CRL — Q1 2019 Earnings Call Transcript

Thank you. Good morning, and welcome to Charles River Laboratories' First Quarter 2019 Earnings Conference Call and Webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer; and David Smith, Executive Vice President and Chief Financial Officer, will comment on our results for the first quarter of 2019. Following the presentation, they will respond to questions. There's a slide presentation associated with today's remarks, which we've posted on the Investor Relations section of our website at ir.criver.com. 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 466217. The replay will be available through May 21. You may also access an archived version of the webcast on our Investor Relations website.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 make about future expectations, plans, and prospects for the company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements. During the call, we will primarily discuss results from continuing operations and non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and future prospects. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations on the Investor Relations section of our website through the Financial Information link. I will now turn the call over to Jim Foster.

Good morning. In the first quarter, we saw a continuation of the robust business trends that we experienced throughout the second half of last year. Organic revenue growth for each of the three segments was at or above our long-term targets. We attribute this performance to the success of our ongoing efforts to enhance our position as the leading early-stage CRO, as well as the strong industry fundamentals, including biotech funding. Overall, we believe our first quarter performance supports our solid outlook for the year. By continuing to invest in our portfolio, our people, and our infrastructure, we believe we are maintaining and enhancing our leading position among early-stage CROs and our ability to support our clients' diverse research needs. The acquisition of Citoxlab, which was completed on April 29, is another step forward in our strategy and will enable us to deliver incremental value to clients. The success of our strategy was validated by the fact that we worked on 85% of the FDA-approved drugs in 2018 and have discovered 80 novel molecules for our clients. Before providing further details on our first quarter performance and the Citoxlab acquisition, I will briefly comment on the cybersecurity incident that we disclosed last week. On April 30, we notified clients of unauthorized access into portions of our information systems after recently determining that some client data was copied. This incident did not disrupt our day-to-day operations and was not a malware or ransomware attack. Further details on this incident can be found in our 8-K filing and on our website. We have reached out to affected clients, which represents approximately 1% of our total number of clients. The client response has been appropriately measured to date, yet most were understanding. I was struck by the collaborative nature of many of our client interactions. In several cases, the client offered to lend their expertise or assistance in our remediation efforts, which we truly appreciate. Other clients have requested additional discussions with our teams, often scientist-to-scientist or CIO-to-CIO. We will continue to work closely with our clients to address their questions and concerns. While it's too early to determine whether there will be any revenue impact from this incident, we believe it would be minimal. In addition, the costs to fully remediate this matter are not expected to be material based on our preliminary estimates, and we believe that potential revenue and cost impact can be accommodated within our current guidance range for 2019. I will now provide highlights of our first quarter performance. We recorded revenue of $604.6 million in the first quarter of 2019, a 22.4% increase over last year. Organic revenue growth at 10.8% was broad-based across our portfolio and was above the 10% level for the third consecutive quarter. From a client perspective, biotech clients were the primary contributors to our first quarter revenue growth as they continue to benefit from a robust funding environment. The operating margin was 16.3%, a decrease of 50 basis points year-over-year. The decline was primarily driven by the RMS and Manufacturing segments, which I will provide further details on shortly, as well as the adjustment to our compensation structure that we implemented on July 1 of last year. Earnings per share were $1.40 in the first quarter, an increase of 8.5% from $1.29 in the first quarter of last year. Strong revenue growth was partially offset by the operating margin decline, resulting in earnings per share that were in line with our prior outlook. As a reminder, venture capital investment gains are now excluded from non-GAAP results in both periods as well as from future guidance. Based on the first quarter performance and our outlook for the remainder of the year, we are reaffirming our revenue growth and non-GAAP earnings per share guidance for 2019, including Citoxlab. We continue to expect robust organic revenue growth in a range of 8% to 9.5% and non-GAAP earnings per share of $6.40 to $6.55, including Citoxlab. This represents earnings per share year-over-year growth of 10% to 13% from $5.80 reported in 2018 when excluding venture-capital investment gains. I'd like to provide you with details on the first quarter segment performance, beginning with the DSA segment. Revenue was $354.2 million in the first quarter, an 11.2% increase on an organic basis over the first quarter of 2019, driven by broad-based demand for both Safety Assessment and Discovery Services. The Safety Assessment business continued to perform exceptionally well in the first quarter, highlighted by strong demand from biotech clients and increased pricing. Bookings and proposal activity also remained strong, reinforcing our outlook for high single-digit organic growth in the DSA segment for the year. Last week's acquisition of Citoxlab helps us extend our leadership position in the Safety Assessment market by enhancing our presence in Continental Europe and North America and by strengthening our existing capabilities in general and specialty toxicology, agrochemical and preclinical medical device testing and niche discovery services, including drug transporter and drug-drug interaction research. Our efforts to build our global scale and enhance our scientific capabilities through internal investments and the acquisitions of WIL, MPI and now Citoxlab have enabled us to become our clients' partner of choice for early-stage drug research. We are pleased to welcome the exceptional team at Citoxlab to the Charles River family and look forward to working together to help our clients discover and develop new drugs for the patients who need them. Citoxlab's complementary service offering and geographic footprint are an excellent strategic fit and will enable us to enhance the support we can provide for our clients' early-stage research efforts. The addition of Citoxlab's talented staff, extensive scientific capabilities and client-centric approach solidifies our leading position in the outsourced safety assessment market at a time when we believe there is and will continue to be significant client demand for these outsourced services. We believe that the team at Citoxlab is enthusiastic about working with their Charles River colleagues. The collaboration of our respective scientific teams, the implementation of best practices, and the synergies between the early-stage services offered by Charles River and Citoxlab will represent a significant growth opportunity for the combined organization. As we did with the MPI and WIL acquisitions, we had a comprehensive integration plan ready to implement on day 1. To ensure a smooth transition, we have assigned two senior operational leaders, one from Charles River and one from Citoxlab, to manage the integration in Europe and North America. Through our integration efforts, we expect to generate operational synergies of $8 million to $10 million within two years, which we believe will drive Citoxlab's operating margin above the 20% level from its current mid-teens operating margin. As we noted when we announced the acquisition, we expect Citoxlab will contribute $115 million to $130 million to our consolidated revenue and add approximately $0.15 to non-GAAP earnings per share in 2019. As our global safety assessment footprint has expanded, we are now at least 50% larger than the nearest competitor. It has become increasingly important that we ensure a seamless client experience across all of our sites and encourage clients who work across multiple sites. This offers clients access to much broader capabilities than they might have at a single site and reduces lead times to start studies. It also benefits from our operating efficiency through shared resources and optimized capacity utilization. We have and continue to work very hard to standardize and harmonize best practices and processes across our Safety Assessment network, and we intend to do the same with Citoxlab as the integration now begins in earnest. Our initiatives to enhance client mobility will also drive Discovery clients with integrated programs to work broadly with us across the entire early-stage spectrum and into Safety Assessment. The Discovery business had another good quarter led by strong demand for oncology and early discovery services. Our clients' ability to work with a single-source partner to support the discovery of their novel cancer therapeutics, coupled with a significant investment in this area of drug research, is driving demand for our oncology capabilities. Demand for our early discovery services also continues to improve as clients partner with us for a single project or for their larger integrated discovery programs. Our efforts to strengthen our portfolio by expanding our scale, our science, and our innovative technologies continue to resonate with clients as they increasingly view Charles River as their scientific partner who can support their efforts to identify new drug targets and discover novel therapeutics. As we did with our Safety Assessment business, we intend to continue to build our Discovery portfolio so that clients can outsource complex discovery projects to us rather than maintain or try to develop in-house capabilities. Our recent alliances with Distributed Bio to enhance our large molecule discovery capabilities and Atomwise to add artificial intelligence or AI drug discovery capabilities are part of the expansion of our Discovery portfolio. The DSA operating margin was unchanged year-over-year at 18.6%. Leverage from the robust DSA revenue growth was primarily offset by the compensation structure adjustment. Similar to last year, we expect the DSA operating margin to rebound above the 20% level starting in the second quarter. RMS revenue was $137.2 million, an increase of 5.4% on an organic basis over the first quarter of '18. The primary drivers of RMS revenue growth continued to be strong revenue growth for Research Model Services and robust demand for research models in China. From a services perspective, the Insourcing Solutions contract with NIAID, which commenced last September, contributed slightly more than 300 basis points to the revenue increase. Aside from the benefits from the NIAID contract, the Insourcing Solutions business continued to perform very well as clients took advantage of our flexible solutions for their vivarium management and related research needs. We can support our clients through a variety of working arrangements, including providing staff and expertise to manage the vivarium at a client site, to provide a flexible vivarium space at a Charles River site supported by our staff. The latter option is our CRADL initiative, or Charles River Accelerator and Development Labs, which has become an increasingly popular solution to provide both small and large biopharmaceutical clients with turnkey research capacity in the Boston/Cambridge biohub. Utilizing CRADL allows clients to invest in the research programs instead of their infrastructure. Our GEMS business also continues to benefit from our clients' use of CRISPR and other technologies to create genetically modified models faster and more cost-effectively. Clients come to us because we have the expertise to help them derive and maintain their proprietary model colonies, which play an increasingly critical role as drug research becomes more complex with a shift to oncology, rare disease, and cell and gene therapies. Excluding the NIAID contribution, RMS organic revenue growth was consistent with our long-term target in the low single digits. As we often point out, demand for our products and services is now linear, which was reflected in our first quarter performance of the research models businesses in North America, Europe, and Japan. Similar to last year, research model sales to large biopharmaceutical clients started slowly. Large biopharma's ongoing efforts to reduce internal infrastructure and externalize research by outsourcing to CROs like Charles River and by partnering with biotech companies and academic institutions also contributed to softer demand from this client base. Not surprisingly, we saw an increase in demand for research models from both biotech and academia in the first quarter. In China, our research models business continued to grow at double-digit rates. China represents less than 10% of total RMS revenue but offers a significant opportunity for growth. We intend to continue to expand capacity in China to support robust client demand and drive future growth. In the first quarter, the RMS operating margin decreased 170 basis points to 28.1%. Most of the decline was driven by three known headwinds: the lower-margin NIAID contract, the compensation structure adjustment, and the MPI intercompany sales, for which the revenue and profitability are now recognized in the DSA segment. The year-over-year effect of these factors will be anniversaried during the second half of the year. The remainder of the first quarter margin decline was primarily attributable to the lower sales volume for research models outside of China. As large biopharmaceutical clients continue to reduce internal infrastructure and the mix of the RMS business shifts toward services, it's vitally important that we remain focused on initiatives to enhance operating efficiency in order to sustain the RMS operating margin. In the first quarter, these efficiency initiatives included the decision to consolidate a small RMS site in Southern California by the end of this year and transition operations to an existing larger California site. Revenue for the Manufacturing Support segment was $113.2 million, a 17.2% increase on an organic basis over the first quarter last year. The increase was driven by double-digit revenue growth in both the Microbial Solutions and Biologics Testing Solutions businesses. Microbial Solutions had an excellent quarter. Our advantage as the only provider who can offer a comprehensive solution for rapid quality control testing continues to resonate with our clients, demonstrated by robust demand across our Endosafe testing systems and cartridges, core reagents, Accugenix microbial identification services, and Celsis bioburden solutions. Sales of Celsis products benefited from a large stocking order from our strategic partner in certain non-pharma markets. Even adjusting for this order, Microbial Solutions growth was well above the 10% level. The Biologics business also reported strong growth in the first quarter. A number of biologic drugs in development, as well as the efforts we made to position the Biologics business as a premier provider for these critical services, have led to a rapid increase in demand for our services. To accommodate this demand, we are adding capacity. The new Pennsylvania facility, the largest of our Biologics expansion projects, continues to progress well, and the transition is expected to be completed by the end of the year. In order to ensure that the transition is seamless for our clients, we are operating two facilities as we transfer services to the new site. This is creating duplicate costs during the transition; however, these costs are expected to moderate over the course of the year. The Manufacturing segment's first quarter operating margin was 31%, a 90 basis point decrease year-over-year. The decline was primarily related to the ongoing capacity expansion in the Biologics business, which reduced the segment operating margin by 80 basis points. The first quarter margin in the Manufacturing segment is typically the lowest point of the year as a result of the seasonal impact of lower sample volume in the Biologics business after the holiday period. Our unwavering focus on our strategy has enabled us to enhance our position as the leading early-stage CRO. We have differentiated ourselves from the competition through our science, our broad early-stage portfolio, and the flexible relationships that we can offer clients. With the acquisition of Citoxlab, we continued to expand our global scale and unique portfolio of essential products and services, which support the discovery and early development of new therapies for the treatment of disease. Acquisitions remain a vital component of our growth strategy as we endeavor to further enhance the scientific expertise, global scale, or innovative technologies that we can offer clients across all three of our business segments. Investing in our scientific capabilities and in the necessary staff and resources will help us ensure that we can meet the needs of our clients and support our current and future growth. Investments that we continued to make have enhanced our position as a scientific partner of choice for pharmaceutical and biotechnology companies, academic institutions, and government and nongovernmental organizations worldwide. The success of our efforts was evident in our first quarter financial performance and is further demonstrated by the fact that we remain confident in our outlook for the year of 8% to 9.5% organic revenue growth and a non-GAAP earnings per share of $6.40 to $6.55. In conclusion, I'd like to thank our clients and shareholders for their support and our employees for their continued exceptional work and commitment. Now David Smith will give you additional details on our first quarter results and 2019 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, and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation. Highlights of our first quarter performance include a continued robust revenue growth, which was above the 10% level on an organic basis, and earnings per share that were in line with our outlook from February. In addition, we are pleased to have completed the $500 million acquisition of Citoxlab. We have already begun working with their talented team to share best practices and drive operational synergies between our businesses as we move forward with the integration process. First quarter non-GAAP earnings per share were $1.40, an increase of 8.5% from $1.29 last year. The primary driver to earnings per share growth was better-than-expected organic revenue growth of 10.8%, partially offset by a softer first quarter operating margin. On a year-over-year basis, the first quarter operating margin declined by 50 basis points to 16.3%. Similar to last year, the first quarter operating margin was expected to be the lowest level of the year due primarily to seasonality in the Biologics business and higher fringe costs. The impacts of the large RMS government contract with NIAID, the headwind from the compensation structure adjustments implemented on July 1 last year, and the capacity expansion in the Biologics business all reduced the operating margin in the first quarter as anticipated. In total, these items reduced the operating margin by 60 basis points. We expect each of these factors to either be anniversaried or become a much smaller headwind in the second half of the year, which gives us confidence that the second half operating margin in 2019 will improve year-over-year. Similar to the gating last year, the second half operating margin will be significantly higher than the first half level. For the full year, after factoring in the slight dilution associated with Citoxlab's mid-teens operating margin, we believe that the operating margin will be similar to the 2018 levels. Overall, our results for the first quarter support our growth prospects and profitability targets for the full year, which is why we have reaffirmed our guidance, including Citoxlab. We continue to be well positioned to deliver reported revenue growth of 16% to 18%, organic revenue growth in a range of 8% and 9.4%, non-GAAP earnings per share between $6.40 and $6.55, and free cash flow of $310 million to $320 million for the year. By segment, RMS and Manufacturing Support revenue growth guidance is unchanged from our initial outlook of mid-single-digit and low double-digit growth, respectively, on both the reported and organic basis. As a reminder, the RMS growth rate includes the incremental benefit from the NIAID contract this year. But over the long term, we continue to believe the RMS segment will grow in the low single-digit range organically. We continue to expect the DSA segment will achieve high single-digit organic revenue growth in 2019, and including the contribution from Citoxlab, the reported growth rate is now expected to be in the mid-20% range. Unallocated corporate costs are tracking to our expectations and totaled $40.8 million or 6.8% of revenue in the first quarter compared with 7.5% in 2018. The first quarter level is typically higher due to the normal quarterly gating of fringe-related costs, which then normalize over the course of the year. Citoxlab will not add meaningfully to corporate costs this year, and as such, we continue to expect unallocated corporate costs to be slightly below 6% of total revenue for the full year. Our first quarter tax rate was 17.2%, representing a 170 basis point increase from the first quarter of last year. This was consistent with our outlook in February and called for a year-over-year increase due to discrete tax benefits in 2018 that were not expected to recur. As a reminder, the first quarter tax rate is typically at the lowest level for the year due to the impact of equity vesting and exercise activity on the excess tax benefit for stock compensation. We expect 2019 to be no different and the tax rate to be in the mid-20% range for the remaining quarters of the year. We expect this to result in a full year tax rate on a non-GAAP basis in a range of 23.5% to 24.5%, including Citoxlab, which is unchanged from our initial guidance in February. Our total adjusted net interest expense for the first quarter was $16.2 million, which is slightly lower sequentially than the $16.6 million reported on a comparable basis in the fourth quarter. This total adjusted net interest expense is derived from interest expense, interest income, and a $6.4 million FX loss recorded in other income associated with FX adjustments related to our foreign debt. We entered into forward FX contracts to generate interest savings on our foreign debt. For the year, we now expect total adjusted net interest expense to be in a range of $68 million to $71 million, which incorporates approximately $5 million of borrowing costs related to the Citoxlab acquisition. Our capital priorities remain consistent with our February outlook. At the end of the first quarter, our gross leverage ratio was 2.6x and our net leverage ratio was 2.4x. As planned, we financed the Citoxlab acquisition under our existing euro-denominating revolving credit facility. On a pro forma basis, following the completion of the Citoxlab acquisition, our gross leverage ratio was 3.25x, our net leverage ratio was 3x, and we have total debt outstanding of $2.1 billion. Our capital priorities in 2019 will be focused on debt repayment, and absent any additional acquisitions, we remain on track to drive the gross leverage ratio below 3x within 12 months. Free cash flow was a negative $1.9 million in the first quarter compared to a positive $32.3 million last year. The decrease was primarily driven by the timing of certain working capital items related to an ERP systems implementation at MPI as part of the integration process. The effect on working capital is expected to normalize over the course of the year. Capital expenditures were $16.7 million in the first quarter compared to $27.7 million last year. Looking ahead, we are increasing our CapEx guidance by $10 million to approximately $170 million in 2019 to reflect the additional capital requirements of Citoxlab. Factoring in Citoxlab's capital requirements and the transaction and integration-related costs, we now expect free cash flow will be approximately $10 million lower than our prior outlook excluding Citoxlab and in a range of $310 million to $320 million a year. By comparison, we similarly reduced our free cash flow outlook last year when adjusting for the onetime deal costs associated with the MPI acquisition. Beyond 2019, Citoxlab is expected to be accretive to cash flow in 2020, when transaction and integration costs significantly decrease. To recap our guidance for 2019, we are reaffirming our guidance for most financial measures. With the Citoxlab acquisition having closed during the second quarter as expected, our outlook for revenue growth including Citoxlab and non-GAAP earnings per share is unchanged. A summary of our financial guidance can be found on Slide 36. For the second quarter, there are several factors contributing to our outlook, the most significant of which is the addition of Citoxlab. We expect second quarter reported revenue growth in a low double-digit range on a year-over-year basis, including the partial quarter contribution from Citoxlab. On an organic basis, we expect the second quarter growth rate to be in line within the guidance range for the year. As I mentioned earlier, we expect the NIAID contract, the compensation structure adjustment, and the Biologics capacity expansion to continue to pressure the operating margin in the second quarter, resulting in a slight decrease year-over-year. We expect to generate margin improvement in the second half of the year as these headwinds abate. In addition, we expect the addition of Citoxlab to pressure the operating margin in the second quarter, as will modest IT remediation costs. We expect a sequential increase in interest expense due to the Citoxlab acquisition and a non-GAAP tax rate in the mid-20% range, as previously discussed. These factors are expected to result in non-GAAP earnings per share growth in the mid- to high single-digit rate in the second quarter when compared to last year's second-quarter level of $1.45, excluding the venture capital investment gains. In conclusion, we are pleased with our first quarter performance for both the top line and bottom line, including 10.8% organic revenue growth and 8.5% earnings per share growth. We remain on track with our financial and operational plans for the year. Thank you.

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

Maybe, Jim, starting with research models. I think you noted softness some outside of China, in particular for large biopharma. Can you maybe just elaborate on that a little bit?

Yes, certainly. It's always related to infrastructure and capacity management, often involving reductions from these clients. We have seen a continuation of that trend. The business is on a linear trajectory, making it challenging to predict quarterly performance, but the pharmaceutical sector has been decreasing its overall R&D efforts for several years. As we mentioned earlier, we are particularly affected by this because we serve as the main supplier to large pharmaceutical companies. However, China remains very strong for us. Our services had a solid quarter. We likely saw unexpected growth in the academic market and among nongovernmental clients, which somewhat counterbalanced the reductions in the pharmaceutical sector, but nothing out of the ordinary, Tycho.

And if I could ask one related follow-up. We did see an interesting strategic move with the asset transfer between Envigo and LabCorp-Covance this quarter. Did that change anything from your perspective competitively?

Not really. That was to be anticipated for sure. We're the largest player in the research model space, so they will continue to be a competitor of ours. They compete with us in some of the species that we produce, while in others, we don't participate at all. The standalone business that's left at Envigo will be a competitor of ours as it has historically been, primarily in price rather than deep science. The combination of Covance and the former Hannington obviously makes for a larger player on the international stage in safety assessment. We're about 50% larger than they are at this time, and we will continue to distinguish ourselves through deeper science and broader geographic presence. The market is quite favorable. Between the two of us, we hold about half of the market share, with many smaller players providing balance. There is new work regularly coming from biotech clients that is available to any of us. We feel very confident about the strength of our franchise and the three deals we've completed in the last three years: WIL, MPI, and now Citoxlab, which have given us a vast geographic and scientific footprint. So, it's expected that there would be some change, and we acknowledge and accept that. We're feeling increasingly secure and stronger as a franchise.

This is Courtney Owens asking on behalf of John Kreger. I have a quick question regarding the cyber issue mentioned earlier in the call. I noticed it wasn't included in the 8-K. Are you planning to disclose how long it was occurring before you detected it?

We did. We can disclose it again to you now. So we saw some unusual activity in our system in the middle of March. We don't know what that was or where that was or what was going on, and we worked arduously with federal law enforcement and some cybersecurity experts to figure out what was going on. It took us a while to do that. We found that some data had been copied. And it took us until just recently, April 30, to discern what clients were impacted and how they were impacted. We've contacted all of those clients, by the way. So they tell us that we caught it extremely quickly. It takes most people much longer to do that. So I think our systems identified something unusual, and we were able to identify specifically who was impacted and contact them immediately. So we're feeling not good about the incident but really good about our response time and how clients have taken the information we provided them.

It's Luke on for Ross today. Just kind of want to dig in a little bit more on the margin dynamics, if you could break out kind of the magnitude of the various impacts. There's a lot of moving parts there. And ultimately, looking forward to the outlook for the year, the NIAID contract, kind of that rolling off and then how the rest of the margin pressure look for the year.

Sure. I'll address that. Margin is a crucial topic for us, and I understand it is for you too. Let me break down the details. Typically, Q1 experiences a decline due to seasonality, especially in Biologics. This year, Q1 was down by 50 basis points compared to last year, which requires some clarification. Of that, 60 basis points is due to three key factors: the largest being the adjustment to our compensation structure announced last July, the second being the expansion of Biologics capacity, and a smaller component related to the NIAID contract. These three factors account for 60 basis points. Regarding Biologics capacity, I want to mention that manufacturing saw a 90 basis points decline, with 80 basis points attributable solely to the capacity expansion. That outlines the quarterly aspects. We anticipated DSA to perform slightly better, but it remained flat. The adjustment to the compensation structure resulted in a headwind of just over 60 basis points for DSA this quarter, similar to the headwinds experienced in Q3 and Q4 last year, both of which had year-over-year margin improvements. We hoped for a similar outcome in Q1, but it remained flat. However, it is important to note that this business isn't linear. In Q1, we made investments in staffing, and we expect to see the benefits of that in the second quarter. As Jim mentioned, we will see margin improvement, and we expect the second half of the year to perform better than the first half. It’s common for DSA, particularly Safety Assessment, to have a stronger second half. This gives us confidence in our margin for the rest of the year. We also noted that there will be some ongoing pressure from Citoxlab, which has mid-teen margins, similar to what we experienced with WIL. We successfully improved WIL margins over the last two years, and we still expect to achieve similar progress with Citoxlab moving forward.

That's very helpful. Then I guess just more on thinking about China outside the RMS business. I kind of get that RMS is your foothold into the research market and then gaining share there and then you kind of roll in the other businesses. When can we expect the bigger investment in the DSA and Manufacturing, if at all, that is, in the strategy in China?

We anticipate having our full portfolio and presence established in China, primarily targeting the local market. As mentioned previously, pursuing mergers and acquisitions in that area, which is our preferred approach for entering China, is challenging due to valuations and conditions in the public markets. Therefore, we will likely wait until that market stabilizes, if it ever does. If it doesn't, we may have to seriously consider pursuing organic growth instead. The RMS sector presents a significant opportunity for us, so we will remain focused on it for the time being. This will entail continuing to develop sites and educate the market, which we have been doing effectively. We also have some RMS services linked to the research models business. However, at this point, I would say there are no immediate plans, and I don’t expect anything to happen in the near future.

I guess, David, just to go back to the margin question. I want to make sure I was following this. And I was more focused specifically on the DSA margin because that, I guess, you highlighted, came in a little bit lighter than you and what we were expecting. But it looks like based on the slides, you're expecting that to rebound back to 20-plus percent, I think, beginning next quarter. Sounds like you're still facing the wage increases, and you mentioned the mix shift being negative with Citoxlab. So just trying to understand the visibility and the moving pieces as we think about the model forward on the DSA margins. What gets us from the first quarter levels to that 20-plus percent as we move into the next quarter and beyond?

To provide additional insight, if we examine Safety Assessment historically over the past few years, we note that the second half typically surpasses the first half by just over 50 basis points, or nearly 500 basis points. There are various factors contributing to this. Part of it relates to pricing. Last year, we mentioned a stable long-term mix, while this year includes the effects of adjusting our compensation structure. We exceeded our expectations in the second half of last year. Essentially, there’s not much more to elaborate on; we are not a linear business. We have made investments in staffing to support the strong revenue growth you've observed today, and we anticipate a stronger second half for Safety Assessment.

And I guess just one point of clarification on the modest IT remediation costs. Do those fall in DSA? Or is that in other segments? Or is it kind of spread across the business?

Let me clarify that for you. As Jim mentioned, we don't anticipate a significant impact for the year. It's still early, and our preliminary assessments give us confidence, especially regarding remediation. We have insurance that will partially cover some of those costs, though not all. The expenses related to third-party cybersecurity advisors for remediation will, in part, be classified as non-GAAP. However, costs related to internal enhancements that are ongoing in our business may not be included in corporate expenses. While some of those costs may be distributed, I wouldn't consider them a major burden for the overall Charles River or for DSA.

Now that the Citoxlab deal is closed, I was wondering if you could just give us a little bit more color on some of the customer overlap between the businesses and the $115 million to $130 million contribution this year. Just what does that imply for their growth over the balance of 2019?

The customer overlap is slightly less than with MPI, but it's similar. We would like to emphasize that with both WIL and MPI, clients chose them for specific reasons and did not come to us, likely because they preferred to work with a smaller company. These clients moved on to a larger entity. In both cases, we made significant efforts to retain those clients, and we succeeded in keeping them. Similarly, new clients are now going to Citox for various reasons such as history, reputation, and geographic proximity. We will carefully support these clients in their respective locations. We hope to see the same outcomes as with the previous two deals, meaning we have already observed former MPI and WIL clients utilizing multiple CRL sites and the reverse. Legacy Charles River clients are now successfully using WIL and MPI sites, and we expect the same with Citoxlab. I've mentioned in my previous remarks, and I want to stress again, that client mobility is a major focus for us. This refers to clients being satisfied with conducting their work at various Charles River locations. This allows us to utilize our infrastructure effectively and keep it busy. They can initiate studies more quickly and closer to their facilities if that is important to them. Without going into too much detail, I would say that the growth rates of the company we just acquired are comparable to what we’ve seen in our industry. We believe the market conditions are stronger than ever. Bookings and backlogs are robust, and we are committed to ensuring a smooth and effective integration. We would be both surprised and disappointed if we are unable to retain these clients as well.

Great. And as you get into the merger, could you just outline for me the capture of the synergies, what you're expecting in terms of the timing there? And as we sit here today, I know there's been a big focus on the margin point. Do you think DSA margins can return to expansion? Is that what we're looking at in 2020?

For Citoxlab, we expect synergies of $8 million to $10 million over the next two years. Similar to our approach with WIL and MPI, we won't specify the synergies within the year, so we cannot determine how much will contribute to 2019 at this point. However, reaching the $8 million to $10 million in synergies would allow us to increase Citoxlab's margins to the 20% target, which is our initial objective. Regarding your second question about the expansion, can you clarify if you meant DSA, or should I address something else?

Just on the DSA segment overall.

Yes, as I mentioned earlier, we expect improvements as we move through the second half of the year. I'm not sure what additional details I can offer.

Congrats on the quarter. Jim, I joined late but I did hear you just reiterate the strength of the environment, and that shows through on your revenue performance. In DSA, I had thought, I guess, that the contribution of high-margin MPI starting in Q2 of last year might average up the DSA margin performance relative to the first quarter of last year. And it looks like it was more kind of in line year-over-year, so I may have missed some of the factors that impacted that. But if you could help me with the kind of pull-through to EBITDA or EBIT on the better revenue growth, I'd appreciate it.

The discussion brings us back to the linearity of DSA. Historically, we have seen the Safety Assessment in the second half outperforming the first half by slightly over 50 basis points, just under 500 basis points. There are various factors contributing to this, including pricing. Last year, we discussed the long-term steady mix, while this year is partially influenced by adjusting the compensation structure. We exceeded expectations in the second half of last year. Essentially, we want to emphasize that we are not a linear business. We have made investments in staffing to support the robust revenue growth we have experienced, and we anticipate that will contribute positively as the year progresses. We needed to ramp up staffing due to the demand reflected in our order books. To reaffirm, we expect Q2 to exceed the 20% margin, and as we continue into the second half of the year, we anticipate stronger performance compared to the first half.

Got it. You may have mentioned this, and I apologize for joining late. But were there simple mix factors or was it more of an SG&A issue? Additionally, some of the channel checking we've done lately suggests that in the last six or seven months, the pricing environment has likely firmed up. At least directionally, it's better, not worse. I'm just trying to understand some of the specific factors that influenced the first quarter.

So again, the only thing I’ve mentioned regarding the first quarter that’s a little unusual was some timing of investments around staffing to support the growth rate we’re expecting for Q2. There is inevitably a component of mix and a component of price in that. These factors clearly play out on a quarter-to-quarter basis. However, what we’re trying to convey is that we still feel confident about the full year.

Hopefully, a pretty simple one on the quarter. So I want to make sure that I'm following the adjustment to interest expense. It looks like this adjustment decreased non-GAAP interest expense despite it being described as an FX loss. So I don't see an adjustment for this in your reconciliation at the back of the release. It seems like what you're saying is that this is offset by a similar item in other income. So just to put this one to bed, did this item help the adjusted results, hurt the adjusted results, or have no impact?

No impact.

We manage this forward derivative on a quarterly basis, ensuring we have no exposure. The outcome is influenced by the foreign exchange and EURIBOR rates. If conditions remain constant for the rest of the year, we might see around $1 million, which is not a significant improvement, but it's still a positive development. We'd prefer having $1 million rather than not having it.

I'd like to go back one more time to the DSA margin, if you don't mind. If we look at your expectations that you laid out last quarter for that, you did indicate that you expected the DSA margin to be up year-over-year. And it came in flat. So while we understand that there were these compensation structure issues there, it does look like there was something that was a little bit different than your expectation. Is it possible to highlight what that was?

Yes. That was the investments in staffing, which I mentioned. And to Dave's earlier question, there is an element of mix and price. But it’s not so significant that it’s a particular individual item that we wanted to call out. When we look at the full year, we see the corrections taking place.