Susan E. Hardy - Charles River Laboratories International, Inc. James C. Foster - Charles River Laboratories International, Inc. David R. Smith - Charles River Laboratories International, Inc..

Jack Meehan - Barclays Capital, Inc. David Howard Windley - Jefferies LLC Tycho W. Peterson - JPMorgan Securities LLC Derik de Bruin - Bank of America Merrill Lynch Luke Sergott - Evercore Group LLC Ricky R. Goldwasser - Morgan Stanley & Co. LLC Robert Patrick Jones - Goldman Sachs & Co. LLC Jon Kaufman - William Blair & Co.

LLC George Hill - RBC Capital Markets LLC.

Welcome to the Charles River Laboratories First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. As a reminder, this conference is being recorded.

I'd now like to turn the conference over to Susan Hardy, Corporate Vice President of Investor Relations. Please go ahead..

Thank you. Good morning and welcome to Charles River Laboratories first quarter 2018 earnings 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 first quarter 2018.

Following the presentation, they will respond to questions. There's a slide presentation associated with today's remarks, which is 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. And the access code in either case is 447002. The replay will be available through May 24. You may also access an archived version of the webcast on our Investor Relations website.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 13, 2018, 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. I'll now turn the call over to Jim Foster..

Good morning. The year began with robust demand for our products and services with organic revenue growth rate improving sequentially in both the DSA and RMS segments. Clients are increasingly choosing to partner with Charles River for our science, for our support, and for the breadth and depth of our portfolio.

We are continuing to expand this portfolio to strengthen our ability to holistically support our client's drug discovery, early development and manufacturing efforts, and to enhance our position as the premier early-stage CRO.

The acquisition of MPI Research, which was completed on April 3, has enhanced our scale, our capabilities and our value proposition for clients. We will provide further details on MPI shortly, but let me begin by giving you the highlights of our first quarter performance.

We reported revenue of $494 million in the first quarter of 2018, a 10.8% increase over last year. Foreign exchange benefited revenue growth by 4.6% and the acquisition of Brains On-Line and KWS BioTest contributed 1%. Organic revenue growth of 5.6% was in line with the mid-single digit outlook we provided in February.

The DSA segment was the most significant driver of growth and the Manufacturing segment also contributed. From a client perspective, biotech clients were the primary contributor to our first quarter revenue growth as they continued to benefit from a robust funding environment.

The operating margin was 16.8%, a decrease of 180 basis points year-over-year. The decline was primarily driven by the DSA and Manufacturing segments. We attribute the first quarter operating margin decline largely to timing and believe the margin will improve sequentially in the second quarter.

We will provide further details on the operating margin shortly. Earnings per share were $1.38 in the first quarter, an increase of 7% from $1.29 in the first quarter of last year. A lower tax rate and venture capital investment gains drove the year-over-year EPS increase as well as the outperformance versus our initial outlook.

Venture capital investment gains were $0.10 cents per share in the first quarter of 2018 compared to $0.05 last year. Based on client demand, we remain enthusiastic about our outlook for 2018.

We are reaffirming our organic revenue growth guidance of 5.7% to 6.7% and increasing our reported revenue guidance to 18% to 20%, including MPI, due to a more favorable foreign exchange benefit.

We are also increasing our non-GAAP earnings per share guidance by $0.10 per share to $5.77 to $5.92, primarily reflecting the lower than expected tax rate as well as an incremental benefit from foreign exchange. David will discuss the details of these items shortly.

I'd like to provide you with details on the first quarter segment performance, beginning with the RMS segment. Revenue is $134 million, a growth rate of 20 basis points on an organic basis over the first quarter of 2017. The same factors that contributed to RMS growth in 2017 were also the primary drivers in the first quarter.

Growth in the research models business in China and in the research models services businesses, specifically GEMS and Insourcing Solutions. Higher revenue from these businesses was offset by a softer demand for research models in mature markets outside of China, particularly from global biopharma client.

The fact that these trends remain consistent from year-to-year is not surprising as RMS results continue to be influenced by the ongoing evolution of the biopharmaceutical industry.

As big pharma seeks to drive greater efficiency, these clients are reducing their internal infrastructures and externalizing research by outsourcing to CROs like Charles River and by partnering with biotech companies and academic institutions.

The externalization of research is leading to increased demand from the biotech sector, as well as new opportunities to support our clients' broader outsourcing needs. Biotech's cutting edge innovation has helped to propel the complexity of drug research.

Biotech researchers are utilizing specialty models including inbred models for genetic modification and immunodeficient models for oncology research and innovative technologies like CRISPR as critical tools to more narrowly target the causes of disease and successfully discover new drug candidates.

The intensification of our clients' outsourcing efforts is also the reason that the DSA segment is now the largest client of our research models business, and by a wide margin. As a reminder, sales to MPI are now intercompany transactions and will no longer be reported as revenue in RMS.

We also see evidence of the outsourcing trend benefiting the research models services business. GEMS 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. Insourcing Solutions revenue continues to increase as clients look to adopt flexible solutions for their vivarium management and research needs.

We believe that our clients understand the value of utilizing our efficient staffing solutions and if demand continues to increase, we expect the IS business could be a greater contributor to RMS growth over the longer term. Growth accelerated in our research models business in China in the first quarter, as we anticipated.

Our new production facility in the Shanghai area, which began shipments in the first quarter, provides additional capacity needed to support the robust demand and also enables us to gain share in the Shanghai market.

Our RMS business in China represents less than 10% of total RMS revenue, but it has been growing at double-digit rates since we acquired majority ownership of the business in 2013 and remains one of the company's leading long-term growth opportunities. To support this future growth, we intend to continue to invest in China.

Our focus on efficiency initiatives enabled us to generate and an RMS operating margin of 29.8%, only 30 basis points below the 30.1% reported in the first quarter of last year. We are pleased that the RMS operating margin was relatively stable, particularly when compared to the strong RMS performance in the first quarter of last year.

We believe that our focus on optimizing our infrastructure will help us improve the operating margin over the long term and maintain it in the high 20% range. We also continue to work on other initiatives to enhance the client experience, including the speed and ease with which they can interact with us.

Revenue for the Manufacturing Support segment was $100 million, a 6.3% increase on an organic basis over the first quarter of last year. The increase was driven primarily by the Microbial Solutions business and the Avian business also had a good quarter.

Microbial Solutions' first quarter growth rate was moderately below our expectation of low double-digit growth, primarily because we shipped additional products in Europe during the fourth quarter, ahead of a transition to a new distribution facility.

As part of our ongoing efficiency initiatives, we consolidated our Microbial Solutions distribution operations in Europe.

We remain very pleased with the performance of our Microbial Solutions business, which continues to benefit from the strength of our unique portfolio of rapid endotoxin and bioburden testing systems and microbial identification services.

Our advantage as the only provider who can offer a comprehensive solution for rapid quality control testing continues to resonate with our clients. There is an abundance of new opportunities to convert clients to our efficient testing platform and these discussions are taking place daily.

The Biologics business reported significantly slower growth in the first quarter. This results primarily from lower sample volume than anticipated, which can occur in the first quarter after the holiday period.

The number of biologic and biosimilar drugs in development as well as the efforts we made to position the Biologics business have led to a rapid increase in demand for our services, driving the need for new capacity.

In order to support our expectation for continued robust demand, in February, we announced plans to open a new 73,000 square foot facility in Pennsylvania. We intend to transition certain laboratory operations to the new site at a measured pace, starting at the end of this year and continuing through most of 2019.

Our expectation that the Biologics growth rate will improve in the second quarter is supported by increased bookings and proposal volumes. We expect Biologics to continue to be a meaningful contributor to our outlook of greater than 10% growth for the Manufacturing segment in 2018.

The Manufacturing segment's first quarter operating margin was 31.9%, 130 basis point decrease year-over-year. The decline was primarily related to the lower sales volume in Biologics, as well as higher cost associated with capacity expansion in Biologics, and Microbial Solutions' transition to the new distribution site.

We expect the Manufacturing operating margin will improve in the second quarter, and meet our long-term target in the mid-30% range for the full year. DSA segment revenue was $260 million in the first quarter, an 8.3% increase on an organic basis over the first quarter of 2017.

We were pleased with this performance, which reflected broad-based demand for both Discovery and Safety Assessment Services. The Discovery business reported higher growth in the first quarter and we are optimistic about its prospects for the year. Our in vivo Discovery business performed very well, particularly in oncology services.

Oncology is the largest and one of the fastest growing areas in drug research which is the reason we have continued to expand our expertise. In January, we enhanced our position as a premier oncology CRO with the acquisition of KWS BioTest which specializes in immuno-oncology services.

The initial stages of the KWS integration have proceeded well and we are making progress to further harmonize our broader oncology portfolio. Our unique ability to serve as a single-source partner to support the discovery of our clients' novel cancer therapies is expected to drive the continued demand for our oncology expertise.

Revenue for the Early Discovery business also increased in the first quarter. We are beginning to see the benefits of the actions that we have taken to improve the performance of this business. One benefit of the harmonization of our Discovery portfolio is the expansion of our integrated client relationships.

Many of the integrated programs begin with the target identification capabilities of our Early Discovery business and encompass other discovery sites as the program advances. Currently, more than half of all integrated discovery projects span multiple Charles River sites. Furthermore, many programs are progressing into our Safety Assessment business.

We believe this is a firm indication that by combining our Discovery and Safety Assessment businesses into a seamless operating unit, we will be able to better leverage the synergies between these businesses and enhance the service we provide to clients.

Safety Assessment revenue growth was driven by robust client demand, particularly from biotech clients, and sales to global biopharma clients also increased. Our capacity was well utilized and bookings and proposal activity remained strong in the first quarter, reinforcing our outlook for the year.

The study mix had a favorable impact on the revenue growth rate but pressured the DSA operating margin in the first quarter. The mix of long-term and short-term studies fluctuates from quarter-to-quarter, underscoring the fact that our business is not linear. In the first quarter, the study mix was weighted towards long-term projects.

With long-term studies, we incur significantly higher startup costs. This is a timing issue which doesn't affect the overall profitability of the individual studies. As we have discussed in the past, study mix can vary based but on our current backlog, we expect the study mix to return to more optimal levels in the coming quarters.

There were two primary factors that contributed to the year-over-year 210-basis point decline in the DSA operating margin to 18.6% in the first quarter. Foreign exchange contributed approximately half of the decline, reducing the DSA operating margin by approximately 100 basis points. The other primary factor was study mix.

As the long-term studies progress and the study mix normalizes beginning in the second quarter, we expect the DSA operating margin will improve and return to a level above 20%.

As we noted when we announced the acquisition of MPI Research in February, MPI expands our position as the partner of choice to support our clients' early-stage research efforts.

It strengthens our existing capabilities in general and specialty toxicology, adds capabilities in ototoxicology and abuse liability testing, expands our medical device capabilities and adds needed capacity to accommodate the significant demand from biotech and pharma clients.

As we noted when we announced the acquisition, we expect MPI will contribute revenue of $170 million to $190 million and non-GAAP earnings per share of approximately $0.25 in 2018. We completed the acquisition on April 3 and last week marked Day 30 of the post-close integration.

Prior to the close, our teams had been working very hard to plan an efficient integration process. Because of their exceptional efforts, I am proud to report that the integration has proceeded very smoothly over the first month.

We believe that we have established a sophisticated and disciplined integration process, leveraging dedicated staff and improving upon and learning from prior acquisitions, especially WIL.

We fully expect to achieve the goals, both operational and financial, that have been set for the integration, including generation of $13 million to $16 million in operational synergies by the end of 2019.

Similar to our experience with WIL, MPI employees appreciate the benefits of being owned by a synergistic parent, especially with regard to collaboration between the scientific staffs.

We believe that collaboration will leverage the talents of our larger scientific staff, enabling the combined entity to provide an enhanced level of service to our clients. The client response has also been exceptional.

As soon the acquisition was completed, discussions were held with many clients to review our broader capabilities and operational methodologies. We believe that our unique portfolio and extensive scientific expertise resonated with MPI's client base a significant proportion of which are biotechs.

In addition we received a number of inquiries from legacy Charles River clients including global biopharmaceutical companies expressing interest in working with the team at MPI.

We are encouraging client mobility not just with MPI but across our global Safety Assessment network because this will enhance our ability to accommodate client demand when our capacity is well utilized and study start times are elongating. We are optimistic in the robust business environment that gives us excellent growth potential.

Biotech funding remains strong. Funding nearly tripled year-over-year in the first quarter following the second strongest year ever in 2017. It is opportune that the market dynamics are robust at a time when we believe that we have built the premier early-stage contract research organization.

We have done so by focusing on portfolio expansion, scientific expertise, operational excellence and responsiveness which has enabled us to become the go-to partner for our clients and to capitalize on the opportunities in the marketplace.

We believe that the success of our strategy and value that we provide to clients was demonstrated by the fact that we were ranked as the best positioned pre-clinical CRO to work with in three recent sell-side analyst surveys.

In addition to our value proposition, we also believe that our focus on scientific expertise and providing extensive support for our clients are the reason that we worked on 80% of the drugs approved by the FDA last year.

We are gratified to be recognized as a trusted scientific partner by our clients and fully intend to continue to enhance our value proposition, both through internal initiative and strategic acquisitions. This year we are focused on the integration of the MPI and the continued execution of our strategy.

Our first quarter results position us well to achieve our guidance for the year, including organic revenue growth of 5.7% to 6.7%, and non-GAAP EPS growth of 9% to 12% including the contribution from MPI.

We are continuing to make investments in facilities and staff, which will further differentiate Charles River as the CRO partner of choice for early stage drug research, support our future growth and enhance shareholder value.

In conclusion, I'd like to thank our employees for their exceptional work and commitment, and our shareholders for their support. But before David begins, I'd like to take a moment to recognize and express my deep gratitude and appreciation to Susan Hardy for more than 15 years of distinguished service to Charles River.

Susan has led the Investor Relations function since joining the company in 2002. Through her dedication and commitment to excellence, Susan has elevated Charles River's investor communications and has earned an outstanding reputation among her colleagues and in the investment community.

As many of you already know, Susan will be retiring on June 1, so please join me in congratulating her on an exceptional career. We wish her the very best in the next chapter of her life. I'm also very pleased to say that Todd Spencer, who most of you know well, will be taking on the role as Head of our Investor Relations.

Now David Smith will give you additional details on our first quarter results and updated 2018 guidance..

Thank you, Jim and good morning. And I'd also like to echo your comments and sincerely thank Susan for her service to Charles River.

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, and the impact of foreign currency translation.

We are pleased with our accomplishment this year, including first quarter organic revenue growth that met our mid-single-digit outlook, earnings per share that exceeded our expectations even after adjusting for higher venture capital investment gains and a lower than expected tax rate, the enhancement of our capital structure through the $500 million senior notes issuance and refinancing of our credit facilities, and the completion of the MPI acquisition on April 3.

First quarter earnings per share of $1.38 outperformed our expectations. Earnings per share were driven by venture capital investment gain of $0.10 per share compared to $0.05 in the first quarter of last year and a lower than expected tax rate due primarily to $0.055 of discrete tax benefits in the first quarter.

Our initial guidance for 2018 included an estimate of venture capital investment gains of $0.14 which was higher than our original estimate in 2017 because we believe $0.14 more closely aligns with historical performance. The $0.10 gain in the first quarter was $0.065 above our initial quarterly estimate.

We will not forecast the performance of these funds beyond our annual expected return, therefore, we have not increased our full-year forecast beyond the $0.14 which was included in our original guidance. Our first quarter tax rate was 16.5% a 550 basis point decline from the first quarter of last year.

The year-over-year decrease was largely the result of discrete tax benefits which reduced the first quarter tax rate by 330 basis points, primarily related to a favorable state tax ruling. A tax benefit resulting from operational efficiency initiatives also contributed to the lower first quarter tax rate.

The excess tax benefit associated with stock compensation was $0.09 per share in the first quarter, which was slightly below our expectations and below the $0.15 benefit that we recorded in the first quarter of last year. Primarily due to the excess tax benefit, we expect the first quarter tax rate to be the lowest quarterly level for 2018.

In future years, this stock compensation benefit or potential loss should have a greater impact in the first quarter due to the timing of equity award vesting. For the year, we expect our tax rate to be favorable to our initial outlook of 25% to 26%. We now expect our full-year tax rate to be in a range of 23.5% to 25% on a non-GAAP basis.

The lower tax rate outlook is driven by the first quarter discrete tax benefits which will reduce the full year tax rate by approximately 70 basis points as well as a modest benefit from U.S. tax reform.

The tax reform impact is more favorable than the neutral effect we initially expected as a result of further guidance that has been issued by tax authorities. Our favorable tax rate outlook for the year is the primary reason that we have increased our earnings per share guidance for 2018 by $0.10 per share to a range of $5.77 to $5.92.

This range includes approximately $0.25 of accretion from the MPI acquisition, which is consistent with our original outlook. In addition to the lower tax rate, we also expect a small incremental EPS benefit from foreign exchange. The benefit from tax and FX is expected to be more than $0.10 for the year.

However, it is our intention to reinvest a portion of the upside into the business. Because of the favorable movements in foreign exchange rates, we also increased our reported revenue growth outlook by 200 basis points to a range of 18% to 20%, including the $170 million to $190 million revenue contribution from MPI.

The foreign exchange benefit is now forecast at 3% for the year compared to our initial outlook of a 1% benefit. The foreign exchange benefit for the year creates a meaningful headwind to the DSA operating margin, primarily because we are not naturally hedged in our Safety Assessment business in Canada and our Early Discovery business in the UK.

Although the top line FX benefit reduces the segment operating margin, we still will record an EPS benefit from FX in 2018. By segment, we are updating our reported revenue growth outlook to reflect the favorable FX rates and for the DSA segment, the completion of the MPI acquisition.

On a reported basis, we expect low to mid-single digit growth for the RMS segment, low to mid-teens growth for the Manufacturing segment and approximately 30% growth for the DSA segment. On an organic basis, our consolidated revenue growth outlook remains unchanged for the year at 5.7% to 6.7%.

I will now discuss several of the other components that affected our first quarter performance and our outlook for the year. Unallocated corporate costs, which total 7.5% of total revenue or $37.2 million in the first quarter, are tracking to our expectations for the year.

The first quarter level is typically higher because of the normal quarterly gating of fringe-related costs, which are typically highest in the first quarter and then normalize for the remainder of the year.

MPI did not meaningfully add to corporate cost for year and we continue to expect unallocated corporate cost to be slightly below 7% of total revenue in 2018. At $7.6 million, net interest expense in the first quarter was essentially unchanged on a sequential basis.

For the year, we now expect net interest expense of $55.5 million to $58.5 million to reflect borrowing for the MPI acquisition and our current capital structure. Primarily to finance the MPI acquisition, we refinanced our credit facilities at the end of March with a new $1.55 billion revolver and $750 million term loan due in 2023.

The new facilities increased our borrowing capacity by $650 million, but did not change the pricing grid from the previous credit agreement. At the beginning of April, we subsequently issued $500 million of senior notes due in 2026 at a 5.5% coupon rate.

We believe that this fixed rate debt enhances our capital structure by locking in the interest rate on a portion of our long-term debt, extending the maturity date three years beyond the credit facilities, and providing additional capacity to support our acquisition strategy.

On a pro forma basis for the completion of MPI acquisition, our gross leverage ratio was 3.3 times and our net leverage ratio was 3 times. Our capital priorities in 2018 remained focused on debt repayment. Absent any acquisitions, our goal will be to drive a gross leverage ratio below 3 times. I'll now provide an update on our cash flow.

Free cash flow increased to $32.3 million in the first quarter, compared to $18.8 million last year. The primary reason for the increase was higher client payments at the start of new Safety Assessment studies, which is related to the first quarter study mix that Jim discussed.

Year-over-year, CapEx increased by $11.8 million in the first quarter to $27.7 million, primarily driven by capacity additions to support our growth initiatives.

Factoring the MPI acquisition into our free cash flow and capital expenditure guidance, we now expect free cash flow will be $10 million lower than our initial outlook excluding MPI, in a range of $240 million to $250 million for the year.

The operating cash flow that we expect to generate from MPI's operations this year will be largely offset by transaction and integration costs. In addition, we are increasing our CapEx guidance by $20 million to approximately $120 million in 2018, primarily to reflect the capital requirements of MPI.

MPI is expected to be accretive to free cash flow next year when the transaction and integration costs significantly decrease. To recap our guidance for the year, we raised non-GAAP EPS guidance by $0.10, due primarily to a lower-than-expected tax rate as well as an incremental benefit from foreign exchange.

We also increased our reported revenue growth guidance by 200 basis points to reflect a more favorable benefit from foreign exchange. A summary of our financial guidance can be found on slide 40. For the second quarter, there are several factors contributing to our outlook. The most significant of which, of course, is the addition of MPI.

We expect second quarter reported revenue growth of at least 20% on a year-over-year basis with more than half of the increase attributable to MPI. On an organic basis, we expect the second quarter growth rate to be in line with our guidance range for the year and for each of our segments to be within their respective annual ranges.

We expect low to mid-teens growth in non-GAAP earnings per share when compared to last year's second quarter level of $1.29. This outlook assumes sequential expansion of our operating margin in the Manufacturing and DSA segments.

As Jim noted, we expect the DSA margin to improve above the 20% level in the second quarter as the study mix begins to normalize. The operational improvement in the second quarter is expected to be partially offset by less favorability from below-the-line items.

We expect a sequential increase in interest expense due to the MPI acquisition, substantially lower venture capital investment gains versus the first quarter, and a non-GAAP tax rate in the mid-20% range because we do not expect a meaningful benefit from stock compensation or discrete items for the remainder of the year.

In conclusion, we are pleased with our first quarter performance and also the prospects for the second quarter and full year. The strong demand environment for our unique early stage offering remains encouraging, and we remain focused on executing our strategy and achieving our long-term financial and operational targets. Thank you..

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

Thank you. And it has been requested that to limit yourselves to one question. And our first question, we'll go to Jack Meehan with Barclays. Please go ahead..

Thank you. Good morning. So I wanted to start and focus on Safety Assessment.

How has the MPI deal impacted your positioning and some of the conversations you're having for strategic partnerships and has there been any change in the competitive dynamic with any of the other players in the market that you've seen?.

So MPI is doing expressly what we had anticipated that it would. It expands our geographic footprint. It expands our service offering substantially. It also gives us the ability to work on client mobility.

So as you may have heard us say years ago, the most efficient way that we can operate this business is to think of our vast network as, let's say, a single building and be able to make sure that we keep it full. The way that you do that is that you have clients appreciate the capabilities that we have across all of our sites.

So, several things happened pretty much immediately upon close. One is we had inbound calls from current Charles River clients saying we want to know about the site, we want to audit this site, we want to consider using it as part of our work with you. So that's been fabulous.

We also had the inverse, which is MPI clients going to MPI for whatever reasons they originally went there, saying like to learn more about the Charles River portfolio particularly other specialty areas and other geographic footprints and also your discovery business so we can work with you on a more holistic basis.

So, it's opened up a whole opportunity for us to interface with clients in a more efficient way, hopefully a more holistic way, get them to utilize the portfolio and have this incremental capacity that we get with the MPI acquisition be able to help us with our growth metrics as well.

So, certainly it's been not just a larger company but I think stronger from a service offering and both an expansion of current specialty areas and the addition of a couple of new ones..

Great. That's helpful. And then on RMS you mentioned this outsourcing dynamic is benefiting that segment as well.

Can you just elaborate on that? Can you control where more of the models are getting purchased? And on the MPI point, how much of a drag is that as the intercompany sales get moved out?.

It's a modest drag. So the point there to keep remembering and we'll keep mentioning it, it's magnified every time we do a transaction like this, is that virtually all the CROs, virtually all of our competitors, are clients.

And that's a commentary on the fact that our animals are of extremely high quality and they want to use them themselves plus sometimes the sponsors request Charles River animals. So we haven't lost that business. When they're competitors, at least we have a piece of their work in terms of the animals that they buy.

And in the case where we now own these entities, we have the vertical integration, which I think allows a lot of things. It's a lot of planning so we have a sufficient number of animals, we have the right strains in the right places. We obviously control quality, and we have a more efficient model.

On the Research Model side, the principle issue on units has to do with the pharmaceutical infrastructure reduction, which sort of continues. Notwithstanding that, I think we're holding our own well. Particularly pleased with operating margins being nearly 30% in the first quarter. That's where we have guided you all to.

And we're going to see the tailwinds coming from China, and complex services like Insourcing Solutions and GEMS..

Thank you, Jim..

Sure..

And we'll go to line of Dave Windley with Jefferies. Please go ahead..

Hi, good morning. Congrats to Susan and thank you. And congrats to Todd for your promotion. Appreciate all your help..

Thanks, Dave..

Wanted to focus on DSA as well and, Jim, interested in how as you're talking about folding in MPI and the additional kind of client reach that that gives you into the small biotech arena, how, first of all, you manage those client relationships to keep them in the fold.

You touched on that a little bit, but knowing that MPI is now part of a much bigger organization. And then, two, as you think about your capacity, do you think about – I guess, what is the level of utilization roughly, if you're willing to share.

And then, two as you think about long-term growth, do you keep all available capacity because the growth is robust enough to grow into it or are there some opportunities for streamlining somewhere? How do you think about the capacity in Safety Assessment long-term? Thanks..

Wow. So we manage the client relationships very carefully, the way I'd answer that. So clients initially went to MPI for some reason, alleged smallness, alleged better service that comes with their scale, geography, historical preference, been a post-doc with somebody that worked there.

Whatever the reasons are, they are not unlike the reasons that people went to WIL or the reasons that people went to us in the old days versus others, so. We told clients that they (42:47) obviously, at the Michigan site that we just bought.

They can work with the same study directors and that really nothing will change if that's the way they'd like it. And I think some will like it that way. It's not our goal, though.

I mean, our goal is to have them understand, audit and, hopefully, take advantage of the broader Charles River portfolio and, as I said earlier, vice versa, have our current legacy clients take advantage of the MPI site which by the way is a high-science, high-quality, very large facility. So there's a lot of new clients, Dave.

This is not a dissimilar transaction to WIL. It's one site and it's all domestic. So, it's in some ways more straightforward but it's quite similar in terms of scale and client response and we really have done a superb job keeping the clients (43:46) and keeping the clients happy who were legacy WIL.

And we're quite confident we'll be able to do that with the MPI clients and we're absolutely getting positive feedback daily on this. In terms of capacity utilization, we are not going to give you the exact numbers except to say capacity continues to be well utilized.

It's a little less well utilized at MPI, which is a really good thing so that gives us the opportunity to grow there faster should we desire that that's the place we want to grow. The rate limiting factor there, just let me remind you, will be staffing.

So we will have to hire people and have them properly trained to work there but that's a faster turnaround than incremental space. Bite your tongue that we would ever consider streamlining. We're in a situation right now we have really great demand, Dave. It's as good as we've ever seen it in the history of this company.

You know the biotech inflows have been significant. I think the amount of work that the pharma companies are doing externally has increased. And I think that we'll need all available capacity.

Of course as you know since you've seen a lot of it, we do have a significant amount of available space which will have to be renovated in Massachusetts and Reno and some ability to build small pockets elsewhere.

So we feel very good about our ability to utilize our capacity strategically, opportunistically, thoughtfully and professionally and be able to do that without impairing our operating measures..

Got it. Thank you..

Sure..

We'll go to Tycho Peterson with JPMorgan. Please go ahead..

Hey, thanks. And I'll add my congrats to Susan, it's been great working with you over the years..

Thank you..

On Manufacturing, Jim, you talked about seasonality here. Microbial Solutions was below kind of low double-digit expectations and you talked about Biologics really kind of being a timing dynamic. I guess, can you get us comfortable on the recovery here? You talked about bookings maybe being a little bit better coming out of the quarter.

Should we still be thinking about double-digit growth in Manufacturing for the year?.

You should. That's very long-term guidance and certainly our guidance for the year and, as you know, we've been able to do that for multiple years in a row.

Microbial business was just a little bit softer than we would have liked and we explained that in our prepared remarks having shipping some additional product out of Europe in Q4, as we brought a new facility up online.

And it's up and operating extremely efficiently and business is very good there and demand is good, and so we anticipate a strong second quarter. Biologics tends to have just historically kind of a funky first quarter. So it tends to be a little bit seasonal following the end of the year.

So we saw a little bit lower sample volume than even perhaps we would have anticipated, but bookings and proposal volume are very strong there. We have really good franchise with multiple geographies at a time where biologics are getting to market in larger percentages than small molecule, so it's a really critical service that we provide.

As you heard us say in our prepared remarks, we're beginning the process of making some modest modifications and beginning the process of moving into quite a large facility in Pennsylvania where we're going to consolidate space to accommodate demand.

So feel really good about that sector on an organic basis going forward, both top line and bottom line. Even though the margins were terrific in the first quarter at 31% and change, we still think that they can be higher and be moving toward the kind of mid-30s that we told you was our long-term guidance..

Okay. And then one quick follow-up on DSA, you talked about the mix shifting to longer term projects.

Does that start to normalize as the year progresses, are you able to talk about how much of the DSA mix was long-term and any comments on DSA pricing?.

Yeah, we're not going to talk about pricing, as we told you, for competitive reasons. You get these sort of mix issues that are really tough to control, margins are in the final analysis comparable but you got higher startup costs on the long-term work. We have a little more long-term work now than short-term. That will normalize.

It's just the natural ebb and flows of the business and given the strength of the backlog and the bookings and proposal volume, we're quite confident that that will begin to sequentially ameliorate as we move through the back half of the year..

Okay. Thank you..

Sure..

And we'll go to Derik de Bruin with Bank of America. Please go ahead..

Hi, good morning..

Good morning..

Good morning..

Good morning. Susan, it's been a good time. I think we've been together for the entire 15 years, if I remember correctly..

We have..

So two questions. So the Biologics volumes were low in the first quarter and you're also in the middle of expanding capacity in the testing.

So how confident are you that you can fill this new capacity coming online and it doesn't impact margins? And then another margin question, you're are doing a number of deals lately where the margins tend to be lower.

And I guess how long do you get to that consolidated 20% operating margin or is it continually get diluted down by new transactions?.

Yes. So on Biologics, quite confident about the bill for the back half of the year. Quite confident in the demand and the new space is both a consolidation of older space which is less efficient and being able to provide incremental capacity for growth.

So it'll have a very modest impact on margin this year which you won't see, by the way, it's already embedded in our guidance, just to bring that online and the sort of smooth transition of a lot of complex scientific work from site to site and client to client. So we feel really good about that. Your other question's a really good one.

Think about it a lot. We do buy some companies with operating margins of 20% or higher. We just told you that MPI was higher. We're driving significant efficiency out of our business every year and we have sized that – it's north of $60 million the last year or two. And we're getting that in most of our businesses.

You saw that the RMS margin was higher in the first quarter as well. So we're very confident that we're knocking on 20%. Whether we get there this year or not, don't know. That wasn't our guidance, our guidance was to be better than the prior year.

Yeah, it's possible that some M&A could retard our ability to move forward but that's certainly not the way we see it long term. And Derik, we try not to buy anything. Look, our preference would be not to buy anything with margins below 20%. That's a little hard to do but we certainly don't buy anything that we don't believe will get to 20%.

So, we think on a consolidated holistic basis, that we'll achieve and exceed that goal..

Thanks..

Sure..

And we'll go to the line of Ross Muken with Evercore ISI. Please go ahead..

Hey, guys. It's Luke in for Ross. I just kind of wanted to unpack a little bit of what you're seeing in China. It seems like it hit a real inflection this quarter.

Just kind of give us your overall thoughts on the business there and how that's changing and then how your overall strategy with the overall Charles River business is kind of focusing on China?.

Yes. So China was slower in Q4 than we would have liked because we were capacity constrained. As we indicated, we have opened our new facility, which is outside of Shanghai with the express purpose of servicing the Shanghai market.

It's a large facility that should not only allow us to support that marketplace much more efficiently than coming from Beijing, which is what we were doing previously, but to take share and grow with that market, which is dynamically growing and probably – not probably, Shanghai is certainly the center of a lot of biomedical research.

So, we feel good about that. We will continue to invest in and around that area and other areas as well because China is going to be a geographic expansion play for us. So, unless we build new facilities, which are further west and south of where we are now, we won't be able to garner the work that's available in those locales.

Competition continues to be government-backed organizations who are capable, but don't have the scientific history and rigor and capability and experience and reputation that we do, so quite confident in our ability to take share from them in this rapidly growing market. So, feel really good about that business going forward.

As we said previously, we will slowly – probably acquire, but there may be some organic growth but we will slowly acquire other capabilities in China that mirror the current portfolio we have in the U.S. and Europe.

That will be a reasonably insular marketplace where drugs will be developed in China for China and the work will have to be done in-country. The M&A opportunities are pretty robust, but we are carefully working our way through them. So you should expect that that would be an area of M&A expansion for us over the next few years..

Helpful. And then last, I guess another margin on the MPI, it's more of a kind of where you see the puts and takes with achieving your stated synergy goals? I mean you guys have been doing this a long time and things sound like they're off to a great start.

So what's the upside scenario to those synergies and timing on achieving those?.

So I would refer you back to the WIL experience with a (54:47) similar sort of business. Again we had a raft of synergies that we were hunting to pull out. Very similar in the case of MPI. It's all about articulating what those synergies are, engaging fully which we did with WIL and there is no reason why we shouldn't do the same with MPI.

So, in terms of talking about whether there's upside, well, we're 30 days or just over 30 days in, so why don't we just focus on delivering these synergies that we've called out..

Fair enough..

Not get too far ahead of ourselves there. (55:17).

Touché. Fair enough. Fair enough. Thank you..

And we will go to the line of Ricky Goldwasser with Morgan Stanley. Please go ahead..

Good morning, and congrats, Susan. Thank you for all your help over the years..

Thank you, Ricky..

A couple of questions here.

Jim, I know that you said that you're not going to comment on pricing for competitive reasons, but just given the discussion questions around capacity, can you just give us any directional color on what you're seeing in terms of pricing?.

I'm just pausing to figure out how to do that without talking about pricing.

I would say that capacity in Charles River's shop is fully utilized and while we never get in to see what our competitors are doing and I would actually say that, as we look back, WIL was more full than we would have had anticipated as a competitor of ours and maybe MPI is less full than we would have considered as a competitor of ours.

So, you never know, I guess is my point. So, it is what it is, but we're not seeing any sort of aggressive or crazy or aberrant pricing behavior on the part of our competitors and really haven't for a while. So, I think everyone is filling up nicely. I think there's enough work to go around.

I think we're certainly taking share when we want to, rarely using price except if somebody comes after us hard, which as I said is not happening very often. And then I guess the only thing I would say about price is that we certainly try to achieve it when we can.

We have a lot of clients that have long-term contracts that are both price protected or at least protected in terms of the amount that we would increase price year-over-year.

But I think – obviously our costs go up annually and we're delivering exceptional science in a responsive fashion, so we intend to get paid well, we intend to have our margins continue to improve. So, we'll continue to get as much price as is possible..

Okay.

And then we recently heard about another pharma M&A, so just kind of like your current thinking about the M&A environment and your customers and what it means for the business?.

Yeah. So, we obviously pay careful attention to that. There was a small deal announced this morning. So it will continue. There's 20 biotech deals that have happened since the beginning of the year. Lots of them – perhaps close to all of them – but certainly lots of them were clients. I'm talking about the targets.

And there's a smoothing-out effect that we get. So our client base is so broad, particularly with the small clients that we don't really feel it but several things happen.

Either nothing happens and those are complementary portfolios and an acquirer that doesn't have any internal capacity either or already works with us and wants to keep that work with Charles River. It's possible that that doesn't happen, but as I said, it gets sort of smoothed out in mix and there'll be new companies being minted all the time.

So, we don't really notice that. You know that we don't have any large clients that account for more than 3% of our revenue. So, even if there was a big deal, the one that you're referring to, it's possible we have – there's no impact from that. I don't want to speak too specifically about that one.

But usually there's a positive benefit when we have two large companies getting together on the service side, particularly on the Safety Assessment side as they will inevitably take out lots of costs. And so one of the ways that they get the benefit of that is by doing more outsourcing. So, typically isn't an issue for us.

I doubt this one that was announced will be and we like our position and the breadth of our client base..

Thank you..

Sure..

And we'll go to the line of Robert Jones with Goldman Sachs. Please go ahead..

Hey. Thanks for the questions. And Susan, I too would like to thank you for all your help over the years..

Thanks, Robert..

Best of luck..

Thank you..

I guess, most of the fundamental questions around the business have been asked. So, maybe just one on tax.

You mentioned that the incremental tax savings were more than the 10% that guidance was raised by, and so I'm just curious where those reinvestments in the excess tax savings would be focused? I mean maybe you could just share a little bit, are those areas that you're currently investing in, are there new areas that you plan on investing in? Just trying to get a sense of where the reinvestment would be directed?.

Yes. So, the reinvestment is actually some new areas and we've have been – as we come through the year, we see some other opportunities, been discussing them with the executive team. And given the opportunity we had with the tax, we thought we'd use that to deploy that into securing growth, more for the future.

I think the impact you'll see from those investments are not in-year, more for future..

Got it.

And then, Jim, actually if I could sneak one more in, not a huge part of the business, but I was just curious if you had any updated thoughts on the chem or ag business? Obviously you saw one of your competitors is getting out of that business, just curious how you guys view that today?.

Yeah. It continues to be a solid business for us. It continues to provide nice diversification. On a pure pharma world, you know that we do a bunch of that at WIL and at Edinburgh. So and have strong relationships with large clients who depend on us heavily. So, we like it..

Got it. Thanks, guys..

Sure..

And we'll go to the line of John Kreger with William Blair. Please go ahead..

Hi. Good morning. This is Jon Kaufman on for Kreger. So, in Early Discovery, it seems like you're making some nice traction there.

Can you talk about what types of clients are driving this? Is large pharma becoming more open to outsourcing this type of work? And in terms of pull-through, what percent of these programs are moving into Safety Assessment today and where do you see that going longer term? Thanks..

Sure. So, very pleased with the stabilization of that business and the strength of the Discovery business in totality.

You all know that we got into this business to interface with the clients earlier and to effectuate some pull-through because clients absolutely don't want to stop and have multiple providers along the drug discovery and development pathway. So, we're seeing increasing number of integrated deals.

So large proportion of integrated deals for the Early Discovery, a large proportion of deals at all for this Early Discovery business are integrated. So that's very good. A larger number are across multiple sites, which is even better. So they're utilizing the whole Charles River portfolio.

And I'm not going to give you a specific percentage except to say that the numbers that are moving into Safety are increasing.

We also have some long-term Safety clients who of course we did do discovery, we haven't done it for that long, who are very interested in our discovery work and want to start with us earlier on their next compound or compounds after that. So we're beginning to see probably a better articulation on our part of the pull-through.

I do think that the organizational change that we made recently about literally pulling these businesses together from an operational point of view, having a more holistic sell-in process, very high scientific sell for Discovery is working very well for us.

We have a much stronger competitive position than anybody in both Discovery and Safety, and the combined entity is one the clients are resonating with. So what we always (1:04:22) is beginning to happen. As we always said, this is somewhat a function of scale.

Also a function of getting the word out, probably a function of clients talking with one another about the quality of the work that we're doing and us being able to connect the dots more effectively and clearly for them. So pleased with the way it's progressing..

Great. Thank you. And then just one housekeeping question.

On the tax rate, that 23.5% to 25%, is it fair to expect a similar rate in future periods? And then would that be inclusive or exclusive of any potential benefits from stock-based comp?.

Do we want talk about guidance for 2019? I think I would say – without getting into guidance for 2019, I think I would say directionally we're in the right sort of zip code. We might see some nuances, but it's fair to say that we're in the right sort of zip code..

Okay. Thank you..

And we'll go to George Hill with RBC. Please go ahead..

Yeah. Good morning, guys. And I want to echo my congratulations to Susan and Todd.

I guess, Jim, just asking about the new Biologics capacity, and I guess how long do you think it takes to fill out the capacity, and what are the implications for margins over time?.

So we hope it takes a while. It's really a big building. The business is growing very fast. So it will take a few years to fill it which is exactly what we anticipated. The history space is such that it's not going to be a big drag on margins.

As I said earlier, it's definitely a little bit of a drag this year because we have some duplication of costs as – and we may have some duplication of costs as well next year as we sort of move things from one site to the other without disrupting either the quality of the science or the work that's going on for certain clients.

But it's a very high growth business and we needed space badly. It's actually very proximate to our old space so in terms of employee retention and the quality of work space, it's going to be terrific for our employees.

So important the margins of that business should continue to remain strong going forward and we should be able to capture in the top line the significant demand that we're seeing by not being space-bound..

Okay, and I guess the margin profile or is that something we're not ready to talk about yet?.

Well, I mean the margin profile, it's a north of 20% margin business going forward..

Okay. And then, maybe just a quick follow-up. On the M&A environment, it would seem like there's a lot of fragmented stuff that you can buy.

And I guess I would just ask, I don't think we talk about this much, how do you think about the M&A environment where you guys buy assets versus how you think about the venture capital deployment?.

The environment continues to be extremely strong. So, there are a lot of assets for sale across our whole portfolio, it's mostly PE owned, which means that nothing is going to come cheap, but we won't chase anything that doesn't have the sorts of returns that we would like. So to some extent, we become a natural consolidator in the nonclinical space.

I think we have a strong leadership position. I think our balance sheet holds us in good stead. So, we feel good about the environment out there for the next few years..

Okay. I appreciate the color. Thank you..

And we'll go to Powers with Bloomberg Intelligence.(1:08:23) Please go ahead..

Hi, good morning. And also congratulations to Susan. Just a quick follow-up on China. I know, it sounds like the go-forward strategy is more of a focus on the domestics, but if you look at your existing book right now there, is that also primarily domestics or is it a mix of globals doing work in the market? And then, I have a follow-up..

Yes. Small amount of globals. That was not what we originally anticipated when we did this deal. It's mostly Chinese clients, mostly government clients as so many companies are. And that's clearly the way that market is going. There's a huge infusion of capital in there by the government to invest in the life sciences.

There's a proliferation of new biotech companies and pharma companies. You got a whole bunch of people being educated in the U.S. and Europe going back to China. So yeah, it's mostly going to be domestic..

Okay. And then just on the capital raising environment, 1Q was huge and I was wondering if you could help us think about more broadly how that kind of materializes into bookings and eventually revenue.

Just trying to get a sense of timing of when we see a big raise like that, how that impacts the growth funnel? And then also just a quick update on the VC strategy and how that's been contributing to growth? Thank you..

It's hard, sorry, VC strategy was the first question..

Biotech funding trends..

Yeah, it's somewhere between hard and impossible to predict it, because we've been asked this for years. I guess we would say that we rarely see a surge – be nice to see one and I guess we could – but we rarely see a surge even with big inflows. What we would tell you is demand is amazing, amazingly strong.

Biotech continues to be the principal driver of growth even though the pharma business is strong for several years. We don't have any clients complaining about inability to fund programs. So, it's steady state. If we see a surge, great, but we don't really anticipate that.

And I would say on your VC question, those relationships have been very powerful for us in terms of strategic understanding of the marketplace and how other companies like the ones that are being started by the VCs think and how they want to work with us.

And just on a pure revenue basis, the aggregation of these new companies that are being started by the VCs has become a significant number for us. I think we sized it in our last call, rapidly approaching $100 million in revenue, so – and that should continue to increase..

Thank you..

Sure..

Thank you for joining us on the conference call this morning. We look forward to seeing you at the Bank of America Conference next week or the Jefferies and William Blair conferences in June. This concludes the conference call. Thank you..

Thank you, ladies and gentlemen. That does conclude the conference. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect..