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Edited Transcript of CRL earnings conference call or presentation 6-Nov-19 2:00pm GMT

Q3 2019 Charles River Laboratories International Inc Earnings Call

Wilmington Nov 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Charles River Laboratories International Inc earnings conference call or presentation Wednesday, November 6, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David Ross Smith

Charles River Laboratories International, Inc. - Corporate Executive VP & CFO

* James C. Foster

Charles River Laboratories International, Inc. - Chairman, CEO & President

* Todd Spencer

Charles River Laboratories International, Inc. - Corporate VP of IR

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Conference Call Participants

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* Andrew Brooks Wald

Barclays Bank PLC, Research Division - Research Analyst

* Courtney Patrice Owens

William Blair & Company L.L.C., Research Division - Associate

* Daniel Gregory Brennan

UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences

* David Howard Windley

Jefferies LLC, Research Division - Equity Analyst

* Donald Houghton Hooker

KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst

* Eric White Coldwell

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Erin Elizabeth Wilson Wright

Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst

* Jack Rogoff

Goldman Sachs Group Inc., Research Division - Research Analyst

* Juan Esteban Avendano

BofA Merrill Lynch, Research Division - Associate

* Rong Li

Morgan Stanley, Research Division - Research Associate

* Tycho W. Peterson

JP Morgan Chase & Co, Research Division - Senior Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by. Welcome to the Charles River Laboratories Third Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to Corporate Vice President of Investor Relations, Mr. Todd Spencer. Please go ahead.

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Todd Spencer, Charles River Laboratories International, Inc. - Corporate VP of IR [2]

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Thank you. Good morning, and welcome to Charles River Laboratories' Third Quarter 2019 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 2019. Following the presentation, they will respond to questions. There is a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our website at ir.criver.com. A replay will be -- 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 472865. The replay will be available through November 20. 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 vary materially from those indicated by any forward-looking statements.

During the 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.

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [3]

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Good morning. I'm pleased with our overall third quarter results, which were highlighted by high single-digit organic revenue growth, consistent with our long-term targets and operating margin expansion that represented a positive step towards achieving our 20% target in 2021.

Market demand for our leading early-stage portfolio has remained strong throughout the year. While biotech funding levels and the number of molecules approved by the FDA may end the year slightly below peak levels, industry fundamentals and scientific innovation remain as robust as we've ever seen. And outsourcing is key to our clients' success. This is promising to be another solid year for the biopharmaceutical industry as clients discover solutions for previously unmet medical needs using new technologies like cell and gene therapy and immunotherapies and rely on CROs like Charles

(technical difficulty)

to support the research programs. We have no indication that the relationships with our clients or their spending levels have been affected by the geopolitical rhetoric involving the trade war and [drug pricing]. And we firmly believe that our clients will continue to partner with Charles River in order to bring new drugs to market faster and more efficiently for the patients that need them.

Let me give you the highlights of our third quarter performance. As you know, we issued preliminary third quarter results on October 21, in conjunction with our successful issuance of $500 million of senior notes, about which David will provide more details shortly. Our actual third quarter results were at the higher end of the preliminary ranges that we've provided. We recorded revenue of $668 million in the third quarter of 2019, a 14.1% increase over last year. Organic revenue growth was 7.9%, with each of our business segments contributing meaningfully. From a client perspective, biotech continued to drive revenue growth. While acknowledging that third quarter revenue growth was slightly below the outlook that we initially provided in late July, we were pleased with the high single-digit organic growth rate, which is consistent with our long-term target. I will provide more details on each of the business drivers shortly.

The operating margin was 19.4%, a 60 basis point increase year-over-year and above our prior outlook. This improvement was driven by the Manufacturing Support and RMS segments and more than offset headwinds from the Citoxlab acquisition, the Biologics capacity expansion and a large insourcing solutions contract. We believe that the third quarter margin expansion demonstrates our ability to leverage the investments that we have made in staff, capacity and infrastructure to accommodate the robust growth in a more scalable and efficient manner and provides a line of sight to our 2-year goal of 20%. With the significant investments largely behind us, coupled with our continued focus on driving greater efficiency, we expect the operating margin in the second half of the year will be higher than the first half, resulting in a full year operating margin that is approaching last year's level of 18.8%.

Earnings per share were $1.69 in the third quarter, an increase of 16.6% from $1.45 in the third quarter of '18. The increase was due primarily to higher revenue and operating margin improvement. From a guidance perspective, we now expect organic revenue growth for 2019 to be in a range from 8.25% to 8.75%. This has been moderated from our prior outlook, but still well within the high single-digit range. The organic growth outlooks for each of the business segments are being narrowed but remain within the previous ranges for the year. We do not believe the narrowing of our organic growth range demonstrates any diminution in market conditions as we believe both market demand and our fundamental business trends remain robust.

We continue to be well positioned for organic revenue growth in 2019 to be near the 8.7% reported last year, the highest level in a decade and consistent with our long-term growth target in the high single digits. As a result of the third quarter operating performance, non-GAAP earnings per share guidance for the year is being narrowed to the upper end of the prior range to $6.50 to $6.60. This represents 12% to 14% growth from $5.80 last year.

I'd now like to provide you with details on the third quarter segment performance, beginning with the DSA segment. The DSA revenue in the third quarter was $420.1 million, a 7.9% increase on an organic basis, with both the Discovery Services and Safety Assessment businesses contributing. We believe that high single-digit organic growth in DSA segment will continue to be driven by demand for our outsourced services as global biopharmaceutical clients choose to partner with Charles River rather than build and maintain capacity in-house and biotech clients leverage our expertise because they have limited or no internal capabilities. To meet our clients' needs, we have focused our business on unmatched scientific expertise, rapid turnaround times, flexible creative solutions and the ability to accommodate the increasing complexity of our clients' research programs.

Our business model has made us an attractive partner for large pharma, biotech, academic institutions, governmental agencies and NGOs, but it is clear that we have become the principal partner of choice for biotech clients of all sizes. Biotechs are a demanding clientele, focusing on exquisite science and speed. Our unique portfolio and client-focused business approach have made Charles River an indispensable research partner, tailor-made for this expanding client segment.

The Discovery business had an excellent quarter as we continue to distinguish ourselves through the breadth of our portfolio and the synergies between our Discovery and Safety Assessment businesses. The third quarter performance was driven by broad-based growth across oncology, Early Discovery and CNS services. Our clients' programs often begin with the target identification capabilities of our Early Discovery business and encompass multiple DSA sites and services as the programs advance. We have successfully demonstrated to clients that working with us through a broader portion of the early-stage drug research process enhances the value we provide them, both from a scientific and cost-effectiveness perspective.

Our efforts to strengthen our Discovery toolkit and expand our footprint continue to resonate with clients, both large and small. We continue to evaluate new opportunities to add innovative discovery capabilities to our portfolio as we believe creating a comprehensive solution at the earliest stage of drug research will enhance client retention as their programs progress through the pipeline. Our recent partnership with Distributed Bio is progressing nicely. Distributed Bio's large molecule discovery capabilities have generated considerable client interest and we believe this relationship and our broader partnership strategy will create additional opportunities to work with clients on their integrated programs.

Client utilization of our expanded South San Francisco Discovery site also continues to increase. The site offers a wide range of capabilities from CNS to DMPK and bioanalytical services to the fast-growing West Coast biotech client base. And we expect to expand the services offered there. Whether by internal investment, partnership or acquisition, we intend to continue to build our discovery portfolio to reinforce our position as the premier single-source provider for a comprehensive range of Discovery Services.

Revenue growth for Safety Assessment was consistent with both our full year and long-term expectations for the overall DSA segment. The business continued to perform well, driven by robust demand from biotech clients and increased pricing. Bookings and backlog improved year-over-year, supporting our Safety Assessment outlook for the remainder of the year and into 2020. As you know, Safety Assessment growth is not linear and will modestly fluctuate from quarter-to-quarter because the balance between price, volume, mix and the timing of study starts is not always uniform.

The integration of CiTox remains on track, and its financial performance is in line with the acquisition plan. As anticipated, it is a complex integration across multiple sites in multiple countries, but the collaborative efforts and hard work of Citoxlab's talented staff and their Charles River colleagues have resulted in the successful first 6 months together. With Citoxlab to date, and MPI and WIL beforehand, we have done an excellent job on the integrations, achieving our goals of adding and retaining hundreds of new clients, enhancing the work experience for our employees, expanding our capabilities, both geographically and scientifically, and driving operational synergies and greater efficiencies.

The DSA operating margin declined 50 basis points to 22.1% in the third quarter due entirely to an 80 basis point headwind from the Citoxlab acquisition. As we said at the time of the acquisition, Citoxlab has a lower operating margin than the legacy Safety Assessment business, but we believe it will reach the 20% level within approximately 2 years of the transaction, driven by acquisition synergies and continued growth.

We have built a global DSA footprint with unparalleled breadth and depth by adding capabilities, capacity and staff through acquisitions and internal investments and as a result, have become the partner of choice for a broad range of clients. We have invested significantly in the last few years to achieve appropriate staffing levels so that we could accommodate growing client demand in the Safety Assessment business and believe we have achieved this goal. With the appropriate head count going forward, continued modest capacity additions and a focus on operational excellence, the DSA segment is well positioned to achieve a mid-20% operating margin over the next 2 years.

RMS segment revenue was $132.5 million, an increase of 5.8% on an organic basis over the third quarter of last year. Our research model business in China delivered another excellent performance and Insourcing Solutions also continued to perform very well.

As we mentioned at Investor Day, there are abundant opportunities to expand into new regions in China to support the substantial growth in its rapidly emerging biomedical research market. In addition to our current footprint in the major R&D hubs of Beijing and Shanghai, we have plans to open a new site in Central China in 2020. Expanding our presence supports our goals of market leadership and achieving a market share in China similar to that in Western markets. Because the research model markets outside of China are mature, volume growth continues to be limited. In Western markets, we expect a continuation of the research model trends that have been largely present for many years: declining demand from large biopharma, increasing demand from biotechs and consistent price increases.

From a services perspective, Insourcing Solutions, or IS, continues to perform very well as clients increasingly adopt flexible models to enhance the operational efficiency of their vivarium management and research efforts.

The NIAID contract contributed approximately 350 basis points to RMS revenue growth in the third quarter. We anniversaried this contract in mid-September, so the year-over-year contribution to revenue growth and the corresponding operating margin headwind will normalize beginning in the fourth quarter. As a result, we expect the RMS growth rate to moderate to a low single-digit rate in the fourth quarter. The IS business continues to be a [flexible option] for academic and government institutions, which have historically been IS's primary client base. Insourcing Solutions is also gaining traction with new biopharma clients, particularly through the success of our CRADL initiative. CRADL, or Charles River Accelerator and Development Labs, provides both small and large biopharmaceutical clients with turnkey research capacity in the Boston/Cambridge biohub, and beginning early next year in the South San Francisco biohub. Through both unique models like CRADL and more traditional in-source staffing arrangements, the IS business has become an important partner for clients who need this type of support for their research programs.

In the third quarter, the RMS operating margin increased by 60 basis points to 26.5% due primarily to the research models business as well as our ongoing efficiency initiatives. The improvement was partially offset by the lower-margin NIAID contract, which reduced the RMS operating margin by approximately 50 basis points in the quarter. Our goal is to maintain the RMS operating margin above 25% through our continuing efforts to enhance operating efficiency.

Revenue for the Manufacturing Support segment was $115.3 million, a 10.6% increase on an organic basis over the third quarter of last year. The increase was driven by strong demand across both Biologics Testing Solutions and the Microbial Solutions businesses.

The Microbial Solutions had a good quarter with broad-based growth across all 3 of its major testing platforms: Endosafe endotoxin testing, Celsis bioburden and sterility testing and Accugenix microbial identification services. The primary driver of third quarter revenue growth was demand for our Endosafe rapid testing systems and cartridges. We sold significantly more Endosafe instruments over the prior year, which in turn, will drive greater demand for cartridges. Endosafe improves the efficiency of our clients' manufacturing and lot release testing processes. And because there's no competitive alternative to our rapid testing system, we are continuing to convert the marketplace to our more efficient and reliable testing platform.

The continued expansion of the installed base of instruments drives demand for the consumable cartridges, which provides a healthy recurring revenue stream. In addition, investments in process improvements that we discussed last quarter are already beginning to result in improved operating leverage. We're very pleased to see that as expected, biologics revenue growth rebounded well above the 10% level in the third quarter. We are adding capacity globally to accommodate the robust growth in a number of biologics in the pipeline and on the market and the demand for our services. The largest global expansion is taking place in Pennsylvania. Our new site in Wayne, Pennsylvania, which we have been transitioning into for the past year, will provide the required scale in the U.S. to support growth through the next 3 to 5 years. The site has been registered with the FDA, and we are working with clients on their validation activities at the new site, which are expected to be substantially complete by the end of the year.

In addition to building scale, we also continue to enhance our biologics testing capabilities to accommodate more of our clients' process development and quality control needs. Cell and gene therapies continue to be the fastest-growing area for our biologics business, and we are developing new assays to provide a more comprehensive portfolio of these services.

The Manufacturing segment's third quarter operating margin was 36.4%, a 300 basis point improvement year-over-year. The increase was due primarily to enhanced operating efficiency in the Microbial Solutions business and operating leverage from robust revenue growth in Biologics Testing Solutions business. We were very pleased that the Manufacturing segment's operating margin rebounded to the mid-30% level in the third quarter, which is consistent with our 2-year target for this business.

At our recent Investor Day, we highlighted the manner in which we have executed our strategy and continue to do so: to become the early-stage CRO partner of choice for our clients' drug research, development and manufacturing support efforts; to build our extensive scientific expertise, which we believe is unique and unparalleled in the early-stage CRO universe; and to invest in our people, technology and infrastructure to create a more efficient and responsive organization that provides flexible customized solutions to our clients. As we look to the future, it's imperative that we continue to expand our portfolio of essential products and services to enhance our ability to comprehensively support our clients' drug research efforts. We intend to do so through strategic acquisitions, which is always our preferred use of capital.

Our pipeline of M&A candidates remains robust, and we continue to evaluate a number of opportunities ranging from unique research tools to discovery capabilities to manufacturing support activities. We also must stay current with new technologies and modalities, such as cell and gene therapies. To do so, we are increasingly utilizing a partnership strategy, such as our relationship with Distributed Bio, to add innovative capabilities and cutting-edge technologies with limited upfront risk. Our partnering activities extend beyond the Discovery business as we have signed several of these relationships to date, encompassing most of our businesses and intend to sign more. These partnerships allow us to assess breakthrough technologies, typically with a small upfront investment and have the potential to result in longer-term collaboration agreements or can be a precursor to acquiring the company. We look to add at least $1 billion in annual revenue through acquisitions and partnerships over the next 5 years. And the transactions with which we choose to move forward will not only fit our strategic rationale, but also meet our disciplined investment criteria in order to generate greater shareholder returns.

We have spent the past several years investing internally in capacity and staffing to levels that are commensurate with growing demand, while striving to enhance the scalability of the business. While we will need to continue to invest, we believe that we have achieved an appropriate balance. We now have an enhanced ability to leverage top line growth and drive greater efficiency, which will enable us to achieve the 2-year financial targets that we provided at Investor Day, including an aggressive but realistic 20% operating margin in 2021.

As we also mentioned at Investor Day, as we work towards our business and financial goals, we are maintaining an intense focus on sustainability. We are committed to environmental, social and corporate governance initiatives and believe that this commitment will enable us to minimize our impact on the environment as we: implement sustainable practices; enhance our corporate citizenship by focusing on improving the quality of people's lives including patients, clients, employees and our communities; and operate our business with integrity and accountability as we have always done.

We were pleased to welcome Gina Wilson to our Board last month. Gina's diverse experience across multiple industries will enhance the financial acumen of Charles River's Board and its ability to oversee our broader strategy and focus on driving profitable growth. Gina brings highly valuable knowledge and experience in managing the finance organizations of growing businesses, strategically allocating capital and driving operating efficiency, which will complement the combined skills and experience of our current directors. We will continue to evaluate adding new members to our Board to further enhance the diversity of skills, experience and perspectives.

We are pleased with the performance of the collective portfolio in the third quarter. And over the longer term, we expect to deliver high single-digit organic revenue growth, earnings per share growth at least in the low double digits and strong free cash flow.

In conclusion, I'd like to thank our clients and shareholders for their support and our employees for their exceptional work and commitment. I'll ask David to give you additional details on our third quarter results and updated 2019 guidance.

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [4]

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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, a discrete tax benefit related to our international financing structure and certain other items. Many of my comments will also refer to organic revenue growth, which excludes the impact of acquisitions and foreign currency translation.

We are pleased with our results for the third quarter, which included high single-digit organic revenue growth, mid-teens earnings per share growth and both sequential and year-over-year improvement in the operating margin. The third quarter results demonstrate our progress towards achieving the 2-year financial targets that we provided at our Investor Day in September, which included high single-digit organic revenue growth, at least low double-digit non-GAAP earnings per share growth and a non-GAAP operating margin of 20% in 2021.

I will now provide more detail on 2 recent accomplishments: the third quarter operating margin expansion and the enhancements to our capital structure. As you are aware, operating margin improvement is a priority for the company. We are very pleased with the collective efforts that have enabled us to leverage revenue growth and drive greater operating efficiency. Operating margin of 19.4% for the third quarter represented a 60 basis point year-over-year increase and a 90 basis point sequential increase. This was well above prior expectation, which was that the operating margin would be similar to the second quarter level. The outperformance was driven largely by the fact that we are benefiting from the scalable investments that we have made in staff, capacity and infrastructure as well as our continuing focus on operational excellence and cost management. The margin improvement was driven by the Manufacturing and the RMS segments as well as leverage of unallocated corporate costs. We also anniversaried the year-over-year headwind from the compensation structure adjustment at the beginning of the third quarter.

Unallocated corporate costs for the third quarter were $40.2 million or 6% of total revenue, a 40 basis point decline from 6.4% last year. At 6% year-to-date, we continue to expect unallocated corporate costs to be at or slightly below 6% of total revenue for the year.

We are particularly pleased with the margin performance because we continued to be impacted by headwinds from the large government contract in the RMS segment, the Biologic capacity expansion in the manufacturing segment and the acquisition of Citoxlab in the DSA segment. As you may recall, Citoxlab had mid-teens operating margin when we acquired it, which is well below that of the legacy Safety Assessment business. Citoxlab's operating margin will improve over time through the attainment of deal synergies. We believe that the third quarter operating margin performance reflects our ability to leverage the investments that we have made and our focus on increasing efficiency to drive profitable growth. For the full year, we continue to expect the operating margin to be approaching the 2018 level of 18.8%.

The other important accomplishment was the issuance of $500 million of senior notes due in 2028 at a 4.25% coupon rate. We believe that this fixed rate debt enhances our capital structure by locking in a favorable interest rate and staggering the maturity of our long-term debt. We also upsized our revolver by $500 million, which will provide additional long-term borrowing capacity to support our M&A strategy.

During the quarter, we reduced our outstanding debt by $158 million to $1.9 billion at the end of the quarter compared to $2.1 billion at the end of the second quarter. Our gross leverage ratio at the end of the third quarter was 2.96x and our net leverage ratio was 2.7x. Through our capital management strategy, we were able to reduce our leverage to less than 3x within 6 months of the Citoxlab acquisition, which was ahead of our initial outlook of 12 months. The sub-3x leverage ratio generates interest savings on our variable rate debt, reducing the rate by 25 basis points to LIBOR plus 125 basis points.

We continuously evaluate our capital priorities and intend to deploy capital to the areas that we believe will generate the greatest returns. Strategic acquisitions remain our top priority for capital allocation, followed by debt repayment. We are comfortable with the gross leverage ratio below 3x, and absent any acquisitions, we continue to repay debt. Year-to-date, we have not repurchased any shares and do not intend to in the fourth quarter.

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Operator [5]

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Todd Spencer, Charles River Laboratories International, Inc. - Corporate VP of IR [6]

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All right. Sorry for the technical difficulties. We will restart the -- David's prepared remarks. Thank you.

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [7]

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Repurchase, okay, okay. Good, we just worked out where we cut off from. So I'll continue from that point. So we continuously evaluate our capital priorities and intend to put capital to the areas that we believe will generate the greatest returns. Strategic acquisitions remain our top priority for capital allocation, followed by debt repayment. We are comfortable with a gross leverage ratio below 3x, and absent any acquisitions, we'll continue to repay debt. Year-to-date, we have not repurchased our shares and do not intend to in the fourth quarter.

Total adjusted net interest expense was relatively stable at $17.4 million in the third quarter, an increase of $0.4 million year-over-year and $0.6 million sequentially. For the year, we expect adjusted net interest expense to be at the low end of the previous range of $68 million to $71 million. This change is due to lower rates, resulting from our sub-3x leverage ratio and the Federal Reserve's rate reductions, partially offset by higher interest expense associated with our new $500 million senior notes. As a reminder, adjusted net interest expense is calculated as the net of interest expense, interest income and an FX adjustment related to forward FX contracts recorded in other income.

Our third quarter non-GAAP tax rate was 23.6%, essentially unchanged from 23.5% in the third quarter of last year. Since we are trending to the low end of the range of our previous guidance, we are reducing our full year non-GAAP tax rate outlook by approximately 50 basis points to a range of 22% to 23%. The GAAP tax rate for the third quarter was more favorable than the prior year due primarily to a noncash discrete tax benefit of $20.4 million related to our international financing structure.

Free cash flow increased 27.3% to $120.7 million from $94.8 million last year. The increase reflected our continued focus on working capital management and the third quarter operating performance. Our free cash flow guidance for the year remains unchanged at $310 million to $320 million. CapEx was $35.2 million in the third quarter, an increase from $22.4 million over the prior year. At $77 million year-to-date, we now expect to invest approximately $140 million in CapEx for the full year. This is $30 million below our prior outlook due primarily to the timing of projects, some of which have shifted into 2020.

With respect to 2019 guidance, we are moderating our revenue growth outlook to a range of 15% to 15.5% on a reported basis, and organic revenue growth of 8.25% to 8.75%, reflecting the third quarter performance and foreign exchange, which is expected to be a greater headwind than previously anticipated. FX is now expected to reduce reported revenue growth by 1.5% to 2% compared to our prior outlook of 1% to 1.5%.

In light of the strong third quarter operating performance, we are also narrowing our full year non-GAAP earnings per share guidance to the higher end of the previous outlook to a range of $6.50 to $6.60. Although we narrowed our outlook for organic revenue growth for the full year, our expectations for segment revenue growth on an organic basis remain within the previous ranges, which were mid-single digits for the RMS segment, high single digits for the DSA segment and low double digits for the Manufacturing segment. Including the unfavorable foreign exchange rates and the Citoxlab contribution in the DSA segment, reported revenue growth is expected to be in the low to mid-single digits for RMS, low 20% range for DSA and just under 10% for Manufacturing Support. A detailed summary of our financial guidance can be found on Slide 40.

With 1 quarter left in the year, our fourth quarter outlook is effectively embedded in our guidance for the full year. We expect fourth quarter organic growth to be at or slightly below the third quarter level, primarily because the anniversary of the NIAID contract in September will reduce the RMS growth rate by more than 300 basis points. As we mentioned at Investor Day, we continue to expand our second half operating margin to be above 19% this year. For non-GAAP earnings per share, our full year range equates to a robust 12% to 18% growth in the fourth quarter from $1.59 last year.

In conclusion, we are pleased with our overall third quarter performance, which included consistent revenue and earnings per share growth and meaningful operating margin improvement. The demand environment for our unique early-stage portfolio continue to be encouraging, and we are on track to achieve our full year target. Thank you.

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Todd Spencer, Charles River Laboratories International, Inc. - Corporate VP of IR [8]

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That concludes our comments. Operator, we will now take questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll go to Tycho Peterson with JPMorgan.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [2]

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Jim, just maybe starting with dynamics in the quarter and the reduced outlook. Can you talk a little bit about where things slowed relative to expectations? And what are you tempering exactly in the outlook?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [3]

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Yes. It's our usual commentary, Tycho, which is that we have a nonlinear business, particularly in the services, particularly in Safety. We do the best we can to call it on a quarterly basis, but we do, I think, a very good job calling it on an annual basis. We're actually quite pleased with the results for the quarter. I think our forecast is a little optimistic. That probably can happen from time to time, but we're pleased with the results. We're pleased with where we are on track for the fourth quarter. We're pleased with the fact that we are going to have comparable results in DSA to the prior year, which was the best year in a decade. Demand remains quite strong across pretty much the entire portfolio of clients, particularly biotech, who is very, very much dependent on us. We think our international footprint is working very well to support a whole range of clients increasingly with respect to proximity to them.

So really nothing fundamentally changed. We have a modest diminution in what our expectations were. But again, feel very good about the tack that we're on for the year, and that's consistent with, I think, how we've been in the last 4 or 5 years.

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Tycho W. Peterson, JP Morgan Chase & Co, Research Division - Senior Analyst [4]

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Okay. And then a follow-up on margins. How much of the margin upside is driven by delayed investments in cyber, et cetera, versus the benefit of the comp structure adjustment and NIAID contract dropping out? And I guess, going forward, as we think about margins for manufacturing, obviously, you're expanding capacity. So how much of the margin expansion in manufacturing in 3Q do you think is sustainable given the ongoing expansion?

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [5]

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So in respect to cyber, that's not been a huge drag at all. So that's not a dynamic that portrays into the expansion of our margins this year. I mean we are good. It's an operational beat in the earnings per share and driven by the enhanced margin.

DSA, we just signaled that we got a sequential improvement. We were anticipating the sequential improvement. We got 100 basis points higher despite an 80 point drag on Citoxlab. So I wouldn't characterize that that's a surprise. We had signaled that DSA would be improving in the second half of the year as it is.

Manufacturing was a surprise, a positive surprise. We said when we spoke at the end of Q2 that we would be approaching mid-30s by Q4. We've done that already. So we're pleased with the speed with which that's rebounded and expect that to bleed nicely into the future. RMS was up sequentially as well by 100 basis points despite the NIAID drag. The drag, of course, is a part quarter drag because we anniversaried mid-September.

So the way that we're looking at the margins, if you look at the year-to-date, year-to-date we're 18.1%. That's pretty much sitting on where we were year-to-date last year of 18.2% despite the fact that we have meaningful drags this year, namely from the NIAID, which of course, made sort of an 8.5 month drag compared to last year. Citoxlab is a drag. I mean, MPI, yes, but it's not -- MPI was not the drag that we're getting from Citoxlab. And of course, we've had Biologic this year as well. So we're very pleased with the fact that our margins are tracking the same as last year, year-to-date, notwithstanding the drags that we've had.

So that puts us in a good position for next year. Do feel positive about getting to the 21 -- 20% by 2021. So we'll say more about it in February.

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Operator [6]

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We'll go to David Windley with Jefferies.

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David Howard Windley, Jefferies LLC, Research Division - Equity Analyst [7]

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I just toggled over, so I apologize if this has been covered. But on margins, it sounds like you were just answering a little bit about margin. But looking at the overall, as we back into the math, it looks like your fourth quarter, to get to the approaching the -- flat with year-over-year, fourth quarter would be up about 50 basis points. I don't mean to over-interpret the words, but been using the words approaching, I'm interpreting that you don't expect it to quite get there. And so a 50 basis point increase in year-over-year margin in the fourth quarter would be kind of the ceiling of what you expect the performance to be? I just wanted to see if you could comment on that, if you believe that's accurate.

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [8]

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So in order to get to the 18.8%, which is the margin we had last year, we would need to be at the top end of the guidance that we've given you. So we would need to have something of the order of 20-point -- give it 20.5% ZIP code. Or another way of putting it, the same sort of ZIP code as Q4 last year. Now that is possible. And in fact, when we met in New York, I said that it was possible that we could be doing that in Q4. We're certainly in the hunt, but we've got a range for a reason. It's not guaranteed that Q4 will be a strong quarter or a very strong quarter. Q4 tends to be funky. It depends on how, I guess, some clients want to use up some of their R&D budgets. And we're expecting a strong quarter for Q4, but we would need a very strong quarter in order to get to the same level as last year.

Now as I said, it could be done. Don't be overly surprised if we achieve it, but we are guiding to approaching the 18.8% for reasons that we can't quite call exactly where Q4 will fall.

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Operator [9]

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And we'll go to Erin Wright with Crédit Suisse.

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Erin Elizabeth Wilson Wright, Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst [10]

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Great. I guess in Safety Assessment in general. I guess can you talk about the capacity utilization, study mix and pricing across that business as it stands today? And then I have a follow-up as well.

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [11]

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So our capacity utilization is in good shape. We have sufficient capacity to grow at our current growth rate, which is high single digits. We made modest enhancements and increases in capacity in multiple geographies and we'll always do that for proximity reasons. You'll recall when we bought MPI, that's the large building, that's a strategic benefit for us to have additional capacity, but that operates with incremental capacity and still terrific operating margin. So that provides us with great operating leverage, given the demand curve. There's a little bit of capacity in some of the CiTox sites, which is a positive as well. So capacity is in a good place as we end the year and we go into next year. We'll be able to accommodate a growth rate comparable to maybe slightly higher than we are now.

Mix is pretty comparable. It tends to run sort of 50-50, general and specialty tox. We don't give an update on that quarterly, so probably going to stay away from that. We do a lot of specialty work. We picked up additional specialty capacity with these new acquisitions. So we like that balance from a margin and growth point of view. And while we don't give specific guidance or information on our pricing for competitive reasons, we're actually very pleased with the pricing that we've gotten this year. We get price when possible and when appropriate. The studies have become increasingly more complex, and they need to be priced accordingly. So I'd say it's a pretty good mix right now of the mix of price and sufficient capacity to do the work, both now and for the foreseeable future.

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Erin Elizabeth Wilson Wright, Crédit Suisse AG, Research Division - Director & Senior Equity Research Analyst [12]

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Okay. Great. And then can you speak to the runway for growth across China and RMS? Has there been any sort of meaningful changes in the competitive landscape in China? If you could give an update there, that would be great.

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [13]

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Yes, not really. There's constantly new Chinese competitors sort of cropping up, believing that the business is more simple and more trivial than it actually is. And they tend to fall into difficulty relatively quickly. So the competition sort of comes and goes. Having said that, there's a fair number of small Chinese competitors, and while we're a substantial player, we only have a 30% market share. We hope we can get that to 50% or 60% going forward. So we like our competitive position. The quality of the product from the competition is inferior. We don't have any of our sort of usual competitors on a worldwide basis producing animals in China. And it's about geographic expansion. So we're working on our third facility, which will be in centrally -- Central China and we'll then look to Southern China. That will give us a much broader portfolio than the competition. And the locales in which we are moving are so substantial that being close will be important.

So long runway. We look at the world in 5-year increments because that's we do, a 5-year strategic plan. I think the runway is way longer than that, certainly a decade, probably longer. But we're going to see the growth rates that we've been enjoying now. There's a major investment by the Chinese government in the life sciences, particularly in biotech. So they're really working to play competitively on the international stage and high-quality work is going to have to be done locally. And those tools are going to often require high-quality analysts.

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Operator [14]

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And we'll go to Eric Coldwell with Baird.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [15]

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First one, unallocated corporate, you're showing some improvement there. Could you be a bit more specific on the drivers of that improvement beyond just revenue leverage? And how do you get to your longer-term goals, which I believe are still a fair amount lower than this?

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [16]

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Yes, we've been bringing down, as a percentage of revenue, about 50 basis points for a number of years. And at New York, we did signal we'd get from the 6% that we're at this year, down towards a 5%. We are getting leverage and have been over that period and continue to get leverage out of the way we've built our corporate offices. We've got shared service functions, for instance, centers of excellence, which allow us to -- basically scalable and actually put more through with the same staffing structures. We've been doing that in HR and IT as well, continually thinking about how we structure so that we can actually leverage more M&A out of the back of that.

So it's not something that is built overnight. We've been working on this for a number of years. We're seeing those economies coming out each year. And we do feel comfortable we'll see that going into 2020 and '21 as well.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [17]

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Great. Biologics, the new Wayne site registered. You're doing validations with clients. I guess my question is, I'm still not sure I'm 100% comfortable with the process of moving out of the old site to new one. Is there nonduplicative unencumbered work happening in the new site right now? Or are you still going through these validations through the end of the quarter, such that we would get another pop in margin as you're able to move out of the old facility early next year?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [18]

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We should probably stop giving details on this because I think we're dragging everybody through the day-to-day movement activity. So the reality is we're very -- we're largely in the new site, lots of clients. So some of the work is unencumbered and is straight up. Clients are validating. There's a lot of assays to be moved. We're moving them constantly sort of daily, certainly weekly. We closed 1 -- we had 2 other sites. We've closed 1 and the other 1 is being sort of repurposed. It's going to stay open but do some other things in there.

I would say that the margin drag is meaningfully over, certainly will be over by the end of the year. We'll stop giving you the gory details. We're really pleased with the facility. Clients are very pleased with it. We're actually pleased with how easily work has been moved. It's just a lot of it to move because -- and you saw that the growth rate for this business is terrific. So it's growing dramatically in spite of the move, in spite of those changes. So I think it will be a positive contributor as we go in.

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Eric White Coldwell, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [19]

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That's great. My last one, quickly. Microbials, nice production here in Endosafe, good sales there. I know you always get that razor-razor blade model with the cartridge pull-through later. Is there any way to quantify the increase in Endosafe sales or number of units so we could have some sense on the growth rate therein as products lead future consumable sales?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [20]

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Hard to do that. Obviously, there are substantial cartridges used with every unit that we sell. Increasingly, we're selling units, Eric, that are -- use multiple cartridges at the same time, we call it an MCS. These big robots that use lots of them. So the cartridge utilization is increasing substantially. We have a relatively small percentage of clients that we've transferred over to this new technology. So there's a lot more market opportunity for us, even though that we have a lot of the market dollars so far. So -- we're so far ahead of the competition just in terms of the sophistication of the gear. Clients are so happy with it and using it in multiple systems across big sites, let's say, for many of the big pharmaceutical companies that we're quite confident this will continue.

We've launched some new products in 2019, and we'll continue to do so. So, harder to get more granular than that. In our prepared remarks, we did say that there's a lot of new systems being installed. Obviously, nobody buys a system without intending to use cartridges on a sustainable basis.

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Operator [21]

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We'll go to Ricky Goldwasser with Morgan Stanley.

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Rong Li, Morgan Stanley, Research Division - Research Associate [22]

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This is Rong Li for Ricky. So I have a question on RMS. You previously have mentioned about the increasing focus on streamlining the RMS cost structure to kind of offset the volume pressure in the mature markets. Can you maybe elaborate on some of the initiatives you have been doing and the progress you are making here?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [23]

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Why don't I start? We're doing a whole host of things, where we're making sure that our capacity is in sync with demand. So we pared down some facilities at multiple sites. We work to make sure that our head count is also accordingly at the right levels. We've also taken a lot of our sort of standard manual processes and computerized them. So that's helped with the labor component, that's helped with efficiency, that's helped with inventory management, and that's also helped with capacity utilization.

We have this downward pressure from the Western locations, particularly the U.S. and Europe, where a lot of space has been taken offline by the drug companies that -- sort of one step forward and a couple of steps back, hard to predict how much more of that there'll be or how deep those cuts will go. But putting those aside, I think our capacity is well utilized now. We are getting some margin accretion. You saw that in the margin in the third quarter. China is growing nicely in some of our services businesses. By the way, some of the services businesses have extremely high operating margins. So I don't want you to think of the services only as a drag. As we said, some of the in-sourcing solutions, particularly the government contracts, are lower.

So we will continue to drive efficiency in RMS like we do in all of our businesses. It's running appropriately lean and appropriately focused on driving margin.

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Operator [24]

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And we'll go to John Kreger with William Blair.

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Courtney Patrice Owens, William Blair & Company L.L.C., Research Division - Associate [25]

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This is Courtney Owens on for John this morning. So in your earlier prepared comments, I think you guys mentioned that demand environment is pretty robust at present. However, I guess, thus far in Q3 and also into Q4, we're seeing kind of that biotech funding is starting to cool on a year-over-year basis, but it's still pretty solid on a dollar basis. But are you guys kind of starting to hear any commentary from clients around that? Just kind of any early, more cautionary commentary from them?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [26]

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Yes. Biotech funding has been so strong for so long that I think people are watching it too closely for any indications of a slowdown. We have been answering those questions and the time -- you all keep asking them for at least 5 years. So what are you seeing? And when is it going to slow down? And what's that going to do to your business? It's a fair question. The reality is that the funding levels are still quite substantial. We reckon they have 3 or 4 years of cash in the bank from the capital markets, plus a lot of money is coming in directly from pharma. I would say, increasingly, money is coming in directly from Big Pharma. VC funds are quite plentiful.

A lot of M&A. We had 48 biotech companies bought so far this year, some by Big Pharma, some by larger biotech companies. So we are hearing nothing from our clients. Our biotech client base has increased dramatically, to some extent through M&A, but just a constant increase in new modalities that are requiring them to outsource. We would hear it probably before anyone because our services are so broad gauge and we have so many clients. If there was any concern or hesitancy in terms of available funds, we would begin to see that maybe in multiple geographies, but certainly across multiple clients, and we're just not. So doesn't mean we don't watch it as well. But you have to have something pretty diabolical and dramatic to happen or to cause any sort of pullback given the strength of the science these days.

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Operator [27]

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We'll go to Juan Avendano with Bank of America.

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Juan Esteban Avendano, BofA Merrill Lynch, Research Division - Associate [28]

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You mentioned in your prepared remarks that you intend to add about $1 billion in annual revenue through M&A over the next 5 years. Outside of Safety Assessment, can you share with us what are your interests and how many deals, let's say, annually you anticipate being able to complete to get to your target 5 years from now?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [29]

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So we never have an artificial number of deals that we'll do. That would be frustrating and something we couldn't fulfill. So we're well financed. You saw that we did a bond. Our balance sheet is really strong. Our leverage has come down. Our free cash is good. But you heard us say in our prepared remarks that there are a lot of M&A targets out there, mostly private equity owned, so they're by definition for sale. If we don't do a deal in fiscal '20, let's say, we would be surprised but not necessarily disappointed. If we didn't do a deal, the prices wouldn't have held up or we would have -- something would have failed in due diligence, and we would have been disappointed. So we're constantly enhancing our portfolio. That's the reason we're doing it. We're not doing it to be large. So you're going to see us do more in Discovery, in therapeutic areas, in more Early Discovery technology, maybe in the antibody space, definitely more in cell and gene therapy, perhaps more geographically. We have some interesting deals in the research model studies, believe it or not, something you would not anticipate, some small opportunities in biologics and microbial. So -- and we wouldn't do anything in Safety unless it was a small niche deal, small niche technology of something that we don't do now and I can't imagine what that is or something that could be additive to something we'd like to do more of. And we got that with CiTox and with MPI, we picked up those capabilities.

So we feel very good about where we stand right now. We're 6 months post CiTox, even though that's a complex one. We're locked and loaded financially to do deals, but we won't do one unless it meets our financial hurdles. We have multiple conversations going on right now real time, as we always do. So don't be surprised if we do something and don't be surprised if we don't. But no artificial number.

So -- and I think you're asking the question because we threw out the $1 billion, so it's a fair question. So given the landscape that we see, given the size of the company and the growth rate, given the types of things that we want to add and their growth rates, on a composite basis, we think that's a pretty realistic number. And while we have a real clear view today what the composite will be, we could actually tell you what companies that would comprise, if not the way it will turn out. But the areas in which we invest will be quite similar. And we don't -- we have some but we have less strategic competition than we have historically, although I would say an increasing amount of sponsor competition, financial sponsors. So that's the M&A strategy.

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Juan Esteban Avendano, BofA Merrill Lynch, Research Division - Associate [30]

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Got it. I appreciate the color and detail. And you just completed a compensation adjustment last year and that just annualized. How do you feel about your compensation structure now? And how likely is another adjustment necessary over the next 2 years?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [31]

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That was an important catch-up in multiple geographies, and we have a whole new human resources organization, and we're really working hard to stay way ahead of that. So I think if we ever had to make any adjustments, they will be small subtle specific geographic adjustments because competition waxes and wanes in certain geographies. But our starting wages are competitive with different types of companies in the geos that we're in. It's easier to recruit people and our retention has improved as well. So highly unlikely we would ever have to make an adjustment with that magnitude.

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Operator [32]

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And we'll go to Jack Meehan with Barclays.

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Andrew Brooks Wald, Barclays Bank PLC, Research Division - Research Analyst [33]

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This is Andrew Wald on for Jack. In RMS, how did the GEMS business perform in the quarter? We noticed that wasn't called out in the slide deck.

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [34]

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Good catch. It's doing fine. Things fluctuate from quarter-to-quarter. The GEMS business has been a very steady growth business for us and very strong pretty much across the world, certainly in the U.S. and Europe, and thirdly, in Japan. So technology is a great necessity to the researchers. I think we're one of the premier players in terms of producing and providing those models to our clients.

Just -- there are a couple of other facets in the quarter that were more dramatic from a financial point of view so we called those out more readily. That's really what it's about.

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Andrew Brooks Wald, Barclays Bank PLC, Research Division - Research Analyst [35]

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Great. And in the past, you've spoken about legacy Charles River clients beginning to audit some of your newer sites, like MPI. Have you seen this play out with clients becoming more flexible?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [36]

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We have. So the real -- it's a really big footprint. If you look at our Discovery and Safety sites, it's something like [37]. And so we can do multiple things. If they just want to work close by, there's a site we're close by. If they want to work in multiple sites, they can do that. If they want a specific scientific capability, we can point them to a single site or multiple sites. So it's given them more flexibility and us more flexibility as well.

We -- sometimes, the clients are agnostic to where they go so we can place them there, and sometimes, they have very specific needs. It's important for them to audit and see the facilities themselves. So it's a very powerful footprint right now, and we're definitely using it strategically to our advantage and should be able to continue to do so.

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Operator [37]

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

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Jack Rogoff, Goldman Sachs Group Inc., Research Division - Research Analyst [38]

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This is Jack Rogoff on for Bob. So it sounds like you feel good about your staffing levels in the DSA business and I think some of the margin headwinds in the first half of the year were related to staffing increases to meet demand beyond the wage increases, which had been known since 2018. So at this stage, do you foresee another bolus of DSA hiring on the horizon? Or should we expect a more smooth progression going forward?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [39]

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You should see a more smooth progression. What we tried to iterate clearly in our prepared remarks, so let me repeat it, is that we've invested heavily in capacity and infrastructure, in wages and in numbers of people to do the work. Some of it was catch up because the business had been more robust than we had anticipated. I think that we've caught up nicely. We'll have to add people sort of subtly as we continue to grow. And we're quite confident that we'll see some leverage from those investments in the bottom line going forward.

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Operator [40]

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We'll go to Don Hooker with KeyBanc.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [41]

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So you guys don't talk about pricing, I get that. But in terms of the study start timing, or any kind of delays there? I know it's hard to kind of -- I know you do a lot of different types of studies, but any kind of commentary that you can give us around study start-ups?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [42]

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So we'd like the clients to wait as long as possible. They don't agree with that philosophy. So we have to be flexible enough to accommodate clients who really need to start immediately. And I think we have enough capacity right now that we're able to do that for clients where we have rational price points and rational relationships. So we certainly are competitive from a study start point of view. We -- I mean, occasionally, we might lose some more, but that's probably something that we consciously know and we've done a very good job accommodating clients' needs throughout the year. And there's no reason why that shouldn't continue.

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Donald Houghton Hooker, KeyBanc Capital Markets Inc., Research Division - VP and Equity Research Analyst [43]

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Okay. And then one last quick one. In terms of capital spending to sort of maintain your infrastructure as you grow, it sounded like some CapEx was delayed into 2020. So I guess I would assume 2020 is going to be a pretty intense year for capital spending. What is a normal sort of CapEx rate, maybe as a percent of revenues or something else that we can sort of think about going forward for you guys?

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [44]

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So in New York, we signaled that the sort of typical yardstick would be under 7% of revenue. That said, just a couple of comments on this year, which actually reflect on next year as well. We've not starved any business of CapEx. They've got the means to deliver the sort of growth rates that we're expecting in the near term. And we're very pleased with the aggregate space that we have in Safety Assessment. In North America, we've still got an opportunity in MPI in the space there. And Citoxlab gave us some opportunities in Europe, which enabled us -- Citoxlab did enable us to delay some of the spend into 2020.

But we're continuing to control the spend, making sure that the capacity that we put on is kind of at that bleeding edge of the need for the service that we need to provide. So we're actually looking at this year, from our perspective, it's a good news item because we've been able to control that spend on CapEx that's similar to 2018.

Now to the core of your question, we'll obviously give more detail as to where we think CapEx will be in 2020, but we will continue to make sure we control it tightly without starving the units. But at the moment, the uptick is under 7%, and we will sharpen that up in February for 2020.

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Operator [45]

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And we'll go to Dan Brennan with UBS.

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Daniel Gregory Brennan, UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences [46]

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Great. Maybe the first one, just within the 120 basis points or so of the margin expansion targeted through 2021, could you just give us a bridge? Just I know you've given us quantification for CiTox in biologic capacity absorption and unallocated corporate overhead, but like is it possible to just kind of bridge that 120 basis points with some of those discrete factors?

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [47]

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Yes. So we've -- in New York, we gave some signals as to where the margin should be. RMS, north of 25%. The real expansion is in the DSA segment. Manufacturing is already in the mid-30s and we expect that to continue next year. And then the unallocated corporate costs will continue to come down.

So the 2 areas where you get the bridge is through DSA and through the unallocated corporate costs.

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Daniel Gregory Brennan, UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences [48]

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And specifically though, David, like in terms of that biologic capacity absorption in CiTox, how much are they kind of viewed -- if you just separate those 2 out for the $120 million, how much would they kind of account for that?

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David Ross Smith, Charles River Laboratories International, Inc. - Corporate Executive VP & CFO [49]

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Well, we don't break out microbial from biologics. But Manufacturing, obviously, we've had a drag from biologics this year. But we were in the mid-30s prior to that investment this year. And as you heard this morning, we are back into the mid-30s for Manufacturing. So we expect that to continue.

So you get, obviously, from an EPS point of view, you get the leverage on the revenue growth, but bringing back to your question about where the margin expansion is, it's really the expansion in DSA and unallocated corporate costs.

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Daniel Gregory Brennan, UBS Investment Bank, Research Division - Senior Equity Research Analyst of Healthcare Life Sciences [50]

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Great. And then maybe just one other unrelated one. I know at the Investor Day, you were very bullish on Discovery. Sounded like you thought there was a real inflection coming in terms of penetration opportunity. Could you just help us think about kind of how -- like the magnitude of this coming penetration opportunity you see and how that might influence the current growth rate of Discovery as we look out over the next couple of years?

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James C. Foster, Charles River Laboratories International, Inc. - Chairman, CEO & President [51]

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A whole host of technology will be beneficial for our clients once they discover a target or molecule, or in some cases, we help them to do that. So we've got -- we have an increasing number of Discovery clients working across our whole portfolio. That was the logic of the strategy. And we think that will continue to increase dramatically. We also think that a lot of our M&A -- and as we said in our prepared remarks, we haven't commented yet in the Q&A, we're doing technology deals where we're finding pretty cutting-edge technologies where we're making a small upfront investment, sort of seeing whether the technology is as good as the company says it is. And those will either to be long-term marketing arrangements or deals that don't work out or potential acquisitions. So if they're continued market arrangements or acquisitions, that will expand the Discovery portfolio even earlier.

So the strategy is to grab the clients as early as possible, and they're always in a race to get to market. So if we get them early, we do good work for them, they'll tend to stay with us through the development and life cycle of the drug. So very, very important strategic lever. It's going really well. It's got nice growth metrics, should have improving margin metrics. It's very, very complex science. So that's a lot of the places where we grab these very small biotech clients, very early, who are very -- who are insistent on world-class science, instead of bringing it in-house.

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Operator [52]

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And I'll turn it back to Todd Spencer for closing comments.

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Todd Spencer, Charles River Laboratories International, Inc. - Corporate VP of IR [53]

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

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Operator [54]

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Thank you, ladies and gentlemen, that does conclude the conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.