Charles River Laboratories International Inc (CRL) 2016 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Charles River Laboratories' first-quarter 2016 earnings call.

(Operator Instructions)

As a reminder this call is being recorded.

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

Please go ahead.

Thank you.

Good morning and welcome to Charles River Laboratories' first-quarter 2016 earnings conference call and webcast.

This morning, Jim Foster, Chairman, President and Chief Executive Officer, and David Smith, Executive Vice President and Chief Financial Officer, will comment on our first quarter results and update guidance for 2016.

Following the presentation they will respond to questions.

There is a slide presentation associated with today's remarks which is posted on the investor relations section of our website 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 number in either case is 391001.

The replay will be available through May 18.

You may also access an archived version of the webcast on our investor relations website.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 12, 2016, as well as other filings we make with the Securities and Exchange Commission.

During this call, we will be primarily discussing results from continuing operations and non-GAAP financial measures.

We believe that these non-GAAP financial measures help investors to gain a meaningful understanding of our core operating results and future prospects, consistent with the manner in which Management measures and forecasts the Company's performance.

The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP.

In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations to those GAAP measures on the investor relations section of our website through the financial information link.

Jim, please go ahead.

Good morning.

I'm very pleased to say that we are off to a great start in 2016.

Our financial results were strong across our three business segments, which reinforces our confidence in our outlook for the year and is enabling us to increase our non-GAAP EPS guidance.

We believe our performance demonstrates solid execution of our business strategy and our focus on exceptional client service.

As a result, clients continue to choose to partner with Charles River for our science, our support, and the breadth of our portfolio which enables them to work with us throughout the early stage research process.

The acquisition of WIL Research, which was completed on April 4, has definitely enhanced our capabilities and our value proposition for clients.

We will provide further details on WIL shortly but let me begin by giving you the highlights of our first quarter performance.

We reported revenue of $354.9 million in the first quarter of 2016, a 12.4% increase over the first quarter of 2015 in constant currency.

Acquisitions contributed 3.7% to first quarter revenue growth and our legacy businesses generated 8.7% organic growth, which is in line with our long-term target.

The most significant contribution came from the Safety Assessment business and we were also pleased to see 4.6% growth in RMS with higher sales of models in all geographic regions and improvement in the services businesses.

From a client perspective, biotechnology clients were the primary driver of revenue growth.

Sales to these clients increased at double-digit rates as they continued to invest in their pipelines.

The operating margin increased 220 basis points year over year to 18.4%, each of the three business segments reported an improved operating margin benefiting both from higher revenue and efficiency initiatives.

The RMS and DSA segments reported the most significant margin improvement, increasing 370 basis points and 350 basis points year-over-year respectively.

Earnings-per-share were $0.98 in the first quarter, an increase of 24.1% from $0.79 in the first quarter of 2015.

The improvement was due primarily to higher revenue and operating income.

First quarter EPS also benefited from our venture capital investments, which contributed a gain of $0.04.

We were exceptionally pleased to see such robust performance across our portfolio for the first quarter.

Our operating efficiency has continued to improve as a result of our ongoing performance improvement initiatives, so constant currency revenue growth of 12.4% translated into non-GAAP EPS growth of 24.1%.

On the strength of our first quarter results, we are increasing our 2016 non-GAAP EPS guidance to a range of $4.32 to $4.45, which is $0.05 higher at the midpoint of the range than our original guidance.

I'd like to provide you with details on the first quarter segment performance beginning with the RMS segment.

Revenue was $124 million, an increase of 4.6% in constant currency over the first quarter of 2015.

Sales of research models were the primary contributor to the increase, driven by higher revenue in North America, Europe, and Asia.

As we have for more than a year, we continue to see increased demand for inbred research models which we believe are the models of choice for translational research.

Research model services also contributed to the RMS segment's mid-single-digit growth in the first quarter.

As we noted previously with the anniversaries of the NCI contract cancellation and the reduction of a significant GEMS colony behind us, we expected revenue to improve for the service businesses.

Primarily as a result of higher volume and the benefit of our efficiency initiatives, the RMS operating margin increased by 370 basis points to 30% in the first quarter.

As you know, the research model business historically has a seasonably strong first quarter when both commercial and academic researchers return to work after the holidays and initiate new projects.

We were very pleased with the improvement, which exceeded our annual operating margin goal.

I would remind you that RMS -- the RMS segment margin is highly leveraged to volume so we would not expect a similar margin performance in quarters where revenue is seasonally softer.

From a long-term perspective we continue to expect an annual operating margin in the high 20% range.

Revenue for the Manufacturing Support segment was $72.9 million, a 22.5% growth rate in constant currency, over the first quarter of the year.

The acquisitions of Celsis and Sunrise contributed 14.8% to growth.

On an organic basis, growth was 7.7%, driven primarily by the Biologics and Microbial Solutions businesses.

The Biologics business reported a very strong year-over-year performance in the first quarter, with robust revenue growth as a result of strong demand for our virology and cell banking services.

The Biologics business supports the development of biologic drugs, which are representing an increasing proportion of drugs in development.

In order to accommodate greater demand for our services, we have expanded and are continuing to add infrastructure in both the US and Europe.

This additional capacity enabled the Biologics business to take on new business in the first quarter and our plans to continue to expand at a basis for growth in the coming years.

Microbial Solutions reported a good quarter, but revenue was lower than expected due to upgrades we had undertaken to enhance our manufacturing capacity.

Demand for PTS cartridges has increased significantly over time.

With the expansion of our product line from PTS to MCS to Nexus, and most recently to Nexgen, we have now sold more than 7,000 readers.

With more machines in service and greater requirements for testing generally, the demand for cartridges has increased.

In order to meet the demand we invested in new manufacturing capabilities, which will increase our cartridge production capacity by 40%.

The conversion occurred in the first quarter, and as we work through the process, some orders were backlogged.

With the conversion process now completed, we expect that the organic revenue growth rate will increase from the first quarter level and exceed 10% for the full year.

Integration of the Celsis acquisition is proceeding well, we are now focused on expanding our footprint in the market for rapid testing and microbial identification.

The acquisition of Celsis was a critical building block in our strategy to position Microbial Solutions as the only provider that can offer a unique comprehensive solution for rapid quality control testing of both sterile and non-sterile biopharmaceutical and consumer products.

We are optimistic that our ability to provide a total microbial testing solution to our clients will be a driver of our goal for microbial solutions to continue to deliver at least low double-digit organic revenue growth for the long-term foreseeable future.

The Manufacturing segment's first quarter operating margin was 31.4%, a 150 basis point increase year over year.

The improvement was driven by the Biologics and Avian businesses due to both increased volume and to the benefit of efficiency initiatives.

DSA revenue in the first quarter was $158 million, a 14.7% increase in constant currency over the first quarter of 2015.

The acquisition of Oncotest contributed 2.1% to the segment's first quarter growth.

The organic revenue growth of 12.6% was driven primarily by the Safety Assessment business, which reported a double-digit revenue increase over the first quarter of 2015, marking the sixth consecutive quarter with growth above 10%.

We were exceptionally pleased with this performance which resulted primarily from improved client demand, especially from biotech clients and the successful execution of our targeted sales strategies.

The DSA operating margin was 23.3%, an improvement of 350 basis points from 19.8% in the first quarter of 2015.

The improvement was due primarily to the Safety Assessment business as a result of leverage from higher revenue and also the discovery business as a result of both higher revenue and efficiency initiatives.

We were very pleased to see the Safety Assessment margin about 20% and believe that we will continue to see drive further improvement.

However, I will remind you that WIL 's margin is lower than the DSA margin.

We expect WIL's margin to improve but it will modestly reduce the DSA segment's operating margin in 2016.

We're optimistic about the prospects for our Discovery business.

Our In Vivo business did very well, particularly the oncology services, which we expanded with the acquisition of Oncotest in the fourth quarter of last year.

Integrated with Charles River's broader oncology portfolio, the acquisition created a premier oncology CRO with the ability to support the validation of novel cancer therapies.

The integration has proceeded well and with so many drug companies focusing on oncology therapies, the demand for expertise has increased.

The Early Discovery business is performing well and our pipeline is robust, which gives us confidence that revenue growth will strengthen in the coming quarters.

We continue with our efforts to inform our client base on the breadth of our unique portfolio and the value of working with a single partner through a larger portion of the early-stage drug research process.

There's great potential for growth in outsourcing of early discovery, however the decision process is lengthy.

That said, we have a reputation for expertise and are winning business competitively.

Our scientists are solving some of the most complex challenges of identifying disease targets and finding the keys which will unlock therapies to treat and cure diseases.

In fact, in February a client informed us that a drug candidate identified by our early-develop discovery scientists, had been approved to begin the early development process, making this our 64th drug candidate.

This is an achievement that few pharmaceutical companies can claim and one of which we are very proud.

As I mentioned, our Safety Assessment business had a very strong quarter, with most of our facilities reporting significantly higher revenue.

Having invested in portfolio expansion and enhanced our scientific expertise, improved our operating efficiency and developed flexible customized working relationships with clients, we are positioned exceptionally well to provide the services which our clients require in order to support their drug research efforts.

Our extensive capabilities are especially important now, when global biopharma companies are increasingly reliant on CROs and small and midsize biotech companies which have always relied on external resources are investing in their pipelines.

As clients have increasingly chosen to work with us, capacity at our Safety Assessment sites has continued to fill, and opening Charles River Massachusetts provides infrastructure to accommodate growth.

As we noted when we initially announced the acquisition of WIL Research in January, WIL is another key element of our continued ability to support our clients' early-stage research efforts and our long-term growth goals.

It strengthens our existing service offerings in different geographic regions, enabling us to provide support more proximate to our clients' locations in North America and Europe.

As a result of tremendous effort on the part of our deal and integration teams and an extensive group of employees at both Charles River and WIL, we were able to close the acquisition on April 4, at the beginning of the second quarter.

Today is day 30 post-close and I am proud to say that the same enthusiasm with which everyone approached the process of getting the acquisition closed, is now being applied to the integration process, which was meticulously planned.

Many organizational decisions were made by the joint integration teams prior to the close and meetings were held with all employees within the first few days following the close.

As soon as the acquisition was completed, discussions were held with many clients to review our broader capabilities and operational methodologies.

As a result, we believe there was minimal disruption to WIL's workforce or to ongoing client projects or business development efforts.

I am pleased to say that similar to our experience when we acquired Argenta and BioFocus, the WIL employees are already seeing the benefit of being owned by a synergistic parent, especially with regard to collaboration with the scientific staffs of both Charles River and WIL.

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.

I also noted in January that we had established a broader integration function to ensure that we achieved our targeted goals for the WIL acquisition.

In addition to staffing the function with dedicated personnel, many at a senior level, we defined key performance indicators to quantify our progress on integration.

We are carefully tracking these KPIs to ensure that we achieve the expected cost synergies of $17 million to $20 million over a two-year period as well as a number of additional measures.

As a result of our extensive planning, we are confident that the integration will proceed in line with our plan and that we will achieve the goals that we set for the acquisition.

We're continuing to have strategic discussions with heads of research at global biopharmas and small and midsize biotech companies and are expanding our discussions with academic institutions to identify the opportunities to work together across a broader portfolio.

These discussions are particularly important now because the addition of capabilities and expansion of our global footprint presents greater opportunities to support our clients drug research efforts.

The breadth of our unique portfolio and extensive scientific expertise resonate with all types of clients.

Global biopharma companies, which are increasingly making a more significant commitment to outsourcing as they strive to improve operating efficiency and increase pipeline productivity.

Biotech companies, which have traditionally preferred outsourcing to building infrastructure and academic institutions which are partnering with biopharma to monetize innovation and require partners to provide expertise in drug discovery and development.

We believe that this is the right time to pursue these relationships because R& D spending is stable to increasing.

The use of outsource is trending higher and funding is available especially for biotech.

As with the case in 2015, biotech companies were the primary driver of first quarter revenue growth and sales to these clients increased at high teens rate year-over-year and at a slightly higher rate for the DSA segment.

We commented when we announced our planned acquisition of WIL that even if biotech funding from the capital markets were to slow, we believe that biotech companies had sufficient cash on hand to fund research for a minimum of three years, a point of view which has been supported by a number of analyst reports published since.

This cash will be buttressed by continued support from large pharma.

We expect that biotech companies will be a significant source of revenue growth for us, which is one of the advantages of WIL's exposure to small and midsize biotech.

Our priority over the next 18 months will be to integrate the WIL acquisition in order ensure that we obtain at expected benefits and to repay debt.

We intend to continue to assess opportunities to broaden our early-stage portfolio with strategic acquisitions and in-house development as we continue to increase our capabilities and therapeutic area expertise to enhance our ability to support our clients.

We believe that the extensive support we provide for our clients is the reason that we worked on more than 55% of the drugs approved by the FDA in the last two years.

We remain focused on our long term strategy to maintain and enhance Charles River's position as the premier early-stage contract research organization, to achieve our long-term goals and to enhance shareholder value.

In conclusion, I would like to thank our employees for their exceptional work and commitment and our shareholders for their support.

Now I'd like David Smith to give you additional details on our first quarter results.

Thank you, Jim, and good morning.

Before I begin, may I remind you that I will 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.

We're very pleased with our first quarter performance especially given that the start of the year can be difficult to predict as clients prioritize their budgets for the year and the associated impact on study starts.

We believe that the strong start this year is a testament to the demand for and quality of the early-stage products and services that we provide.

From an operational perspective, our first quarter results were ahead of our expectations primarily driven by a return to mid-single-digit growth and margin expansion in the RMS segment.

First quarter earnings per share of $0.98 were further aided by other income which contributed approximately $0.05 to earnings per share.

This was primarily driven by a forethinking from our life science venture capital investment.

The guidance for 2016 which we provided in February, included an expected gain of $0.04 per share for the year which we fully achieved in the first quarter.

We expected an annual return on our investments in these venture capital funds in line with our weighted average cost of capital but do not forecast the performance of these funds beyond our annual expected return.

Therefore, we have not forecasted additional gains from these investments for the remainder of the year.

Our primary purpose in partnering with life science venture capital firms is to enable us to access a large portfolio of emerging biotech companies at an early stage.

This offers us the opportunity to become the preferred provider for that their drug discovery and early development need.

The investment returns, while attractive, have always been a secondary element of these relationships.

With respect to our revised outlook for 2016, our first quarter performance was certainly one factor that led us to raise our non-GAAP earnings-per-share guidance by $0.05 to a range of $4.32 to $4.45.

Higher expectations for RMS for the remainder of the year and the timing of the WIL close also contributed to our improved outlook for the year.

Revenue for the RMS segment will be marginally better than we expected in 2016, and as you know, the incremental margin on that revenue will be higher than the second margin.

This will result in a modest expansion of the RMS operating margin in 2016 compared to our prior outlook of a margin similar to 2015.

In addition, we closed the WIL acquisition on April 4, which was very early in the second quarter so we expect EPS contribution from WIL to be at the upper end of our implied $0.20 to $0.23 range.

Our revenue guidance is unchanged for the year.

Excluding WIL's revenue contribution, our outlook for each segment is also unchanged.

Just to recap, we expected low teens growth for the DSA segment, and mid- to high-teens growth for the Manufacturing segment.

As noted in our earnings release, the majority of WIL's operations will be reported in our DSA segment due to its Safety Assessment focus.

WIL's CDMO business, which had annual revenue of nearly $20 million in 2015, will be reported and our Manufacturing Support segment.

On a constant currency basing including WIL, we expect revenue growth in the upper 30% range for the DSA segment and above 20% for the Manufacturing segment.

We continue to expect constant currency revenue growth in the low- to mid-single-digits for the RMS segment, and as I just mentioned, the RMS operating margin will expand modestly in 2016.

Our outlook for the DSA and Manufacturing operating margins is consistent with our previous expectations.

We expect the DSA operating margin to be modestly lower in 2016, reflecting the impact of the WIL acquisition as well as the 80 basis point headwind from the Quebec tax law change that was enacted in October, 2015.

We continue to expect the operating margin in the Manufacturing segment to modestly improve this year.

On a consolidated basis, we expect the operating margin will be similar to or slightly higher than 2015.

Our outlook for the foreign-exchange impact is also in line with our initial guidance in February.

We continue to expect foreign-exchange to reduce reported revenue growth by approximately 1% and provide a slight benefit to earnings per share.

The Canadian dollar has strengthened over the past three months but in aggregate other foreign currencies have been relatively stable and have not meaningfully effected our outlook.

I will now discuss several of the non-operating components that effected our first quarter performance as well as our outlook for the year.

Unallocated corporate costs increased $6 million year over year to $31.6 million in the first quarter.

The year-over-year increase was primarily attributable to the factors that I mentioned in February, including investments to support future growth.

For the year, we have updated our outlook to adjust for the WIL acquisition, which does not add meaningfully to corporate costs.

We now expect unallocated corporate costs to total approximately 7% of the revenue including WIL, which implies unallocated corporate costs of approximately $115 million to $120 million in 2016.

This is essentially unchanged on an absolute dollar basis from our prior outlook.

At 8.9% of revenue, the first quarter level was significantly higher than our outlook for the year.

This was primarily due to the normal quarterly gating of health and fringe related costs, which are typically highest in the first quarter and then normalized for the remainder of the year.

At $3.9 million, net interest expense was in line with our expectation for the first quarter.

The $400,000 sequential increase was due to the impact of the Federal Reserve's interest rate increase in December, while the $1.4 million year-over-year increase was primarily driven by incremental interest expense related to our 2015 acquisitions.

For the full year we now expect net interest expense of $26 million to $28 million including WIL.

This is at the top end of the outlook that we provided in February because the WIL acquisition closed very early in the second quarter and we also borrowed slightly more than initially anticipated.

The non-GAAP tax rate increased approximately 180 basis points in the first quarter to 28.2%.

The increase was primarily driven by certain assertions we made in order to access cash outside of the US in a tax efficient manner.

For the year, our non-GAAP tax rate guidance is unchanged from our prior outlook of 28% to 29% including a 50 basis point increase from WIL.

I'll now provide an update on our cash flow and reiterate our capital priorities for the year.

Free cash flow increased to $30.3 million in the first quarter, compared to $600,000 last year.

The reasons for the significant increase was a strong year-over-year earnings growth and our past working capital management, as well as the timing of cash inflows associated with UK R&D tax credits and other tax items.

Looking at this year, we have now factored the WIL acquisition into our free cash flow and CapEx guidance for 2016.

We continue to expect free cash flow in the range of $235 million to $245 million for the year.

Our strong first quarter performance and the cash generated by WIL's operations will be offset by transaction and integration costs related to WIL in 2016.

WIL is expected to be accretive to free cash flow next year when the transaction and integration costs significantly decrease.

Capital expenditures decreased by $2.4 million to $8.2 million in the first quarter.

For the full-year we are increasing our CapEx outlook to a range of $80 million to $85 million to reflect WIL's capital requirements.

This compares to our prior outlook of approximately $70 million for the Charles River legacy businesses.

Our primary focus for capital deployment in 2016 will be the repayment of debt.

It anticipation of funding the WIL acquisition we amended and expanded our credit agreement on March 30.

We increased our borrowing capacity by $350 million to $1.65 billion, which includes a term loan of $650 million and a multi-currency revolving credit facility of up to $1 billion.

We had $1.4 billion of outstanding debt on our credit facility at the end of April.

Which equates to a pro forma leverage ratio of approximately 3.4 times.

We are committed to our goal to drive our pro forma leverage ratio below three times within 18 months of the acquisition's close.

Based on our current leverage ratio, our interest-rate is now LIBOR, or at the applicable local rate, plus 150 basis points for drawn amounts.

One of the benefits of reducing our leverage ratio will be that the interest rate spread will decline to 125 basis points once we are below three times.

We did not repurchase shares in the first quarter because we do not anticipate any meaningful stock repurchases in 2016 as a result of our focus on debt repayment.

We expect our average diluted share count to increase to a range of $48 million to $48.5 million for the full year.

As Jim mentioned, the early phases of the WIL integration are progressing well.

We have already begun to implement initiatives to help us achieve our two year goal of $17 million to $20 million in operational synergies.

Many of the initial projects have been focused on generating efficiencies primarily through elimination of duplicate roles as well as corporate savings.

In addition, we have also begun to implement procurement initiatives such as optimizing the supply of research models for WIL.

Productivity and process efficiency will also be a significant focus of the integration efforts going forward, through implementation of best in class processes from both Companies and managing KPIs and other metrics.

To recap our guidance for the year, we have raised non-GAAP EPS guidance by $0.05 due primarily to our expectations for a stronger operating performance, while most of our other metrics are tracking to our initial guidance.

On a non-GAAP basis, revenue is unchanged.

Our operating margin outlook has improved slightly, partially offset by interest expense that will be at the top end of our previous range and guidance for the tax rate, diluted share count, and free cash flow all remain unchanged.

For the second quarter, there are several factors contributing to our outlook the most significant of which of course is the addition of the WIL.

We expect second quarter reported revenue to increase more than 20% on a year-over-year basis with more than half of this increase attributable to WIL.

On a segment basis we expect the year-over-year growth rate in each segment to be similar to the first quarter trend before factoring in the contributions from the WIL in the DSA and Manufacturing segments.

We expect low teens growth in non-GAAP earnings-per-share when compared to the second quarter 2015 levels of $0.96.

This outlook assumes significant revenue growth and a slight sequential expansion of our operating margin in the second quarter partially offset by below-the-line items, including a sequential increase in both the tax rate and interest expense due to the acquisition of WIL.

We expect that lower corporate cost due to the normal quarterly gating of health and fringe related costs and margin improvement in the Manufacturing segment will be mostly offset by a sequential decline in the DSA operating margin due to the inclusion of WIL.

Over time we continue to expect WIL's operating margin to improve as acquisition synergies ramp-up and capacity continues to fill.

So 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 early-stage products and services is encouraging, but we will not be complacent.

We are well aware that the business challenges will inevitably occur, but we are confident that we will meet those challenges while maintaining focus 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.

(Operator Instructions)

Dave Windley with Jefferies.

Hi.

Good morning.

Thanks for taking the question.

Jim, I am seeing in your prepared notes that you're talking about strong growth on the biotech side and I'm curious about how they are engaging you.

I hear you at the same time talking about broader relationships and things like that.

Are the biotechs still mostly buying a la carte or one or two services, or are you seeing -- are you able to engage them more broadly, as well?

It depends on the size of the client, Dave.

I would say that we have seen no slowdown in demand or interest from biotech generally, including very, very small virtual ones and modest-sized ones.

Since they are essentially all net outsourcers, the larger the client, the more products they have in the pipeline and the more complex their business is.

They tend to look like larger drug companies in terms of their portfolio buying approach to our service offering.

The unique portfolio that we put together continues to distinguish us versus other siloed providers that they could utilize.

That's been quite beneficial for all of them.

Also, the smaller the company often the faster they need to move.

And so, they want a smaller number of partners.

So, yes, we are definitely seeing biotech embrace the portfolio, as well and certainly as well as pharma.

Why don't we leave it at that.

Okay.

Tycho Peterson with JPMorgan.

Okay, thanks.

Great quarter on margins.

Wanted to maybe just talk a little bit about the sustainability of some of the trends.

I know for RMS you're calling for some tapering due to seasonality, but as we look out a little bit further, can you talk about much room there is for margin expansion in both RMS and DSA?

And if you could talk a little bit on the timeline for improving the WIL margins, when you think you can get those up to a reasonable level?

That would be helpful, as well.

So I will take it back, which David can jump in if I forget something.

So what we have said about the WIL margin, it's that they're lower.

They're mid-teens and we are quite confident we can get them to our goal of 20% in the next two years.

By the end of the next two years.

We, of course, I will remind you, exceeded 20% in the first quarter, so our goal will eventually be to continue to drive their margins higher, as well.

So we are quite confident, by the way, Tycho, that since we've improved operating margins and driven efficiency throughout our entire preclinical network.

And of course I will remind you that be preclinical business is the aggregation of several acquisitions that we did over a 15-year period, that we are quite familiar with best practices and looking at procurement and utilization of labor and efficiencies.

And then of course WIL has a modest additional opportunity of obviously buying animals directly from Charles River.

So we feel good about that.

The Research Model business, we are happy to see the top line invigorate.

We're getting some price.

We're getting some mix.

We're getting some share for sure in the academic marketplace worldwide.

We are also getting, obviously, some sustained volume growth in China in particular.

I think all we want to say at this point is that we are confident we can keep the operating margins in the high 20%s, and obviously, if we can sneak them into the low 30%s, Tycho, we will do that.

And on the Manufacturing segment, that still feels like low 30s operating margin business for us.

Look, by definition we are organized to drive efficiency in all of our businesses, whether it's a business that we have owned for a long time or acquired or started.

So we will do that with all of our businesses.

We have spent a lot of time and effort in Safety Assessment in particular and we have obviously seen substantial benefits from that where we are focusing similarly in the research model business and we are beginning to see some actions pop there, as well.

So we hope to see it along most of our lines of business and, obviously, we are going to work hard to improve the operating margins at WIL while maintaining and perhaps enhancing the scientific capabilities of that enterprise.

And in New York in our Investor Day we talked about our ambitions over a five-year horizon and we talked about trying to get the total Charles River margin above 20%.

We set our first, if you like, beachhead was to get to 20%.

Clearly with WIL, that defers the speed with which we can get to 20%, because it has, as Jim just mentioned and we mentioned before, lower margin.

But I would actually say that because the majority of WIL's income is in Safety Assessment and we have a margin that is north of 20% in our basic legacy Safety Assessment business, I would say the ability for us to go above 20% is now better because of the acquisition of WIL.

So a little bit of delay to get there, but actually the risk profile of getting to above 20%, I think, is reduced.

That's helpful.

If I could just add one quick follow-up on Manufacturing.

Jim, you talked about adding capacity for biologics.

Can you maybe just talk about where you think you're in building out additional capacity?

You talked about some business wins associated with the capacity you've added.

How much more do think you need to add?

We will add capacity is the demand increases, so it's -- it has capacity needs that are dissimilar to other businesses, so large laboratory services capability.

We will probably want to add capacity both in the US and in Europe where we have locations in both locales.

And we will add it ahead of -- slightly ahead of the demand as we continue to.

We're quite confident that given the strength of biologics in the portfolios of most of our clients and in the drugs that have been approved in the last few years, that the demand for biologics should at least be sustained and probably will intensify.

So, obviously superb scientific staff and sufficient capacity in the right geographic locales is critical to our growth and development there.

So we are thrilled to be able to add the space and have clients utilize it and continue to see that business grow on both the top and bottom line.

Okay.

Thank you.

Sure.

Derik de Bruin with Merrill Lynch.

Hi, good morning.

Good morning.

Hey, could you talk a little bit about where you are in terms of just total capacity utilization in terms of the Safety Assessment business?

And what does adding WIL bring to your overall capacity?

And once again just a little bit more color on what you are doing with the Massachusetts facility and the opening up there?

And have your plans at all changed, and are you planning opening up more?

It just looks like from our channel checks and everything that demand for the Preclinical Services is just really booming right now.

So just a little bit more color on what your plans are.

So, Derik, we are happy to say that capacity continues to fill rapidly, pretty much in all of our locations around the world.

So we are essentially fully utilizing our capacity.

Doesn't mean we have any space to take on additional work.

But we're quite full and, for instance, the space that we brought on -- some of the space we brought on last year in the Midwest has filled up nicely.

So we are able to add it and have it be utilized.

WIL provides some additional capacity, and also some additional capacity geographic locales that we would like -- would have always wanted to have the benefit of and our clients have been demanding, principally in Continental Europe.

Having said that, I guess we would have to say that WIL is more full than we had originally anticipated and so that's -- we are thrilled with that.

But it continues to provide a need for us to increase space worldwide.

So we will be able to do that at multiple European sites including WIL, certainly, Massachusetts which is open and thriving.

It is not fully staffed, but it is significantly staffed.

The management team is exceptional.

Work has started.

And, the client base is both diverse and enthused.

I was with a client yesterday from a local pharma company who said to me that all things being equal, he would always prefer proximity.

And he was describing the obvious point that their study monitors would prefer to go and stay and be in the same place with the people that were doing the work and be able to do that pretty much at will by car.

Obviously, they are flying all over the world to do that now.

But we continue to have space closer and closer to our clients and we do think that Massachusetts will be incredibly valuable to Boston Biotech.

And also Boston Biotech is now Boston Pharma, and there's a lot of pharmaceutical companies here.

So we are thrilled to see our space well utilized.

Obviously, we are getting, as a result of that capacity utilization driving efficiency, we are getting a pop in operating margins.

We have the infrastructure that we already own, which I think is very important to underscore.

It has some incremental space to add to, not the least of which was opening Massachusetts after too long having it shuttered.

So we will -- we feel our ability to accommodate clients' demands on a worldwide basis is quite strong.

If I may do a quick follow-up, could you talk a little bit about employee retention at WIL and key employees?

I noticed in the past there has always been some issue of, if when CROs merge you could have some of the people with institutional memories maybe disappearing.

What you doing in terms of employee retention?

Is there lest risk of that today?

And your comment on what you're doing to make sure that you are not losing anybody important.

Yes, so we are very impressed with the WIL organization in terms of the quality of the people and the quality of the science and the quality of the culture and we found it quite similar to our own.

Their ability to have been such an effective competitor and provider to clients, I think speaks volumes.

We have retained and/or promoted all of the senior people that we wanted to.

They're all very enthused to be in their former positions or in new ones.

We have embraced the WIL management team, both in the US and Europe.

And we already are reworking quite closely and collaboratively with them both as general managers and scientists.

So we are quite confident that given the strength of both franchises independently and the collective collaborative strength of putting them together that we are going to be able to retain people and I don't even like putting it that way.

I think the WIL employees are enthused to be part of a synergistic parent that understands what they do and will be able to enhance what they do just in terms of continuing to improve and enhance the quality of the science.

So we will be able to maintain those folks.

And the track record that we've had with other acquisitions has been good, as well.

So we have history to suggest that the way that we approach and I'm a particular individual that has been impacted by that.

It's a very respectful approach that I believe that Charles River has in respect to how we genuinely listened to the managers that we acquired and how they can bring advise and thoughts to the table.

And we are looking for best solution.

So in terms of the acquisition with WIL, we are genuinely looking at some of the processes that they have that we can apply across Charles River and vice versa.

Thank you very much.

Greg Bolan with Avondale Partners.

Hello.

Thanks for taking the questions and congratulations on very good results.

Got a couple questions here, but just going to follow the rules with one.

As you think about the weighting of improvement as it relates to RMS first-quarter 2016 over first-quarter 2015, I am really focusing on the very high year-over-year incremental operating margin, much higher than what we have been expecting, I know there is some seasonality in there.

We obviously had modeled for that.

But you mentioned, Jim, obviously high leverage to volume, makes a lot of sense.

Obviously you made some production cuts in the Hollister facility a little while back.

That's probably helping.

But you mentioned price.

And can you maybe weight the improvement in incremental operating margin, whether it be between volume and price?

And then one other thing, obviously, your largest competitor in this business, obviously is going through some changes themselves, and you specifically mention academia, Jim, and gaining share.

And do think that might be as a result of some disruption that has occurred at your primary competitor?

That's all I got.

Thanks.

So we will both take a crack at this.

The operating margin, the research models is a result of a host of things.

One is that we run that business efficiently and have for a long period of time and we have rationalised our infrastructure to definitely be in line with demand.

We are gaining some price.

We are definitely getting some mix and we have finally, I say somewhat embarrassingly, refocused our efforts in driving efficiency in that business, which we've been -- we're entering our seventieth year.

And as we've told you many times, the business has been too manual.

And we are really putting some wonderful systems in there that are driving efficiency in areas like inventory management and others.

All of those factors are definitely contributing to that.

The share gain we have been, I think our competitors have seen some challenging times.

I don't-- we can't get inside of them, so we don't know what they are doing in areas like efficiency.

They have small infrastructures, and they don't have broad gauge portfolios, and so they tend to be very siloed.

It's unclear whether the ownership structure, Greg, has helped or hurt us, or helped or hurt them, frankly.

Our competitors, particularly the one that you're talking about, has primarily competed with us on price only, forever.

That's harder and harder card for them to play over time.

And our clients are very interested in quality.

I will let David --

So if you look at the price increase.

If you look at also the efficiency programs that we have and then you look at the cost pressures that come in year-on-year.

We've got pay rises and inflation to deal with.

You may not like the sense of it, but it doesn't really matter whether you apply the price to the cost pressure or the efficiencies to the cost pressure.

It's essentially a blend of the three.

And the actual numbers we're talking about are similar across all three of those components.

Congratulations.

Thanks,.

Sandy Draper with SunTrust.

Thanks very much and, again, I will add my congratulations on a very strong quarter.

Maybe following up on some of your comments, Jim, about the early -- the discovery side of the business and the opportunity there and the nice pickup in demand.

You commented around, I think it was a comment from a customer about competition.

And when you think about it, and I may have asked you this before, do you view competition now in that business as primarily getting stuff that is being done in-house at pharma and having people willing to look at you?

Or is it really now people are starting to really look at this and it's how do we put this together and it's whether it is Charles River or some of the other people who may do something like this?

Where do see the competition today versus maybe a year or two ago when you really started talking about this?

Thanks.

I think it's both, Sandy.

Clients -- for a lot of clients the knee-jerk reaction when we talk to them about discovery is, that's terrific that you have a discovery offering, but that's what we do for a living.

The drug companies feel that that is their most significant capability, which is probably true, by the way.

Notwithstanding that, as we've said in our prepared remarks, we have identified 64 development candidates for a whole host of clients, all of which are in clinical trials right now.

That is a big deal.

So we actually have some capability in very, very early discovery, which I do think that drug companies want to collaborate with anybody that can help them in any way.

And if we can't help them in the very earliest phase, we can help them improve the targets, improve the molecules, identify lead compounds and do the, obviously, the testing all along the way then to determine whether the drug should and will get to market.

So I would say that increasingly, if they -- when they listen, they are open to it and it's a lot like Safety was a long time ago.

I was talking to a client about this yesterday, in fact, about how years ago there was a great reluctance to give us safety work, and over time our capabilities have enhanced theirs and in some cases exceeded theirs.

So I do think it's going to be a gradual process.

We can do more for some clients then others and the work is coming outside.

There are things that we can do that are industrialized and more routine.

There are assays that we have that they don't have.

If you look at oncology, the cell lines and capabilities that we have that they don't have as well.

If you look at CNS we have some imaging and methodological capabilities that they don't have.

There are slivers of competition along way.

Some of it is Eastern competition, some of it is Western.

It tends to be a little more siloed than we are.

So as we've said countless times, I do think that putting the portfolio together of in vivo and in vitro capabilities, very early discovery through later stage discovery has a lot of the clients to take notice of what we are capable of doing.

And I think we are very early days in the outsourcing trend.

We hope it will be a trend, but we are seeing clients really happy with the quality of the work, we're seeing them come back and we're seeing very large pharma and very small biotech companies use us.

So we believe that the thesis is a good one.

We do think that scale will continue to be important for them, both breadth and depth.

George Hill with Deutsche Bank.

Yes, hello.

Good morning, guys, and thanks for taking the question.

Jim, you gave a lot of color talking about the strength in biotech.

Just one concern we hear from a lot of investors is that, how often they biotech companies have been revalued that could potentially set them up for sale or exit.

I know it's probably a longer-term risk, but could you talk about what you have seen historically when some of these biotech companies have transacted and whether or not there is any risk to the business?

Yes, so it would obviously be company specific.

We have a couple of clients now who are potentially going to be acquired, at least that's what we read in the press.

It depends.

If we're running studies for those clients and the science is -- if the quality of our science is what they are looking for, then I think they are likely going to stay with us.

It's also quite likely, not always but quite likely, that the acquiring company, whether it's larger biotech or a large pharma, is a happy Charles River customer, as well.

And we'd support that.

So they are not going to buy these biotech companies to kill their pipelines.

They are only buying them for their pipelines.

So I just think that, that expands the portfolio for them, and I think there's a very strong possibility that we should notice nothing, frankly.

And to put the most positive spin on it, we could be the sole provider to a small or medium-sized biotech company who gets acquired by a larger one, who's not a Charles River fan, and we could get access and provide -- they could get understanding of us by doing that deal.

So we actually feel really good about that, and of course, we have more clients now in biotech because of that reason, because of the quality of the work that we are doing.

So it's not -- we don't see that as a significant risk at all, or perhaps any risk.

Okay, and then maybe just a quick follow-up.

Nice little bonus from the performance of the venture portfolio in the quarter.

Can you just say whether those are cash returns, or the change in the mark on the portfolio?

There are two different valuations on the underlying asset that we bought shares in.

Okay.

Appreciate the color.

Thank you.

Ross Muken with Evercore ISI.

Good morning.

Maybe just quickly now that WIL has closed, can you just help us think about -- you laid out a number of different metrics at the last Analyst Day in terms of longer-term aspirations and certainly in the context of the recent performance and the WIL transaction, those certainly seem readily achievable.

As we think about WIL now being closed, how does it -- I'm not asking you to provide specific details but maybe more directionally, how do you sort of relay that to those goals and where you will likely to be tracking as we hear from you next at the upcoming Analyst Day?

I would say that WIL will likely enhance our ability to grow the top line in our Safety Assessment business, which would obviously be beneficial to the DSA segment's top line.

You know because we've discussed it several times, that WIL is currently a drag to operating margins in Safety Assessment and will be for a couple of years, albeit improving during that time.

And so it's a little bit difficult to estimate where -- what the margin growth will be in that segment once we catch it up.

Although we would certainly hope that we could continue to drive efficiency, get some price, have a healthy mix and that the margins will continue to improve.

Where the margins in the Preclinical business are going to end up, is a little bit difficult to estimate.

They are quite attractive at the moment.

They're north of 20%, which was our corporate goal for the longest period of time and obviously they were substantially below that for a number of years, so we are quite pleased with them.

We are not complacent about that.

So, clearly WIL will help the top line.

We hope eventually it will help the bottom line.

But if you look at the whole DSA segment, given the continued improvement in operating margins in discovery, particularly, not particularly, both on the top line and driving efficiency, we should continue to have slightly better and improving operating margins at DSA, as well, both from discovery and ultimately from WIL.

We have broken out a fair bit of information about WIL in our previous call.

And as Jim mentioned, it is only day 30.

So before we start committing to additional, if you like, targets above what we've already shared with you, I just think it's a little bit early in the -- for us to declare where we think we might get it.

Fair enough.

Thank you, gentlemen.

Tim Evans with Wells Fargo Securities.

Thanks.

I wanted to ask about the Microbial Solutions.

It seems like the demand there maybe caught you a little bit off guard.

That business has been doing very well so I just wanted to see, is the demand here even stronger than you anticipated or just maybe a little more color on what's going on there?

Thanks.

Thanks for that question.

Let's just be clear about that.

Demand is really good in that business and continues to be.

We do believe that this business will continue to grow at double-digit rates for the balance of the year and out in future years.

And it has, as you I think know, it's grown at double-digit rates for a least a half a dozen years historically.

Strong high-growth business.

What happened in the first quarter is the demand for the cartridges are so robust, we are obviously happy with that, that we upgraded our manufacturing capacity.

And as a result of this conversion process, we got orders backlogged a little bit, of cartridges, and we were unable actually to satisfy the demand in the first quarter.

We're through that now, and we should continue to be back to growth metrics.

So its yes to both ways you answered the questions, that the business is so good, and the demand is so good, and we are upgrading our manufacturing capability to service the demand and the conversion process slowed us down a bit in the first quarter.

Got you, okay.

Thank you.

John Kreger with William Blair.

Hi.

Good morning.

It's Robbie Fatta in for John today.

Thanks for taking the question.

I was just curious for your perspective on longer-term R&D spending trends, particularly from the smaller clients in light of any potential pressure on the drug pricing.

We certainly haven't heard anything directly from clients.

Whatever pressures on drug pricing are pretty much alleged and more conversational than reality.

In fact, they have not been a reality.

I don't think we've ever seen pipelines this robust.

I'm talking about in the aggregate, both big pharma and biotech companies.

The quality of the pipelines, the amount of work that they have, the target hits that they are experiencing, the amount of work that is being outsourced.

Really feels that we are at a very positive inflection point just in terms of demand and interest and a lot of it has to do with immunotherapies, probably particularly immuno-oncology, things like RNAi working.

So I think we would all be speculating in terms of what, if any, moderation of drug pricing we see.

But we certainly haven't seen or heard any of it in dialogue with clients.

And certainly we haven't seen it in terms of the volume of business that we have been so pleased to encounter in the first quarter.

And obviously, given our forecast for the year, we continue to think the demand will be quite strong.

Great, thank you.

Sure.

Robert Jones with Goldman Sachs.

Good morning and thanks for the question.

This is Adam Noble in for Bob.

Just curious, thinking about the guidance given your expectation for higher RMS revenue and the slightly larger WIL contribution, given the earlier closing date, why you didn't raise the revenue range as well?

Is it just simply being conservative, given we're only one quarter into the year or are there some pushes and pulls with the other segments, as well?

Just clarity around that would be really helpful.

Yes, so what I would say, first of all quarter one, we met our expectations for quarter one.

There are puts and takes in any forecast and at this time we think that the revenue guidance that we have given you is appropriate when you put it all together.

Not really much more really to add then to that, other than we are only three months into the year.

Still nine still months to go.

And I think given the fact we met our expectations in Q1, on balance we felt that the revenue guidance to what it was is appropriate.

Got you, thanks for the question.

Garen Sarafian with Citigroup.

Hello.

Thanks for squeezing me in.

Two quick questions.

One tactical and one a bit more strategic.

On the WIL acquisition now that it's closed, you mentioned the margin improvement.

So could you elaborate on that a little bit as to what areas you are targeting, maybe by priority?

I know that in the prepared remarks you mentioned, I think, better purchasing of research models.

But is it just re-contracting with the clients?

Is it more procurement?

And also, that will give us a little bit more color as to the timeline over two years rather than something a little bit more forward.

And the second one is M&A.

In two portions of prepared remarks it was still looking to strategic M&A to advance the quality and the scientific work, but at the same time reduce your leverage ratio.

So it sounds like you are taking a balanced approach between the two.

So wondering what type of areas would compel you to revise that timeline?

And with that buy-down, what types of companies would be appealing enough to reconsider that approach?

Thank you.

So, I'll take the first question.

So just a bit of background.

So we have declared this $17 million to $20 million synergies over two years, and we also believe that once we've extracted those synergies, that gets our operating margin in the ballpark of the 20%.

We have not, and deliberately, broken out what portion of that $17 million to $20 million will come this year.

Obviously, we have that internally in targets that we are all shooting for, but we have not broken that out publicly.

Some of the activities that we're doing, you know we've already mentioned in my pre-prepared remarks, that the duplicate roles, they were announced in terms of changing those on day one, being done.

We've already beginning to move our research models, which will work buying from various sources and supplying them directly.

So that's quite a quick win.

Procurement has got off to a good start.

But of course the procurement savings start to come in as we go through the year.

So we are making leverage on our global procurement opportunities there.

And there are some internal supports that WIL can use instead of using external consultants.

So for instance, we've got pretty good and strong tax department team, so we will be leaning on our internal tax team there.

And then it gets into the harder aspirations that we have of looking at the processes that they have which can be applied to Charles River and the processes that we have that can be applied to WIL.

That will take some time.

And so when you put all that all together we are still confident that we can deliver that $17 million to $20 million savings and therefore get to the 20% operating margin within the next two years.

On the M&A question, we want to continue to be very clear about that.

We just did a big deal.

Integration is going really well.

It is complex and we are going to focus most of our effort on the smooth integration of this important asset while we pay down our debt.

So we are committed to get below three turns as quickly as possible.

I think we originally said in the next 18 months.

Having said that, we will continue to be active in looking at M&A targets.

Whether we do something small in the intervening 12 or 18 months or not, we will see.

But we're certainly open to doing that.

And we eventually, we will want to continue to build out our discovery portfolio and expand and enhance other areas so that we can be a more important and beneficial provider to our clients.

So we will certainly keep working on M&A.

But we are going to take a balanced approach, as you put it, and swallow what we have just bought effectively and reduce our debt.

That is helpful.

Thanks again.

There no further questions in queue.

I'll turn it back over to Susan Hardy for closing remarks.

Thank you for joining us this morning.

We look forward to seeing you at an upcoming conference and if you have any further questions feel free to give us a call.

This concludes the conference call.

This concludes the conference for today.

Thank you for your participation.

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