Charles River Laboratories International, Inc. (CRL) Q3 2014 Earnings Report, Transcript and Summary

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

Thank you. Good morning, and welcome to Charles River Laboratories Third 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 third 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 3203653844. The access code in either case is 338339. The replay will be available through November 13. And you may also access an archived version of the webcast on our Investor Relations website. I'd like to remind you of our Safe Harbor. Any remarks that we may make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors, including, but not limited to those discussed in our annual report on Form 10-K, which was filed on February 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 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'd like to begin by providing a summary of our third quarter results before commenting on our business prospects. We reported revenue of $327.6 million in the third quarter of 2014, a 12.1% increase over the previous year. The acquisition of Argenta and BioFocus, now known as Early Discovery, contributed 8% to third quarter revenue, and foreign exchange added 40 basis points. All 3 business segments reported revenue increases, in constant currency, RMS gained 10 basis points, DSA gained 24.1% and Manufacturing gained 12.9%. 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 and second quarters, mid-tier clients again generated a double-digit revenue increase. We are continuing to benefit from our targeted sales efforts and the many enhancements to our sales and marketing structure we have identified and implemented since we first reorganized it in 2010. The operating margin declined 70 basis points year-over-year, but the decline was due primarily to a difference in tax benefits, which were greater by 260 basis points in the third quarter of last year. The addition of Early Discovery, which has an operating margin below the corporate average, also affected the operating margin, as did unallocated corporate costs, which increased primarily due to performance stock units issued to management to align its interest with those of its shareholders. Earnings per share were $0.86 in the third quarter, an increase of 8.9% from $0.79 in the third quarter of 2013. Given our year-to-date performance and our expectations for the fourth quarter, we are narrowing our revenue guidance to a range of 10% to 11%. We are also narrowing our increasing -- and increasing both GAAP and non-GAAP EPS. The non-GAAP EPS range is now $3.33 to $3.38, which represents a full year earnings increase of approximately 13.5% to 15.5% over last year. Based on our outlook for the fourth quarter, we are confident that we will achieve our guidance for 2014. Before I discuss the segment results, I would like to provide some details on the ChanTest acquisition. As you know, we are focused on selectively acquiring companies that expand our unique portfolio, either through the addition of nonclinical products and services or by broadening our geographic footprint. With the acquisition of ChanTest ion channel testing expertise, we will significantly increase our Early Discovery capabilities, enhancing our ability to support our clients' discovery and lead optimization efforts. We think this is particularly important, because focus on ion channels is increasing from 2 perspectives: First, because of their importance in cell physiology, ion channels represents a rich source of current and future drug targets for a variety of diseases, including pain, cystic fibrosis, inflammation and hypertension. Second, precisely because ion channels play such an important role in cellular function, it presents safety concerns for drug development. To address these safety issues, the FDA is in the process of developing guidelines that will increase ion channel testing for potential new drugs. These new guidelines are referred to as the Comprehensive in vitro Proarrhythmia Assay or CiPA. The guidelines are still in a development phase, however, many biopharma companies are planning for or have already begun early adoption, due to the potential risks that ion channel impairments present and the benefit of more specific testing. ChanTest is extremely well positioned to support the anticipated increase in demand. Its scientific expertise is extensive, and it offers a panel of more than 120 validated assays to test ion channels, which we believe is the most comprehensive channel in the industry. ChanTest scientists are thought leaders in the field of ion channels, and are currently working with the FDA on the CiPA guidelines. ChanTest is a particularly strong strategic fit with the in vitro capabilities already resident to BioFocus. The breadth of those capabilities, combined with our long-standing in vivo expertise, will provide clients with a leading nonclinical program for cardiac risk assessment and for risk assessments generally. We are very pleased to welcome the ChanTest staff to Charles River, and look forward to working with them to enhance the support we provide to our clients. As part of our continued efforts to streamline the organization and enhance the support we can provide for our clients' integrated drug discovery program, we are integrating our Early Discovery and in vivo discovery operations within Charles River Discovery Services. Our clients' drug discovery efforts are an iterative and continuous process, and one seamless discovery organization will allow us to better engage with clients at the earliest stages of drug discovery and support their complex scientific needs. David Smith will lead the integrated Discovery Services business. He has been promoted to the position of Corporate Senior Vice President, Global Discovery Services. In this role, David will focus on expanding our in vitro and in vivo capabilities, and creating a more seamless drug discovery offering for our clients. David joined Charles River through the acquisition of Argenta and BioFocus, and as Corporate Vice President, Early Discovery Services, has been responsible for leading their integration with Charles River. Prior to joining us, David was Chief Executive Officer of Galapagos Services, the contract research services division of Galapagos from which we acquired Argenta and BioFocus. David has more than 20 years of financial and operations management experience at organizations including AstraZeneca and PricewaterhouseCoopers. Working with David, Dr. Emily Hickey, Corporate Vice President, in vivo Discovery Services, will continue to manage the in vivo business. We also promoted Joe LaPlume to the position of Corporate Senior Vice President of Corporate Development. Joe has been managing our corporate development function, responsible for strategic transaction, which expand the company's early-stage portfolio and geographic footprint. Joe has been instrumental in enhancing the company's growth profile through the acquisitions of Accugenix, Vital River, Argenta and BioFocus and ChanTest, as well as multiple licensing transactions. We expect he will continue to identify strategic portfolio additions like those. Joe was formerly deputy General Counsel at Charles River; prior to joining us in 2005, had extensive experience in both corporate law and mergers and acquisitions. I'd also like to mention that in March 1, Dr. Jörg Geller will retire. Jörg has been with Charles River for more than 28 years and throughout his tenure, he's been one of the most effective operating managers. That was the reason that Jörg was the ideal choice to head our global efficiency initiatives. As Corporate Executive Vice President of Global Productivity and Efficiency, Jörg was responsible for overseeing the initiative to enhance efficiency and drive increased productivity across all of our businesses worldwide. Jörg has performed exceptionally in his role, as he always has, and we are very appreciative of his years of service. Following Jörg's retirement, Jeff Goldsmith, Corporate Vice President, North American Operations Optimization, will continue with these important global initiatives. I'd like provide you with details on the third quarter segment performance, beginning with the RMS segment. Revenue was $124 million, a 10-basis-point gain in constant currency. We were very pleased to see another quarter of year-over-year growth for research model sales in North America, which we believe the effects of consolidation of the biopharmaceutical industry are moderating. Although consolidation in Europe and Japan is continuing, the improvement in North America offset the declines in those geographies. Revenue for research model services was down slightly in the third quarter. As a reminder, research model services now includes only GEMS, RADS and IS since Discovery was consolidated into the DSA segment. The decline was due primarily to our GEMS business, mainly because one client significantly reduced the number of colonies that we maintain. We believe that this was a result of the normal assessment of the value-specific models by this client, and not indicative of any shift away from genetically engineered models or from our GEMS business. Translational medicine continues to drive development of more complex models of human disease. Working with these models is quite complicated, requiring expertise which most organizations do not have in-house. As a result, they're turning to us for the scientific knowledge required to manage their model colonies. We expect each of the research model services businesses will benefit, as global biopharmaceutical companies increase their use of outsourcing through earlier stages of discovery. And mid-tier biotechnology companies utilize better funding to invest in their pipelines. That said, you should bear in mind that research model services will face difficult comparisons over the next 4 quarters due to the termination of the NCI contract on September 25. As you know, this was an IS contract for the production of NCI models for academic and government researchers. We are continuing to produce those same models, but the revenues will be recorded in research models, rather than Research Model Services. The outreach program, which we launched in July, has progressed very well, and our estimated fourth quarter revenue shortfall, as a result of the contract termination, is unchanged at approximately $1.5 million. In the third quarter, the RMS operating margin decreased by just 30 basis points to 25.4%. This small decline was due primarily to lower GEMS revenue, as higher revenue in North America offset the impact of lower revenue in Europe and Japan. The operating margin also benefited from our efficiency initiatives, particularly the facility rationalizations in California and Michigan. The impact of our facility consolidation in Japan will be a benefit in 2015, and did not affect the third quarter results. We are continuing to identify opportunities to streamline our Research Model Services operation. And we believe that our annual RMS operation -- operating margin in the high-20% range is achievable. DSA revenue was $140.9 million, a 24.1% increase in constant currency. The Early Discovery business contributed $23.3 million in the third quarter, effectively in line with our expectations. The integration is progressing extremely well, and we have continued to make progress on our outreach to heads of R&D and other decision-makers at leading biopharmaceutical 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 continue to support research programs as they move downstream through in vivo discovery and safety assessment. With the acquisition of ChanTest, we will be able to offer what we believe is the most extensive portfolio of essential products and services designed to support our clients' drug discovery and early development efforts, and especially, in the area of risk assessment. We believe that the addition of ChanTest makes our value proposition even more compelling for clients, and will lead to the placement of additional work with us. The Safety Assessment business reported a mid-single-digit increase over the third quarter of 2013 and only a slight decline sequentially from the extremely strong second quarter. We were very pleased with this performance, which resulted from a combination of improved client demand, especially from the mid-tier, as well as our intense focus on scientific expertise, exceptional execution and outstanding client service. We believe that improved demand is demonstrated by increased inquiry levels, placement of studies, and higher capacity utilization as well as industry commentary generally. However, we also believe that our science, execution and client service are critical to our clients' decision to choose Charles River as their outsourcing partner. This is true for our global clients when they make the decision to reduce in-house infrastructure, and for our mid-tier clients who require a partner to provide the capabilities, which they do not have internally. As we work with our clients on the same side of the table, they gain confidence in our ability to provide a superior level of scientific expertise. We also recognize that we are committed to supporting the requirements as efficiently and cost effectively as possible. As a result of all these factors, backlog has been steadily building, capacity is filling, and we are evaluating our global network of facilities to determine the optimal method for capacity expansion in 2015. DSA operating margin declined by 170 basis points to 18.3% in the third quarter. But as you may recall, there were a number of tax-related items, which increased the DSA operating margin from the third quarter of last year. When excluding the tax items, the DSA margin would have increased when compared to last year, primarily as a result of leverage from higher Safety Assessment sales. We achieved the improvement, even including the Early Discovery business, which has an operating margin below the segment average. That said, the Early Discovery margin improved in the third quarter and we expect it will continued to improve in the fourth quarter. Tom will give you more detail about the DSA operating margin shortly. The Manufacturing Support segment delivered revenue growth of 12.9%, with each of the 3 businesses: EMD, Biologics and Avian, reporting revenue growth greater than 10% in constant currency. The PTS franchise is continuing to drive EMD business, as a result of our continuous product innovation. Each new PTS model is enabling us to target additional market opportunities, whether as a result of faster processing like the Nexus or improved connectivity like the Nexgen. Because of these capabilities, we are converting clients who use our traditional LAL testing methods to the PTS, and are taking market share as new clients make the change from other providers. We just introduced our latest innovative product at the PDA conference in late October. The PTS-Micro is a rapid test of bio bacterial contamination or bioburden; and like the PTS, is an important advance over current testing technologies, because it delivers significantly faster results. Our introduction of the PTS-Micro positions us as the only provider of real-time quality control monitoring products and services for pharmaceutical manufacturing, who can offer a combination of FDA-licensed rapid endotoxin testing, rapid bioburden testing and microbial identification, utilizing Accugenix's extensive bacteria library. We believe this is a clear distinction between Charles River and other competitors. As was the case with the PTS when we introduced it, we expect sales of the PTS-Micro to ramp slowly over the next few years. As we work with our key clients to solve their unmet needs for more rapid detection of bacterial contamination. We believe that our ability to provide a total microbial testing solution to our clients will be a key driver of our global -- of our goal for the EMD business to continue to deliver at least low-double-digit organic revenue growth for the foreseeable future. Our Biologics business also delivered double-digit revenue growth in the third quarter. As I explained last quarter, this business supports all testing services required to bring large molecules to market, including cell line characterization and banking, assay development and testing and viral clearance. We have invested in this business over the last few years and believe we have achieved our goals to become the premier provider of these services. During this time, we maintained our focus on efficiency, and are seeing the benefit now in margin expansion. We will continue to invest in this business, which is well positioned to benefit as the number of large molecule drugs in development and on the market increases. Manufacturing segment's third quarter operating margin was 33%, a gain of 130 basis points year-over-year. The improvement was due to both the EMD and Biologics businesses, the result of leverage from higher sales; and for Biologics, 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. I want to take a moment to comment on the performance of our clients segment. Our broader portfolio and sales strategies we initiate to promote the portfolio have been very effective in enabling us to create new and expand existing relationships with clients in all 3 segments: global key accounts, mid-tier and academic clients, and to take market share. Sales to global key accounts have stabilized, despite the consolidation in Europe and Japan, and the ongoing changes as other global biopharmaceutical companies as they realign their drug discovery and development process. The global key accounts, many of which have strategic relationships with us, have either increased the services they outsourced to us or are discussing the options for expansion. Sales to academic clients are also stable, as we have offset softer sales due to funding uncertainty with expanded relationships and market share gains. The mid-tier clients were the primary drivers of revenue growth in the third quarter, as they have been for most of the year. These clients are benefiting from robust funding from both the capital markets and from global biopharma and are investing heavily in their drug pipeline. As you know, the biotech model has always required outsourcing, since the majority of funding has been directed at drug discovery, rather than building infrastructure. We have built long-term relationships with many of these biotechs, but given their limited pipelines and our in vivo focus, they were only able to place work with us periodically. Now that we also provide Early Discovery Services, we have the opportunity to work with these clients from target discovery through IND filing. This provides a more significant value proposition for clients and a prospect for us to build larger, longer-term, truly strategic relationships. The opportunity to enhance our relevance to clients is at the heart of our portfolio expansion strategy, and our focus on scientific expertise. The addition of Early Discovery is enabling us to support clients through earlier stages of their research with our integrated drug discovery capabilities, and to stay with them through the entire early-stage process, a capability that no other CRO can fully match. We strongly believe that there will be additional acquisitions like ChanTest, through which we will be able to offer even more critical capabilities. Our ability to provide an increasingly compelling value proposition is very much dependent on expanding the scale of our current portfolio. However, building our business is not just about acquisitions. Continuous improvement and our investment in our people is also necessary. The depth of our scientific expertise is a significant differentiator between Charles River and other CROs, and is greatly appreciated by our clients. Target discovery and early in vitro testing are incredibly complex, and decisions are made at these stages about whether the next drug for cancer or Alzheimer's or Parkinson's progresses through the pipeline. We intend to nurture and expand our scientific expertise in order to continue to provide the exceptional support for which Charles River is known. 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 third 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. A reconciliation of non-GAAP items can be found in our press release and on our website. We are very pleased with our third quarter performance. Earnings per share of $0.86 exceeded our prior outlook, primarily as a result of favorable operating results. We entered the third quarter facing a cumulative headwind of $4.4 million to operating income from tax-related items that provided a large benefit in the third quarter of 2013. As a result, we anticipated that the third quarter operating margin would decline year-over-year, which it did by 70 basis points. However, the third quarter margin of 17.8% exceeded our previous expectation. This was the result of continued strength in the manufacturing and DSA segments as well as foreign exchange. In addition to last year's tax-related items, the margin improvement was partially offset by higher unallocated corporate cost and the mix impact from the Argenta and BioFocus acquisition. Because of their importance to the year-over-year comparison, I would like to review the tax-related items that benefited the DSA segment's operating income by $4.4 million or 390 basis points in the third quarter of 2013. These items included a $1.7 million benefit from the U.K. tax law change, a $1.1 million gain from a real estate tax abatement in Scotland and $1.6 million benefit from a multiyear Canadian tax settlement related to R&D tax credits. The only tax-related item which also affected the third quarter of 2014 was the U.K. tax law change. This change, which we adopted in the third quarter of 2013, resulted in the reclassification of R&D income tax credits, the segment operating income and benefited the DSA operating margin by similar amounts in both the third quarters of 2014 and 2013. This is because the third quarter of 2013 included a true up for the second quarter, since the law was retroactive to April 1, 2013 and the third quarter of 2014 included an additional benefit from Argenta and BioFocus, which we acquired on April 1, 2014. In total, the tax-related items resulted in a net headwind of approximately 260 basis points to the DSA operating margin in third quarter of 2014. This was partially offset by foreign exchange, which benefited the DSA operating margin by approximately 60 basis points as a result of the weaker Canadian dollar. Excluding the tax-related items and FX, the DSA operating margin would have increased by 30 basis points year-over-year. This is a positive performance for the DSA segment, because the Early Discovery operating margin was dilutive to the DSA segment margin by approximately 70 basis points and by approximately 30 basis points to the consolidated operating margin. We said at the time of the Argenta and BioFocus acquisition that we expect this business's operating margin to improve over time, which it did in the third quarter. Given the movement of foreign exchange rates over the last 2 to 3 months, I will now provide additional detail on our foreign exchange exposure. As I just mentioned, foreign exchange contributed 60 basis points to the DSA operating margin, and nearly 30 basis points to consolidated operating margin in the third quarter. This is principally the result of our foreign exchange exposure in Canada, where we invoiced a majority of our revenue in U.S. dollars, but incurred most of our cost in Canadian dollars. U.S.A. -- U.S. Canadian dollar mix represents a change from several years ago when our revenue in Canada was more evenly split between U.S. dollars and Canadian dollars. That shift occurred, because of a change in client mix. As you know, we are naturally hedged in most of our other geographic locales, where revenue and cost are recorded primarily in local currencies. As a result, the foreign exchange would translate to operating income at approximately the margin rate in these geographies. By currency, approximately 54% of our total revenue was generated in U.S. dollars in the third quarter. 18% in euros and 16% in British pounds, which reflects an increase related to Argenta and BioFocus' U.K. footprint. Sales in Canadian dollars and Japanese yen each represented another 4% of revenue and the Chinese yuan contributed 2%. Current spot rates in all currencies are less favorable than at the beginning of the year therefore we expect an FX headwind in the fourth quarter and in 2015. Based on the current rates, foreign exchange would reduce revenue by slightly more than 1% in the fourth quarter and by up to 2% in 2015. The impact on 2015 EPS would be approximately $0.05. We anticipate that rates may be volatile through the end of the year and into next year, and plan to update you on our FX assumptions for 2015 when we issue guidance in February. Unallocated corporate cost increased to $2.1 million from the third quarter of last year, thereby reducing third quarter operating margin by approximately 70 basis points year-over-year. The increase was primarily driven by higher stock compensation expense related to the performance of stock units or PSUs, that we began to issue on 2013. Costs associated with the PSUs increased in the third quarter of 2014 due to the fact that the company has performed very well this year, as well as to an increase in the number of managers having been included in the program this year. Unallocated corporate cost were up $0.2 million lower sequentially, and we continue to expect these costs to be at or slightly below 6.5% of total revenue in 2014. I will now discuss earnings per share. Third quarter EPS growth of 8.9% was driven primarily by higher sales, as well as the tax rate and the benefit from stock repurchases, particularly the second quarter repurchase activity. The comparison to the third quarter of last year was negatively affected by tax-related items and a limited partnership investment gain that benefited the third quarter of 2013 by $0.02 and $0.05 per share, respectively. A gain a $0.05 per share in the third quarter of 2013 related to our limited partnership investments in large life science venture capital funds, which we report in other income. In the third quarter of this year, you should note that we booked a $0.01 loss on these investments. Despite this loss on our limited partnership investments, other income net was $0.3 million in third quarter of 2014 because the investment loss and other miscellaneous items were more than offset by a $2.1 million gain related to the termination of the NCI contract and associated transfer of assets at our RMS facility in Maryland. Since other income is principally driven by investment gains or losses that are largely based on market returns and are difficult to predict, we have not forecast any gains or losses in the fourth quarter in other income. The $0.11 year-to-date gain in 2014 creates a significant headwind for EPS next year. Net interest expense was $2.6 million in the third quarter, an increase of $0.4 million year-over-year due to higher debt balances associated with the acquisition of Argenta and BioFocus. However, net interest expense decreased $0.5 million from the second quarter. We now expect 2014 net interest expense to be $11.5 million to $12 million, which is below our prior outlook of $12 million to $14 million, due primarily to debt repayment in the third quarter. This revised outlook includes a small amount of interest expense associated with the ChanTest acquisition for the final 2 months of 2014. The non-GAAP tax rate decreased significantly year-over-year from 31.1% last year to 27.1% in the third quarter of 2014. The decrease was primarily the result of $2 million of additional tax expense in the third quarter of 2013, associated with an ongoing tax audit related to Canadian transfer of pricing. With a year-to-date tax rate of 27.2%, we have narrowed our non-GAAP tax rate outlook to a range of 27% to 27.5% for 2014. Free cash flow was $57.4 million in the third quarter and $122.4 million year-to-date. We currently expect 2014 free cash flow to be in a range of $180 million to $185 million, which represents an increase of $10 million to $15 million over 2013. This is at the lower end of our previous range of $180 million to $190 million, due to higher-than-expected DSOs and additional cash expenses such as severance and acquisition-related cost. DSOs increased to 59 days in the third quarter, 1 day above the second quarter level and 3 days above the year end 2013. We don't believe increase in DSOs represents additional collection risk. However, we are working to improve DSOs in the fourth quarter. We have revised our CapEx estimate to the lower end of our previous range of $55 million to $60 million for the year due to timing. As we reiterated in August, our top priority for capital deployment continues to be disciplined M&A activity, strengthen our early-stage portfolio and drive profitable growth. We will also deploy capital to repurchase shares and repay debt, as we did in the third quarter by repurchasing approximately 380,000 shares of stock, at $20.4 million and repaying $33.2 million in debt. For the fourth quarter, we currently plan to limit our stock repurchase activity due to the completion of the ChanTest acquisition. As a result, we could see the diluted share count increase slightly in the fourth quarter. We paid $52 million for ChanTest with a potential earn-out of up to an additional $2 million, representing a trailing 12-month adjusted EBITDA multiple of 7.6x. We financed approximately half of the purchase price using our revolver, and the remainder with cash on hand. ChanTest will become part of our Discovery Services business and be reported in the DSA segment. It is expected to add approximately 1% to annual revenue and be modestly accretive to 2015 EPS. Given the timing of the close, with only 2 months left in the year, ChanTest is expected to provide only a minimal benefit to 2014 revenue, and be neutral to 2014 EPS. As Jim discussed, we updated our 2014 sales guidance to 10% to 11%, or the high end of previous range and raised our non-GAAP EPS guidance from $3.33 to $3.38. In the fourth quarter, we anticipate that normal seasonal trends will result in revenue, operating margin and EPS below the third quarter levels. The softer seasonal sales volume is expected to have a more pronounced impact on the RMS segment, consistent with historical trends. In recent years, the RMS segment's operating margin has dipped below 25% in the fourth quarter, and we also expect this to occur in 2014. In addition, the termination of the NCI contract and subsequent transition of the Frederick, Maryland facility to a commercial research model operation is expected to result in a small and incremental headwind in the fourth quarter. While there could be a slight down -- slowdown in order activity at the DSA and Manufacturing Support segments around the year-end holidays, we anticipate that the robust underlying trends for these businesses will continue to drive our year-over-year growth in the fourth quarter and into 2015. The high end of our 2014 guidance range suggests that fourth quarter EPS will be at a similar level to last year as the benefit from year-over-year revenue growth is expected to be offset by increases in unallocated corporate cost, as well as in the tax rate. Last year's fourth quarter tax rate benefited from several discrete items, resulting in a low 22.8% non-GAAP rate. We expect a more normalized tax rate this year. We are very pleased with our third quarter performance, which has enabled us to increase our non-GAAP EPS guidance for the third time this year. Thank you.

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

[Operator Instructions] And our first question, we'll go to Tycho Peterson with JPMorgan. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Jim, I want to ask about some of the gives and takes on the research model business. You talked about North America being a little bit stronger, obviously still some softness in Europe and Japan. But going back to the Analyst Day, when you talked about a path to get back to kind of mid-single digit growth for that business, can you maybe just talk about the trajectory from here? When do you see Europe and international markets getting better? And what's the growth rate you're seeing in the U.S. now for animal model?

Yes, sure. We -- the U.S. market has stabilized now for a couple of quarters, and we're pleased to see that. It's very much related to consolidation and infrastructure reduction activity, which of course is virtually impossible to predict. But there has been a fair amount of it, plus we continue to get some price. We've historically seen Europe and Japan lag the U.S. for things like infrastructure reductions. We're certainly seeing it this time as well. So there's been more activity there for the last couple of years. Those locales have been declining. And U.S. has been essentially offsetting it nicely. We would expect that at some point, the declines in infrastructure reductions overseas would slow down as well and level off. We do believe that the long term, we will continue to be able to get price in the research model business worldwide. We're going to continue to have some increased growth in China. We can't forget that locale that's a new business for us, which is growing nicely. We're going to continue to have a slight improvement in mix as the models get more valuable: Inbreds and hybrids and transgenic and immuno-compromised animals. And also, yes, remember that part of that segment will be -- is related to the service businesses. And we would expect to see continued growth in all of them. And we at -- GEMS is a little slow this quarter, because of one major client. But we think that genetically engineered models will play a critical role. So modest growth in units, continued growth in improvement in price, continued improvement in mix and some increasing demand for services, pretty much across all 3 service lines that are left in research model. So we feel pretty good that business will track low- to mid-single digits sort of for the long term. And we ought to begin to see that as Europe and Japan stabilize. Tycho W. Peterson - JP Morgan Chase & Co, Research Division: Okay. If I could just one clarification for comment and I'll hop off. On capital deployment, you talked about $50 million remaining at the Analyst Day, obviously you've done the deal here. Any change in your target leverage ratio going forward? And should we think about kind of deals being off the table for the first part of next year? I'm just trying to understand here that position [ph].

I don't see any changes in our leverage outlook. We count our stocks historically about being somewhere in the mid-2s. I missed the very first part, did you ask about CapEx or... Tycho W. Peterson - JP Morgan Chase & Co, Research Division: No, no, it's capital deployment. So it's the same question, what would you change your target leverage ratios or...

No. I mean, we're -- I think our target would be around the same. And I don't see our outlook for that or our targets for that impacting our M&A, particularly given the sizing of most of the candidates that we've actually look at in the free cash flow that we do generate.

And we'll go to the line of Sandy Draper with SunTrust.

I guess maybe just following up, Jim, on your comment about the strength primarily coming from mid-tier biotech, and a lot of that coming from the investments. As you look at the large pharma guys, do you feel like as they're looking at the early stage is primarily coming from those investments in the mid-tier smaller guys? Or what's your sense of what the actual larger pharma guys are doing in the early stages, and how they're acting?

Yes, so we would expect -- look, our business with our global accounts is very strong. But that scenario where there are -- there's a lot of consolidation and reduction in capacity. So that's why we're seeing larger revenue in total to biotechs, which of course to a large extent have become a proxy for the large pharma companies, for a lot of the discovery efforts. And it's a more straightforward proposition with the smaller companies to do the discovery work, because while they do, obviously some internally, they're happy to use external resources. We're feeling that as we have a larger portfolio, of course we've been out now since -- we've been out for many years. We've been at it since we did Argenta and BioFocus in April. Meeting with all the heads of R&D for all the major drug companies and most of the major biotech companies about this expanded portfolio. The reception is really quite positive. Companies that weren't even thinking about outsourcing, we've engaged them in conversations. Clients with whom we do some -- do some outsourcing with us are really interested in a larger value proposition. And we feel really good about the fact that ChanTest expands that even further. So we're quite confident we're going to have continued good uptake with biotech companies, and expanded opportunities with Big pharma companies; both those that we already have strategic deals with who want to expand those, others that we're having conversations real-time right now about larger deals to talk about a comprehensive integrated program, to start very, very early and go all the way through drug development that there are significant opportunities with those. And it takes a while to get the story out and clients need to have some confidence in both the depth and breadth of our capability across multiple therapeutic areas. And of course, we now have that both in vivo and in vitro. So it's a more powerful and comprehensive conversation.

And we'll go to the line of Eric Coldwell with Robert W. Baird. Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division: The questions relate to your DS&A segment and specifically there's been a lot of consolidation in the industry outside of what you've been doing proactively here. And 2 of your recent large peers recently merged. They've already started closing sites. I'm just curious, does all of this discovery and preclinical, nonclinical M&A activity: How is changing the market environment? Is it changing client decision cycles, changing pricing dynamics, and what might be the impact of some of your peers actually starting the process of closing down facilities?

Yes, Eric. That activity is continuing. I would say that the amounts of I would say have either been closed or contemplated to be closed are relatively modest. Obviously, the closure of any facilities, assuming they were well utilized previously and one doesn't really know that, but assuming they were, shrinks the overall amount of capacity in the system, which should be beneficial to the rest of we players. So I think directionally, it's obviously a good thing. I do think that this industry has been waiting for and need some consolidation, given the capacity glut that we've had for the last 5 years. But while you have some of that, you also have unquestionably, an increased demand across many of our clients for those that have better pipelines, and those that are shutting down infrastructure. So demand is much better. Our capacity is getting quite full, as we've said in the prepared remarks. We'll be looking to expand capacity in the next fiscal year. The good news with all the capacity we built is that we have space available. And we can get it online relatively quickly. We have other space available that either has been closed or wasn't fully finished that we can get online with some further investment and in validation of hiring of employees. So I think what you're going to see across all of the major players, let's say, the top 6 is, we will all be fuller, clients will wait a bit longer, we should hopefully get some pricing power, because the only difficulty with the preclinical business right now is the price point, which are lower than they ought to be given the complexity of the work. And this whole supply and demand imbalance seems to be improving significantly, and we should see more balance next year. Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division: Jim, could you talk at all -- and I'm sorry if I missed this, but could you talk at all about pricing that you've seen recently in the Safety Assessment marketplace?

It's pretty modest. We're getting some pricing with certain types of studies across certain clients, depending on the nature and complexity of the work. I would say that the spot pricing scenario that we talked about previously is -- doesn't seem to be very apparent. So while we directionally see the opportunities for additional pricing, I would say that it's still quite subtle, as is still a fair amount of space in the system. But it's unquestionably filling up. We can tell that based upon how long it's taking us to start studies or clients that might otherwise utilize the competitor, and they're calling us because they're waiting too long for a competitor or vice versa. So it's all sort of solidifying and shoring up. And of course, our margins are continuing to improve, as a result to better capacity utilization, as a result of better mix, probably a small amount to price. And also the benefit of efficiency initiatives that we've driven for the last -- we've driven seriously for the last 5 or 6 years and continue to do so.

And we'll go to the line of John Kreger with William Blair. John Kreger - William Blair & Company L.L.C., Research Division: My question is where do you see the longer-term potential for margins in Discovery Services? If we're doing the math right, it seems like ChanTest is quite profitable compared to your other legacy Discovery Services businesses. So is there a potential for that to approach some of your higher-margin areas like manufacturing?

We look at that whole segment from an operating margin point of view, without breaking out the pieces. So as we've said, we are quite confident that we'll get DSA to 20% all in fully loaded. Obviously, we have different margin profiles in different businesses there. We're focused on getting the 20% first. And once we achieve that, we'll continue to drive margins and talk to you about better profitability. We are definitely making great inroads in the safety assessment fees. And the discovery business, I think as we continue to build scale, should help and be accretive to that process. John Kreger - William Blair & Company L.L.C., Research Division: And Tom, one quick follow-up. It was helpful to have you quantify the FX impact. Next year, I think you said a $0.05 hit. Any other key factors that we should be thinking about as we take an early look at models in 2015?

No, not really. I mean we did mention the FX. And I also noted that we haven't locked into anything at this point. There's just been a lot of chatter about foreign exchange out there so we thought we'd address it head-on rather than Q&A. I did mention that we've reported a lot of other income this year from our venture capital funds. It's an extremely difficult area to predict, and generally, we kind of stay away from that. So that creates a little bit of a headwind as well. But beyond that, I think it's more of about the basic trends, which we did touch on a little bit, but without making too many comments about the underlying trends at each business for 2015, which we'll address in February.

And we'll go to line of Ricky Goldwasser with Morgan Stanley.

This is Saurabh Singh in for Ricky Goldwasser. I was wondering in the DSA business, if you look at the organic growth backing out the Early Discovery, it seems like it's for 4.5%, give or take. I know that your goal is mid- to high-single digits, so what do you think is going to drive that. Is that going to be driven mostly by Early Discovery and cross-selling, or improvement in the safety assessment business as well?

We've consistently said that we see the Safety Assessment business at the moment has a lot to do with the price paradigm as a mid single-digit growth business, which is essentially where it's at, of course, we had much higher growth for the second quarter. As we explain and nuanced in the second quarter, this business is not linear. The studies starts in the middle of quarters, and some are -- provide higher growth potential over prior years, and sequentially than others. So we have to look at Safety Assessment and we're trying to get you folks to look at it the same way, which is it's on an annual basis. And so yes, we're quite confident on its own as currently structured in price, Safety Assessment will do mid-single. I -- we hope to get that to high single in the not-too-distant future. But we're going to need some price and some further capacity utilization for that to happen.

And we'll go to the line of Sung Ji Nam with Cantor. Sung Ji Nam - Cantor Fitzgerald & Co., Research Division: Jim, I was wondering, you talked about you're in discussions with some of the large pharma with -- for potential strategic partnerships. And kind of curious as to, given that we haven't heard any recently, just kind of, if you could kind of talk about where the discussions are. And kind of maybe what the biggest hurdles might be at this point, in terms of your customer is kind of moving forward with some of these strategic partnerships?

So we rarely get to announce them because clients don't want us to go public with those, for whatever reasons. I mean, we've only have one that's allowed that. So we have to talk about them collectively and euphemistically, as we will continue to do. And I wouldn't say there are any hurdles. I mean, different companies have different perspectives on outsourcing, and they have different philosophies on it. And some are aggressively driving it and immediately see the benefit. And that's not -- and some of them are very, very strong companies financially and others aren't. So they come in all shapes and sizes. I'd say that there's a whole group of companies that are sort of trying it, and testing it out. And obviously, we have to prevail upon them by doing really good work to do more of that. And there are a small number of large clients who have historically done everything in-house, and are a bit reluctant and slow to really embrace outsourcing. But I would say that along all 3 of those paradigms, everybody seems to be moving sort of over to the right, which is that they're more open to outsourcing and more interested in it. So it has to do with how much infrastructure they have, what do their pipelines look like, what do their P&Ls look like, how much have they historically done. And what their relationship is with us and comfort level is in our ability to do this sort of work. And on the pure discovery side, which is a big focus of ours. I mean, look obviously, Safety Assessment we have a huge ability, greater than all of our clients. And it's just simply a matter of them deciding that they no longer want to do the work, which most of them have. Discovery, particularly for large pharma, they've done their work inside and as we build a bigger capability, which we're doing as of our announcement yesterday with the further acquisition, I think it's helping to move them along the trajectory as well. So we're quite confident that current deals will expand, and new deals will happen. The receptivity is quite positive with clients and they are really listening and they're -- our capabilities have to be in sync with their desire and need and philosophical openness to do this. And we're seeing that in an increasing number of clients.

And we'll go to the line of Doug Schenkel of Cowen and Company.

This is Adam Wieschhaus filling in for Doug. As we think about the medium-term horizon, given you're strong in building Early Discovery portfolio, how are you thinking about potentially gaining more economics from your customers? And will there be opportunities to perhaps leverage strong customer relationships as they go from the Early Discovery work to more downstream in the development process?

What you're asking -- you're asking about how we're going to get greater pricing out of the clients, or just do more work with them generally, or both?

More of the second question.

Yes. So we have a large growing portfolio that gives us the capability to provide an integrated service to clients that want it. So certainly, with regard to small molecules, we can actually identify targets, develop -- actually develop the drug for the clients and test it in vitro and in multiple stages of in vivo. All that work has to be done by someone. They can do it all internally. They can use 20 different CROs. They can use 2 different CROs. But we could do it all. And we have competitors in lots of parts and pieces of what we do, but we don't have any competitors across the whole portfolio. So as the clients have a greater interest in this, and our portfolio continues to strengthen, and as we continue to do better -- more work, more expansive work for them, I think that's how their confidence level grows. So our strategy is very clear. We're going to continue to invest heavily in the quality of our staff, most of whom are coming from the pharmaceutical and biotech industries, so that we kind of look our clients. We're going to have greater relationship with venture capitalists and NGOs and academic institutions. And we are going to aggressively buy -- do strategic acquisition to expand this portfolio, and try to buy the best-in-class businesses across multiple therapeutic areas, both in vivo and in vitro, large and small molecules, so that the client can comfortably outsource. And you have to understand, a lot of these companies who -- obviously a lot of these companies we buy are already providing lots of services to lots of their clients. So this sort of preordained, we sort of do -- do very good preliminary due diligence on them. And the aggregation of these companies has just built a stronger capability for us. So we're just going to stay focused on our strategy and continue to drive greater growth, we're having capabilities to support these clients.

And we'll go to line of Ross Muken with ISI Group.

This is James Clark in for Ross. I was just wondering on the RMS slide, you talked about some opportunities to get operating margins up into the high 20% range. I was just wondering if you've identified any specific actions that you could talk about. And then how much of that OM expansion is dependent on a pickup in volume?

We're in a hunt right now to do this. I mean, our operating margins for, I think, last quarter in that sector were like 29%. So they move around a little bit from quarter-to-quarter. We have lower volume in research models in Q3 versus Q2, and lower again in Q4. Although the first of those, obviously very strong. So I think as the business is currently, the constituent parts and pieces of this business can very soon deliver high-20s margin, given the margin portfolio of the service businesses and the product business, obviously it depends upon ability to continue to get price, which we think that we can and ability to drive efficiency. We have spent more time driving efficiency in the preclinical business over the last 5 years, and are now getting very serious about doing end-research models, which of course is an older business that we know well, but it's been very, very manual in a lot of ways. And there's lots of specification, and IT initiatives that we are in the process of bringing to that business. So we're going to be driving that harder over the next couple of years. And we're very, very confident that we can have operating margins sustainable in the high 20s.

We'll go to line of Rafael Tejada with Bank of America.

It's Derik De Bruin in for Rafael. Can -- I guess at your Analyst Day, you mentioned that in the Safety Assessment business, you felt it was about 70% capacity utilization right now. Is that -- if you still put that number right -- is that still where your same thought right now. And I guess, what do you think that could be at the end of '15?

That was industry. Yes, we think -- we think industry is around 70%. And I think it can certainly be at 75%, and probably at 80%, given the demand that we're seeing. We have a very strong business, but we have 18%, 19% market share. So we don't have all the work. So 80% of the business is going elsewhere. So everybody has to be filling we all have incremental space. We only know what we -- we only know exactly what our capacity of utilization is. And while we don't put that out there publicly, we obviously know what it is, and we've said publicly that it's higher than the industry. So we expect everyone is filling, and while we all probably have space that we can, will and should open, we're going to be really careful. I think I can speak for everyone, we'll be really careful about how we do that. So we don't cause a glut on the market again. By the same token, it's actually good for our clients that we have space to do that, so they don't have to wait unnaturally long periods of time. So I think that we've seen the market expansion in the industry about 1,000 basis points for the last 2 years. That's possible we can do that again this year. But sure, we'll get to the mid to high 70s, I would imagine by the end of '15. And that would be...

Great.

Yes.

So just one question. I know we always talk about pricing and talks in Safety Assessment. But what's going on in the animal model side of business? Are you still getting pricing on the -- your rodent models?

Yes. We're getting about 2% to 3% net. Prices -- price lift increases are higher, but we have lots of clients that are price protected, lots of big deals, et cetera, et cetera. But on a global basis, we're getting about 2% to 3% net.

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

I wanted to ask a question on Argenta and BioFocus. That duo has outperformed the revenue expectations, at least we had in the first couple of quarters. I wondered if there's any seasonality in their businesses relative to kind of how I think about their contribution trending sequentially in the fourth quarter?

We're just pausing, because we don't think so. That's a business that has lots of long-term -- some of this -- some of this stays out longer in nature, some are multiyear contracts. So we target IV for instance. Some are shorter in nature, but a lot of that work is contracted early on, on an FTE basis, in particular. They have a very good visibility, and I think it sort of falls the way it falls. It falls the way it's contracted from year-to-year, quarter-to-quarter. So it sort of feels like it's more consistent throughout the four quarters than some of our other businesses are. But it could probably last [ph] a little bit longer to, as we put it together with our business to know that categorically. But I would suspect it's going to feel a little bit like some aspects of Safety Assessment and some of our other services. So probably less impacted by holidays and year's step in the research model.

Okay. And then on sticking with DSA, I apologize again if you may have covered a little bit of this. But I want to understand the dynamic of Argenta and BioFocus coming in, supposedly having lower margin, maybe it's the difference between gross and net -- gross and operating margin that I don't fully understand. But DSA gross margin was better, despite organic growth being kind of low. And Argenta and BioFocus, I thought, would kind of drag down margin on margin at the margin. And so could you help me understand the mix issues that are going on in that segment that are affecting both gross margin and operating margin line with those 2 now in there?

Yes. We're just speaking to the operating margin line, Dave, which we had touched on, which is fine. It actually did create a headwind. I think we said it was 70 basis points in DSA, and 30 basis points at the bottom line at the OI level. So clearly, while it's contributing an additional or incremental operating income in sales, at this point in time, it does create a little bit of a drag on those respective margins. But it did improve from Q2 to Q3. And as we talked about before, it is our objective to. And we believe we can continue to improve those margins over time.

And Tom, does it have a higher gross margin but a higher SG&A load? Or is that not the case?

No, I don't think it's anything out of the ordinary, Dave. I mean, I think their SG&A is somewhat in line with the overall or the other businesses. It's a typical service business where the margin -- gross margins are different from a product business. It's reliant on people in space and things like that.

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Jim, I know we touched on tox in the outsourcing. I know a bulk of that is already outsourced today. And you've made references to some large pharma that may be still are reluctant to embrace outsourcing. I was just curious if there's any kind of factors you look at in the marketplace that you think could trigger more of that outsourcing, or more of that work coming into the outsourcing space to create an opportunity for Charles River. And I guess along those lines, are there any large asset transfer deals still being shopped around the marketplace today?

Yes to the last question. But there are always are. And we look at the model with some reluctance, given the amounts of space that we have, and given the nature of those facilities from an efficiency point of view versus ours. But I think those are always kind of out there. You sort of have to look, depending on where they are geographically and what sort of business comes, or doesn't come with. Outsourcing is only about 50%, maybe 50 -- sort of 45% to 55%, so it's about half outsourced. There's a lot of work still done internally. There's very few companies that do all of their long-term tox internally, just a few. And there are some smallest -- kind of smaller pharmaceutical companies that historically have done majority of their work internally. So it's cultural and it has to do with their financial pressure from drugs rolling off patent up pipelines that kind of causes them to focus in on an area that they've been comfortable doing internally, and have to take a look at outsourcing capabilities. And of course, when they the do that, seriously they find out that companies like us have capabilities that far exceed theirs and the value proposition is quite good, or companies that have just managed their P&L extraordinarily well and have to continue to drive additional EPS and understand the power of outsourcing. So we feel it's quite inevitable, particularly with Safety Assessment that the vast majority of all this work is going to be outsourced. They need to retain a very small internal capability to manage us and to manage conversations with the FDA. And we've certainly seen that with the biotech companies. And so, there's not much that we can do to trigger that, except be out there, do good work, execute well, and have a good reputation, and continue to call on these companies and tell them about the benefits of outsourcing. But you can see more and more companies being open to it, virtually every quarter.

And we'll go to the line of George Hill with Deutsche Bank.

It's Stephen Hagan on for George. Kind of a similar follow-on question. You mentioned that you're looking -- seen more kind of partnerships from the larger strategic clients. I'm wondering what's driving that, instead of them trying to keep most of the capabilities in-house?

What's driving that is necessity on their part to improve their internal value proposition, refine their infrastructure, reduce cost and invest their money, where they can get the best return. A lot of them are still doing discovery internally, but even that is beginning to be outsourced. Then most of the development efforts can be done well externally. So I think it's a fiscal need, and it's the growth and evolution of the drug industry that's gotten them to the point of having to -- having in line to utilize outsourcing as a lever, providing leverage to utilize their cash and people better. And as long as companies like us continue to invest in infrastructure and science and execution and IT interface, more work is going to come outside.

Okay. And then as kind of that grows, are you seeing a mix shift in terms of your customers? Or are you still seeing a fairly consistent mix between large customers, midsize customers and then small biotech?

We've seen our mid-tier clients, which is primarily the biotech industry as of the last 12 to 18 months be a larger proportion of our revenue than large pharma, which is exactly what you would expect to see, given that they net outsourcers, and given the fact that pharma is the bank rolling them to fuel other discovery work.

And at this time, there are no questions in queue.

Thank you for joining us this morning. This concludes the conference call. We look forward to speaking with you soon.

Thank you. Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.