second half 2017 levels to a low single digit growth rate in 2018, but continue to be pressured by lower sales volume in mature markets. RMS is expected to benefit from continued growth in the services business and new production capacity to support robust demand for research models in China. We expect the DSA segment will deliver organic growth in the same range as 2017. We expect safety assessment growth in the same range as the segment and improved growth in our discovery business. The manufacturing segment is expected to generate organic growth about 10%. The microbial solutions and biologics businesses are expected to continue to grow at low double digit rates in 2018, biologics growth is expected to moderate in the first half of the year until we bring additional capacity online to support the increasing demand. In our guidance, we are estimating the impact of foreign exchange based on bank forecasts of forward rates. The 1% benefit that we expect from foreign exchange in 2018 is less favorable than if we were using current rates, but given the volatility and weakening of the US dollar since the beginning of this year, we did not feel it was prudent to include a higher benefit from foreign exchange in our guidance because rates could fluctuate over the balance of the year. In addition to revenue growth, we expect modest operating margin improvement will drive earnings growth this year. The manufacturing segment will be the primary contributor as it benefits from manufacturing efficiencies and volume leverages in our microbial solutions business. We will continue to add staff this year to support growth across many of our businesses. Although we will continue to invest in additional staff to keep pace with demand, we believe that we are well positioned to gradually improve the consolidated operating margin to reach our long-term goal of greater than 20%. Efficiency savings are also expected to continue to be a driver of operating margin improvement. In 2017, we achieved incremental efficiency savings of over $65 million. In 2018, we expect to generate efficiency savings of $60 million to $65 million before the benefit of the expected MPI synergies. The benefits from our efficiency initiatives help offset annual cost increases. Unallocated corporate expenses in 2018 are expected to be slightly below 7% of revenue compared to 7.1% of revenue in 2017. Our 2018 outlook demonstrates that the investments in our people, processes and systems over the last several years are beginning to generate the intended goal of greater efficiency and productivity. Before factoring in the incremental interest expense associated with the intended MPI transaction, net interest expense is expected to be in the range of $29 million to $31 million in 2018 compared to $29 million recorded in 2017. This outlook assumes that higher interest rates in 2018 will be largely offset by debt repayment. We are in the process of evaluating our financing options for the MPI acquisition, including the planned expansion of our credit facility. We are also actively evaluating fixed rate debt financing alternatives. Our MPI accretion outlook includes an estimate for incremental interest expense related to this refinancing activity. This year’s non-GAAP tax rate is expected to be in the range of 25% to 26%, excluding MPI, which compares favorably to the 27.2% rate last year, primarily because of the benefit of operational efficiency initiatives. This will be partially offset by the $0.09 headwind associated with the excess tax benefit from stock compensation. The excess tax benefit reduced the tax rate by 310 basis points in 2017, but only reduces the 2018 rate by 180 basis points. As we disclosed last month, we expect that US tax reform will be effectively neutral to both GAAP and non-GAAP earnings per share in 2018. However, we expect additional opportunities to be identified as we continue to refine our understanding of this legislation. In the fourth quarter of last year, the one-time charges related to the transition or toll tax, the revaluation of deferred tax liabilities and the withdrawal of the indefinite reinvestment decision reduced GAAP earnings by $78.5 million or $1.66 per share, but this amount was excluded from non-GAAP results. US tax reform did not have an impact on our non-GAAP results in 2017. Free cash flow in 2017 was $242 million, a decrease of approximately $20 million from $262 million in 2016. Free cash flow was below our November outlook of $265 million to $275 million because of two primary factors, the timing of capital projects and working capital, specifically DSOs. Capital expenditures of $82 million in 2017 were $27 million higher than in 2016 and $7 million above our prior outlook. In addition, DSOs ended the year at 60 days, which was higher than our expectation. However, we believe this was largely a timing issue and expect DSO will improve in 2018. This year, we expect free cash flow to be in a range of $250 million to $260 million, excluding MPI. The toll tax is expected to reduce free cash flow by approximately $15 million. Excluding the toll tax, free cash flow would increase by 9.5% to 13.5% over the 2017 level. Capital expenditures are expected to be approximately $100 million in 2018 before factoring in MPI’s capital requirements. The increase from 2017 will be driven primarily by additional projects to support growth, including continuing to add capacity in RMS China, biologics and the safety assessment business and modest investments in our own information systems. A summary of our 2018 financial guidance, excluding MPI can be found on slide 46. Including the MPI acquisition and assuming an early second-quarter close, our guidance for 2018 would be reported revenue growth in a range of 16% to 18% and earnings per share in a range of $5.67 to $5.82. From a financial perspective, we believe this acquisition delivers compelling financial benefits, which will generate value for shareholders. It provides an attractive contribution to revenue growth and is immediately accretive to non-GAAP earnings. It will exceed or meet our return on invested capital hurdle rate within three to four years and it presents an opportunity to enhance MPI’s operating margin with synergies of $13 million to $16 million by the end of 2019. Following the acquisition, our capital priorities will be focused on debt repayment. Our pro forma leverage ratio at closing is expected to be slightly below 3.5 times, which is similar to our post WIL debt level. At this time, we do not intend to repurchase any shares this year in the absence of any M&A activity, our goal will be to drive the leverage ratio below 3 times.

Moving ahead to our first quarter outlook, we expect year-over-year revenue growth will be in the high single digits on a reported basis. Organic growth is expected to be in the mid-single digit range, due primarily to slower growth in the manufacturing segment. The biologics growth rate will be lower due to capacity constraints until we open our new Pennsylvania facility later this year. The RMS segment also faces a difficult prior year comparison due to the strong first quarter in 2017. First quarter earnings per share are expected to be moderately below last year's $1.29, due in part to meaningful headwinds from venture capital investment gains and the excess tax benefit from stock compensation, which totaled $0.05 and $0.15 respectively in the first quarter of 2017. This year, we are forecasting $0.03 to $0.04 of these gains and expect the excess tax benefit will be approximately $0.10, creating a year-over-year headwind of $0.06 to $0.07 in the first quarter. When adjusting for these items, earnings per share growth is expected to be in the low single digits in the first quarter, primarily as a result of the year-over-year operating margin decline in the RMS segment. To conclude, we are pleased with our financial performance in 2017. We believe that 2018 is positioned to be an excellent year, particularly with the expected completion of the MPI acquisition early in the second quarter and the associated benefits this acquisition provides to our clients and Charles. We are also optimistic about our outlook for earnings per share growth this year. When adjusting for the previously mentioned headwinds, growth is 8% to 11%, excluding MPI and 13.5% to 16.5%, including MPI. In addition to the benefits from the MPI acquisition, we are confident in our ability to achieve our long-term targets of high single-digit organic revenue growth and an operating margin greater than 20%, because of our ongoing focus on disciplined investing to support the growth of our businesses, our efforts to drive global efficiency, the speed and responsiveness with which we operate and our goal to enhance the relationships with our clients. Thank you.

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

Questions on MPI. First off, I'm sorry if I missed any of this. Facility utilization, can you talk about where they are with their capacity utilization and also any additional commentary on overlap you might have with their client base or perhaps lack of overlap in terms of ability to cross-sell or upsell into MPI’s specific accounts?

So Eric, we have a similar client base. So, I’d say that highly complementary, their client base is largely small and medium size biotech clients and obviously that's been the major driver of our growth. As we said in our remarks, it's a very large facility, 1 million square feet, conservatively larger than the ones that we have. The facility has some capacity available, which we think is extremely opportune, both in terms of its geographic footprint and the scale and diversity of what they do at that site. It will allow us to expand smoothly into new space as we need it, probably in lieu of building it out somewhere else. So we think this will be a highly strategic facility addition to our portfolio and one that expands our capabilities in a few new areas, but also expands some of the areas that we are currently participating in a more robust way.

Jim, can you share with us whether they were using Charles River’s animal model business or in part or in whole or were they using other providers?

I don't think we have a lot of details on that yet. So I'm going to modify my answer by saying that I suspect that they are a meaningful client of ours. And we'll have to get back to you on the extent of that. Most of the large CROs are meaningful clients of us. So I suspect at least in part, Eric, this will add to our assertion that our largest client of the RMS business is indeed our DSA business as well. Additionally, regardless of what percentage of their research models came from us, we would hope to have an opportunity to supply more to them and there is just great operational elegance and symmetry in that, as we've seen in France in particular and as we've seen in other parts of our business across the world. The supply of the animal models is obviously critically important from both a timing point of view and the diversity of models point of view.

Jim, I understand you want to move away from discussing pricing in DSA. I'm interested in the trajectory of margin improvement there. I'm remembering that in 2017, the WIL acquisition reached its 20% target, which you mentioned was more sustainable. So, the margin contribution from WIL should have been positive, but you indicated that year-over-year margins faced some pressure due to labor costs and other factors. I would like to gain clarity on the various factors affecting margins in BSA and your outlook on how they can continue to improve over time.

It’s a complex situation as we've mentioned before. The balance of work primarily involves specialty and general toxicology, with our emphasis leaning more towards specialty services. There will be some pricing changes and ongoing improvements in capacity utilization. We expect some moderation in our aggressive hiring as we are nearing our staffing goals. We are continuously enhancing efficiency; as David indicated, we realized $65 million in efficiency savings in 2017, and we anticipate similar savings of $60 to $65 million again this year, largely in safety and discovery areas. While WIL’s margins have reached our target of over 20%, they still lag behind those of legacy Charles River, indicating potential for margin growth. We’re pleased that we are starting with MPI, with margins that exceed those of WIL at the time of acquisition, yet still below those of legacy Charles River, suggesting room for improvement. Lastly, in relation to the DSA segment, we expect margin enhancements in overall discovery. Therefore, whether you consider just safety or the entire DSA area, we anticipate improving margins that align with our upgraded long-term goals.

And Jim, the promotions that you announced today, congratulations to those two. I think natural progressions of two folks that have been with the organization for a long time. Could you talk about how your focus may evolve and perhaps what your horizon is?

So. We're very pleased, as you say, to have two significant contributors to the company take on large responsibilities, particularly as the company gets larger. The advent of MPI makes us a larger, more complex business. So we have to continue to parcel out the work to additional shoulders and of course there's a whole range of people who will be working with that for the two of them, who have new and different and somewhat enhanced jobs. As I said in my remarks, I look forward to continuing to work closely with them. We flagged the five-year horizon for two reasons. One is that we look at the world that's in five-year chunks, commensurate with our strategic plan and we really do think we can double the size of the business. I did not say explicitly in my remarks, but I will say explicitly in response to this question that I have just signed a five-year contract with the company. So I intend to stay here and participate significantly, principally in my current role and more and more strategic focus I would say going forward.

Hi, thanks. I wanted to ask about the synergies. So the $13 million to $16 million you outlined is that all in the cost side, and what are you targeting? And then what would the underlying MPI EBITDA growth be in 2018?

So, the $13 million to $16 million is all to do with cost synergies, same as we did with WIL. We didn't feel at this stage we should be factoring in any revenue synergies. So our valuation model is based on the $13 million to $16 million in cost and slight subtlety with WIL. WIL, we said $17 million to $20 million over two years. With MPI, we're talking $13 million to $16 million by the end of '19, so slight difference in timeline there. As we've mentioned, we have called out that the operating margin for MPI is slightly above 20%. And we do intend to be able to walk that up as we've been walking up on WIL to the sort of legacy safety assessment margins that we have.

Great. And then could you just give us a sense for the recent growth of MPI over the last few years. I know you gave us 2017 and 2019 range. But maybe just a little bit of a view on what the trailing has been, and then what gets us to the step up in 2019?

MPI has been performing extremely well, at least at the same growth rates we have enjoyed. The diversity of their capabilities I think has made them an important partner for lots of companies, particularly small and large high-growth biotech clients. And we're confident because of their scientific footprint, and capability, and client interface, that they will be able to continue at similar growth rates going forward. We didn't justify this deal from a valuation model point of view on sales synergies. There are some cost synergies, so we called out. We of course have had some sales synergies with WIL. We'll really work hard to have clients have a positive experience with Charles River generally, and specifically with our MPI capabilities. So we would be disappointed if we didn't have some sales synergies, but it's premature to call those out specifically.

Hi, thanks very much. Hey, Jim, can you just talk a little bit more about the strategic review that you did? What's the sort of underlying macro view of your broader markets baked into that sort of updated five-year targets? And the organic revenue growth goals that you gave across the three segments, what do you think the underlying market growth is there versus some share gains that you think you can deliver over the next five years? Thanks.

Sure. We operate in various markets that differ significantly. I believe your question pertains to DSA or possibly just SA. If not, please clarify. Regarding that, we believe biotech is the main driver of growth. Even though the pharmaceutical sector is actively restructuring and outsourcing, we are engaged in promising discussions with several major pharma companies to expand our services, both on an individual basis and collectively. Biotech is currently experiencing a substantial influx of capital from the financial markets and direct investments from venture capital linked to large pharmaceutical firms. We are optimistic because we are well-funded, possess several breakthrough technologies, and saw an increase in drug approvals last year compared to the previous year, albeit modestly. The market conditions appear to be the best we've encountered. Our portfolio is diverse, and we have substantial engagement with clients, as illustrated by our involvement in 74% of last year's approved drugs, a figure we believe could grow. We are positioned at the heart of the demand and needs of both pharma and biotech, providing services that they would typically handle internally. The safety assessment market is expanding at an approximate rate of 5%, and we have been outpacing market growth. While the overall market is expanding, we are pleased with our growth rate, our expansion potential, and the opportunity to enhance our margins. Our diverse client base allows us to take on a bigger role. One reason for the recent organizational changes involving Davide and Birgit, among others, is to improve our integration from Discovery to Safety and vice versa with current Safety clients seeking Discovery collaboration. By managing these units cohesively without operational or marketing distinctions, we believe this will significantly bolster our growth rates in the future.

Hey, Jim. My main question is about reconciling your 2018 revenue guidance with your long-term goals. You're aiming for high single-digit organic growth in the long term, but for 2018, it seems your consolidated organic growth rate is around 6%, which feels closer to mid-single digits. It appears that you expect the DSA segment to be the key driver for growth in the long run. However, I'm finding it difficult to envision a more favorable environment for DSA than we currently have, considering the state of biotech. Am I understanding this correctly? Is the DSA segment indeed the bridge between your 2018 figures and long-term targets? Also, what factors contribute to that expected acceleration?

There are several factors that should contribute to the high single-digit growth rate. RMS is expected to deliver low double-digit growth, whereas it was in the very low single digits in 2017. As China and the services sector expand, we believe we can achieve this growth. Although this business is still significant, it isn't expanding as quickly as it once did, despite China showing strong growth rates. As we noted earlier, capacity constraints affected us in the latter half of the year, but as we develop more sites, we expect this to improve. Discovery has also been a challenge, but we are optimistic that we will see an increase there. We anticipate ongoing improvement in safety as we offer more solutions to clients. Importantly, as we execute effectively and capitalize on the synergies between Discovery and Safety, we recognize that our approach has been somewhat fragmented, which has influenced how clients perceive and purchase our offerings. Furthermore, many clients still view Discovery as a new service, so adopting a more integrated selling strategy should be highly effective. We expect manufacturing to maintain low double-digit organic growth rates, though the Avian business has been a recent hurdle. We believe that overcoming this will be beneficial. Our main competitive advantage lies in the broad and diverse portfolio we have. Each year, we tell this story more effectively, leading to increased sales as clients are more inclined to purchase from us due to a compelling value proposition. As we continue to invest in our current businesses and expand our portfolio through M&A, along with potential additional capabilities, we anticipate this will also support our organic growth moving forward.

Yes, good morning. Jim, when you mention doubling the revenue over the next five years, that clearly includes both organic growth and acquisitions. You've recently announced a significant acquisition, and it's never too early to discuss what's next. Personally, what expectations do you have for leverage following the acquisition's completion? Additionally, considering your strategic plan for the next five years, what do you believe is necessary to continue and enhance growth?

So, I'm going to let David talk about leverage in a second. But I just want to remind you that we like to hang out below three turns. So that's kind of our goal as we come off of acquisitions. Obviously this is the big one. We have a lot of confidence in our ability to integrate this one well because we did a really good job with WIL, probably our best integration effort and result. They're obviously not the same company, but WIL had multiple sites, and this is a single site, so we feel that we're going to be able to focus on this WIL. And of course we have a guy who was a senior WIL executive who is running a WIL site now and a Charles River site who's going to be full time on the integration. So we have a really strong feeling that the integration will go well. Having said that, we need to close it, and we hope that will be early in the second quarter, and then we need to get to work on the integration. And I think we need to do that before we move on to the next deal. Having said that, we have been active across multiple fronts, obviously in Safety, as you've just heard, definitely in Discovery, and in a few areas that we're not in, in Discovery. We actually have opportunities across most of our businesses, including RMS, including Biologics, including Microbial, and for sure in China. And what the cadence of those deals will be, it would be inappropriate for me to say because we can't really control it. But we have a very clear line of sight on what we would like to buy, what we can afford, and how we will feather those into the portfolio over the next, let's say, three to five years. And the whole purpose is not just scale. The purpose is to have a much better value proposition or much greater service offering for our clients, all of whom want that. So whether you're a second-year startup biotech company or the biggest pharma company, you just want to stop doing this work yourselves. And you don't want to find 15 partners to do it; you'd prefer to have one or two. So, we feel very good about our ability to afford these deals, find them, afford them, and integrate them, and increasingly to promote them. And I'll let David talk to you about leverage.

Yes, so about two years ago, when we bought WIL, we went to 3.5 turns. As we speak, at the end of 2017, we're actually at 2.2 turns. So it's interesting how it looks like it can be a bit of a repeat performance because the MPI acquisition will also take us back up to 3.5 turns, similar to where we were with WIL. And again, it is our intent to bring that leverage down below 3 turns.

Okay. And then one follow-up, as we talk about the opportunity to grow with biotech customers, can you just remind us of anything about your revenue mix, where is biotech now versus pharma versus academics and government? And how do you think this mix will look like five years out?

It's a bit challenging to clearly distinguish between biotech and pharma since there are many gray areas, especially with significant funding flowing from pharma into biotech. We haven't focused as much on defining the boundaries as we would like. The last time we evaluated, pharma made up about 25% to 30%, while biotech clients were around 50% to 60%. Academic clients were roughly 20%. There's no doubt that we're experiencing rapid growth in biotech clients, which is expected to continue. The distinction between biotech and pharma, if it remains significant, will likely become more pronounced. We're dedicating considerable effort to improve our communication and service for clients racing to market, some of whom may have only one compound, and we've organized ourselves to manage that effectively.

Thank you very much. Many of my questions have already been addressed, so I appreciate the insights and also want to extend congratulations on the transaction and the promotions. Jim, could you share a bit about RMS and its outlook? There seem to be some positive factors related to China and biotech, but challenges persist, particularly with major pharmaceutical companies in the US. Looking at the long-term perspective, what level of risk do you see? How do you assess the possibility that this business might not just grow in the low single digits but could potentially remain flat or even decrease slightly in the next three to five years? What factors would contribute to such a scenario?

We don't believe that is the direction we're going, otherwise we would have indicated that. We are confident in our ability to maintain pricing, as we've always done. We consistently achieve appropriate pricing levels. This is not a service that clients choose to perform themselves. Animals are acquired externally and are crucial for completing our work, so we expect to maintain pricing. We possess a unique and extensive geographic footprint, even after streamlining operations at the Maryland facility and previously making cuts. Should we need to make further reductions due to demand constraints, we would consider it, although we hope it doesn’t come to that. We see significant growth opportunities mainly in the US and, to a lesser extent, in Europe, particularly in the academic sector, where we already generate substantial revenue but believe we can capture more. Our presence in the pharmaceutical and biotech sectors is significant, and our academic business is expanding. We anticipate continuing to introduce more specialty models that offer higher value and potentially better profit margins. Our service businesses are performing well, showing modest growth in the low to mid-single digits, and they are well-positioned geographically. These services are not ones that clients prefer to manage internally. Additionally, China represents a major growth opportunity and is still an emerging market where we believe we are competing effectively. It’s essential to build sufficient capacity in anticipation of demand, and this could be substantial enough to stabilize our growth rate. We are confident this will support the low single-digit growth we discussed.

Hi, this is for Derik. Our question is on the tax rate. You provided tax rate guidance of 25% to 26% for 2018, and excluding MPI. What can you tell us at this time about your anticipated tax rate in the out years, including MPI beyond 2019?

So, while I'm not really going to comment beyond 2019, I am certainly happy to comment about MPI; MPI being based entirely in the US actually fits quite nicely into the 2018 guidance that we've given on 25% to 26%. So we actually don't think that the acquisition of MPI is going to distort the effective tax rate for '18.

Thank you. And then regarding your recent acquisitions in the DSA segment, Brains On-Line and KWS Test; at what run rate of an M&A revenue contribution do you expect out of these two businesses?

If you’re talking about exact dollar amounts, we haven't given those. I would describe those businesses as quite small, but highly strategic from a scientific point of view. So, Brains On-Line enhances our CNS franchise, KWS enhances our oncology franchise, but they're not moving the needle very much in terms of top-line contribution.

Hey guys, this is Tejas on for Tycho. Jim, just one big picture question here on MPI for you, you know, preserving the high-touch responsive feel of the service offering is probably very important to their customer's skew towards the mid-cap segment, how exactly post-integration do you expect to continue to preserve that within sort of the broader Charles River structure, particularly as you seek to drive some of those cost efficiencies that you talked about earlier on the call?

We had a similar opportunity; let's put it that way, with WIL. We had a lot more small clients who had great expectations on personalized service, because we try to give personalized service to all of our clients. And so, I think we've done a very thoughtful professional job in making those clients feel good, keeping them close to us, and to the extent that they wanted to continue to work at a WIL site with the same study director; nothing really has changed. So we're going to be very cognizant and sensitive about the same need and desire from MPI clients and change as little as possible, except to probably have more consistency across SOPs and allow them the opportunity to work with other Charles River sites to get to no other Charles River sites and get to work with them if they want to. And if they are delighted with where they're at, which I suspect most of them will be, then we will preserve those opportunities for them. So we are buying this company because we think it's a very good company, with happy clients, they had a nice growth rate, they're profitable, they do very good science. And our responsibility is to embrace that and to the extent that we can enhance the science and some of the capabilities, we will do that. To the extent that we can't enhance them, then we won't, we will herald what they're capable of doing. In terms of cost synergies, we've been working really hard for approaching a decade on driving efficiency. It's something that we've done progressively better from year-to-year. We believe we can provide them with the same capabilities while enhancing their work. So that's an opportunity that we are excited about.

Got it. And then one quick follow-up sure, given that a bunch of these clients are presumably at the pre-revenue stage, is there any shift in terms of contracting structures perhaps that you need to put in place, or do you anticipate that your bad debt levels might pick up a little bit, or since it's all sort of upfront payments before the work begins, you don't really anticipate that as a real risk?

We do not expect that, as the client base is significantly different. This deal has just been signed, and we haven't spent much time analyzing it or had access to a lot of those materials. We will be working through those during the integration period before closing. Additionally, we have a team that assesses clients’ ability to pay. We request upfront payments, and historically, we have had a very low bad debt write-off in our industry and at Charles River as well.

Hey, thanks. Can you comment on what you're seeing from the VC partnership? I know you shared some metrics in the past on that front. But can you give us an update on the traction there and how that's helping you to get new customers? Thanks.

Sure. Very, very pleased with our VC relationship. Some of those as you know we are LPs and some we are not. The relationships are slightly different when we are LPs just in terms of the level of activity, amongst and between us, and more strategy with regard to therapeutic area of focus and some M&A. But increasingly the VCs like to work with us and get the benefit of our science and capability and value as if they were one large client, which is kind of the way we work with them to ensure that they have access to us in great response times. None of these little companies will ever, that's probably a fair statement, ever internalize the capabilities that we provide to them now. So, we are providing a significantly important capability for them. And of course you get so many new companies mentored by these VCs every year that access to this sort of work is really critical, we get the drugs filed, and to get them in market. I think the last time we reported on this, collective revenue from our VCs was approaching $100 million. That should continue obviously to increase both as we have new services and we reach out to more VCs, and they mentor more companies. So very, very important part directionally of our client base; most of the new companies are literally virtual, small number of people buying everything externally. All they own is IP, and they’re very much dependent upon us. And so, our job is to communicate effectively with them often, and to help them with regulatory filings and the interpretation of data. And they really make us better. They really demand explicit science and fast turnaround time. So, we are enjoying our relationships with them a lot.

And just a quick clarification in terms of MPI growth rate, you said a similar growth profile to yours, is that on an organic basis?

Yes, MPI haven't done any acquisitions.

Hey, good morning guys, and thanks for squeezing me in. I guess, Jim, most of my questions have been answered, I guess the last thing I would come back to is that if we think about like the emerging and development stage biopharma companies, the venture-funded companies, it sounds like given the visibility you guys have assumed that the current growth rate continues, I just want to think about how do we think about the risk to the guidance, should we see some type of funding slowdown should something in that end-market reverse or stagnate?

It's a bit uncertain. There's always some level of risk we consider. Those companies are currently very well-financed, with several years of cash reserves. We believe there is more funding available if they achieve their milestones and continue to bring innovative treatments to market. Pharmaceutical companies rely heavily on these firms for discovery and often end up either acquiring them or partnering with them. Anything is possible, but we don't see any foreseeable issues. This market is fundamentally different from the past, particularly compared to the biotech landscape of 2008, given the number of companies, their ability to bring drugs to market, and their relationships with pharma. We monitor these numbers closely, watching the demand trends and any changes from clients to detect early signs of funding slowdowns. So far, we haven't received any indications of concerns from our clients, and it seems unlikely that there will be issues in the long-term future.

Thank you for joining us on the conference call this morning. We look forward to seeing you at the Leerink conference tomorrow or Raymond James or Barclays conferences in March. This concludes the conference call.