Charles River Laboratories' CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.12.14 | About: Charles River (CRL)

Charles River Laboratories International, Inc. (NYSE:CRL)

Q4 2013 Earnings Conference Call

February 12, 2014 8:30 AM ET

Executives

Susan Hardy - Corporate Vice President of Investor Relations

Jim Foster - Chairman, President and Chief Executive Officer

Tom Ackerman - Executive Vice President and Chief Financial Officer

Analysts

Greg Bolan - Sterne Agee

Douglas Tsao - Barclays

Eric Coldwell - Robert W. Bair

Tim Evans - Wells Fargo Securities

John Kreger - William Blair

Dave Windley - Jefferies

Jeff Bailin - Credit Suisse

Ross Muken - ISI Group

Steven Valiquette - UBS

Sung Ji Nam - Cantor

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories Fourth Quarter 2013 Earnings and 2014 Guidance Conference Call. (Operator Instructions) I'd now like to turn the conference over to Corporate Vice President of Investor Relations, Susan Hardy. Please go ahead.

Susan Hardy

Good morning, and welcome to Charles River Laboratories fourth quarter 2013 and 2014 guidance conference call and webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer; and Tom Ackerman, Executive Vice President and Chief Financial Officer, will comment on our fourth quarter results and provide guidance for 2014. Following the presentation, we 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 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 315893. The replay will be available through February 26th and you may also access an archived version of the webcast on our Investor Relations website.

I'd like to remind you of our Safe Harbor. Any remarks that we may make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor Provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors, including but not limited to, those discussed in our Annual Report on Form 10-K, which was filed on February 27, 2013, as well as other filings we made with the Securities and Exchange Commission.

During this call, we will be primarily discussing results from continuing operations and non-GAAP financial measures. We believe that these non-GAAP financial measures help investors to gain a meaningful understanding of our core operating results and future prospects consistent with the manner in which management measures and forecasts the company's performance. The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations to those GAAP measures on the Investor Relations section of our website through the Financial Reconciliations link.

Now I'll turn the call over to Jim Foster.

Jim Foster

Good morning. I'd like to begin by providing a summary of our fourth quarter results before commenting on our 2014 guidance and business prospects. We reported sales of $289.2 million in the fourth quarter 2013, an increase of 3.2% over the previous year. Excluding the negative effect of foreign exchange, sales increased 3.7%. PCS segment was the primary driver of the increase at 8.2% in constant currency. The fourth quarter sales increase represented the highest growth rate we reported in the last five years. As expected, PCS sales declined slightly on a sequential basis due primarily to seasonality.

We were exceptionally pleased with the PCS performance, which reflected our market share gain as well as improved demand from both large biopharmaceutical and mid-tier clients. Year-over-year the consolidated operating margin improved by 50 basis points to 16.4%. The UK tax law change, which shifted R&D credits to PCS segment operating income, provided a benefit of approximately 40 basis points to the consolidated margin. Tom will provide additional information on this change shortly.

Higher PCS and EMD sales, the acquisition of Vital River, and improved operating efficiency contributed approximately 50 basis points to the operating margin increase, which was effectively offset by higher corporate costs. Earnings per share were $0.73 in the fourth quarter, an increase of 14.1% from $0.64 in the fourth quarter of 2012. We continued to return value to shareholders in the fourth quarter through our share repurchase plan for the purchase of approximately 1.5 million shares with $77.2 million. In total, we repurchased nearly 3.5 million shares in 2013, which effectively enabled us to achieve our goal of offsetting dilution from stock compensation and the exercise of stock option.

We were generally very pleased with the fourth quarter results, which demonstrated the benefits of the actions we have taken to position Charles River to be the partner of choice for outsourced drug discovery and development services. Our efforts to create a more streamlined and efficient operation without compromising scientific expertise or client service have enabled us to maintain and enhance Charles River's leading market position as a premier provider of essential early-stage drug discovery and development solution and to provide those solutions tailored to each client's specific needs. This in turn has provided clients with the resources they require in lieu of in-house capabilities and supported their goal to increase their use of outsourced services with a reliable scientific partner.

I'd like to provide you with details on the fourth quarter segment performance. RMS segment sales were $172.3 million, a 1% gain in constant currency. The increase was due primarily to the acquisition of Vital River, which continued to exceed our original expectation. In addition to the acquisition, both our GEMS and EMD businesses performed well. The main offsets to growth were research model production and the termination of the two long-term European contracts, which we've discussed in previous quarters. Those contracts, which totaled approximately $5.5 million in the annual revenues, included at the end of 2012, as a result they will not impact 2014 comparison.

The RMS operating margin was 27.1% in the fourth quarter, that’s 20 basis points below the fourth quarter of 2012. Lower legacy sales and research models significantly impacted the margin, which is extremely sensitive to changes in volume. This is particularly true in the fourth quarter of the year when, as you know, normal seasonality reduces unit volume. We mitigated some of the impact as a result of efficiency initiative implemented earlier in the year.

Through our ongoing focus on efficiency, we are continuing to work diligently to enhance the operation of our production business and are reaffirming our goal of maintaining an RMS operating margin at or above 30% on an annualized basis. Excluding Vital River, sales of research models declined by approximately 5% year-over-year. The continuing consolidation of the biopharmaceutical industry, the closure of biopharmaceutical facilities, and the evolution of drug development to eliminate molecules earlier in the process have caused softened demand for our research model, which more than offset our market share gain. We believe that research models will continue to be a critical component of drug research, and based on our position as a market leader, we will gain additional share with our global biopharma, mid-tier, and academic clients.

We also expect that demand for our models will continue to grow in China, a market which is developing well and in which we have established Charles River as a premier provider. However, we also believe that the factors I mentioned will continue to impact demand in 2014. We have a number of sales initiatives in place to enable us to gain market share, particularly in the academic sector. And as I mentioned, we implemented specific efficiency initiatives focused on research model production.

We've evaluated our production infrastructure to determine optimal capacity and determined that we could reduce capacity in North America. This led us to the decision implemented last week to close our Michigan facility in late 2014. We will continue to provide our clients with research models from our other facilities without compromising either availability or on-time delivery. Research Model Services were effectively flat in the fourth quarter with gains in DRS and GEMS offset by the impact of the European contract terminations.

We were very pleased with the solid growth in both DRS and GEMS, increased outsourcing, combined with our market share gains that is driving growth for these businesses as well as for Preclinical Services. In DRS, sales increased year-over-year and also continued the positive trajectory we saw through our 2013 with sequential growth in the fourth quarter.

Our expertise in oncology and CNS is widely known, and we intend to expand our therapeutic area expertise to other disease areas in order to enhance our value to clients. Because we believe that the majority of discovery work is still done in-house and the outsourcing opportunity is significant, this is one of the areas for which we are pursuing acquisition opportunities. We are focused on expanding upstream to enhance our discovery expertise, as clients continue to look to partner with CRL in the earlier stages of their R&D program. We believe that by providing support for a larger portion of the discovery process, we can enhance the value of our portfolio to our clients.

The GEMS business also reported sales growth in the fourth quarter, predominantly in the US, as researchers continued to develop more complex models of human disease to use in translational research. They're outsourcing services to us in order to access expertise they no longer have in-house or perhaps never established. Genetically-engineered models present unique set of challenges in research, which are not easily solved. Given the expertise we have developed over our long history, we believe there is no CRO better able to address these challenges than Charles River.

The EMD business delivered a very good performance, highlighted by sales of testing products outside the US and Accugenix service sales. The PCS franchise continued to exhibit strength as we saw additional instruments and cartridges and continued to take share in the conventional testing market. Sales in the US was slightly behind our fourth quarter plan, primarily as a result of product introductions, which occurred later in the year than anticipated. However, we expect that sales growth will be in the low-double digits in 2014 as new products are introduced, and we continue our efforts to convert large pharmaceutical manufacturers’ central laboratories to the PCS cartridge technology.

As I mentioned on our last conference call, Accugenix marked its one year anniversary as part of the Charles River portfolio at the end of August. We continue to be very pleased with the integration and our efforts to expand sales. Cross-promotion of the legacy portfolio and Accugenix services has enabled us to take market share as clients recognize the value of doing both microbial testing and identification through one provider. We intend to continue investing in both product extension and acquisitions like Accugenix in order to drive the EMD growth.

Strengthening demand for outsourced services and our market share gain drove an impressive 8.2% increase in the fourth quarter PCS sales in constant currency. At $117 million, sales was just below the third quarter level, which was the highest level in any quarter since the first half of 2010. As I mentioned, the slight fourth quarter decline was expected, as launches often delay steady starts during the holiday. Growth was driven by the continued benefit from market share gain as well as the increased steady starts and steady volume versus last year, which we believe is indicative of improving demand. As was the case in the third quarter, mixed results are favorable.

The improvement in volume and mix as well as the benefits of efficiency initiative generated a significant increase in the fourth quarter PCS margin. At 13.3%, the operating margin was 320 basis points higher than in the fourth quarter of the previous year. The increase was driven primarily by operating factors, which contributed 230 basis points of the improvement. The change in R&D credits accounted for only 90 basis points of the margin gain.

As a result of improved demand, our preclinical capacity is continuing to be better utilized. Pricing has generally remained unchanged, although intermittently there is aggressive pricing by all of our major competitors who have more unused capacity. As the industry utilizing approaches more optimal levels, we are confident that pricing will eventually improve. While price is an important consideration, expertise and quality are most often considered more critical. We have continued to win RFPs for which we were not the lowest there, because as global biopharmaceutical companies reduce their infrastructure, they were reliant on CROs. They do not want to compromise on scientific expertise. And that criterion is critical. Charles River is their preferred choice.

We believe that the strategic relationships we have won with global biopharmaceutical companies demonstrate that as these companies increasingly choose to build strategic relationships with a smaller number of partners, our unique early-stage portfolio, our scientific expertise and our flexibility are recognized as key competitive differentiators. Now that the first group of strategic relationships we won in insuring and the logistics of working together are established, the opportunities to expand the relationships with these clients are becoming more numerous. This has been the key tenet of our strategy that as the relationships strengthen and the clients use us as colleagues on the same side of the table, they will expand the scope of products and services they purchase from us.

PCS sales to our global key accounts, which comprise approximately 25 of the largest biopharmaceutical companies, increased 5%. This is primarily the result of new agreements signed in 2012 and 2013, as well as the expansion of services under existing agreements. In 2013, sales from strategic relationships represented slightly more than 25% of total sales. Discussions with these clients are ongoing, adds to our discussions with other biopharmaceutical companies about new strategic relationships.

We believe that as large clients continue to rationalize capacity, they will select Charles River to provide outsourced services, relying on us for the expertise they are no longer maintaining in-house. Furthermore, they will look to purchase products from their outsourcing partners in order to achieve their goal of reducing the number of suppliers and maximize favorable pricing. We are focused on goal of winning a majority of share of these opportunities. And based on our discussions with clients, we believe the outlook for these relationships remain good.

The same attribute that convinced large biopharmaceutical companies to partner with Charles River also resonate with mid-tier biotech companies. As global pharma increasingly partners with these companies, it is imperative that the biotech companies an expert CRO, which can provide the critical services they need to ensure their partners can meet pharma's standard. Many of them have chosen Charles River as their principal early development partner, which was reflected in an 11% increase in PCS sales for these companies in the fourth quarter.

In 2013, for the first time, total sales to our mid-tier biotech clients were greater than those to global key accounts. This is the result of biotech's improved access to funding from both large pharma and the capital markets and our targeted sales effort to win businesses for these companies. Sales to academic and government clients declined slightly in the quarter, but higher sales to academic clients offset primarily by soft sales to the US government clients.

For the year, the impact with sequestration in the US remained approximately $3 million. And although the government shutdown did not have a significant effect on fourth quarter sales, we believe that some of our academic clients took a more conservative approach to purchases. We also believe that the recent announcement of $1 billion increase in NIH funding will have a positive effect on 2014's spending. It may take some time for the funding to play out, but ultimately this should enable our clients to resume or expand research that was restrained during sequestration.

As successful as our sales strategies have been, we believe we can improve our effectiveness by coordinating the dialog between large pharma, biotech, academia, non-governmental organizations and venture capitalists. As these groups increasingly rely on one another, it's essential that we continue to develop deeper strategic relationships with each of these constituencies and assist them in working together. We've already begun to make progress towards this goal as our VC partners are now helping us to enhance our relationships with pharma as well as with their portfolio of companies, many of which are virtual and require a CRO partner for almost everything they do. We will continue to work towards establishing ourselves as the hub with relationships between all of these groups.

With our sales strategies firmly in place, we view 2014 as a year of continuing improvement. We expect sales growth at Charles River to be in the range of 3% to 5% and expect both business segments to deliver growth rates within the consolidated range. We expect that almost all businesses will contribute to sales growth, although closure of pharmaceutical facilities will continue to impact our research model production business. We expect both RMS and PCS operating margins to improve as a result of operating leverage from higher sales and the improve capacity utilization as well as from ongoing effort now firmly embedded in our culture to improve efficiency.

As I'm sure many of you know, we made organizational changes at the beginning of December and assigned Dr. Jorg Geller, one of our most seasoned operating executives, to head our efficiency effort. Jorg and his dedicated team are in the process of identifying efficiencies, which we expect will generate some savings in 2014 and more significant amounts in 2015 and thereafter. We expect that the efficiency initiatives will push the RMS margin back above the 30% level in 2014 and continue to generate improvement in the PCS margin.

Corporate costs will increase slightly to approximately 6.5% of sales, but we expect that the consolidated margin will increase by up to 50 basis points. Taken all these factors into account, we estimate 2014 non-GAAP earnings per share to be in a range of $3 to $3.10. Tom will give you more details about this guidance in a moment, including guidance on the cash flow.

Many investors asked us if we think that the preclinical demand has turned. We believe demand is certainly picking up. There's more of our global biopharma clients making decision to outsource in lieu of maintaining in-house infrastructure. It's our goal to be ready to win work when it's outsourced. Toward that end, we have undertaken targeted initiatives that will focus on differentiating Charles River as a preferred partner for early-stage drug development, expanding our broad early-stage portfolios to internal development and selective strategic acquisitions, maintaining and enhancing our extensive scientific expertise, improving our operating efficiency so that we can cash the savings on to our clients, providing best-in-class client service, developing state-of-the-art data systems and portals which offer clients real-time access to data and structuring creative solutions that support each client's drug development goal.

We believe these actions have been crucial to our success in persuading clients to work with Charles River and will continue to drive our future growth. But as our clients continue to evolve, we must evolve with them. We continuously assess our organization and identify actions we can take to enhance the value we provide to clients. Just within the past year, we have globalized and unified our RMS and PCS operations under Dr. Davide Molho, added the scientific bench strength, taken our efficiency initiative to the next level and continued to invest our capital in strategic acquisitions to expand our unique portfolio.

We will continue to embrace change, because in doing so, we enhance our ability to support our clients, which is fundamental to our ability to drive sales, cash flow and earnings growth. In conclusion, I'd like to thank our employees for their exceptional work and commitment and our shareholders for their support. And I would like Tom Ackerman to give you additional detail on our 2014 guidance.

Tom Ackerman

Thank you, Jim, and good morning. First, let me remind you that I will speak primarily to non-GAAP results, which exclude acquisition-related amortization, charges related primarily to our global efficiency initiatives and certain other items. This morning, I will also focus my discussion on our 2014 financial guidance.

For 2014, we expect sales growth of 3% to 5% on both the reported and constant currency basis and non-GAAP EPS of $3 to $3.10. We expect only a small benefit from foreign exchange at this time, despite the favorable FX movements in recent weeks. As Jim said, we expect sales growth of both RMS and PCS to be within the 3% to 5% consolidated guidance range in 2014.

For RMS, a notable improvement in organic growth in 2013 is a result of a number of factors. These factors include anticipated increase in average realized pricing of 2% to 3% compared to 1% to 2% in 2013, more stable demand from large pharmaceutical and government clients and low double-digit sales growth for the EMD business. In addition, we have anniversaried the termination of two long-term contracts for certain services in Europe. As we previously noted, these contracts concluded at the end of 2012 and represented approximately $5.5 million in annual revenues.

Favorable PCS sales growth trends are expected to continue in 2014. We will anniversary several large strategic relationship wins and the corresponding sales ramp under these agreements would expect to continue to execute on our goal of expanding the range of products and services we sell to these clients beyond the initial scope of the RFP and entering into strategic relationships with new clients. We also expect growth from our mid-tier clients as we continue to benefit from a combination of market share gains and an improved funding environment for biotechnology companies. We have also forecasted an approximate 1% increase in PCS spot pricing for 2014, which is similar to the 2013 increase.

We intend to generated consolidated operating margin expansion in 2014. This did not occur in 2013 due primarily to the impact of biopharmaceutical facility consolidations on our research model business, which is very sensitive to client changes. In 2014, we expect that the consolidated operating margin will improve by up to 50 basis points from 17.3% in 2013 with improvements in both segments.

Annual cost increases, including wages, are expected to increase 2% to 3% in 2014, but will be more than offset by the fixed cost leverage from higher sales, price increases primarily in RMS, and our continued focus on operating efficiency. We remain committed to driving efficiency throughout our global organization. We have identified $25 million to $30 million of incremental sales in 2014, which are already included in our guidance. These savings are derived from a combination of projects that were implemented within the last year and new projects that were identified through our ongoing global efficiency initiatives. We continue to evaluate additional initiatives, which when finalized we expect would generate greater savings in 2015 and beyond.

In the RMS segment, the primary drivers of the margin expansion are expected to be the 2% to 3% average price increase and our global efficiency initiatives. As Jim mentioned, we plan to close our research model production facility in Michigan by the end of the year, which will generate savings beginning in 2015. Once this is completed, we will have consolidated approximately 8% of our global research model production capacity, including the three rooms in California last year.

And payments, severance and related charges associated with the Michigan closure are expected to total approximately $4 million to $5 million in 2014 or $0.05 to $0.07 per share, which will be excluded from non-GAAP results. We have only included charges related to the specific action in our 2014 GAAP EPS guidance.

In 2014, we also expect to generate operating margin improvement in the PCS segment due primarily to increased study volume, favorable study mix, and the benefits of our global efficiency initiatives similar to the trends in the third and fourth quarters of 2013. Because it was affected for the last three quarters of 2013, when you take tax law change, we'll only have a small 20 basis point incremental benefit to the PCS operating margin in 2014.

The 2014 PCS operating margin guidance implies that the margin on incremental sales will be higher than these segment average as it was in the second half of 2013. This incremental margin assumption depends on a more optimal sales mix, fixed cost leverage from increased study volume and stable pricing, but will vary based on the strength of these factors. It can also be affected by the addition of capacity and staff in order to accommodate higher demand.

In aligning with our prior outlook, unallocated corporate cost totaled $72.1 million in 2013 or 6.2% of sales. We expect unallocated corporate cost to be approximately 6.5% of sales in 2014, a slight increase from the 2013 level due primarily to modest investments in IT as well as performance-based compensation expense. We expect higher sales and the operating margin expansion of up to 50 basis points due to primary driver of the 2014 EPS increase. In total, below-the-line items are expected to have a minimal effect in 2014 as the higher tax rate and less favorable other income, which we do not forecast, are expected to be partially offset by our slightly lower share comps.

I will now discuss these items in more detail. Net interest expense is expected to be relatively flat in 2014 in a range of $12 million to $14 million compared to $13 million in 2013. This represents slight increase in the second half run rate after we refinanced our convertible debt last June, in part due to our assumption that LIBOR rates will be slightly higher in 2014. Other income totaled $7.2 million or $0.l1 per share in 2013 due primarily to gains in our investment in a large life science venture capital fund. Several of the portfolio companies cleared their IPOs and their market performance resulted in investment gains.

Since the impact of these investments is largely based on market performance, we do not forecast this item. As a result, other income has been forecasted [ph] zero or an $0.11 headwind to our 2014 EPS guidance. Excluding this $0.11 from our 2013 results, our 2014 EPS guidance will represent a growth of 6% to 10%. The 2014 non-GAAP tax rate is expected to increase approximately 200 basis points to 300 basis points to a range of 28.5% to 29.5%. This is an increase from 26.6% in 2013, which was lower than our prior outlook in October due to several discrete non-recurring items.

The 2014 tax rate increase will primarily be a result of tax law changes in Canada and the UK, which reduce the benefit of R&D tax credits. These tax law changes will contribute approximately 120 basis points to 2014 increase. The UK tax law change that we discussed in detail last quarter represents only 30 basis points to the increase, because the law was effective three quarters in 2013. The remainder of the 2014 tax rate increase is primarily related reduced benefits from our European debt structure. The higher tax rate and unfavorable other income are expected to be partially offset by a slightly lower share comp in 2014. Our guidance assumes an average share comps of approximately 47 million to 47.5 million shares in 2014, reflecting both the full year benefit of repurchases in the second half of the 2013, as well as continued stock repurchase activity in 2014.

In 2014, we expect our repurchase activity to primarily offset dilution from option exercises and equity grants. For the full year 2013, we repurchased 3.5 million shares for a total of $165.7 million, including 2.9 million shares in the second half of the year. At year-end, we had 139.1 million remaining on our term stock repurchase authorization for $1 billion.

In addition to stock repurchases, our capital priorities for 2014 include debt repayment and potential strategic acquisitions. Given our favorable capital structure with a leverage ratio of approximately 2.5 times and an expectation of continuously low interest rates in the near term, we plan to repay debt in line with or slightly ahead of the schedule installments in the term loan. We also continue to rigorously evaluate acquisition candidates and intend to pursue additional M&A opportunities in 2014. Timing of acquisitions is always difficult to predict, but it's our strategy to continue to supplement our organic growth of disciplined strategy acquisitions that are accretive to earnings.

I'll now provide an update on our cash flow. For 2013, we generated free cash flow of $169.9 million or $3.50 per share compared to $160.5 million or $3.82 per share in 2012. Capital expenditures in 2013 were lower than previously expected at $39.2 million due to the timing of expenditures in the fourth quarter and lower capital requirements on some smaller projects. However, the benefit of lower CapEx to free cash flow was offset by an increase in DSOs at year-end of 56 days from 54 days at the end of the third quarter and 51 days last year. We previously expected a slight decline in DSO from the third quarter level, but do no anticipate any credit risk related to the two day increase.

2014, we expect free cash flow to be between $175 million and $185 million or approximately $3.75 to $3.95 per share. We will continue to focus on receivables and working capital management to improve our DSOs in 2014, but have not forecast a meaningful improvement in this metric. CapEx is expected to be between $50 million and $60 million in 2014, which is slightly higher than in recent years due in part to the carryover projects from 2013. Both projects are expected to represent approximately 40% of CapEx, including further investment in our EMD business and our growing RMS operations in China. The remaining 60% will be spent on maintenance of our global infrastructure.

In the first quarter of 2014, we expect a meaningful sequential increase in consolidated sales. The increase primarily reflects higher sales in the RMS segment compared to the seasonally slower fourth quarter, and order activity for small models is lighter during holiday periods. As a result of higher sales, the RMS operating margin is expected to rebound above the 30% level in the first quarter.

PCS sales and operating margin are expected to be modestly lower in the first quarter on a sequential basis, which is consistent with seasonal trends as there're typically fewer study starts during the holidays. However, on a year-over-year basis, we expect PCS sales and operating margin to be above the first quarter of 2013. The benefit of higher sales in the first quarter will be primarily offset by a higher tax rate, which is expected to be an approximate $0.06 headwind compared to the fourth quarter tax rate for the 22.8%. This is expected to result in first quarter EPS to be similar to the fourth quarter level of $0.73, which would represent a year-over-year increase of approximately 6% from the first quarter of 2013.

To conclude, we were pleased with our performance in 2013. We achieved financial results that exceeded our original guidance range for non-GAAP EPS and were within the targets for constant currency sales growth and free cash flow. In addition, we also continued to deliver value to our shareholders, resulting in a 50 basis improvement in our free cash flow return on invested capital to 13.1% or further improvement expected in 2014. We also made significant progress on many critical initiatives to strengthen client relationships and gain market share to enhance our focus on operating efficiency and to expand our leading early-stage portfolio. We believe these efforts position us well for 2014 and beyond.

Susan Hardy

That concludes our comments. We'll now take questions.

Question-and-Answer Session

Operator

(Operator Instructions) We'll go to the line of Greg Bolan with Sterne Agee.

Greg Bolan - Sterne Agee

Just looking at 2013, Jim and Tom, finished the year around 5.9% constant dollar revenue growth in PCS, and you're talking about kind of 3% to 5% for both segment growth and 2014, but just kind of targeting on PCS for just two seconds, what's assumed there? Is it same-store sales growth from your existing strategic partnerships, and that's kind of the primary pillar for growth? Is there any assumption for further market share gain or acceleration in the trends that we've seen over the past six to nine months for the underlying ties for demand and for outsourced preclinical services? Maybe if you could dig a little bit deeper, that'd be great.

Jim Foster

First, I would remind you that that’s the range. Second place, I would say that it assumes similar market metrics, which are space selling in the industry, but not full pricing, a little bit of spot pricing, but still pricing being tough. We said in the prepared remarks that we are intermittently seeing aggressive pricing from virtually all of our key competitors, so that may or may not continue. We're assuming strong sales from the clients with which we have large strategic deals. We're assuming robust sales in the mid-tiers. Of course, in the mid-tiers, there's is a little bit of churn in that sector given that those companies get bought, sold, merged, or go bankrupt, so we're doing very well. You heard the 11% growth and we actually have more revenue than large pharma, but it's a little bit difficult to call.

So what we haven't built into that is the significant new strategic deal or multiple new strategic deals. We're certainly pursuing those. We certainly have conversations in place. It appears that we have clients that are interested and ready, but we don't control the extent of their readiness, and the other big driver of course is infrastructure reductions which while they are a little bit tough on the core animal business, tend to be very beneficial to the service businesses, and it is virtually impossible to predict any of that, so I would say that we give you that range with knowledge that we'll be able to perform well within that range with the opportunities of larger deals, I suppose to improve that, but it's impossible to call, so we just think it's irresponsible to do so.

Greg Bolan - Sterne Agee

You guys alluded to mix being a little bit better in PCS in fourth quarter. We have heard, though, from a couple of players that there was an elevated level of non-GOP studies in the fourth quarter, so higher animal costs. So I guess as you think about the mix, Jim, just given the current capacity utilization, is the mix where you'd like it to be or was maybe there a little bit of an unfavorable -- maybe less than optimal mix than you'd have liked to have seen in the fourth quarter, or no?

Jim Foster

Well, the study start issue was always a complex one, particularly with our large animals, so there can be a significantly higher cost as a result of that. So I think we had some of that in the fourth quarter. Having said that, the mix is slightly better in terms of long and short-term studies, there’s a better balance. There tends to be a mix in terms of our whole portfolio of general versus specialty stocks as well. Obviously, nuancing and emphasizing mix as it becomes more specialty, and as there is more primate work work that actually gets going as opposed to just get started, the opportunities are obviously there that drive higher top and bottomline growth.

But we're happy with the general trend and the trajectory. We're happy with the way the space has been selling. We're definitely happy with the huge increase in mid-tier client sales, and generally our engagement with the drug companies as a whole. So mix is definitely something that we hope to get some benefit from. I will just remind you that predicting that, how it's going to fall, when it's going to fall, continues to be a little bit of a challenge.

Operator

Our next question comes from Douglas Tsao with Barclays.

Douglas Tsao - Barclays

First, just curious on the Vital River acquisition, which has performed quite well, what's the typical mix of models that you are seeing in terms of demand from China? Is it largely on the outbred side or are you're seeing demand for the specialized models?

Jim Foster

Well, we are very pleased with the trajectory of growth in top and bottomline from that business. There is really opportunity to educate the marketplace, and I think performs well versus mostly governmental competitors. We have a relatively small portfolio of most of the big outbred strains and the big inbred strains and a little bit of immunocompromised strains. So I do think that over time, there's an opportunity to sell increasingly more complex models, and that allows us to be beneficial for the margin.

But even more than that, there's just an overall opportunity to sell significantly higher volumes to other parts of China, so while we have a big Shanghai sales contingent, this is a Beijing center facility, and so we tend to sell to that marketplace first in Shanghai, second Tokyo as we continue to build out capacity and geographically expand the reach. There's opportunities to sell both, kind of the bread-and-butter core models in time, add the more sophisticated.

Douglas Tsao - Barclays

In terms of the PCS market, do you have a sense of the lag time for study starts now for clients? I mean are they having to wait meaningful period, and is that sort of the inflection point for any kind of opportunity to become a little bit more aggressive on price?

Jim Foster

We're seeing relatively swift study starts, I would say. A month or more as opposed to months or more, so while space is selling to the industry and it's not start of the study next week, like we have seen for last few years, there's still enough space where clients were not necessarily all that discerning about quality and science and just want to move quickly, we'll move quickly. So I would say we haven't reached an inflection point yet, Doug. There's a coordinated opportunity between waiting longer.

Operator

And our next question comes from Eric Coldwell with Robert W. Bair.

Eric Coldwell - Robert W. Bair

Talking about research models, I knew you're seeing good growth in China and obviously very focused on market share gains, but also going through a lot of efficiency programs to pare back infrastructure and maintain that strong 30% margin. I guess the question is there appears to be possibly a structural or even a secular shift in demand for the legacy core models, the rodent models. At the same time, we're seeing more evidence of the pickup in areas like fish, for example, and even some comments that rabbit demand has picked up recently, other animals strains. So the question is do you consider shifting your mix of model sales, do you look for targets perhaps in some of these other categories that appear to have more momentum in the future? Or do you think you'll stick with your core book presence just focusing on doing what you do better in the future? And I guess there's kind of maybe an acquisition or a strategy question there as well?

Jim Foster

So the change in demand is nothing new. It's been happening for a long time. It started with a more responsible use of laboratory animals and an effort to drive the three Rs. And I think that has continued to happen significantly and consistently, but more subtly. The lack of settlement has appeared in the last three years, as we have seen big R&D facilities be closed. And last year was really dramatic. We saw multiple facilities reduced or shut down in Japan, also one in the States and so the beginning of the some infrastructure reductions in Europe as well. So I would say that a drug company is going from, let's say, six or seven or eight R&D centers to one or two or three has had the largest impact on all of this.

Some of the models that you talk about are very interesting. I don't think they're going to be big revenue contributors. We look seriously at fish business for years. We went over that on several side of our business. It's an interesting model, but it's going to be a low contributor to revenue and profitability. And of course, we are already in the rabbit business. So I don't see more likely continued increase in complex animal models, more immunocomprised models, more multi-genetic, more humanized animal models and some stabilization of the core model, because obviously a lot of discovery and basically all of safety assessments are still predicated on the use of animals. And I think they are markets of prominent scale profitability and there's enhanced initiative to drive efficiency should hold us in good stead.

So the biggest wildcard to that business, particularly 2014 or '15, is what will be the additional significant infrastructure reductions. And the answer to that is we don't know. We're assuming something in our plan. There's also some noise around the edges as to who is going to do mergers. And the reality of this is there's no way to predict it except that the industry has to get more refined and has to do more outsourcing. And of course, that will impact their pipelines as well. And we do continue to think as I think the fourth quarter really showed 1% on asset and over 8% in preclinical sort of the best preclinical numbers that there's a corresponding relationship between the shutdown of these big sites, a reduction in research model business and an increase in service revenues. And of course, I don't know the numbers, 70% of our revenues is service related.

And so at the margin or greater than the margin, that should benefit us.

Operator

We'll go to the line of Doug Schenkel with Cowen and Company.

Unidentified Analyst

This is [ph] Chris in for Doug today. On PCS margin, I guess you (inaudible) various one-time items. Is it sure to say PCS margin performance is good in 2013. Can you just give an update on where do you think PCS margins can go over the next few years and how many more levers can you pull on your side in terms of implementing various operating efficiency? And do you think we can get more leverage to get internal controls versus improve the pricing or volume from customers?

Tom Ackerman

As you mentioned, we have improved the margin in 2013 up just over 14%. Some of that was contributed with the tax change in the UK that we talked about. But even excluding that, we improved the margin going into 2013. And in remarks, in regard to 2014, we indicated that we thought the margin would also improve slightly in 2014. So it seems like we've been really grinding and not making much progress in margin, the reality is margins up come kind of nicely over the last couple of years from a range of 11% to 12%. And that's an environment where we haven't seen really much or any price increase. So we're going to keep working the efficiency initiative side of the table. We have a number of ideas that we're looking at in 2014 to help provide lift.

The market seems to be in a little bit better spot. And I think if we can continue to drive topline growth and volume and have better demand from our clients overall, I think we'll start getting a little bit more priced in with and talking about over the last couple of years, '13 and '14 where we're really talking about 1% spot pricing. So I think we'll continue to look at efficiencies. And as the market improves, I think we'll do a little bit better on pricing, capacity utilization. And I think those things will be what would allow us to continue to improve the margin beyond mid-teens and up into the high-teens over the next couple or three years.

Jim Foster

And the other thing I would emphasize there is there are some opportunities within that. We think the capacity is a big issue for us and for the industry. Capacity utilization appears to be better. It's higher for the whole sector. Latest estimates are around 70%, were higher. That's good for us. It's good for everyone. And we do need a rebalance between our available capacity and the planning metrics of our clients. So we have to get the extra time for the last minute stuff. That ought to get a little bit more price. Obviously none of us are going to run out and build new space or hold a lot of new space anytime soon.

So we're all very focused on filling that space, but also using it well for the highest margin business that we can generate. So I'd say that all the factors are lining up well. We're very pleased with the margin profit in the fourth quarter. But to have it get us to the high-teens, which is certainly a goal of ours, we're going to have to see some price.

Operator

We'll go to line of Tim Evans with Wells Fargo Securities.

Tim Evans - Wells Fargo Securities

I want to talk a little bit about the corporate overhead. Over the past seven years or so that's gone up from the levels of 3.5%, now it's going to be 6.5%. Is that increase permanent? Is it going to go higher? Are there opportunities to bring it back down in the future? Maybe just some long-term commentary there would help a little bit.

Tom Ackerman

I think the seven year historical reference and that increase has a lot to do with how we've aligned some things in IT, for example, where it expanded globally, but have done that through the corporate group and therefore are sort of varying a little bit and moving that to corporate number. It's an area where we looked at keeping cost in line with our sales growth and some relation to our sales, which I think over the last couple of years have been a little bit more on the 6% range. IT continues to be an area that we need to invest in for competitive reasons as well as for our back-office systems and what not. So I think we need to put a little bit of pressure on the number.

Our global efficiency initiatives that we talked about today, corporate overhead is a focus of that, as are all of our business segments, so that's an area where we'll look to try to get more efficient, more open services that we buy and how we manage ourselves globally in SG&A. The idea going forward would be to try to at least have that number remain constant, but ideally generate some leverage from it. That'll continue to be a focus of ours.

Operator

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

John Kreger - William Blair

Just going back to Eric's question a bit, you talked about some of the longer-term downward demand trends within the models business. But I thought I heard when you talked about guidance for '14 that you assume there's only some stabilization. So can you just clarify that a little bit? Are you expecting demand to kind of bottom-out in '14, and what drives that confidence and give a view of what that underlying unit growth goes longer term?

Jim Foster

So we'd say that all things being equal, in 2014, we should have more stable demand. We should get more pricing. We should get maybe 2% to 3% net price than 1% to 2% that we had in '13. And that would be just the core research model. And of course, if you look at the whole sector, you got EMD on top of that and discovery, et cetera. We'd say that all things being equal, there's likely to be some stability, but the wildcard just continues to be what is the extent of infrastructure reduction. And we had an awful lot in '13 and we have to expect something in '14. So that has just an undue impact on driving units down.

The good news is we have the primary share in the big pharmaceutical companies. The bad news is whey shut facilities, that has an undue adverse impact upon us. So it just feels kind of irresponsible to just assume that there'll be none of that. Obviously if it was more subtle or less pronounced or they took a year off, whatever, we could have better numbers. But for now, we're assuming sort of overall stability it'll better price and some inevitability of additional infrastructure reduction.

John Kreger - William Blair

So longer term, do you view that as sort of a flattish business or do you think it can have underlying growth?

Jim Foster

If and when the infrastructure reductions start, we think that's a business where we can continue to get price, we can continue to build share for sure in the academic marketplace, but we're doing a lot better I'd say in the last three or four years, given the lack of substantial premium of our price versus the competition. We've actually been picking up a little bit of share in big pharma in places and a few clients where we don't have that much share and new biotech companies as well.

But having said that, just thinking about that globally for a moment, it's probably the core, the business is going to be low single-digit grower. I do think that we're going to spend in significant efficiency initiatives that we have in place, while the company will focus more directly on RMS. So we do think that it's not going to actually expand operating margin in what is already an extremely high operating margin business.

Operator

Our next question is from Sean Dodge with Jefferies.

Dave Windley - Jefferies

Hi, it's Dave Windley. I wanted to try to get into your growth assumptions here on topline. So if I understood correctly, you're saying that your kind of mid-tier client base is driving greater amount of revenue now than your strategic clients would, so greater than 25%, I presume. And you've talked about that number being in the fourth quarter like 11%. So I guess if I extend that out and assume that growth rate continues, that mid-tier client base alone gets to the low-end of your revenue growth assumptions. What about that framework is incorrect? Follow me? I'm saying greater than 25%, maybe 30% of your business growing at 11% gets me to 3%, gets me to the bottom end. So seems like a 3% to 5% is pretty conservative.

Jim Foster

We're not going to acknowledge conservative or not. We're going to acknowledge that we have a range that we have certain uncertainty from clients, could be better than we think, sure, as well as could not. We had an uptick in the fourth quarter in the big global accounts, of which we have 25% all over, about 5% in mid-tier, about 11% talking about preclinical now. Those are obviously very good metrics. We have big strategic relationships and several that we are in discussions with now. Again, we don't control the decision-making timeframe. But we like the way those are moving.

Look, there's just so much inherent uncertainty related to continued availability of space and so there is periodic very low price metrics that we see sort of from everyone all of a sudden. It's directly related to how our competitors' desire and needs to fill the space. So if the incrementals are conservative, fine. We're not going to use that, because we've been doing this for too long and the predictability is too difficult. Look, all we can say is demand is definitely better, it's more consistent, it could be very well accelerated by the multiples or clients at the same time saying, yeah, we're ready to outsource.

So the conversations are great, but we've learned from several of them in the past that sometimes it's a matter of months and sometimes it takes a year or two. So it's not in our best interest to predict that. Having said that, we're obviously very pleased with the fourth quarter, both margin and topline and there's a lot more work out there. And we don't mean to be difficult or evasive. We just want to give as much clarity as we can to how the world and the business occurs to us, the demand occurs to us. I would say that bidding on large pieces of work is still highly competitive and a challenging environment.

Dave Windley - Jefferies

When I think about your commentary on the mid-tier, I'm thinking about companies that are maybe increasing their activity more because their pipelines have grown or their funding situation has improved, a lot of the recent IPO window, and that that demand would be a reflection of kind of organic demand or activity increase as opposed to just a shift in venue, say, insourced versus outsourced. And if I'm right on that, should that also have a knock on benefit for models demand?

Jim Foster

I think that's right. The difference is this that as we talked about big pharma clients, it's clear that an increasing number of them always choose to work on coming from outside of their companies, principally from biotech. So a lot of our increase in biotech, a lot of money coming in from capital markets. And so maybe a compound that they couldn't afford to develop. But a lot of it's coming in from big pharma, as it always is. And so I do think to some extent, there's a shift in works that have historically been done in big pharma on the discovery side. And now since the biotech colleagues or partners are doing the discovery for them, we're seeing a big uptick there. And so the animals that would been utilized in big pharma and now being utilized by biotech.

I think it's unlikely that there's a net add-on effect, although it's possible that you could have both with certain clients. But depending on who you talk to between 40% to 70% of these drugs that they're working on are licensed in, maybe the average is 50%, that's a lot. And I think it's growing substantially. And so we would expect biotech to be effortless, but there is a real distraction of for that.

Operator

Our next question is from Jeff Bailin with Credit Suisse.

Jeff Bailin - Credit Suisse

The benefit of another year in the rear-view mirror, thoughts on some of the key strategic partnerships that Charles River disclosed, do you offer any high-level commentary on how these performed relative to expectations maybe in terms of volume and profitability and then looking forward to how meaningful the potential upsell opportunity is?

Jim Foster

As we said many, many times, they take a multiplicity of sizes and shapes and forms on the long-term contracts and some of short-term. We get a quintile weekly of margin by clients and there's a fair amount of variability, although most are moving in the right direction. I would say that by and large, we are pleased with all these relationships without strategic feels regardless of the contractual nature. We're pleased with sense of true partnership, their respect for our science, them sooner than later treating us like they were themselves and not as a third party. As the volume increases and productivity improves, in many of them, the margins have improved significantly. I can take one or two where we've been disappointed with the revenue contribution vis-à-vis what we were told, not to say contracted for, but vis-à-vis what we were told.

I do think we know how to do these deals and we do really listen closely to the clients and we try to design a structural relationship that works for them. And as we did say, I believe, in the prepared remarks, may have bee lost in there, one of the strongest aspects of these deals is regardless of how the conversation initially starts, we tend to almost always inevitably get additional business contemplated by the first conversation, which increases the size and scope and often in profitability of those relationships. So a little bit higher than 25% of total sales. It's not an insignificant number in terms of predictability of top and bottomline. We're going to continue to drive as many of those as clients are interested in talking to us about. But it appears that an increasing number are seeing their way to wanting to work on that basis and they definitely want to reduce the number of research partners that they have.

Operator

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

Ross Muken - ISI Group

I just wanted to touch again on the labor piece of PCS just in terms of where staffing is. And should we see sort of the inflection point, what needs to occur in order to make sure you can sort of efficiently meet any incremental change in demand that could happen, as this biotech environment continues to be robust?

Jim Foster

That's constant issue for us. We feel that our facilities are in good shape in terms of having excess space and we actually could bring on more as necessary with some advanced planning, which of course we're doing. I'd say the senior scientific staff is quite deep as our study directors are quite strong across all sites and our pathologists are as well. So as we continue to take on additional work, we will have to add direct labor, which we do all the time. We did it in 2013. We'll certainly do it again this year. We're thrilled to be hiring people back. Some of our marketplaces are easy to recruit in than others.

All of our jobs, no matter how basics require fair amount of training, so we have to hire people slightly in advance of when we need them, but not a year in advance of when we need them. So we think we're all over that. We're a good place to work. And our business model certainly on the preclinical side is more stable than has been historically. So we feel that we'll be able to manage our headcount in a way that we're able to do great work for our clients and stay slightly ahead of the demand.

Ross Muken - ISI Group

And you had such an experience with a few recent acquisitions. As you look at that environment, obviously you're going to be still generating a fair amount of cash flow, how would you characterize kind of the tuck-in M&A activity out there and tertiary spaces that you guys may look to, to kind of supplement what you already have?

Jim Foster

The deal flow is particularly good at the moment. It's a combination of we're doing a better job at it and more assets are available particularly from venture funds that have owned them and invested in for a while, even pretty clear. So let me reemphasize the fact that we're looking primarily upstream. We want to engage with our clients as early on in the process as possible and help them with multiple steps, some of which are earlier than what we do now. We are looking at several companies with several technologies and service businesses that would incorporate that description.

We're also looking at expansion of our current therapeutic areas as well as expanding into additional therapeutic areas. And I would say, thirdly, we're looking at some geographic expansion. I would list them and prioritize in the way that I just described them. And as we continue to say on our calls, we can't promise that we can deliver any of these deals, because they're not done till they're done. But we have both the end straps, the finances and the strategic need and opportunity to broaden our portfolio or engage with our clients. So it's an important focus of us at the moment.

Operator

We'll go to Tycho Peterson with JPMorgan.

Unidentified Analyst

This is (inaudible) for Tycho this morning. Just had one quick one on PCS margin. Can you share any color on how you see them trending sequentially in 2014? I mean should we expect more of a back-end-loaded or is that just quarter-to-quarter variation that's hard to predict?

Tom Ackerman

My comments is that as is typical in the first quarter, we expected to see it seasonally down a little bit. But beyond that, I think it should be somewhat steady. I don't think it'll be dramatically back-end-loaded or whatever. So I take a little bit slower start in the beginning. And then it'll be steady for the remainder of the year.

Unidentified Analyst

Okay. And can you comment quickly on your outlook for the genetically-engineered models business within RMS for 2014 and what you're seeing there?

Jim Foster

We're optimistic about our GEMS business. It had a very good fourth quarter. The demand for these models continues to increase more, are being made by our clients and academic institutions. They continue to be an important translational vehicle for drug discovery. So we would expect to see a increase again in 2014.

Operator

And our next question will come from Steven Valiquette with UBS.

Steven Valiquette - UBS

I just wanted to quickly question on seasonality pattern in the PCS side of the business. In this call, you definitely sound optimistic around PCS overall for overall 2014. But again, you just mentioned for 1Q that you're guiding for PCS sales and margins to be down sequentially. And while it is consistent with your historical patterns, probably I think it gets you worried about. And it does seem that one of your peers does have a more optimistic sequential outlook for their comparable business. So just trying to triangulate all those data points. I guess the main question might be is your guidance for PCS in 1Q, based on what you're seeing in the first half of the quarter to mid-February or is it based more on previously established budgets and historical patterns?

Jim Foster

We're going to say what we're seeing so far in the quarter, because it's often misleading. And January has become an increasingly funky and complex month with clients not getting back to work and taking a lot of time to figure out what drugs they're going to work on what drugs they're going to outsource. It's possible that different commentaries from us and other people in the fields, both public and private, just has to do with our specific client footprint. So that wouldn't necessarily jive. I would say that on a positive, if you roll out everybody's comments, the demand is generally better across both big pharma and biotech. Pricing is challenging, but basically stable. Margins have been improving. And we're optimistic about that business for next year.

Some of our commentary does have to do with the history, which is that Q1 is usually a little bit slower. Q2 and Q3 and stronger in the preclinical business. Q4 usually is slower because of the holidays, but not always. So some of those historical seasonal factors are pretty much uncertain.

Operator

The final question will come from Sung Ji Nam with Cantor.

Sung Ji Nam - Cantor

I just have a quick one. Was wondering if you might be able to comment on what percent of your research model production revenues came from pharma in 2013?

Jim Foster

We don't really spend time anymore parsing it that ways, sorry. It's a very large percentage, possibly a slight majority, I would sort of guess. But we have pharma starts, biotech starts and it's sort of blurred for us, I would say, in the last five years, because they work so closely together. If you think it's important, it's important. We're just saying it's a distinction we spend less time on.

So if you take those as a whole, if you take pharma and biotech, are not for process footprint is 24%, 25% of sales and the rest is industrial. The other is low medical device and ag, farm. A vast majority of that is pharma and biotech with biotech going up faster.

Operator

And 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.

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Charles River Laboratories International, Inc. (CRL): Q4 EPS of $0.73 beats by $0.05. Revenue of $289.2M (+3.2% Y/Y) misses by $0.36M.