Ladies and gentlemen, thank you for standing by. Welcome to the Charles River Laboratories Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. [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. Welcome to Charles River Laboratories second quarter 2015 earnings 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 2015. 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 363905. The replay will be available through August 13. You may also access the archived version of the webcast on 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 17, 2015, 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 in non-GAAP 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 forecast 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 the 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 second quarter results before commenting on our business prospects. We reported revenue of $339.6 million in the second quarter of 2015, a 5.7% increase over the previous year in constant dollars, and a 6% sequential increase. Having anniversaried the acquisition of Argenta and BioFocus in the first quarter, acquisitions contributed just 1.5% to year-over-year revenue growth. Many of our businesses performed extremely well with the strongest performance contributed by safety assessment. We are particularly pleased that the research models business improved due in part to robust sales to NCI researchers and also to stabilization in Europe. The operating margin improved by 100 basis points year-over-year to 20%. This is the highest operating margin we achieved since 2008, and the first time that we have reached our 20% margin target. All three business segments reported increased operating margins, but the most significant increase was in the DSA segment, which gained 450 basis points year-over-year. Each of the segments reported a sequential increase in operating margins driven by either higher revenue, or improved operating efficiency, or both. Earnings per share were $0.96 in the second quarter, including a $0.01 loss from our limited partnership investment. This compared to $0.97 in the second quarter of last year, which included a $0.03 gain for limited partnership investments. In addition foreign exchange reduced earnings per share for the second quarter of this year by approximately $0.03. The second quarter results demonstrate the effective execution of our sales and marketing strategies. We are continuing with our outreach to heads of R&D and other decision-makers at the leading biopharmaceutical companies as well as many of the larger biotech companies. The addition of discovery assets to our early stage drug research portfolio has allowed us to…

.: Jim provided details about the second quarter performance in each of our business segments, so I will discuss some of the other items. Unallocated corporate costs decrease of $3.3 million sequentially to $22.3 million in the second quarter due in part to lower health and fringe related costs. The $2.2 million year-over-year increase was driven primarily by higher stock compensation expense. For the year we expect unallocated corporate costs to be nearly 7% of total revenue. Consistent with historical trends, the annual rate anticipates and slight reduction of these costs during the second half of the year from 7.3% of revenue in the first half. Net interest expense was $3.3 million in the second quarter which was approximately $700,000 higher than the first quarter, due in part to higher capital lease expense related to a facility build-out. Interest expense was essentially unchanged from the prior year. We expect net interest expense to be at the high end of our previous outlook of $12 million to $25 million in 2015, primarily reflecting the incremental interest expense from the Celsis acquisition and the capital lease. In the second quarter, the non-GAAP tax rate of 26.7% remained below our outlook for the year of 27% to 28%. We continue to expect our annual non-GAAP tax rate to be in a range of 27% to 28%. The tax legislation related to R&D tax credits in Canada that I mentioned last quarter is still pending. Assuming the legislation is enacted this year, it will provide a small benefit to earnings per share in 2015, and also modestly increase our tax rate from the first half level. Free cash flow improved significantly in the second quarter to $72.4 million, compared to $47.7 million last year. The increase was primarily driven by two factors, the strong…

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

Thank you. [Operator Instructions] At this time, we’ll go to line of Derik de Bruin with Bank of America. Please go ahead.

Great. Thank you very much. So can you talk little bit about the Shrewsbury opening? And I’m just curious to how should we think about that having financial impacts going forward. And when you talk about the business that you’re seeing in safety assessment, how much of this is new projects starts with your customers versus potential share gains? I assume there is a lot fewer player since the 2008 downturn in the market. Just some color on that, and particularly how should we think about the margin impact of Shrewsbury going forward? Thanks.

Yes, Derek, demand is definitely a combination of share gains. I would say that we’re taking shared consistently from competitors both large and small, based upon the quality of our science and capabilities and geographic footprint. Clearly there is de novo business that was never available before, the result of cutbacks and infrastructure and closure of infrastructure and shifts and therapeutic areas. It is a little bit tough to tease that out. I would imagine maybe there’s slightly more in de novo business and share gain, but they’re both contributing substantially, and as we said in our prepared remarks, so it price for sure. We have a mix component, given our mix of specialty versus gentox, which is both historically and now often a contributor to operating margins. Our space is approaching optimal utilization. We’ve opened a little bit of incremental space this year which is giving us the freedom to take on new work. We have a pretty interesting demand curve, demand curve, demand quotient, from local Boston and Cambridge biotech clients, who have been asking a lot about Shrewsbury, and since it’s close and competitively a wonderful place, really excited about the ability to open it. So as we said will open it in Q1. It will be non-GLP activity at the beginning. We will open only a portion of it. We are quite confident that the work that we put there will be profitable, and virtually no drag, or if it’s a small drag, on the particular business. Certainly, it won’t be noticeable. And based upon whether the conversation turns into real business, we will move to validate the equipment and be training employees to bring on new employees for GLP capabilities. Our goal obviously is to have that be a combined to GLP and non-GLP space if that makes sense. I will remind you that when we opened it originally, we had a lot of this is but it was a challenging situation. It was all GLP. I would say that we’ve written down some of the facility. We understand our costs better. We are essentially more efficient. So we are confident that the work that we will do next year which will probably be principally, if not entirely non-GLP, will not be a drag on the market.

Great, that’s what I was looking for, just the mix of the GLP. I didn’t realize at the last time. Thank very much. I’ll get back into queue.

We’ll go to line of Dave Windley with Jefferies. Please go ahead.

Hi, good morning. Thanks for taking the questions. Our questions stick to my one. I’m interested in your renewal of the AstraZeneca relationship. Jim, I apologize if you gave some details. I jumped on a few minutes late, but I saw that it was extended for five years versus the original three. I wondered if it also incorporated more pieces of AstraZeneca, more types of services? Anything that would expand the potential revenue run rate from the client?

I would say that the original three-year deal kind of expanded as we were in it. We do need to do additional work for them. I would also say parenthetically that this is among our best scientific collaborations. I mean there’s almost no demarcation between Charles River and AZ when we work on activities together, so we’re their principal provider of GLP tox and DMPK services. Obviously, we’re talking to them about a broader portfolio now, and as they move facilities and as we have a greater dialogue, we’re hopeful that over time we will be able to expand our relationship with them. We’re thrilled that it’s five years as opposed to three. That’s a real commitment by both of us. It’s certainly a commitment from them that they really see us as their partner. If you aggregate the two deals, it’s almost a decade of commitment to us. Given the strength of that franchise, we would certainly hope that our business would grow with them.

Very good. Thank you.

Okay.

We’ll go to line of John Kreger with William Blair. Please go ahead.

Hi, good morning. It’s actually Robbie Fatta in for John today. Just another question on Shrewsbury, it was great to hear that margins aren’t expected to be impacted in 2016. But will we see any impact in the second half of this year? Are there any costs that you had to incur ahead of the opening of Q1? Thanks.

No, you won’t see it. There are some costs that’s in our forecast, in our guidance. We anticipate some capital expenditures and some modest operating expenditures to hire some people and get the facility shipshape. Given the scale of the amount of space that we are opening, and the timeframe over which we’re opening, and how strong the safety assessment business is at the current time, you won’t see any impact.

Great. Thanks very much.

We’ll go to line of Eric Coldwell with Baird. Please go ahead.

Thanks. I guess most my questions have been covered on Shrewsbury or Charles River Massachusetts. I guess I’ll just pile on though with one last one. Any commentary at least on initial thinking for percent of total square footage to be open, number of rooms, if you want to do it that way? How many clients? You originally said when you first previewed this theme that you would hope to have maybe two or three anchor clients coming into the site. I’m just curious if you still hold to that thought process, or are you thinking perhaps opening up to a broader audience more quickly, and not necessarily having one or two anchor clients? Thanks very much.

So look in a perfect world, particularly for the tox side, we’d like a few large clients to anchor it. That may or may not happen, Eric, but we will see. I don’t think we can actually drive it that way. But given the types of clients that are interested, it’s likely we will have a large pharma/big biotech clients in there. That’s not the way were opening it up though. We’re opening it with non-GLP. There are host of clients that we will be servicing in that in the facility for those purposes. We’re not going to give the exact amount. I would say that you should just take it as a relatively modest amount of the facility will be open. A manageable amount of the facility will be opened, subject to the caveat that if demand is extremely intense, which obviously would be delighted with, we can quite readily open additional portions of it as you may recall. There are corridors of space, and we can bring those on over time. The basic HVAC systems will be up and running, but we won’t have the GLP quality validation of the infrastructure until we’re clear that we’re going to have a significant number or meaningful number of GLP quality clients. So we’re doing it in a very measured way. We are excited about opening it, given the amount of business that’s nearby. The safety assessment business is so strong and growing so well and so profitable that we want to do it in a measured fashion, have the ability to have additional capacity, have our clients know that, but not bring on so much, so quickly that it adversely impacts our financial results.

We’ll go to line of Tycho Peterson with JPMorgan. Please go ahead.

Thanks. Jim, just a question on the visibility on Argenta and the BioFocus pipeline. Given the softness you saw in 2Q obviously you had the contract termination, but you did talk about longer decision times as well. Can you maybe just talk about whether the trajectory of that business has changed meaningfully since you acquired it?

Yes. The trajectory of the business and our rationale for buying it is as strong as ever. It certainly has opened up much more interesting and meaningful and expanded client conversation with legacy Charles River clients. We’ve also had the opportunity to introduce the Argenta BioFocus capability to large Charles River clients and have gotten some work as a result of that. I would say that the timeframe to negotiate and execute larger integrated deals takes a while. Not necessarily longer than we thought, but it’s probably 12 months to 18 months. They’re complicated. They’re expensive, and they require sort of a lot of strategic input from the client. We’re having lots of conversations. We’re getting a lots of interest in traction. I’d say the core business is strong. We’ve moved into new facilities. The Argenta and BioFocus, which have been individual entities are working much more closely together. We brought them into the Charles River fold from a certainly marketing and selling point of view but from portfolio presentation point of view. We still feel very good about it.

And then if I can ask for a quick clarification to the point earlier, on Shrewsbury, you have in the past talked about breakeven in the first year. I just want to make sure you’re still committed to that. Then on AstraZeneca, any change in the margin profile from the five-year deal versus the three-year deal?

We’re committed to not having Shrewsbury be a drag. And AstraZeneca will be at least a financially beneficial going forward as it has been historically.

Perfect. Thank you.

We’ll go to Ricky Goldwasser with Morgan Stanley. Please go ahead.

Hi, this is Julie Murphy in for Ricky. I just want to ask about the broader pricing environment, and I guess the general trends you are seeing there. And then more specifically, as you think about bringing capacity back online, can you talk about pricing and how you’ll ensure it doesn’t come under pressure?

Yes. If you’re talking specifically about safety assessment, which I think you are, we’re getting about 5% price which is compatible with what we saw in the first quarter. We’re getting some pure price. It’s hard to tease it out, maybe 1% or 2%, and we’re getting the benefits of change orders that we’re getting from clients which is quite usual for this business. Last of the four or five years there was less of that because studies were more stripped down. So studies are is more complex now. So clients will be in the midst of studies, and they will be excited about the compound, and they will want to drive that study faster and more expansively, and they will add on testing an additional endpoints. And we are – that’s part of the pricing increase paradigm. So it’s hard to predict where that’s going to go. We’re delighted that it’s around 5%. We didn’t plan for that in our operating plan. We didn’t think it would be that strong. And certainly at the beginning of the year, our guidance didn’t necessarily contemplate that, but we’re delighted to have it. As I said previously, we’re confident in our ability to open Shrewsbury for non-GLP that purposes without it dragging operating line.

Okay. Thank you.

We’ll go to Ross Muken with Evercore ISI. Please go ahead.

Hi guys, this is Luke on for Ross. I just wanted to touch on Shrewsbury more of like broad strokes on it. How does the cycle of the biotech funding remind you of the last one, where you guys were able to be proactive and close the facility before the end of the cycle? And kind of what leading indicators do you guys look at to see what the demand is going in the overall decision of opening Shrewsbury?

It doesn’t remind us of the cycle before at all. I think historical trends and actual results in this business are not necessary indicators of anything and not just positive and aren’t even helpful. What we have to think about where we are now. We have a totally different marketplace where biotech has come of age. They have drugs and profits and extraordinary pipelines and are principally providing at least half the compounds that are getting to market, many by big pharma. So that’s quite different. We have major infrastructure reductions by many of the pharma companies. That wasn’t the case. We have huge amounts of funding coming in to biotech clients, not just from the capital markets but directly from big pharma. And so we’re quite confident that biotech is here to stay, that biotech is if you think about the immunotherapies in particular, the really powerful ways not just to treat, but perhaps to cure diseases, including cancer. And so I’d say the market dynamics are much better. Our competitive position is stronger. We’re being actually very careful about the way we open Shrewsbury, probably just because of how painful it was before. Had we not had that history, I don’t know. Maybe we would be more aggressive with the way we’re opening it. But we’ve got a really strong backlog. Our space is essentially full. Our margins are way up. Demand is extraordinary, getting more price. I would say we have every indicator that we could. We continue to take market share. This is the only facility that’s within a stone’s throw of major biotech and pharma research, and it’s time to open. It’s just become increasingly clear to us. So we’re quite confidence with vision, and we can kind of open the balance of it as quickly or as slowly as the market indicates with demand. So that’s also works to our strength.

Okay, thanks.

We’ll go to line of Garen Sarafian with Citigroup. Please go ahead.

This is Allen in for Garen. Can you guys just provide some commentary on how the Cures Act could ultimately impact your business?

I’m sorry. On the what?

The Cures Act.

[indiscernible] You’re talking about the one in Europe?

The 21st Century Cures Act.

I’m sorry, Allen, you’ll have to give us a little more insight into the question.

Got it. So it would increase funding for the NIH, and theoretically the NCI, just sort of broad assumptions around that.

I’ll believe that when we see it. Probably NIH has really been fully funded. Look I mean obviously, that would be modestly beneficial to us. We have a meaningful amount of work that’s academic related, so directly government or folks funded by the NIH, so that would be great. So I think we have a modest benefit of that. NCI obviously as a significant spender in cancer, but I would say that they’re substantially dwarfed by the pharma companies that are working on oncology. So happy to see it. Believe it when we see it. It’s probably a smaller impact for a Company like Charles River which is principally commercially oriented than some of the other tools, companies let say that sell principally to the academic institution.

Got it. And then one follow-up, you guys mentioned an increase and model sales in China. Are you seeing any changes in that market just given some of the macro headwinds that they are facing?

No, we really haven’t. We don’t expect to. I mean I get your question. It’s a good one. It’s a really nascent research market, little bit unsophisticated. Not a lot of money has gone into it on the research model side, relatively unsophisticated market in terms of understanding quality of animals used. I don’t know what the percentage is in China, but the percentage of the cost to producing the percentage, the animal cost is a percentage of the cost of making a drug is probably, I don’t know, a 10th of 1%. It used to be 1%. It’s probably way below that now. In China, it’s insignificant as well. So we’re working hard at bringing quality animals to China as we did in the U.S., Europe, and Japan. It’s kind of a critical resource in terms of drug development. I would be surprised if some of that economic headwinds that you’re pointing at or two, whether its stock market, or just general pull-backs on currency, or whatever will have any impact on the purchase – the way people are purchasing research models.

Got it. Thanks.

We’ll go to the line of Tim Evans with Wells Fargo Security. Please go ahead.

Thank you. Jim – or maybe Tom, whoever wants to take it, we are at a situation here in which you’ve done a good job on our DSA margin. You’ve done a really good job in your manufacturing margin, and both of those are kind of above, at or above the long-term targets that you have given. How should we be thinking about that going forward? Should we be looking for those long-term targets to reset higher, or should we expect things like Shrewsbury would ultimately limit that margin expansion beyond those targets that you’ve already reached?

Thanks, Tim. We’re certainly delighted with where our margins are, and recognize that we have more work to do. So I – where we are currently is in line, as you said, with what we’ve talked about as targets. So I do think that’s something that we need to think about. We have always said that from quarter-to-quarter, there will be some variability in our margins due to demand, mix, and things like that so. While we’re delighted, and I do think in the near term that margins will continue to be strong. We are continuing to think about where our long-term target should be. As you mentioned earlier, we are probably seeing a little more price than we thought we would this year. We are certainly seeing more demand than we thought we would. So I think all of that will play into, as we begin putting together our 2016 plan and having our strategic discussions, we will certainly focus more on those and see where we think we are headed.

So what we did, 20% for the quarter, which we were delighted by, it has been our corporate target. It is at quarter. We want to first deliver that for a year. We have ongoing efficiency initiatives across all of our businesses. We hope to get more price and a better mix, kind of directionally, our hope and our goal is to continue to drive margin improvements. I think it’s a really good question because we’re in the low 30%, and manufacturing support and over 20% in the DSA business, and already the high 20% in RMS. So we’ve – at least for the moment kind of achieved our targets. We’d like to do it for a sustained period of time, and then we’ll take a look at the reality of being able to increase those long-term goals.

Great. And then one quick point of clarification, did I understand correctly that your 5% pricing comment would be composed of 1% to 2% pure pricing, and then I’ll call it 3% to 4% of change order activity?

It’s kind of hard to tease it out. So yes, it’s probably closer to a couple of points of smart pricing. And then the rest are change orders.

Got you. Thank you.

And we have time for one final question. We’ll go to Dave Windley with Jefferies. Please go ahead.

Thanks for taking the follow-up. So a little bit of a pivot off of Tim’s question there, so you I think had taken some cost actions in RMS that were helping to improve the profitability sequentially in 2Q. And that happened, and it was nice to see. And I know you typically have and I think you’ve commented on the revenue seasonality for RMS in the back half of the year. Are there still benefits from cost actions that will flow through the back half and kind of keep the margin up, or should we expect margin to also compress in the back half, similar to that – similar to the revenue seasonality? I just want to drill into that a little bit more?

Dave, a lot of the efficiencies that we are obviously put in place. I don’t want to say in perpetuity, that was the first thing that popped in, but they will continue without question. And some of those are larger things like the consolidations we’ve talked about in Japan and North America, as well as in addition to another – number of other efficiencies in barrier rooms or certain areas of production and service. So we did have a nice sequential gain. We were up very modestly over last year, and as we look to the remainder of the year, we did talk about seasonality as being a mechanism to drive down sequential margin. But I think compared to 2014, I would expect our margins to be up in RMS on a year-over-year basis, but not sequentially.

Okay. Thank you. And on the topic – staying on the topic, thinking longer term, I know, Jim, you’ve talked about automating some data capture or recording processes in barrier rooms and things like that. Are those longer term efficiency initiatives complete at this point, or is there a pretty healthy list kind of lean initiatives that you’re still pursuing?

They’re not complete. And we began to roll them out early at some of our sites, and I think there is a meaningful opportunity to get the margin benefits of those across the world. And so we would be guardedly optimistic that we continue to drive margin improvement in the core research models business, which as you indicated, and has been way too manual for probably too longer time. And we’re excited about being able to sort of enhance our ability to monitor lots of things more quickly, and costs are the result of that.

Very good. Thank you.

Thank you, and speakers, I will turn it back to you for closing comments.

Thank you for joining us this morning. And we hope you will join us again on Tuesday, August 11, in New York for our Investor Day. If you need more information, please give me a call, or send an email to susan.hardy@crl.com. This concludes the conference call. Thank you.