Welcome to the Charles River Laboratories Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and 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 our host, Corporate Vice President of Investor Relations Mr. Todd Spencer. Please go ahead.

Thank you. Good morning and welcome to the Charles River Laboratories Third Quarter 2018 Earnings Conference Call and Webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer; and David Smith, Executive Vice President and Chief Financial Officer, will comment on our results for the third quarter of 2018. Following the presentation, they will respond to questions. There's a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our website at ir.criver.com. A replay of this call will be available beginning at noon today and can be accessed by calling 800-475-6701. The international access number is 320-365-3844. The access code in either case is 455326. The replay will be available through November 21. You may also access an archived version of the webcast on our Investor Relations website.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 make about future expectations, plans and prospects for the Company constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements. During this call, we will primarily discuss results from continuing operations and non-GAAP financial measures, which we believe help investors gain a meaningful understanding of our core operating results and future prospects. 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 on the Investor Relations section of our website through the financial information link. I will now turn the call over to Jim Foster.

Good morning. In August I mentioned that we were benefiting from an extremely healthy market environment and believe that the pace of demand for our essential products and services would accelerate in the second half of the year. We're very pleased with our third quarter results, which are evidence of that demand and the successful execution of our strategy. We reported organic revenue growth above 10% for the first time since 2008. And while we expect the growth rate to fluctuate over time, we believe the third quarter growth rate supports our view of high single-digit revenue growth over the life of our strategic plan. Fundamental changes in the biopharmaceutical industry over the last decade and changes we have made internally to drive greater efficiency and create a seamless, best-in-class early-stage portfolio by driving tremendous opportunity for us. By continuing to invest in our portfolio, our people and our infrastructure, we believe we are extremely well-positioned among early-stage CROs to support our client's increasingly complex research needs. The success of our strategy has been validated by the fact that we worked on 80% of the FDA-approved drugs in 2017. And we were once again ranked as the best position non-clinical CRO to work with by our clients in two recent sell-side analyst surveys. Let me give you the highlights of our third quarter performance. We reported revenue of $585.3 million, a 26.1% increase over the third quarter of last year. Broad-based growth across our portfolio of early-stage drug research and manufacturing products and services delivered strong organic growth of 10.7%. Both our RMS and DSA segments reported significant increases in the organic growth rates from the second quarter level and the Manufacturing segment continue to grow at a low double-digit rate. From a client perspective, biotechnology clients were the most…

Thank you, Jim, and good morning. Before I begin, may I remind you that I'll be speaking primarily to non-GAAP results from continuing operations, which exclude amortization and other acquisition-related charges, costs related primarily to our global efficiency initiatives, the divestiture of the CDMO business in 2017 and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions, the CDMO divestiture and the impact of foreign currency translation. We're very pleased with our results for the third quarter, which included double-digit increases in revenue growth and non-GAAP earnings per share as well as significantly higher free cash flow. Our business continued to benefit from robust market conditions and the accelerating pace of client demand for our early-stage product and services. Despite the disciplined investment in portfolio and people and infrastructure that we made, the operating margin was flat year-over-year and would have increased by 50 basis points when adjusted for the previously discussed change to our compensation structure. The strong performance is reflected in third quarter earnings per share of $1.53, an increase of 17.7% year-over-year, exceeding our expectations due to the combination of the strong operating performance and an $0.08 gain on venture capital investments. We anticipate that the third quarter VC gain will be offset by an approximate $0.10 loss in the fourth quarter based on the preliminary market performance of the fund and in particular, a loss from one of the portfolio companies. For the year, we now expect VC gains of $0.24 per share. As a reminder, given the inherent difficulty of forecasting VC gains or losses, we will eliminate VC investment performance from our guidance beginning in 2019. In that spirit, our normalized third quarter earnings per share growth rate, excluding VCs, was essentially the…

That concludes our – sorry, operator. It is now time for the Q&A session to being.

[Operator Instructions] Your first comes from the line of Ross Muken with Evercore ISI.

Good morning and congrats guys on a great quarter. Maybe, I thought calling out the effort in RMS around the IS unit was kind of interesting, and it seems like a really sensible long-term strategy. Maybe just talk a bit about sort of how long that group has been together? What sort of the success has been so far? And why you're kind of highlighting it now? And why it feels like there's sort of a potential for maybe some elevated momentum in that unit?

The business that we have had for quite some time, Ross, I would say certainly couple of decades anyway. It's been historically largely government and academic. But I'd say the last decade has been more biotech and pharma. It's an international business, so we manage these vivarium all over the world. It's a very efficient way for the clients to utilize us particularly those who have head-count limitations or lack of expertise. To be frank, as you probably heard us say a few years ago, we're somewhat surprised that this business hasn't grown faster and isn't larger given the dramatic outsourcing trend. And I don't want to get out over my skis but we still would anticipate that it would follow similarly as the expertise is requested and demanded externally. But it's happening slowly but its happening and it's picked up as of the last few years. This big contract that we just got is obviously particularly meaningful. It's one of the biggest institutes of the NIH. And it's a large cadre of employees that we're taking over from veterinarians all the way to entry-level employees. It's really pretty powerful stuff. So in terms of additional government work, it's obviously helpful when we have some and we do really good work for one agency vis-a-vis others. We have conversations with every client. Certainly, all the big ones, Big Pharma and mid-to large size biotech about the ability and desire for us to do this sort of work for them. And their receptivity is all over the place. But it's a business that we're definitely seeing accelerate. One we know that we can make a difference for our clients. One that's utilization of our expertise in a really meaningful way. So worth watching. Again, I do want to overstate it but this is a big contract.

And maybe just on the margins. Obviously, I now you've commented – you took down sort of the full year expectation a bit. But the incremental margins or the momentum has been kind of gaining over the balance of the year. As we sort of jump off – I mean, there's a lot of moving parts between the new contract, which is sort of dilutive and then obviously the wage hikes but then you're getting all the volume absorption. I guess how do you feel about kind of that progression and the jump-off into 2019 and sort of the ability to get back to the expanding margins given all the efficiency initiatives etcetera you have going on as well?

We feel very strongly that we are making the right investments for our clients and our employees and for the company. So we are investing heavily in staff and capacity. We did make our wage adjustments which is just sort of a – essentially a one-time catch up. But a really important one in terms of enhancing our recruitment efforts. We continue to work aggressively on efficiency across all of our businesses and will continue to do so. The Discovery business is improving nicely but it's still a drag. The WIL businesses, little bit of a drag, Biologics we've definitely called out as a drag but with very clear reasons for it. So we're certainly not going to talk about 2019 but we are organized always to drive margin in this business. It's a combination of additional business, the mix of business, how much price we get, how well capacity is utilized and how much share we are able to take with respect to de novo work and/or work from the competition. We feel really good about the strength of this franchise. We feel really good about the strength of the demand pretty much across all of our businesses on a world-wide basis. And we don't see any logical reason why that demand should dissipate anytime soon, it certainly gives us confidence in the balance of the year. I suspect it will give us confidence when we talk to you about 2019.

Great thank you.

Sure.

Thank you. Our next question from the line of David Windley with Jefferies.

I kind of want to, at the risk of being repetitive, I kind of want to follow up on Ross' question on margin. Jim, is it possible – or maybe it's a David question. But is it possible to kind of bridge – I appreciate that you quantified the wage impact, I guess, 75 basis points to, I think, you say DSA. And 50 basis points overall. Is it possible to kind of walk us forward from margins that were in DSA. For example, about the same level last year. You've added over $100 million in revenue, which included MPI, which I think was a higher margin business. And margins are relatively flat. So I'm kind of hoping to understand how much underlying operating leverage and efficiency are you getting that is then being offset by some of these discretionary investments.

Seriously we will let David jump on this.

We got a list of things that were going to comment on margins. And Jim actually did a great job on jumping through all of the different pieces that we think you ought to be aware of. The only item I would add is that we have been investing, as we made clear for a while now, in the infrastructure, including back office, to make sure that we're a scalable business for the future. And in the comments that we've actually shared with you today about the unallocated corporate costs, you can see we're beginning to get some of that leverage now as we scale up. So I think the commentary is very similar to what we said in New York, right? There are difficult choices that we're making between investing in today to generate benefit for the future. There's a lot of puts-and-takes. It's difficult to call out all the different math to help you go to the answer in 2019. We will clearly give you more information in February to give you guidance to decide where 2019 will end up. But we remain as we said in New York, we remain over a five year period in the hunt to get north of 20%. And we think that the investments that we've made have been thoughtful and generating the returns. So I think the quarter returns you're seeing today, are beginning to show some of the fruits of this endeavor.

Great. Appreciate the extra color. Thank you.

Thank you. Our next question comes from the line of Tycho Peterson with JPMorgan. Please go ahead.

Hey, good morning. I want to start with DSA. It sounds like things have gotten better. Steady mix issues in SA are maybe still a bit of a drag. So could you talk kind of where we are in that process, is this more structural versus temporal on the study mix issues. And then any comment, Jim, you're willing to make on pricing trends and then future capacity expansion. I know you talked about South San Francisco, could you just talk if there's other planned extensions underway.

Yes. So, on the study mix, as we said the last two quarters, sort of impossible to design the study mix, it comes as it comes and profitability is essentially comparable between long and short-term studies. So we had long-term studies nuanced at the beginning of the year as you recall, which added to the cost. That has continued to sort of moderate out through the year and will continue to do so. And it was kind of an unusual quarter. It's kind of always – you always have whatever study mix comes through the door and it's the first time, I think, we've ever had to comment on it. So what we're most pleased with is that we are essentially extremely well utilized in our capacity throughout the entire world, we still have enough to take on enough business for the growth rates we've talked to you about today. Of course, MPI had a significant amount of capacity, which we hope to use as soon as the work comes in. So we feel that we're in really good symmetry with capacity and demand. You know we're not going to talk specifically about pricing except that I would say that you obviously get the benefit of mix if and as specialty work is nuanced or strong. You'll recall that our specialty work is more significant than anybody else's in the industry and we actually picked up some specialty capabilities with both of these acquisitions so you should presume that the specialty business is strong. You should also presume that anybody that calls us doesn't have a long-term agreement. If there was some sort of pricing escalation limit, we're going to try to get price and you should assume there's some price playing through these numbers. In terms of capacity, I would say that we're looking carefully across the world. We will continue to add space at multiple sites because proximity is important, because some sites we're out of space, because some sites we want to turn on space that was available, but it's being used. And we feel very good about the scope and span of our geographic footprint just in terms of really being able to be responsive to our clients. We have a lot of clients who want to come and visit. We have a lot of clients who just sleep better knowing the work is being done closely and maybe somebody can speak to them in their own language and they can get billed on their own currency. And if there's a problem or an opportunity, they can go and dialogue with their study director. So we think that the geographic footprint of the portfolio continues to be a strategic advantage for us.

And then just a follow-up on RMS, it sounds like some of the uptick was driven by better growth in mature markets outside of China, IS and in GEMS. So can you maybe talk to the sustainability of the 4.5% growth you saw. And then on IS, it seems like that's dilutive to margins. Is there anything you can do to kind of improve the margins for that part of the business?

So IS will never generate the margins that the core business will do. The core business is extremely profitable and all we can do is reiterate – or maybe a couple of things. We can reiterate the fact that while it's a drag on margins, the cash flow generation is quite significant and the return on invested capital is quite significant because the investment in CapEx is somewhere between zero and trivial depending on what deal we're working on. Sometimes there's a little bit of CapEx. So it's going to be part of who we are. It also is – and we didn't say this, but perhaps should have, it also is a way to literally live inside of your clients and provide an opportunity to talk to them about the other products and services that we provide and pull some of that work through. So on a see-through basis, there is a larger benefit from it. And what's the first part of your question?

Just the growth was driven by…

Okay. You asked about mature markets, yes. So I don't want you to get overly focused on that except to say that if you step back, we're extremely pleased with the organic growth rate of RMS. It's a low single-digit grower and I'd say this is better than low. We'll take it a quarter at a time. All of the products and pieces are performing well. So you have the drag of the MPI business going intercompany. Notwithstanding that, China rocks IS and GEMS do extremely well and the mature markets did better. And as we said in our prepared remarks, that business does generate more researches being done by our clients, both large and small. So that's a pure-play growth in that business with some mix and some pricing playing through. So we feel really good about the RMS quarter. It's the best quarter we've had in a long time. We obviously feel wonderful about the added benefit of having NIAID contract on top of that. You have to adjust your thinking a little bit about the impact to the margins. Having said that, we will continue to work hard to drive efficiency in that business, use better IT solutions in that business, better inventory management in that business and also to take share in that business. We don't have a 100% share. So some share growth opportunity particularly in the academic marketplace, so I think RMS is in a very good place, right now.

Yes. And just to make sure people will understand some of the math. I mean, while we don't call out the margins on any individual customer, what we have called out on the NIAID contract given how large it is we've given you the revenue for the five year contract, we've given you the revenue per annum and we've also told you that the pressure on the RMS margin is 50 basis points of people.

Okay, thank you.

Thank you. Our next question comes from the line of John Kreger with William Blair. Please go ahead.

Thanks very much. Jim, can you maybe talk about kind of the inherent cyclicality of the business that you guys have lived through before and how you might manage it? It's interesting to hear some of the comparisons to 2008. Given the lessons learned in 2009 and 2010, how are you thinking about things like pricing and capacity expansion for when we get some inevitable cooling off in demand? Thanks.

Okay. So seasonality is a little bit of a moving target for us and so the research model business has always and historically been seasonal. So we've got third quarter and fourth quarter pressure. The Biologics business tends to start slow and accelerate during the year. And safety tends to accelerate stronger in the back half of the year, but more pronounced these days than before. So the seasonality is a bit hard to predict and I would say is improving. In other words, the business is remaining stronger except for RMS, which is people are not going to buy animals but they can use during holidays. Having said that, we've had last few years with even RMS isn't strong in the fourth quarter because they're getting ready to do studies and they get back from vacation or they don't take vacation. I fundamentally disagree with the use of the word cyclicality in our business. I just don't think it's cyclical anymore. I don't think it was historically. You've had a fundamental shift in a very structured pharmaceutical industry so they do less work internally and the work is coming outside to folks like us and the money is coming outside to support biotech companies. And then you just have an enormous additional cadre of biotech companies, most of whom are virtual and have no internal capability with science that's working. So whether that's immuno-oncology or gene therapy where there's been directionally 1,000 INDs being filed and monoclonal antibodies continuing in the first RNAi drug getting to market. It's just a different marketplace. So clients are externally focused and spending more money in discovery and they have more tools at their disposal. So we don't worry about the cyclicality. And the last part of your question is an interesting one,…

Very helpful. Thank you.

Thank you. The next question comes from the line of Erin Wright with Credit Suisse. Please go ahead. Erin Wright, your line is open.

Hi, can you hear me now?

Yes.

Sorry about that. So a couple of RMS questions here. I guess, what do you think kind of the supply-demand dynamics look like outside of that IS segment? And do you still anticipate the ability to take price for the foreseeable future? And how is the China business growing in the quarter? And do you see that the longer-term run rate for growth there? Is it running ahead of your expectations? Thanks.

Yes, so China is a very high-growth business. I don't want to oversimplify it, but the market is so robust. Competition is so – sort of government infused with kind of a lack of historical scientific prowess that as we build the space and make animals available, we will be able to sell them. I think we have extremely good reputation in China. Really, really good market so we have to accommodate for that. So we opened a new facility in Shanghai at the beginning of this year. We haven't finished that whole facility and we were in the process of doing that. So we had incremental animals available to sell to that market. You recall from last year, Chinese growth rate was a little slower than we would have liked because we were capacity constrained, we're not any longer. So it's growing as quickly as we can build the space. And we don't see any possible slowdown there for – we look at the world in five-year increments in our strategic plan. We certainly think it will continue to grow nicely as long as we accommodate the space. And I would say that parenthetically we have a very strong management team there, so I'm confident in their ability to meet the market demands. If you strip away the IS contract and just figure that IS will continue to grow nicely as another business that we have, the supply quotient is good. It was a little better in the third quarter than we had seen historically in some of our mature markets like the U.S. and Europe. We are getting priced and we'll always get priced. And so you can just – you can plan on that. And as I said earlier, we're quite confident – we also have some…

Okay, great. Thank you.

Yes.

Thank you. Our next question from the line of Derik de Bruin with Bank of America. Please go ahead.

Hey, good morning, everyone.

Good morning, Derik.

Jim, I appreciate that the business is not as cyclical as it historically was. I agree with you on that. But you clearly were tied to the biotech capital markets and the funding cycle in biotech. And I'm just – clearly, with the VC gains going up and down, you've benefited from gains over the last couple of years because the markets have been strong. I'm just curious about the downturn – the loss in Q4 and so how should we think about how well you're hedged in case of a biotech downturn in the capital markets and sort of if that comes out of favor. And also I know you're going to exclude gains and sort of commentary on this from your guidance next year. Could you just clarify exactly what that means and how you're going to talk about that?

Yes, so I'll let David do that in a second. I just want to make sure maybe less for you and more other people who are listening to that question that we bifurcated. So infusion of capital from the capital markets to biotech is really strong. It continues to be strong and it's three to four years of capital there, and we have a plethora of new clients. And I think things are very robust there. So we don’t see any rationale that, that's going to slow down for the long-term foreseeable future. And as long as a science is good, I do think that the capital markets and the pharmaceutical companies will invest in them. And obviously, that's part of our growth rate, the investment in biotech and the fact that biotech is driving our growth significantly. That's different than returns we get from the VC funds in which we invest on, David will talk about that.

Yes, so a couple of things on VC. So just to talk about what's taking place in Q3, Q4 and then we'll turn to your specific question around guidance. So in the an instant gain in Q3, we had one fund, which had a clinical trials issue, and therefore, the known loss, which is unlikely to recover in the short-term. And then when we did our mark-to-market calculation, which we gave at the end of last week, when you put the two events together, that's brought to me about a $0.10 loss for Q4. Now clearly, the markets could change, that could get up or down. But in broad ways of looking at this, the $0.08 gain in Q3 is somewhat offset by the changes in Q4. So in a way, they neutralize each other out. And that's the way we're kind of looking at the business. We're looking at our core performance we've been calling out. Even in this quarterly results, we've been calling out what our underlying performance has been if you exclude the VC. Going forward, and we've been talking about this since February, for next year, we will take the VCs out of our guidance, but our current intent is to report the loss' actual numbers. But again, we would make sure that when we're talking to our numbers, we would talk about what our core business performance looks like, i.e., we would rip out the VC gains and losses from our results, so that we could compare that to the guidance that we're giving.

Great, thank you.

Thank you. Our next question comes from the line of Robert Jones with Goldman Sachs. Please go ahead.

Great, thanks for the question. You guys covered a lot of the other topics in DSA and RMS, so maybe I'll just ask one in Manufacturing Support. Looks like the margins there were slightly down from where we were last quarter. It sounds like the expansion related to Biologics, the Biologics business probably largely responsible for that. I'm just curious, was there anything incremental relative to what you guys had expected or planned for around the Biologics expansion? And then as we think about 4Q and beyond, can you maybe just help us bridge from where the margins are today to where they are expected to get back in that mid-30s range? Thanks.

The microbial business, which is the biggest part of that segment, continues to be very strong and I suspect that, that will continue. The big facility that we're moving into in Pennsylvania is a complex move. It requires the hiring of people and a fair amount of cost in setup and validation of assays that we're moving there and we need to do it in a very measured fashion. So I'm not going to comment on 2019 except to say that it's going to be a bit of headwind. Whether how profound that is or not, we'll talk to you about that in February. And I would say that there's nothing incremental to what we saw. It's getting to be a good-sized business with low single – low double-digit demand, very frothy market and it simply requires investment in capacity, one big one and a few small additions in space and people to stay up with the competition who is quite good in this business and to stay up with the market demand. So we feel really good about where we're making those investments and a modest bit of headwind going forward. Next question, please.

Thank you. The next question comes from the line of Ricky Goldwasser with Morgan Stanley. Please go ahead.

Hi, good morning and congrats on a great quarter. So just a question on the workforce. Obviously, you've had some incremental costs associated with the increase in wages. Demand is very strong across the industry. When we think about what are the limiting factors, is labor one of them? And where are you hiring people from?

Yes, so I just said a minute ago, we're looking internally. That's – our opportunities and challenges, the good news is they're very much internally based and so it's incumbent upon us to stay ahead of the demand for people and capacity. Capacity is a bit easier. If you have to plan for it, you just have to the cash, which we do, and you have to allocate it. People is more complicated because even entry-level staff here takes often several months to be trained. So you have to find them, you have to keep training them and you have to keep them. And of course, Ricky, as you know, we are recruiting in multiple geographies. And some of them are remote areas where there's less competition for the people, but there's less people. And then if you look in Boston, in Cambridge, there's a lot of people available, but there's a lot of competition, obviously, with biotech and big pharma. So the improvements that we made in our wages was principally directed towards entry-level employees where we were not doing as well as we would have liked or having some challenges there. And simply as a result of improving this in July, we're doing much better. And we're hiring a lot of people and I think doing a very good job – we're hiring more of them together and training them together so they go into the workforce together. And we have a little bit of compression with existing employees, which we had to moderate as well. So it is a rate-limiting factor. It's one that we focus on dramatically. I would say that we are all spending lots of our time on that. It's a great place to be and it's actually a bit easier to get senior scientists than actually was – than entry-level people. So I think that we've improved that and we're getting a lot of senior scientists from big pharma and biotech because I think we've just become a very congenial and scientifically rigorous and interesting to work, particularly given that we worked in 80% of the drugs that were approved last year. So that's more straightforward, I would say. And we've made a lot of progress this year, not just since July but over the year. So I feel very good going into next year and we will continue to check in because every geographic locale is different and we need to make sure that we are at least competitive, if not slightly ahead.

And then one follow-up on the contract that you're seeing. Could you give us already some color on what's the average size of the contracts that you're winning today and that you have in your pipe versus contracts – what contracts were a year ago? So kind of like size and scope in the term just to give us a little bit of sense of how we should think about the pipeline and the opportunity?

It hasn't changed much. You've got very short-term studies in tox that are a couple of weeks or 30 days and you have long-term carcinogenicity studies that are a year or two. So I would say that the overall mix hasn't fundamentally changed and is unlikely to because we're so heavily regulated. Most of the discovery work is shorter except for target identification, which can take years. The biologics work comes in really quickly and goes out really quickly. So we haven't had any massive shift in the time frame associated with that. I think the demand pretty much across-the-board has intensified, certainly intensified for the third quarter. As we said, bookings and backlog were quite strong in the third quarter, which should bode well for the fourth quarter. So no fundamental changes in the sort of structural nature of our work.

Thank you.

Sure.

Thank you. Our next question comes from the line of Jack Meehan with Barclays. Please go ahead.

Hi, thanks. Good morning everybody. I was hoping you could just elaborate a little bit more on where you're going to be investing in the fourth quarter. There's a big step-up embedded to get to the $120 million of CapEx in guidance. So just a little bit more color on where some of those funds are going would be great.

Yes. We're in a good place these days and that such a large proportion of our capital is going for growth. So meaningful investments in, I'd say, safety first, some investments in our Research Models business, definitely some investments in our Discovery business. And as we called out, significant investments in Biologics. So – and to a lesser extent, in fourth quarter, but we're always investing in our Microbial business. So the good news is, if we also step back and look at the company right now, very high growth rate in the third quarter, growth rate in every one of our business segments at or above our long-term targets, which necessitates additional capital investment and additional space. Yes, so we're working hard to make sure that we go into next year with sufficient capacity to accommodate the demand.

And when we were in New York on our Investor Day, we gave some signals for CapEx for 2019. We said it'd be sort of mid to high single-digits as a percentage of revenue. So what you're seeing in Q4 is a little bit of that stepping up to service that growth in demand that Jim has just mentioned as we scale into 2019.

Great. And David, one follow-up. I know you said you're getting, on the tax rate, a little more clarity with tax reform and you're gliding a little lower than you previously expected. Do you think this is a good run rate as we think about a leaping off point in 2019?

Yes, and again, in New York, we also shared a little bit of insight into the tax rate for the feature, which we said our normalized tax rate should be about the mid-20s. So what you're seeing for Q4 is we're heading up to that sort of mid-20 range. The reason that you're seeing a stepping up in Q4 over the previous quarters is really to do with the way the stock compensation benefit's gait throughout the year. We get more of a benefit at the beginning of the year than we do in the end of the year. So yes, you're seeing in Q4 a sort of an entry point into where the sort of normalized level should be for Charles River, which is mid-20s.

Thank you.

Thank you. Our next question comes from the line of George Hill with RBC. Please go ahead.

Hey, good morning, guys. And thanks for squeezing me in. Jim, we saw the news out of Novartis this week that they were cutting a lot of their preclinical pipeline. And I guess, maybe just walk through how we should think about that as it relates to either Charles River exposure or there's been a lot of talk on the call about where are we in the cycle. And I guess just how should we think about the risk if a lot of bigger pharma companies and bigger biotech companies started taking a closer look at the early stage work and doing a lot of pruning around things that might have a lot of future economic value?

No, we are aware of your comments about Novartis so it's hard for me to comment on that specifically. I don't know, I guess have two answers to that. One is remember that we get paid to tell the clients whether the drug looks promising or not or whether it should continue to the development pipeline. So we're often helping make those determinations. So that's something that we've always liked about our business model. And I would say that every drug company obviously has different strengths in different therapeutic area of focuses and different quality of pipeline. I think everybody has been very evaluative about the strength of their pipelines over time. But having said that, the flip side is there are so much more scientifically rigorous and beneficial avenues to go down like gene and cell therapy that I would be surprised if the pipelines don't stay where they are or expand. And also so much of work is being done sometimes literally by biotech for pharma. But if not literally, instead of pharma, which eventually they'll have the deal with these companies or buy them so, so much of the R&D effort in the pipeline is nuanced towards biotech. And as you know, we have more of our revenue with biotech than pharma. So not feeling that, hearing that or are seeing that with our clients or our overall demand.

Okay, that’s helpful. Thank you.

Thank you. And our last question comes from the line of Dan Brennan with UBS. Please go ahead.

Thank you. Dan Brennan. So Jim and David, just a few questions. First, I was hoping, Jim, you could discuss cap allocation and M&A. Just give us a little flavor for what the market looks like from an M&A perspective. Any color on types of deals, adjacencies, things like that, sizing would be interesting. Thanks.

It’s about time somebody asked that question. Thanks for that. I would say that – so I just want to reiterate the fact that we have – we planned a $50 billion market that's growing at 5% to 6% a year. So we feel that market is more than sufficient to provide a very long runway for us to do M&A in that space. So you shouldn't expect us to take any dramatic detours or they get into adjacencies and that's sounds good, but it's really risky if it's an area that you don't understand. So in the businesses in which we are currently in with some modest modification while Distributed Bio, which we talked about, isn't an M&A deal, it's a really powerful adjacency providing capabilities to do better large molecule discovery target identification, which our clients have really been wanting. So we're going to fill in, in areas like that. We're going to fill in, in our current space. So we actually have M&A opportunities in every segment of our business right now. It doesn't mean any of them happen, as you know. We have conversations going on with multiple potential sellers, businesses that absolutely will be for sale. Not necessarily to us but many of them are private equity owned, a few of them are privately owned. We feel that we are well financed, that our leverage is way below 3x. Our promise to ourselves, to our board and to our shareholder base was twofold, one that we would take the time to properly digest NPI. And while we don't think digestion is full – fully accomplished at, that acquisition and integration is going extremely well. I was just there this week – last week and it's really going well from a client point of view and…

Great. And then I wanted to just ask a question on your tox business. I mean, throughout the prepared remarks, you seem to indicate that you're gaining share across-the-board. So maybe can you just remind us what your share is of that market today and kind of how much of your growth is coming from the overall end market growth versus share gains? And are you seeing any change in your share gains over the last couple of quarters?

Hard to nuance how much is pure market growth except to say that it's probably slightly more of that than share gain, maybe significantly more. You just have so many new companies, right. So they didn't exist nor did their work exist last year or two years ago when they had the need for buying our discovery or toxicology services. So there's a lot of them. Our relationships with venture capital firms, whether we're a limited partner or not, have been very helpful in us securing a lot of that business. So I think we're getting share. We're not necessarily taking it from a competitor, it's work that's currently available. I think we are consistently taking share from our competition when we have a head-to-head opportunity to win business that we didn't or where we're trying to protect business that we do have, I think that's going quite well. We're going to see a lot more work come outside of big pharma. We have several conversations going on now to re-up in our launch deals, but also companies that are saying to us we are considering closing our space, we just want to make sure you have enough capacity to accommodate us. There are a fair number of conversations about that. So the demand is as good as we have probably ever seen it, but certainly as good as we've seen it in the last decade. And since we're the largest player and has such a broad geographic footprint, we have an opportunity not to look at everything, but to look at the vast majority of work that either is new or there's an RFP out to go after it. So I don't see any reason why that should not continue.

And I'm going to sneak one final one. Just back to margins, David. So is it possible to at least just quantify what the drags are that we know of today for 2019? And maybe chain NIAID and also the wage increase like is that - I mean, are we starting 2019 with a 20 to 30 basis point drag and then we'll obviously get the official guidance on 2019. And then related to that, the hourly wage increase that you've done, is there any more to do with other parts of the company that need to get wage increase or is there anything in 2019 that could reoccur there? Thank you very much.

The only other item over what you just called out was, as Jim mentioned, still a bit of a drag in Biologics as we go through, setting up the double running of that Pennsylvania site. But other than that, you've called out the main drags that we've already shared in The Street either in the Investor Day or today.

Okay, thank you.

Great. Thank you for joining us on the conference call this morning. We look forward to seeing you at upcoming investor conferences. This concludes the conference call. Thank you.

Thank you, ladies and gentlemen. That does conclude your conference for today. Thank you for your participation and for using AT&T TeleConference Service. You may now disconnect.