Charles River Laboratories International, Inc. (CRL) Q2 2014 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Charles River Laboratories Second Quarter 2014 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Susan Hardy, Corporate Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, and welcome, to Charles River Laboratories Second Quarter 2014 Conference Call and Webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer; and Tom Ackerman, Executive Vice President and Chief Financial Officer, will comment on our second quarter results and update guidance for 2014. Following the presentation, we 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. The access code in either case is 324004. The replay will be available through August 22. You may also access an archived version of the webcast on our Investor Relations website.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 25, 2014, 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 on 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. Before turning the call over to Jim Foster, I'd like to mention our upcoming Investor Day on August 12, in New York. If you would like to attend, please call or send an e-mail. My contact information is on the press release. Jim, Please go ahead.

Good morning. I'd Like to begin by providing a summary of our second quarter results before commenting on our business prospects. My comments address the new business segment, on which Tom will give you more details shortly. We reported sales of $341.2 million in the second quarter of 2014, a 15.9% increase over the prior year. The acquisition of Argenta and BioFocus contributed 8% to second quarter revenue and foreign exchange, 1.4%. All 3 business segments reported sales increases. In constant currency, RMS gained 30 basis points, DSA gained 31.4% and Manufacturing gained 15.2%. In addition to the benefit of the acquisition, we saw improved sales to many of our global accounts. And as they did in the first quarter, mid-tier clients again generated a double-digit sales increase. Sales to academic and government clients also increased, primarily due to Research Model sales in China. I'm very pleased to tell you that year-over-year, the consolidated operating margin improvement -- improved by 170 basis points to 19%. Margins increased in all 3 segments, due primarily to a combination of leverage from higher sales and benefits from our efficiency initiative. Earnings per share were $0.97 in the second quarter, an increase of 32.9% from $0.73 in the second quarter of 2013. Our limited partnership investments contributed $0.04 in the quarter. Once again, we are increasing our non-GAAP earnings per share guidance by $0.10 to a range of $3.25 to $3.35. This increase reflects both the outstanding second quarter performance, as well as the gain from our limited partnership investments. We remain confident that successful execution of our sales strategies and integration of Argenta and BioFocus will enable us to achieve this guidance. Like the first quarter, the second quarter results continue to demonstrate 3 over-arching strategies that are fundamental to the positioning Charles River -- to positioning Charles River as the partner of choice for outsourced drug research services: Productivity and efficiency initiatives, portfolio expansion and sales strategies. The productivity and efficiency initiatives have enabled us to maintain and enhance Charles River's leading market position as a premier provider of essential drug discovery in early-stage development solutions. We can provide cost-effective solutions tailored to meet each client's specific need, and because we operate more efficiently, we have been able to meet our client's needs without compromising scientific expertise or client service. This, in turn, has provided clients with the resources they require in lieu of in-house capabilities and supported their goal to increase the use of outsourced services with a reliable scientific partner. The acquisition of Argenta and BioFocus is a prime example of growth through our portfolio expansion strategy. We are extremely pleased with the progress we have made to date. The 90-day integration plan was completed successfully, and second quarter revenue was slightly ahead of our acquisition plan. We have also made significant progress on our outreach to heads of R&D and other decision-makers at the leading pharmaceutical and biotechnology companies, as well as many of the larger mid-tier companies. We are meeting with these companies to discuss our ability to provide early Discovery Services including target discovery, medicinal chemistry and complex in vitro biology, and to continued to support research programs as they move downstream through in vivo discovery and safety assessment. Clients are evaluating the placement of additional work streams with us, which will enable them to outsource integrated drug discovery and early-stage development programs to a single provider. We believe our value proposition is resonating with many clients, which we believe will result in the expected sales synergies in 2015 and beyond. The second quarter results also demonstrate the effectiveness of our third strategy. Targeted sales efforts. We have developed specific plans for each of our clients' segments, global BioPharma, mid-tier biotech, and academic and government. Our strategic relationships with global clients are continuing to evolve and the introduction of early discovery capabilities is enabling these clients to work more closely with us. After a slow start in the first quarter, several of these clients significantly increased their spending with us in the second quarter. However, the high-teens sales growth of the mid-tier clients outpaced the other segment. We have increased our focus on mid-tier, not only because these clients are benefiting from robust funding, but also because they are the ideal clients for our new early discovery capabilities. Many of the mid-tier clients do not maintain infrastructure, and in some cases, they are virtual. Outsourcing to a partner like Charles River who can work with them at the earliest stages of their molecule and stay with them throughout medicinal development, preclinical development, meets their need for scientific expertise and continuity of service. I'd like to provide you with details on the second quarter segment performance. I'll begin with the RMS segment, which now includes both small and large research models, as well as GEMS, RADS and outsourcing solutions. Sales were $133.1 million, a 30-basis-point gain in constant currency. Consolidation of the biopharmaceutical industry, closure of biopharmaceutical facilities and the evolution of drug development to eliminate molecules earlier in the process are resulting in continuing soft demand for Research Models. Sales of models declined by 70 basis points in constant currency year-over-year. The impact is now most evident in Europe and Japan, which tend to lag the North American market. Sales in North America increased as did sales in China. This marks the second consecutive quarter that we have seen improvement in commercial sales in North America, and we are optimistic that market share gains, particularly in the mid-tier and academia, will enable us to continue to drive growth. Our service businesses reported higher sales in the second quarter primarily due to our GEMS business. Because of the importance of translational medicine, researchers are developing more complex models of human disease. Producing these models is quite complicated, requiring expertise, which most organizations do not have in-house. As a result, they are turning to us for the scientific knowledge required to manage their model colonies. We expect GEMS, RADS and IS to benefit as global biopharmaceutical companies increase the use of outsourcing at the earlier stages and mid-tier biotechnology companies utilize higher funding to invest in their pipeline. I want to take this opportunity to discuss the recent news that the National Cancer Institute canceled the contract with Charles River. Initiated in 2006, this was a 10-year $112 million contract for our Insourcing Solutions business, which had only 2 years remaining. Under the contract, we produced NCI research models for academic and government researchers. Because we will continue to produce the same models, there will be very little change to Charles River's business and the transition will be seamless for researchers. We launched an outreach program to inform researchers that they can continue to obtain the NCI models from us with no change in initial pricing or logistics. From a revenue standpoint, we received between $10 million and $11 million annually to produce the model and expect that we will retain only half of that amount from sales to researchers. That would mean a revenue shortfall in the fourth quarter of only about $1.5 million. Primarily as a result of our efficiency initiatives, the RMS operating margin increased by 150 basis points to 29% in the second quarter. I want to point out that we achieved this improvement independent of the profitable EMD business, which was formally included in the RMS segment. As you know, our efficiency initiatives are focused on various areas including capacity utilization, inventory management and automation to improve data access and reduce manual workload. We are continuing to identify opportunities to streamline our RMS operation, and we believe that an annual RMS operating margin in the high 20% range is achievable. DSA sales were $142.6 million, a 31.4% increase in constant currency. This segment is comprised of all of our Discovery businesses, including Argenta and BioFocus and the Safety Assessment business. Argenta and BioFocus, which are now referred to as Early Discovery, contributed $23.5 million in the second quarter, slightly ahead of our expectations. The Safety Assessment business was the other significant driver of sales growth. For the first time since 2008, sales growth exceeded 10%. We were extremely pleased with its performance, which resulted from our intense focus on scientific expertise and client service and market share gain. However, demand is variable on a quarterly basis, and you should not expect to see this level of growth consistently. I remind you that our annual guidance for DSA sales in 2014, excluding Argenta and BioFocus, is mid-single-digits. It's likely that we will see quarters of higher and lower growth, but on a year-over-year basis, we expect to achieve our targeted growth rate. As a result of leverage from higher safety assessment sales, the U.K. tax law change and foreign exchange, the DSA operating margin increased by 360 basis points to 17.1% in the second quarter. I remind you that operating margins for Argenta and BioFocus are below the segment average, but we expect to improve them. Efficiency gains resulting from initiatives we put in place over the last few years are enabling us to accommodate the increasing volume of studies on a relatively stable infrastructure and generate an improved operating margin. We are focused on standardization and harmonization of processes, on creating centers of excellence rather than recreating expertise in every location, and utilizing technology to provide clients with access to the data in real-time and on efforts to ensure that the client experience is the same high quality no matter at which of our facilities they place work. As a result, we have improved our ability to manage the workload while using fewer study rooms and fewer personnel. This outcome has enabled us to provide scientific expertise efficiently and at a reasonable price, which appeals to all clients. I previously mentioned that we opened additional space in Edinburgh last year to absorb the volume from new strategic relationships, and we recently opened a few study rooms at our Ohio facility. As clients increasingly choose to place work with Charles River, we will continue to add the required space with little or no impact on margin. We are careful about adding space, because despite the fact that our capacity is nearing full utilization, pricing will not improve significantly until industry capacity has filled as well. That said, we have won proposals where we are not the lowest bidder. When scientific expertise is a critical criterion, Charles River is often the preferred provider. The Manufacturing Support segment delivered sales growth of 15.2%, with each of the 3 businesses EMD, Biologics and Avian contributing. The EMD business was largest driver of the segment sales increase, reporting exceptional sales growth of nearly 20% in constant currency. The PTS franchise continued to exhibit strength as we sold additional instruments and cartridges and continued to take share in the conventional testing market. As I've noted previously, the ease-of-use, accuracy of results, and processing speed make the PTS an ideal instrument for endotoxin detection. Because of these capabilities, we are converting clients who use our traditional LAL testing method to the PTS and taking market share as new clients make the change from other providers. Accugenix has been an excellent addition to the portfolio, not only because it is a leader in the field of microbial identification, but also because it allows clients to test for and identify contaminants with a single provider. We expect that EMD will continue to deliver at least low double-digit organic sales growth for the foreseeable future as new products are introduced, and as we to continue our efforts to convert large biopharmaceutical manufacturers' central laboratories to the PTS cartridge technology. I want to describe our biologics business for you because this business has become more important to our portfolio, as large molecules increasingly represent a more significant proportion of drugs in development. Biologics provides all testing services required to bring large molecules to market, including cell line characterization and banking, assay development and testing, and viral clearance, recognizing that large molecule drugs were becoming more important, we undertook an initiative to become the leader in biologics testing. We have expanded our portfolio with the acquisition of new labs and through internal development. We strengthened our organization by deepening our management team and adding scientific expertise. We built the state-of-the-art facility to provide capacity for new business, and throughout, we maintained our focus on efficiency so that we could drive margin expansion. As a result of our efforts, we believe we are well positioned as one of the 2 market leaders in the large molecule testing space, and we intend to pursue our goal of becoming the clear market leader. The Manufacturing segment second quarter operating margin was 33.4%, a gain of 230 basis points year-over-year. The improvement was due to the biologics business, the result of both leverage from higher sales and increased capacity utilization of the new building. We believe that a margin in the low 30% range is sustainable and are working on improving efficiency in these businesses as well. All the actions we have taken in recent years have been focused on differentiating Charles River as the preferred provider for early-stage drug development and positioning us to compete effectively when new opportunities become available. You are familiar with many of these actions: Expanding our broad early-stage portfolio through internal development and selective strategic acquisition; maintaining and enhancing our extensive scientific expertise; improving our operating efficiency; providing best-in-class client service; developing state-of-the-art data systems and portals, which offer clients real-time access to data; and structuring flexible, creative solutions that support each client's drug development goals. We will continue to pursue strategies to enhance our position as a leading early-stage CRO. Perhaps the most important initiative now underway is to identify additions to our portfolio. Acquisitions have always been a critical component of our growth strategy because they enable us to enhance the support we can provide to clients. With the acquisition of the early discovery assets, we believe our portfolio is the strongest it has ever been. We can support clients at the earliest stages of their research with our integrated drug discovery capabilities and stay with them for the entire early-stage process, a capability that no other CRO can fully match. We believe the value of a single provider for the complex challenges of early-stage research resonates with clients and reinforces our strategic relationships. The importance of strong client relationships is fundamental to our ability to drive sales, cash flow and earnings growth in the coming years. In conclusion, I'd like to thank our employees for their exceptional work and commitment and our shareholders for their support. Now I'd like Tom Ackerman to give you additional details on our second quarter results.

Thank you, Jim, and good morning. Before I recap our financial performance, let me remind you that I'll be speaking primarily to non-GAAP results from continuing operations. Before discussing the business segment revisions, I will provide a brief summary of the financial results of our former RMS and PCS segments, so that you're able to compare your models. Going forward, we will not provide financial results for our former segments. On a constant-currency basis, legacy RMS segment revenue increased 3.5% in the second quarter, while the former PCS segment gained a robust 11.2%. This performance was driven by a particularly strong quarter for our Safety Assessment business, on which Jim has already commented. The non-GAAP operating margin also expanded in both of our former segments, as the legacy RMS margin increased 90 basis points to 30.9% and PCS gained 600 basis points to 18.2%. Following the acquisition of Argenta and BioFocus on April 1, we reviewed our financial reporting segments to ensure alignment with our view of the company. As a result of this thorough review, we determined that we should report 3 business segments. Research Models and Services, Discovery and Safety Assessment, and Manufacturing Support. We believe that, in aggregate, the business and financial profiles, end customers and go-to-market strategies are now more closely aligned for the businesses within each segment. The RMS segment now consists of the Research Models in Research Models Service businesses, including GEMS, RADS and Insourcing Solutions. All our Discovery Service businesses, including Argenta and BioFocus, are now being reported in the Discovery and Safety Assessment segment or DSA. The segment also includes our Safety Assessment business, which Wall Street commonly refers to as toxicology or preclinical services. The third segment, Manufacturing Support, is made up of Endotoxin and Microbial Detection business or EMD, as well as our Biologics Testing Solutions and Avian Vaccine Service businesses. The Biologics Testing Solutions business was previously known as Biopharmaceutical Services or BPS, prior to its re-branding initiative. By revenue, the DSA and RMS segments are the 2 largest segments, representing 42% and 39% of second quarter revenue and 29% and 45% of second quarter non-GAAP operating income, respectively. Manufacturing Support represents 19% of revenue and is expected to be our fastest-growing segment due primarily to the strength of the EMD business. Also due to EMD, it will likely be our highest operating margin segment. At 33.4% for the second quarter, the Manufacturing segment represented approximately 26% of total non-GAAP operating income. In addition to our reportable segments, we will continue to provide sales of Research Models, Research Model Services and EMD in our quarterly filings. For the full year 2014, our outlook for the new segments is as follows. we expect approximately flat sales in the RMS segment, as price increases are expected to largely offset the ongoing impact from biopharmaceutical consolidation. The DSA segment is expected to increase more than 20% in 2014, driven by the acquisition of Argenta and BioFocus, which will contribute more than 15% to DSA revenue growth. This equates to mid-single-digit growth for our legacy Discovery and Safety Assessment operations. Manufacturing revenues are expected to increase more than 10% in 2014 as a result of continued double-digit growth in the EMD business and improving trends for our Biologics business. We expect the operating margin in each segment to improve in 2014 due to a combination of our productivity and efficiency initiatives and higher sales volumes. Margin improvement will be partially offset by higher corporate cost, which is expected to result in a consolidated margin that will be similar to or slightly higher than last year's level of 17.3%. I will also remind you that Argenta and BioFocus' operating margin is below the corporate average so it is slightly dilutive to the consolidated operating margin. The business currently has a low- to mid-teens margin, which we expect to improve over time. With regard to the DSA segment, the U.K. tax law change in 2013 and foreign exchange benefited the DSA operating margin by a combined 222 basis points in the second quarter of 2014 when compared to the prior year. These items will benefit the full year DSA operating margin, but are expected to provide less of a year-over-year benefit in the second half as we anniversary the adoption of the U.K. tax law change in the third quarter. I will now discuss the nonoperating items that affected the second quarter performance. Unallocated corporate costs increased $3 million year-over-year to $20.1 million in the second quarter of 2014, but declined by $2.3 million on a sequential basis. We expect unallocated corporate cost for the year to be at or slightly below 6.5% of total sales. Net interest expense was $3.2 million in the second quarter, an increase of $0.6 million from the first quarter 2014. This was driven by higher debt balances, principally associated with the completion of the Argenta and BioFocus acquisition. For the year, we expect net interest expense to be in the range of $12 million to $14 million, which is below our prior outlook of $14 million to $16 million because LIBOR rates remain essentially flat and favorable to our forecast. We reported $2.7 million in other income in the second quarter or a $0.04 gain related to our investment in a large life sciences venture capital fund. Our 2014 EPS guidance has been adjusted for the $0.12 year-to-date gain, but not prospectively for any gains and losses which might occur in the second half of the year. As I have previously mentioned, we do not forecast other income since gains or losses are primarily derived from market-based returns on investments. In the second quarter, the non-GAAP tax rate of 27.2% declined slightly on a sequential basis and was in line with our guidance range for the year. We continue to expect our non-GAAP tax rate for 2014 to be in a range of 27% to 28%. We previously updated our tax guidance in May to reflect the Argenta and BioFocus acquisition and associated legal entity restructuring initiatives. As a result of the strong operating performance, free cash flow increased by $8.5 million to $47.7 million in the second quarter. CapEx was slightly lower at $9.3 million. We continue to expect free cash flow in a range of $180 million to $190 million in 2014, and CapEx of $55 million to $65 million. Our top priority for capital deployment is disciplined M&A activity as we continue to strengthen our early-stage portfolio and drive profitable growth. Major uses of capital in the second quarter were the completion of the Argenta and BioFocus acquisition on April 1, and the repurchase of approximately 1.5 million shares of common stock for $80.5 million. We accelerated a meaningful portion of our planned 2014 stock repurchase activity into the second quarter due to our belief that there was an attractive entry point for our stock. We anticipate a more modest level of repurchases for the remainder of the year, in line with our stated goal to offset dilution from option exercises. As a result of the timing of the stock repurchases, we now expect an average diluted share count for 2014 of slightly higher than 47.5 million shares. At the end of the quarter, we had $48.8 million remaining on our stock repurchase authorization. At the end of the second quarter, our total debt was $803 million, an increase of approximately $163 million from the end of the first quarter. In the second quarter, we borrowed approximately $116 million to finance the acquisition through our euro-denominated revolver. At the end of the quarter, our pro forma leverage ratio was within our near-term targeted range of 2.5x and 2.75x. Debt repayment for the remainder of the year will be primarily related to the scheduled installments on a term loan. I would like provide some additional details with regard to our updated guidance. Our sales guidance of 9% to 11% is the same for both reported and constant currency because we continue to expect foreign exchange to provide only a small benefit in 2014. In addition, we lowered our GAAP EPS guidance by $0.04 to a range $2.60 to $2.70, primarily as a result of additional restructuring charges that we expect to incur as a result of our global efficiency initiatives. In addition to earlier actions in North America and Europe that we've previously discussed, we also implemented a plan in the second quarter to consolidate the number of facilities in our Japanese Research Model operations in 2015. This project, coupled with our other global initiatives is expected to further enhance the efficiency and operating margin in our RMS segment. Following the extremely robust second quarter performance, our second half outlook assumes more normalized results due to a combination of factors. Normal seasonality affects the RMS segment in the second half of the year. The result of lighter order activity during summer vacation and winter holiday periods. Because of the volume sensitivity of Research Model production and the importance of production to the RMS segment results, we expect the new RMS segment's operating margin to decline sequentially in the second half of the year, similar to last year. In addition, we anticipate a modest sequential decline in Safety Assessment revenue in the third quarter, reflecting normal fluctuations in client demand. As Jim said, safety assessment sales growth is not linear quarter by quarter, but we do expect annual increases. We recorded a gain of $0.12 in the first half of 2014 related to our limited partnership investments and have not forecast any gains in the second half of the year. Based on these factors, we believe that third quarter revenue growth will be in the low double digits on a year-over-year basis, including the acquisition of Argenta and BioFocus. We expect non-GAAP EPS to be similar to last year's third quarter level of $0.79, which equates to EPS growth of approximately 10% when excluding $0.07 of investment gains and tax-related items in the third quarter of 2013. We are pleased with the robust second quarter financial performance and successful completion of the Argenta and BioFocus acquisition. Revenue and earnings may vary quarter by quarter based on client demand, but we are confident that our financial performance for the year will show signs of sustained improvement in our business, resulting in 2014 EPS growth above 10%. We also remain focused on driving continuous improvement in our business to further enhance shareholder returns. Thank you.

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

[Operator Instructions] We'll go to David Windley with Jefferies.

I want to focus around DSA in the Safety Assessment business. I'm, first of all, curious if your views on the second half and comments on the third quarter are based on kind of a level of caution after a really strong second quarter? Or are they driven by kind of actual bookings in hand and level of backlog? Are you seeing some moderation in the bookings activity for Safety Assessment headed into the second half?

Dave, we're seeing pretty much all of that. So the second quarter was, obviously, a terrific quarter, it was particularly strong. So kind of all things hitting on multiple cylinders. Lots of studies with larger animals, a fair amount of specialty work and a fair amount of long-term work. Some work which happens often, but you never know when. Some large studies that were originally contemplated for the first quarter ended up moving into the second quarter. So we had a big bolus of work. The margin, obviously, is driven by having a great quarter, having a great mix of work like that and that's driving efficiency. So the margin is a combination of all of the above. We're expecting a really good third quarter and fourth quarter, where as we step back from the second quarter and kind of look at industry and the demand and the competition, and particularly the pricing, we're very cognizant of the fact that this is feeling, at least at the moment, very much because of the price, like kind of a mid-single-digit growing business for us. And maybe we'll get to high single, but that's not what we're guiding to. So we're expecting a strong quarter that will appear to moderate off of the second only because it was unusually strong. We're trying to get others besides us to look at the Safety Assessment business on an annual basis, because as you know pretty well, since you're familiar with the space, studies don't start and conclude commensurate with our corporate reporting quarters. They have different durations. And so taking a holistic view of it -- notwithstanding the quarterly conversations like this one -- we just think is a much better view. So we don't feel -- just to get to the essence of your question, we don't feel like we are being inappropriately or overly conservative. The back half of the year for all of our businesses tends to be somewhat adversely impacted by the holidays and summer slowdowns and sometimes running out of budget. It's not some overly cautious response. It's just cognizance of, while demand is very good and obviously we had a really strong quarter and so have others in the industry, and all systems point positively, given the fact that there's still a bit too much capacity in the system, we still don't have the level of pricing that should be commensurate with the volume and demand. And if and as we do, both the top and bottom line will begin to move much more quickly. So I guess, in a lot of ways, we continue to be cautious about pricing, and while we're delighted with the quarter, I would say that studies are still quite competitively bid and, yes, we talked about the fact that we win some studies where we're not the lowest price point, but price is still an important part of the evaluation process.

And my follow-up is kind on the same topic and on capacity that you just touched on. The demand does seem to be rising around the industry. It seems that all the major competitors' capacity is filling, at least, if not full. And there is some discussion of trying to move price up a little bit. So I'm curious about your comments about efficiency initiatives to stretch your existing capacity and openings and just your thoughts around how much additional work can you take on by squeezing work into your existing footprint versus your thoughts about further additions to capacity?

So first off, we don't think that the dialogue that you're hearing in any way jives with day-to-day, week-to-week, month-to-month pricing negotiations that we have with clients when other competitors are at the table bidding. And trust me, as soon as that changes, you'll be one of the first to know. Because we still don't feel that we're getting paid well for the quality of our services, although we're trying to make up for that by being as efficient as possible. But clearly it will have some pricing -- obviously will have some significant relationship to capacity being very utilized. So I suspect there's more capacity in the system than people are letting on. In our case, we are getting full, and we said that now several calls in a row. We have, depending on the quarter you speak to us, a facility or maybe a couple of facilities that are functionally full. For us, that means 85%-ish. We have a little bit of space at several sites that we have and will continue to open. And by that, I mean, a room that's built and not caged, a room that's shelved but not totally finished. Not major happenings to get it done. At multiple sites we'll be able to subtly bring those online. When I mean subtly, without adversely impacting our operating margins but providing additional capacity for our clients, which of course, is our job. So I think we could do that for 1 year or 2. Could be 1 year, but 1 year or 2. We're concluding a 5-year strategic plan. We're talking a lot about capacity. We have several buildings, like one in Canada in Sherbrooke, which was built for the express purpose of continuing to add onto it. It was built in a modular fashion, to sort of break out a wall and add on to it, and the HVAC is large enough to support the additional space. So we can do that whenever we want. You obviously know that both Reno and Shrewsbury have fallow space, probably in the aggregate over 300,000 feet. That's just shells, that would take a significant amount of time and money to finish. But we own them and they're part of our facility. So even those will be -- kind of give us a leg up. And of course, we want to open Shrewsbury as soon as rationally possible. It's a big facility, it's close to the major research center in the world. And we're going to wait for some significant client commitments, but we're starting to hear a lot of noise about -- from clients that they'd like to see Shrewsbury open. And there are probably ways to open it and do multiple things in it. Like you go to safety assessment, in vivo pharmacology and some variations of those themes. So without going out and adding additional capacity through M&A or green-fielding. We have a really good portfolio. Some, literally, immediately available. Some is available over the next 2 to 3 years, if we want to push out walls and do some construction, and of course, we aspire to get Shrewsbury done. And, obviously, if demand increases in a really significant way, that we have many more large pharma companies, for whatever reason, begin to close down their own facilities, then we'll do things more quickly.

We'll go to the line of John Kreger with William Blair. John Kreger - William Blair & Company L.L.C., Research Division: Jim, can you talk about the historical correlation, if any, that you've seen between your core model business and the tox business? And the real question here is, as the tox business begins to gradually get better, do you think that will eventually be enough to sort of cause the model business to flatten out and start to grow again on a unit basis?

Really good question. The answer is we would have thought so, historically, for sure. So here's the facts. I was thinking about this kind of last 24 hours in preparation for this call. Demand is definitely better for everyone in the CRO safety assessment space, particularly for us, but it's just better. Our North American Research Model business has had 2 good quarters in a row. Not increasing sales but flat sales as opposed to declining sales, and escalating operating margins. So 2 really good metrics. And we used to talk a lot about the correlation that you're asking about and so, on the one hand, there obviously is a correlation. Outbred rats are the model of principal, small animal model of choice and the Charles River CD rat is the principal model of choice within the outbred rat. So, yes, we should see it. I think we're actually not seeing it yet, and I think what's happening is the following: One, is that you have an overall focused reduction in the number of drugs in the pipeline. So that drug companies can spend more money getting the ones with the highest probability of getting to market, to market. So that's definitely a significant issue. The other is that a lot of the work that we're doing, and I suspect that our competitors are doing, used to be done by our clients in their facilities. So they're not doing the work. We used to sell them the animals, now we sell them to ourselves or we sell them to our competitors. So you have a net increase in work. I would just say, anecdotally, and then we should watch it and you can ask me again in 1 year, a lot of people at Charles River are spending a lot time with clients. And I've been spending a lot myself, including a couple last week. And I do ask every client -- and they're all senior R&D people and often the head of R&D, is your discovery spending beginning -- are you beginning to shift more of your spending back towards discovery as opposed to disproportionately feeding the clinic? And many of them are saying, yes. So if that's true, I would say that there is the real potential in 1 year or 2 or 3, depending on what the hit rates are, that we'll see more compounds with more promise beginning to come through the development process without this imbalance that we've had. And of course, the imbalance, if it persists too long, is going to have a really negative impact on drugs getting to market in the future. So I hope that answers your question. Not seeing it now for some very good reasons, but it's better. Even when our competitors win the studies, they often use our rats. So we get a little piece of their work. But on the margin it's really a trade-off between the work being done formally, internally and now externally, using the same animal.

And we'll go to the line of Eric Coldwell with Robert W. Baird. Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division: I'm going to take that to 2 questions. I have many, actually. But first, with Research Models. You kind of hit on this with John, but North America flattish for 2 quarters, China up, Europe and Japan tend to lag. You've lagged for a couple of quarters now. Are you getting any signs in Europe and Japan that perhaps demand could pick up? And I guess as a corollary to that, you're consolidating some sites in Japan. That might be your signal that you really haven't, but I'm curious on the reasoning for the consolidation of the facilities there now.

Great question. Historically, for whatever reason -- you're a student of the pharmaceutical industry as well -- geographically, Europe and Japan have always lagged the U.S., pretty much with regard to everything. All the ways that we've interfaced with them, we see this. So we're not surprised. Europe tends to come right after the U.S. and then Japan typically follows. It tends to be a more insular environment, obviously. So it looks like the U.S., at least for the moment, has kind of stabilized from their capacity reduction. And of course, we have reduced our capacity both in California and currently at our Michigan facility. And so we feel really good about utilization of capacity and the resulting margins that will be derived from there in the States. And we're trying to manage that same process overseas, so we will continue to look carefully at the capacity that we have and refine it as necessary, commensurate with the demand. And we're in the process of doing some of that refinement, a little bit in Japan right now. So no, I wouldn't say that we've seen it stabilize, but we expect that it will -- probably going to be another year, maybe another year or 2. But I would continue to point you and everyone else listening to the fact that while sales have not been increasing in that business, we have some very creative, very aggressive initiatives in process right now to drive efficiencies through capacity utilization, automation and doing things much less manually. And we, like we just showed this quarter, believe we can and intend to continue to drive operating margins up in that business. And we will continue, definitely, to take share in the U.S. in the mid-tier and academics. And we do think that China will obviously grow indefinitely, given how nascent that market is. Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division: And I'm going to ask a follow-up or shift gears a little bit. You've talked about seasonality for the firm in total, and the major themes, which is a recurring theme. No surprise there. But with the new reporting structure, the 3 segments and some of the mix shift, could you speak specifically to the segments in terms of whether Manufacturing Services, perhaps, has a different seasonal pattern now than we might see in Safety Assessment or Research Models? Just trying to get a better sense of the revenue and EBITDA flow by new reporting segment based on the changes in mix.

Well, it's a good question. I would say that Manufacturing is probably slightly less seasonally impacted. So it's got 3 pieces, it's got the EMD business, the Avian business and Biologics. I would say that the EMD business is pretty much not impacted by the season. I would say that the Egg business, where we have, I'm knocking wood, historically been sold out of eggs year after year after year, is pretty much not seasonally impacted. I would say Biologics could be. That's a really tough business for us to call. It's very short-term work, and you don't have much backlog, you don't have much predictability. Although the business is doing much better, very much tied to large -- entirely tied to large molecules. So I'd say that will probably follow some of the ebbs and flows in just the pharma and biotech industry spendings. So somewhat in Manufacturing Support, but less impacted by the seasonality that we're seeing in kind of classic RMS or in the Safety Assessment business.

Eric, I would add to that one comment, because we don't think about it in those seasonal terms. But in the vaccine business, we have several clients who peak production around the vaccine periods, which tend to be oriented at different times of the year. So we actually do see a little falloff in the second half of the year because it's lower [ph] , and given overall demand, we do try to place those eggs at many other customers and sometimes we're successful and sometimes we're not. So it's a little different from other seasonal trends that we talk about, that are more related to summer vacations and things like that. This relates to some of our clients' productivity cycles.

And we'll go to the line of Greg Bolan with Sterne Agee Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division: Tom, going to the -- I know we're not going to be talking about this on a go-forward basis. But just given kind of the very exceptional results this quarter for legacy PCS, I think you had mentioned a 600-basis point rise in legacy PCS operating margin to around 18.2%. Can you give us a sense as to how much of that was driven by the tax credit, as well as FX and then just what the underlying kind of pull-through margin was from just the general improvement in volume?

Yes. We did say, in DSA I believe, that it was about 200-plus basis points for those couple of items. So it would probably be a little bit more than that in the legacy PCS business because it's a smaller size versus adding the Discovery Services to it. So clearly a good percentage of it, probably around half or better, really driven by volume and the flow-through of operating margin, contributed margin, however you'd like to state it, that you guys have sort of been asking about. So we did see a nice flow through of incremental margin on the pickup in volume. Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division: And then, Jim, just thinking about your comments on the North American outbred rat market -- outbred model business. I guess as you think about the spot pricing market for that particular model, your CD rat. I guess one of your primary competitors has kind of gone through some changes. And I guess one of the things that I was wondering is -- is there any indication that the pricing for that particular model is starting to get somewhat of a lift after say, 9 to 12 months of maybe some irrational behavior by some of your competition? Is there any indication of that at all?

No. This is not a model or price sort of variable and changing from time to time anyway. We have an annual price increase that affects different clients in different ways. Sometimes our competition follows us, sometimes they don't. Sometimes they're higher. It's a bit unpredictable. Notwithstanding whatever your conclusions are about the volumes, the volumes are still very significant for this animal model. I suspect they're still the highest of anything we do just in terms of share unit. The margins are very, very good just because we produce so many and we're so efficient. And we do get a meaningful price increase throughout the world. And I think we'll be able to continue to do so just because of the fundamental importance of the animal model. We're not seeing anything particularly unusual from a competitive point of view. And even if we did -- even if competition were to be aggressive in a positive way -- in other words, raising their prices. We would do what made the most sense for our clients, given the relationships that we have with them. But that's a product line that we're still really happy with.

We'll go to line of Tycho Peterson with JPMorgan. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Want to understand some of the gives and takes on the margin line, in particular, just sustainability of the tox margins. You obviously had a onetime benefit from the U.K. tax law change and then some from FX, and I know tox margins are going to be down a bit, sequentially. But what do you think the underlying run rate is on tox margins over the next couple of quarters? And then similarly, where do you see Argenta and BioFocus margins going from here?

We did say that the Argenta and BioFocus to work [ph] Backwards [ph] , Tycho, we're sort of in the mid-teens. We don't necessarily see that changing a lot this year. We are working through the integration, efficiencies and what not. But really, we're looking to leverage that as we exit 2014 and into 2015 and beyond. Whether we can get there or not, our target would be to really try to get that up in line with our corporate target, somewhere up in the 20% range. So that would be our objective. We have reasons to think that that's possible, but obviously that's not a commitment that we would make at this particular point in time. I think we basically want to raise them as much as we can without impacting the business negatively from a quality of service standpoint. And with regard to sort of the legacy PCS, I think, the overall DSA, we'll continue to see it move sideways, I think, in the mid-teens to maybe a little bit better than that. Which is sort of where the legacy PCS business has been and it's kind of where AB is. So I think mid-teens to slightly better is probably a good number to be looking at for DSA. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Okay. And then just a follow up on Jim's comment earlier about capacity. I'm just trying to put the comments on Shrewsbury in context. I mean, have you had discussions with clients about potentially opening that in the coming year? And how do we think about how you would potentially do that? Would it be in pieces or -- I'm just trying to understand how actively you're thinking about taking that step.

I wouldn't say we're having serious conversations. What I did say is, I've had a whole range of Cambridge, Boston-based biotech, large and small, ask me recently about what our plans are for Shrewsbury. So they're starting to think about how they could benefit from that being open. And as I said earlier, that was built as a very sophisticated toxicology facility and could be reopened as one. But I think it's more likely to be reopened with several different services going on at the same time, perhaps regulated safety assessment, some sort of in vivo pharmacology, DMPK, maybe, activity. And then some vivarium utilization by clients, where either we manage or they manage some combination of those. But in any event, we would want some commitments by clients in advance. And I think, typically, at least the last half dozen years or so, people are reluctant to give those commitments. But as they run out of their own space or get out of their own space or failed to want to increase it, we're likely to be able to negotiate some deals like that. And when we do, we'll be happy to open it. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Is there any discussion of dedicated space? I mean, this was a topic 10 years ago, but we haven't heard about it a lot recently.

Yes. And that would be exactly the sort of conversation that we would want. The perfect scenario that we always thought is that we'd have 3 kind of big biotech companies take a third, a third, a third or small pharma take a third, a third, a third. And kind of own the corridors, own the space and get to know the people and have them be dedicated. I don't think that's an impossibility either. So we have a team working on this right now in terms of what do we need financially, what are the best combinations, what are the most likely clients and we're working this because Cambridge continues to expand. Big pharma is adding buildings all the time, there's more biotech companies with [ph] rodents [ph] Et cetera, et cetera. It continues to flourish, and we put that site there for a reason. We wanted to be proximate to where all the work is being done. So we're really desirous of getting it open. But the clients will have to drive that.

And we have a question from Jeff Bailin with Crédit Suisse. Jeffrey Bailin - Crédit Suisse AG, Research Division: Jim, you mentioned earlier that you're not quite yet satisfied with the prices you're getting on the safety assessment side. But could you give us any color on you'd characterize the spot pricing environment right now? Are you seeing any increases and are there any geographic differences worth calling out? I know one of your primary competitors has discussed the trends in European being a little softer, so curious if that's similar to your experience?

I would say that the geography is not particularly relevant. It's very client-dependent. We have clients where we have the enterprise deals. We have clients that are one-offs. We have clients that are very price sensitive and some that will pay up for great science. So it's all over the place. We don't think we're even close to being paid for the quality of work or the level of investment that we're making. Having said that, because capacity is filling, because the mix of work is being enhanced, the margins are improving, and we're proud and pleased with that trend. But we're pretty full. And we're running pretty lean and doing really great quality work and the clients are experiencing a 30% to 50% reduction in what they would be spending internally, at least. And so there's definitely -- and if you consider the fact there we're still probably 25% or 30% below 2008, which was sort of the industry high. There's a lot of room for pricing improvement where the client still feels good about the value that they are getting, and that we feel a lot better, the work that we're doing. And the other thing that's going to invariably happen here is that clients have gone from literally waiting 6 months. In other words, calling us up and they say, how fast can you start the study? And we tell, them 6 months; and they say, okay. And they plan for that, they get their molecule in the queue. Literally, for the last 4 or 5 years, clients could start a study in less than a month or sometimes in a couple weeks. They've grown accustomed to doing that, which I think is not good for any of us. I don't think they plan well, it's really difficult for us to plan. And trust me, they plan better when they did all the work internally. So what's going to happen, putting the price conversation aside just for a moment and then I'll come back to it, is that relatively soon if you believe the anecdotal input from our private competitors, clients are going to have to start to wait. We're all going to say, even as we bring on new space, sorry, we can't start your study in 2 weeks. It's going to be 2 months or 3 months or 5 months. They will get accustomed to that. They will wait in line, that will be fine. And depending on their sense of urgency they may very well be happy or insistent on paying more. And we used to experience that in 2007 and '08. And I do think there's a sort of allocation of capacity, particularly where the client deems that to be really high-quality and they really want it. And they want it and they don't want another client to get it. The people will begin to pay up for that. But there's a lot of reluctance. And I would say the thing that puts a pall over the whole pricing thing is that you have, particularly in big pharma, you have big strong purchasing organizations that have mandates to save billions of dollars. And they pretty much try to do that across-the-board. And so there is a culture in big pharma of trying to get the lowest prices possible. And I do think that that's -- so I get that. That's, I guess, good business, but there has to be some balance between that goal and buying really high-quality science. And in some cases we have that and in others we don't.

And our next question will go to the line of Sandy Draper with SunTrust.

Maybe just a general observation, and Jim I'd love to get your comment on this. When I listened to your commentary about where you are, talking about where you'd be, your portfolio, the way the market is. If I rewind 12 months ago, I would look at it and say your tone sounds more positive. You feel better about where Charles River is sitting today than 12, 18, 24 months ago. But when I look at the sort of your full year guidance this year in the 3 segments versus last year, if you exclude the acquisitions, there's not a whole lot of difference from the growth rate. And I'm just trying to see if I'm misreading anything about your overall positive tone. As you said, we need to focus on this stuff annually, not quarterly, which I can appreciate. But just trying to see if you really do feel that better, but you're just trying to keep a conservative outlook. You said not overly conservative but just generally, due to the lumpiness, you want to make sure that you're not getting ahead of yourselves. Just would love some comments on that.

Tom and I could both take shot at this, I guess. Again, we don't feel that we're being conservative. We really are trying hard to be realistic. Yes, obviously, some of the history is in our present, of course. And there's some unpredictability in this marketplace and availability of funds, and the competitive scenario continues to be challenging. It's okay that it's challenging. But it's more challenging than it was many, many years ago. Having said that, we're quite pleased with the growth rate in the preclinical business versus the last few years. We're very pleased with the engagement with many more clients. We're very pleased with our facilities filling and the mix of business. And the only thing that we're not pleased with is price point, and it sure feels like we ought to be getting some level of relief in the not-too-distant future -- although that continues to be elusive from our ability to call that. With regard to growth rates elsewhere besides our most recent acquisition, the Research Model business has flattened but operating margins are growing. Our Discovery businesses are growing, our EMD business is growing very rapidly, as we reported, for I dunno how many quarters in a row, and we just finished almost a 20% growth quarter -- last 2 quarters we're almost 20%. And we've kind of showcased biologics as a business, which we've been growing and investing in for several years now, and it's beginning to kind of break out and make a difference. So we're generally pleased with the overall demand for our businesses. It's becoming a big complex portfolio. The acquisition the we just did should grow faster than many of our other segments. It should continue to enhance our top line growth. And we think, with some modest amount of M&A going forward, we can get the company back to double-digit growth, which is our goal.

Yes, just to add to that. If you think about our guidance this year, excluding the acquisition of Argenta and BioFocus, we're essentially in the mid-single-digits. Last year, we grew low single-digits. So, clearly, the topline numbers on a "pro forma" basis will be better. That's really being driven principally by the Safety Assessment activity. What we're now calling Manufacturing Support, which includes EMD, continues to grow quite nicely. I think the in-life/safety assessment is actually going to be up year-over-year in terms of the growth rate, which we've talked about. And the new or the old RMS segment, principally the models area itself, continues to be challenged, as we talked, by in large part the consolidations that we continue to see in the industry. So, overall, I do think we're in a better environment, particularly in the in life. I think the businesses that have been doing pretty well continue to do well, like EMD, in life's doing better. And we're continuing to work through challenges in the models business.

And we'll go to Robert Jones with Goldman Sachs.

I guess, just on the RMS side, Jim. The efficiency efforts there, you obviously continue to pay dividends on the margin side of that business. And yet, on the top line, and you guys have touched on some of the challenges here, it looks like, on a constant-currency basis, it's been relatively flat. So I guess just 2 quick ones, how much room is left on the efficiency side to kind of improve operations? And then on the top line, you've called out a few specific things. But I'm just wondering from a higher level, how much of this slowdown, if you will, in growth there do you characterize as structural versus more market-specific in the current environment?

So I think it's early days on driving efficiency. We said on several calls, this is an old business that we've been in for a long time. We're the world's leader. We're really good at it. The margins are terrific, and things are way too manual. And we're rethinking everything that we do. And we're driving efficiency all over the world in multiple aspects of this business. So I'm quite confident that the operating margins will continue to expand in a meaningful way. So that's really good news. I think that we can and will continue to grow our share in the academic and the mid-tier sectors in the U.S. And I think we can continue to grow share once things stabilize overseas as well. And, certainly, China will continue to be a high-growth vehicle for us. So we've been saying for a couple years, the business will probably shake out as a low single-digit growth business. We're saying that the products and services piece now are high-20s margin. And we'll continue to drive that as hard as we can, try to get it as close to 30 as possible. And it's a very big business. It provides an entrée to literally almost every research enterprise in the world. It helps us build the rest our businesses. It's an extraordinary source of free cash. And we do also have some continuing opportunities to participate by creating or licensing in or somehow getting access to specialty models. Which has been our goal for a long time, which should help enhance the value proposition even if the units are relatively small.

That's helpful. And then I guess just one quick follow-up and don't want to be a spoiler here. But looking ahead to the Analyst Day next week, curious if you'll be providing an update on the long-term targets, particularly on the margin side, in light of the change to the reporting structure that you guys gave today.

We'll take that under advisement.

And we'll go to the line of Rafael Tejada with Bank of America.

Just a quick one here on an earlier question. Just for the full year guidance on operating margin. Can you just comment on how much is really being driven just by the business improvement factors as opposed to the other charges that are being recognized?

That would be looking at the whole year or the rest of the year?

Yes, the whole year.

Well, if we go back to our original guidance -- we obviously increased guidance for Argenta and BioFocus. We increased it for a combination, both venture capital money and performance of the business, and then we've just increased it again. If you think about the second quarter, we outperformed by -- by consensus I guess, to use that data point by $0.15, $0.16, we had $0.04 from venture capital. Everybody's got a different take on whether the shares were a little bit better or not. I mean, they were marginally better. Obviously not meaningfully, same with the tax rate. We did mention a couple of hundred basis points with foreign exchange and the tax pickup versus last year. Although, from a perspective basis, I mean we knew about the tax change so we had kind of put that into our forecast, and the currency worked to our favor. So the truth of the matter is, without scratching it out on paper there's a good portion of it that's clearly from operations, clearly some of it is from venture capital. We talked about that being $0.12, and some of it's clearly from the acquisition. Not much I would say, really, from one-time activity at this point in time. Other [indiscernible] activity.

Okay. And then just a quick follow-up to that then, just thinking -- and maybe this is something you'll discuss next week. But longer-term, on the potential EPS growth, I think I'm just trying to get a better handle on the contribution from efficiency savings since these have been changing a bit on a quarterly basis. So what sort of non-GAAP EPS growth do you think is realistic on a year-over-year basis once you're still factoring in all these charges? I mean, can we -- is it something in the high single-digits, low double-digits? And that'll be it for me.

Thanks for the clarification to your question. And what I would say is as Jim just mentioned in reference to a question a few moments ago. We are planning to give a little bit more color on our longer-term growth rates next week at the Investor Day. But in terms of your question now, we still think there's room to improve, relative to efficiencies. We do have a robust program working on that. We've worked through a number of businesses historically, particularly, probably the in-life Safety Assessment business. And as we talked about earlier in the call, we did take some charges relative to our business in Japan. We hope to yield results from that starting next year. So, as Jim said, I think there's a lot of room still to make improvements in efficiency in a number of our businesses. And we continue to do that so that we do think that we can continue to grow earnings as well as the top line going forward.

And we have time for one final question, and we'll go to Doug Schenkel with Cowen and Company.

This is Chris on for Doug today. So maybe a longer-term strategy question. Drug development in China continues to grow at a rapid pace, but I think your presence there is largely limited to Vital River. Can you talk about if expanding services and products to China is priority for Charles River and what steps are being taken to drive growth?

Sure. Good question. Our goal is to do as much of our current portfolio -- provide as much of our current portfolio in China, probably for China, as quickly as possible in the areas that makes sense. So, for instance, we've already opened and closed a GLP tox facility that we opened in Shanghai in 2006. And there was insufficient business to warrant using it. Also, we opened it at a time when there was too much space in the U.S. and Europe at low price points. So, at some point, we want to back in the Safety Assessment business, but I can't see that for a while. We have a small EMD business that we've had there for a long time. We sourced a fair amount of our larger animal models from that geographical account [ph]. And obviously we have a robust growth engine with our animal business, which will have a related diagnostic laboratory and probably GEMS business associated with it. So we're looking at that locale for possibly doing everything else we do. So that would be our avian business. That would be in vivo pharmacology, that would be in vitro pharmacology. That could always be chemistry. So we want to be able to participate in that market, which is growing disproportionally fast from a funding point of view to the rest of the world. And we think we have a lot to offer. But we're going to do that cautiously, and we're continuing to assemble a strong management team in China as we do that. So we're looking at several acquisition opportunities and several organic growth opportunities. And depending on priorities around here and what deserves the most funding and where we think we get the best returns, we'll continue to proceed on those. But China remains an important part of our growth strategy.

There were a few more people in queue today, we'll follow up with you. But for the time being, this concludes the conference call. Thank you for joining us this morning.

Ladies and gentlemen, that does conclude your conference. You may now disconnect.