Charles River Laboratories International Inc (CRL) 2003 Q3 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Charles River Laboratories third quarter earnings conference call.

At this time I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode.

At the request of the company we will open the conference up for question and answers after the presentation.

I will now turn the conference over to Susan Hardy, Director of Investor Relations.

Please go ahead, ma'am.

Thank you.

Good morning, and welcome to Charles River Laboratories' third quarter 2003 conference call and webcast.

This morning, Jim Foster, Chairman, President and Chief Executive Officer, and Tom Ackerman, Senior Vice President and Chief Financial Officer will comment on our third quarter results.

In our planned remarks today we will review our business performance and financial results, and provide some general guidance on future performance.

Following those remarks we will respond to questions.

A taped replay of this call will be available beginning at 10:30 this morning, and can be accessed by calling 800-428-6051 and entering pin number 308187.

The webcast will be archived on our website and available until November 6th.

During this call we will be discussing some non GAAP financial measures.

You can find the comparable GAAP measures and reconciliations to those GAAP measures in the Investor Relations section of our website at www.ir.criver.com.

Finally the 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 those discussed in the Company's most recent annual report on for 10-K, which contains a 'risk factors' section on file with the SEC.

Now I'd like to introduce Jim Foster.

Thank you, and good morning.

I'd like to briefly review the highlights of our third quarter results.

We delivered another quarter of growth in sales, EPS and cash flow.

Net sales gained 7% in the quarter.

EPS increased to 40 cents, compared to 38 cents in the same period last year.

Operating cash flow was $35m, free cash flow was $30m, and we ended with the quarter with record cash and investments on hand of $180m, including $15m of marketable securities.

Our balance sheet continues to strengthen, both through sound financial management and our ability to generate cash.

Research Models and Transgenic Services sales growth was affected by pharmaceutical mergers, continued tightening in pharma spending, and continued financing pressure and righter spending by many biotechnology companies.

In addition, seasonality in the Research Models business was more pronounced in the third quarter than in the third quarter of '02.

The balance of our portfolio performed very well.

Discovery Services, In Vitro Detection Systems and Vaccine Support Products, all reported strong sales and operating income growth.

And our Development Service business continued to strengthen.

The sales increase in and our continued focus on carefully managing expenses, resulted in third quarter sales, earnings and cash flow growth, again demonstrating the value of our diversified business.

Although demand for our products and services was lower in some areas, our broad portfolio of businesses offered opportunities in others, enabling us to report higher results.

From a long-term perspective we continue to see our business strongly positioned as a leading provider to the pharmaceutical and biotechnology industries, and to the medical devices industry, a smaller but rapidly growing business for us.

Our portfolio of businesses provides these industries the products and services which are essential to their drug discovery and development efforts.

The Research Models business grew 5.7% in the third quarter.

Price increases were a primary contributing factor to growth, though unit growth also contributed in North America and Japan.

North America sales, which represent nearly half of Research Models sales, increased 6.9%.

We view this it as a positive [technical difficulty].

North America is the major market for drug discovery and development research.

Although pharma mergers and careful spending patterns, tighter biotech spending and funding issues, and seasonality, affected our third quarter results, the market still supported price and unit growth.

When we gave revised guidance on September 2, we stated that we expected the seasonally weak August to be followed by a stronger September and October.

Business did increase in September to a level in line with our revised guidance, but it was not as strong as we have experienced over the past few years.

We attribute this to pressures on big pharma resulting in more focused spending, and continued financial pressures on biotech companies, exacerbated by the slowness in the approvals of new biologics.

Drug companies are focusing their efforts and spending on where they can have the greatest competitive impact.

We continue to see growth in the Research Models business in disease models.

In addition to diabetic and hypertensive models, we include immuno-deficient models in this category, since they are used primarily for cancer and infectious disease research, as well as certain [in-bred] strains which are the building blocks for many genetically altered models.

Disease models have grown faster than standard models as a result of their greater predictive and correlative value in searching for cures for complex human diseases.

Research Models are federally mandated essential tools to the drug discovery and development effort, demand for which should increase as more classic chemical compounds and biologics gain market approval.

One way we are improving our North American sales is by intensifying our sales efforts in academic research.

Because this market is particularly price sensitive, as a premium price supplier we have historically had a lower market share.

Due to our competitors' aggressive pricing in the past few years, the price gap has narrowed.

At the same time, these not-for-profit institutions, many of whom are engaged in drug discovery efforts funded by big pharma, have become increasingly committed to using the highest quality research models.

This is providing us the opportunity to increase our market share of the academic research community.

We are targeting these customers and expect to continue to grow our share of this important research market over time.

In our Biomedical Products and Services segment, sales growth was 7.8% for the third quarter, Discovery Services, In vitro Detection Systems, and Vaccine Support products all reported strong sales and margin growth.

Our Discover Services business reported double-digit sales growth in the quarter.

All three operations in this group Transgenic Services, Laboratory Service and Contract Staffing Services, contributed to the increase.

In September we commented that the Transgenic Service business was affected by the market environment, particularly the financial pressures facing some our biotech customers.

As a result the third quarter growth rate for our Transgenic Services business was lower than in the past few years, but well in double-digits.

And we expect this rate to continue in 2004.

Because researchers believe that disease models are better predictors of human diseases, we expect that increasingly greater number of models will be created by genetic manipulation, with a corresponding need for sophisticated housing and high value related services.

For researchers involved in this effort, housing the Transgenic colonies with us is a more efficient, cost effective solution for managing these vital research assets, and provides them with our unparalleled bio-security.

The Laboratory Services business also delivered double-digit growth, as sales of reagents and sophisticated related services, the screening of animal health and genetic profiles, continued to increase.

In addition to commercial customers, Laboratory Services provides health and genetic monitoring services for our own Research Models business, and for Transgenic Services customers who increasing need these value added services, including phenotyping and genotyping.

As those businesses continue to grow the volume of Laboratory Services also increases.

The Contract Staffing business continued to increase sales.

We have extended existing contracts and recently added new ones, but at the end of the third quarter a portion of a large government contract was not renewed, a fact which will affect sales growth for this business in 2004.

We have been focusing sales efforts on commercial and particularly academic contract staffing customers, both to balance our core government business, and because the opportunities in those sectors are more plentiful.

We have a long-standing reputation for providing highly specialized services to customers who want to ensure that their animal facilities are operated in the most efficient and cost effective manner possible, without compromising animal health.

For customers building new facilities or looking to upgrade existing one, we are the logical and beneficial choice in order to ensure that the best trained technical staff is utilized.

Sales of In Vitro Detection Products increased in the quarter due to a number of factors.

As was the case in the second quarter, sale continued to increase in Europe where more in-process testing is being done to support [light release] testing for medical devices and injectable drugs.

We expect that increase to continue for at least the next 12 months, both as a result of the growing market and our focus on the sales effort.

The official launch of the PTS, our portable test system for endotoxin detection, occurred in the third quarter, and although we expect that this year's sales will be nominal, we also expect sales to increase significantly in 2004 and beyond.

One reason for our optimism is the interest we are seeing in the drug manufacturing area.

We initially expect that until FDA was obtained we would sell the PTS only for R&D use.

It now appears that quality control departments will pilot this device early in order to validate in parallel with the FDA approved endotoxin detection test.

By doing so they can build the year's worth of validation data required by the FDA to make the switch to the PTS once we receive FDA approval.

We are also very pleased with the diverse group of customers currently acquiring the device, and with their extremely positive feedback relative to its utility and efficiency in a laboratory setting.

The increase in Vaccine Support sales was primarily due to the inclusion of our joint venture in Mexico, which has been consolidated in our operating results since the fourth quarter of '02.

Increased pricing and some volume growth also contributed.

When compared to the third quarter of last year, and including Springborn Laboratories which we acquired in the fourth quarter of last year, the Development Services business reported a slight decline in net sales.

This is due primarily to the slower demand for pre-clinical development services, which began to affect the market in the fourth quarter of '02.

On a sequential basis we have continued to see an increase in demand for development services, as evidenced by its strengthening bid volume, quarter-over-quarter, and by higher sales in the third quarter than in the second quarter.

The Biomedical Products and Services segment operating margin increased in the third quarter to 20.6% from 20.2% in the third quarter of last year, and from 18.5% in the second quarter of '03.

We attribute the margin gain to higher sales, the cost savings initiatives that we implemented in the second quarter, and our continuing focus on limiting expense growth.

When we first discussed the changing spending patterns in the drug development pipeline at the beginning of 2003 we said that we saw a barbell effect.

Pharma and biotech companies were spending more in late discovery as they optimized their lead drug candidates before putting those compounds into the more expensive development phase.

On the other end of the pipeline, there were more funds being dedicated to Phase III as companies pushed to file new drug applications with the FDA.

We believed then that as the year progressed the bolus of work that was building up in late discovery would begin to move through the development pipeline.

Our recent experience supports that belief as more longer term sub-chronic studies are being bid and successfully booked.

Our reproductive and large animal toxicology facilities are reporting stronger net sales each successive quarter, and we expect that improvement to continue.

In addition we are expanding our service offerings, particularly in the medical device testing area, to take advantage of existing opportunities.

There is still excess capacity in the market for these services, which continues to restrict pricing flexibility.

But we believe that demand for outsourced drug efficacy testing and safety assessment is recovering nicely from the low point it reached in the first quarter of this year.

We still expect the slow demand to extend through the fourth quarter, but it is clear that demand is intensifying each successive quarter.

As you know from the press release we are confirming our 2003 guidance today.

We continue to expect sales growth in the range of 9% to 11%, with Research Models sales increasing between 10% and 12%, and Biomedical Products and Services increasing between 8% and 10%.

As a result of higher net sales, improved operating efficiencies, and cost savings initiatives, we expect diluted earnings per share for 2003 to be in the range of $1.58 to $1.63.

For 2004 we are projecting net sales growth of 5% to 9%, which is higher than our expected organic growth rate for 2003.

EPS of at least $1.76, and strong cash flow generation.

We believe that pharma and biotech companies will maintain their focus on getting compounds from Phase III into the market.

We also believe that pharma and biotech spending will continue to shift from discovery to development, as companies move their lead targets through the development process.

Even in view of this shift, and although we expect the effect of pharmaceutical mergers, tighter pharma spending and the biotech funding constraints to persist for at least the first half of '04, we anticipate that growth in our Research Models business, exclusive of FX, will be consistent with 2003 levels.

We are expecting somewhat stronger growth in Development Services, as the pre-clinical studies done prior to and in conjunction with clinical trials, increase.

Pharma and biotech companies are being more selective in their evaluation of compounds in the discovery phase, but once they choose their lead targets they are intensely focused on bringing those drugs to market.

In addition, we have new service offering such as Interventional Cardiology Services, which should add to our growth.

We expect Discovery Services business to perform well in 2004, although the growth rate in this business will moderate as a result of changes in demand.

And our In Vitro and Vaccine Support Services businesses are expected to perform well in 2004, as a result of increased pricing, volume and new product sales.

This guidance is exclusive of any acquisitions we might make for the balance of this year or in 2004.

Acquisitions are a core component of our growth strategy, and on a year-to-date basis in 2003 have contributed approximately 4% to our growth rate.

We continue to identify opportunities in a variety of areas.

In pursuit of these acquisitions we adhere strictly to our guidelines, which are strong top line growth, an operating margin at the corporate goal of 20%, or the ability to attain that margin, market leadership and strong scientific expertise.

And we maintain our focus on doing strategic acquisitions that are fairly priced.

We are very pleased to be in a position to project growth in sales, earnings and cash flow for 2004.

Although overall demand continues to be affected by pharmaceutical and biotechnology companies careful spending patterns, our broad spectrum of products and services enables us to capitalize on opportunities where they are strongest.

From a long-term perspective, we believe our business is well positioned as a leading provider to the pharmaceutical and biotechnology industries.

Our goal is to maintain that position by delivering an increasing array of high quality products and services to existing and emerging markets.

Now I'd like to turn the call over to Tom Ackerman.

Thank you, and good morning.

Jim has already given you the sales highlights, so I will give you color on margins, expenses, working capital and guidance.

As I review these results with you I will comment on both the third quarter and nine month results.

Net sales of $151.2m in the third quarter increased 7% from the third quarter of last year.

Historically the third quarter has been affected by a slow down in research in the summer months.

This year those trends were exacerbated due to pharmaceutical mergers, tighter spending, biotechnology funding issues, and less foreign currency gain that was the case in the first and second quarters of the year.

Sales included a net favorable currency impact of approximately 2.5% versus last year, primarily the result of a strong euro.

Growth in North America, where the effect of currency translation is minimal, was 6.4%.

North American sales represented approximately 73% of our sales in the third quarter.

For the year-to-date net sales were $457.7m up 11.2%.

The growth rate includes the effect of acquisitions of 4.2%, and a net favorable currency impact of approximately 3.9% versus the same period last year.

Both Research Models and Biomedical Products and Services sales increased approximately 11%.

Sales for each business unit within the Biomedical segment also increased.

In Development Services sales growth was due primarily to the acquisitions Springborn and BioLabs (ph).

However, the market growth for Development Services has continued to strengthen and Development Services sales were higher in the third quarter of 2003 than in the second quarter.

Gross margins in the third quarter were 37.4%, a slight decrease from last year, and a 1.2% decrease on the second quarter of 2003.

The Research Models gross margin was 42.9% for the quarter, compared to 44.7% last year.

Slower demand and increased seasonality resulted in the less absorption of fixed costs.

In addition, lower sales of large animals, which are very profitable, affected the margin.

Due to cost controls we have implemented, we believe that fourth quarter margin will be off only slightly from the fourth quarter of last year.

For the full year we expect that Research Models gross margins will be higher than in 2002.

The Biomedical Products and Services gross margin improved to 33.7% from last year's 33.2%, and from 32.9% in the second quarter of 2003.

The year-to-date gross margin was 38% compared to 37.9% in the third quarter of 2002.

SG&A in the third quarter was 13.9% of sales compared to 14.2% last year, due primarily to greater economies of scale and a continued focus on limiting operating expense growth.

For the nine months SG&A was 14.5% of sales compared to 15.1%.

Amortization expense was $1.2m in the third quarter, an increase of $0.3m from the third quarter of last year due to the acquisition of Springborn.

For the nine months amortization expense was $3.7m compared to $2.2m last year.

The operating margin in the third quarter was 22.7% of sales compared to 23% last year, and 22.7% in the second quarter of 2003.

Research Models operating margin decreased to 31.2% from 32.8% last year, principally the result of less absorption of fixed costs and lower sales of large animals.

The operating margin for Biomedical Products and Services improved slightly to 20.6% from 20.2% last year, due principally to higher sales and improved operating efficiency in our Discovery Services, In Vitro and Vaccine businesses, offset by slower performance in our Development Services business.

The 20.6% margin improved 2.1% from 18.5% recorded in the second quarter of 2003.

The year-to-date operating margin was 22.5% of net sales, compared to 22.2% last year.

Net interest expense was $1.7m in the third quarter, and $5m year-to-date compared to $1.9m and $7.5m respectively last year.

The decrease was due to the repayment of our 13.5% senior notes and term loan facilities in the first half of last year.

The income tax rate in the third quarter was 38.5%.

In the third quarter of 2002 the effective tax rate declined due to the release of a valuation allowance in the amount of $0.5m.

The impact of the adjustment on EPS was approximately one cent.

Net income was $19.6m in the third quarter, or 40 cents per diluted share.

These results compared to net income of $18.5m or 38 cents per diluted share in the third quarter of last year.

Net income in the nine month period was $59.5m or $1.22 per diluted share, compared to $32.6m or 70 cents per diluted share in the same period last year.

The first nine months of 2003 included a massive impairment charge of $3.7m for closure of our contract production facility, a litigation settlement in our favor of $2.9, and a $0.9m charge for the cost savings program.

The net charge for these three items was $1.6m or approximately 2 cents per diluted share.

The nine-month period of 2002 included charges for early retirement of debt and cancellation of a revolving credit facility totaling $29.9m, or 36 cents per diluted share.

When adjusting for all charges, this year's non-GAAP earnings per diluted share were $1.24, a 17% increase over last year's non-GAAP earnings of $1.06 per diluted share.

In calculating earnings per share in the third quarter, as we do every quarter, we are adjusting net income by $1m tax affected to eliminate the interest expense in the convertible debt, and using a diluted share count of 51.5m, which includes the shares as if the convert had occurred.

Our comments on working capital.

Working capital was $235.5m at the end of the third quarter, an increase of $23.7m from the second quarter, and an increase of $70.8m from the end of last year, principally due to increased cash.

Cash on had at the end of the third quarter was $164.3m, in cash and cash equivalents, plus $15.4m in marketable securities, or a total of $179.7m compared to $144.3m at the end of the second quarter, and $127.5m at the end of last year.

Cash provided by operating activities was $35.2m for the third quarter, and nearly $84.5m for the year-to-date, due primarily to higher net income.

Free cash flow was $29.9m in the third quarter, and $64.7m year-to-date.

Accounts receivable were $105.7m at the end of the third quarter, slightly less than the second quarter, and $11.4m higher than the end of the fourth quarter.

DSO was 65 days at the end of the third quarter, compared to 63 days at the end of the second quarter.

There were no unusual trends within the quarter; the change in DSO was the result of timing of receipts.

Inventory levels rose slightly to $48.5m at the end of the third quarter, and were up $4.6m from the end of last year, due primarily to foreign exchange.

Long term debt was $196.3m at the end of the third quarter, $185m of which was our convertible bonds.

Capital expenditures were $5.3m for the third quarter, and $19.8m year-to-date.

Our estimate for the full year is in a range between $30m and $35m.

D&A was $7.2m in the third quarter, and $21.3m for the nine month period.

2003 guidance - as Jim already mentioned we are maintaining our guidance for 2003.

We expect sales growth to be between 9% and 11%, and earning per diluted to share to be in the range of $1.58 to $1.63.

Operating cash flow should be between $110m and $115m, and capex between $30m and $35m.

Free cash flow should exceed $75m.

Although our expectations for sales growth in some of our business moderated during the year due to market changes, our balanced portfolio of businesses and strong financial management has enabled us to maintain our cash flow expectations.

We will take your questions now.

Thank you, sir. (Caller Instructions).

Our first question comes from Eric Schmidt with SG Cowan, please state your question.

Good morning everyone.

Jim, I was wondering if you could give alit bit more color on the Contract Staffing arrangement you lost, the contract that you lost with government?

I wasn't aware that you had a lot of competition in that area.

Is that a contract that you outbid on, or did that contract go away, or what happened there?

Hi, Eric.

There was a large contract that we actually acquired when we acquired Testology (ph) Associates a couple of years ago that they had.

So it was up for renewal and it was rebid, we felt, with the intention of breaking that into smaller pieces, which the government did.

There was some small business [indiscernible] and there was a think a desire on their part to spread the business around a bit.

So we were pleased to be able to keep the major portion of it, but we were disappointed but we weren't surprised that it was broken into slightly smaller pieces.

Great.

And then just a question I guess on the guidance.

You mentioned the 5% to 9% growth in sales in '04 is higher organically than the '03 year-over-year rate.

Is some of the 4% acquisitions benefit to '03?

What we said was that we've a year-to-date acquisition benefit already, so that's in the ballpark right.

And that's a result, Eric, just to be clear, of the acquisitions that we did basically mid year in '02.

So we had a benefit this year of having 12 months of those acquisitions.

And I assume all the guidance you gave is basically with the assumption of a constant foreign exchange rate from here on out, or--?

Pretty much.

The rates -- this year picked up a lot in foreign exchange as you know, and the rates are actually a little bit higher than where we are today.

But if you looked at it on a continuum, even if they were to day where they were they would provide some upside for next year, but a lot less than this year.

And of course our position at this point in time would be, whilst there are different opinions out there of whether they will stay depressed - that being the dollar - or in fact whether it will bounce back, our view is that there's probably a little bit of upside from FX, but it's not the kind of thing that we'd be comfortable baking in, if you would.

Okay, so I guess net net - and this is the last question, I apologize - but net net it seems like the 5% to 9% top line growth is what you think the organic business can do in this type of an environment going forward?

That's correct, Eric, and we're pleased with that because certainly it's higher than our expected organic growth rate in '03.

So notwithstanding a tough environment we feel that we've got the Development business moving in the right direction, we continue to have a strong Research Models business, and the Discovery piece continues to grow at double-digit rate.

So yes, we think that's a positive outlook over '03.

Great.

Thanks a lot.

The next question comes from David Windley with Jeffries & Co. Please state your question.

Hi, good morning, thanks for taking my question.

Jim, I think there's a broad but very general view in the marketplace that with capital markets open a little bit more and biotech companies raising capital, that the biotech customer base is getting better.

And you clearly are drawing up a few caution flags about biotech funding issues.

Could you drill into that a little bit and talk about what your view is and what you are seeing at Charles River specifically?

Sure.

Our sense in dealing with the people, Dave, is that lots of these companies have substantial burn rates and are not close yet to having product approval.

And some of the financing window that has opened up, which I think has been beneficial for some of them but is still a tough market, has just helped them try to keep pace with those burn rates.

I don't see that it's helping them intensify spending, at least in areas that we're seeing.

So we've found a more sensitive marketplace.

We talked on our last quarter call, particularly in our Transgenic Services business about the fact that we have had some biotech companies both go out of business and have really substantial cutbacks in their staff and their programs.

We've had a few of our biotech clients take work back in-house because they've had excess facilities or empty facilities.

So we find that it's a marketplace that continues to be under pressure.

My personal opinion is the relief of that pressure comes when we see more approvals of the biologics, more approvals of their products by the FDA, which will allow real revenues to be generated by those companies.

And I think will intensify and reactivate the spending particularly at the basic discovery level.

Great, that's very helpful.

In terms of the revenue growth target, the 5% to 9% - following on the previous question - coming into this year, Tom you talked about the various components of that.

Can you at this point talk about pricing versus volume growth in that 5% to 9%?

Not yet, Dave, we'd prefer to -- we'll provide more extensive outlook on our Q4 call rather than get into selected items now.

We will wait until then to delve into it.

Okay.

And then maybe a more general question, but probably similar.

In terms of pricing, Jim you talked about intensifying your efforts in academia.

I understand the comments about narrowing price gap, is that effort though going to have an impact on your price in order to gain share in academia?

And then part two to that question, in toxicology safety testing some of the bit competitors in that space are planning to bring on yet more capacity over the next 12-18 months.

You talked about still excess capacity in the market; what impact will that have on pricing in Development Services?

With regard to the academic sector, we've debated for years having a different price philosophy or price point for our academic marketplace.

And we have always felt that we would take the high road and we've continued to do so.

So since our infrastructure is much more substantial than the competition, the quality of our research models are consistently higher, and they're available in a lot more places around the world for our academic customers, and across the country for our US academic customers.

We are going to continue to price as we see fit and stay at a price premium to the competition.

The fact that it has narrowed, at least on a price list basis, gives us continued considerable opportunity to take share as the quality becomes more important and the gap becomes less substantial.

We intend to maintain our premium price currently and going forward.

Your question on toxicology was what again?

I was just saying that you mentioned in your prepared remarks that capacity for tox is still a little in excess at the current time.

And two of the bigger players in that space have plans on the drawing board to bring yet more capacity into the market over the next say six quarter or so.

So I am interested in your thoughts about how that will impact your business growth and pricing there?

Well it's an interesting question.

Our experience at the present time - and you have to understand that our toxicology business is entirely domestic - so I can tell you for a fact that in the States there continues to be excess capacity which is being taken up month by month, quarter by quarter, and I think that over time - a relatively short period time we hope - that as that capacity gets taken up that the pricing flexibility loosens.

Right now it's less severe that it was a year ago but it's still a competitive pricing market.

We are not aware of any plans on the drawing board at least domestically to add additional space.

So I suspect what you are talking about is space overseas where the tox market is much more robust.

I know that we have a couple competitors who participate significant in that space, and have been doing well over there.

So while that may have an impact on pricing in Europe, it won't impact us at all.

Okay.

Thanks.

I will drop our.

Thank you.

The next question comes from Paul Knight with Thomas Weisel.

Please state your question.

Hi, guys, can you hear me?

Yes.

I'll try and keep it to two questions.

The Transgenic market, how is that market doing, and what portion of it is of your total firm including the Service portion of Transgenic?

The Transgenic -- the discovery part of our business is about 20% of our revenue, and the Transgenic piece is a significant part of that, which is what we say publicly about that.

So it's an important part of our company, but a piece of Discovery.

The Transgenic business continues to do well, it's growing at double-digit rates, and as I said in my remarks we expect it will continue to next year.

Also, I don't know if we emphasized this well enough, it's a high growth business on an international basis where we're seeing good growth rates in Europe and Japan as well.

So we're the only ones playing on sort of comprehensive international basis.

So it is growing at a much -- not as accelerated rate as we have been seeing in the last couple of years, I think that's a function of the base being much larger.

And also as I said earlier, certainly some sensitivity and lack of cash by some of the biotech clients, and also some of that work just not coming as quickly as we had hoped.

So it continues to be a very high growing, high margin business for us and will contribute I think increasingly so on a worldwide basis.

Thanks, Jim.

The next question comes from Larry Neibor with Robert W Baird.

Please state your question.

Good morning.

Hi, Larry.

You are building a lot of cash on the balance sheet and you haven't made an acquisition now for about a year.

What are the prospect there?

And how do you plan on addressing the European market in toxicology, which as you say seems to be quite robust?

All I can tell you is that we are looking, have been looking and are looking at possibilities for toxicology overseas, both Europe and Japan.

We haven't found anything yet that is of either the quality or in a geographic locale that we like.

Or in some cases we haven't found something that we like that's available.

I would say that our deal flow continues to be significant.

We are looking at a lot of things right now, primarily in the service sector, but a couple of things on the product side as well.

I hope we've been clear with everybody that while we never have a stated artificial amount of revenue that we'll by acquisition, and so we won't do an acquisition just to grow the top line in and of itself.

We have a commitment to continuing to accelerate our growth and fill out our portfolio both internationally and on the service basis.

And several things that we are looking at will do that, so as always, Larry, it's a function of what's available and what's available at a fair price.

I would say that there are several things that we are interested in but they're not at stages where they're imminent.

But as I said, it continues to be an important part of our strategic growth strategy, and we remain focused on it.

Second question.

You are going to be adding $10m to $15m in capital expenditures in the fourth quarter.

What area are you expanding and what are the capital expenditure plans for 2004?

Well we're not expanding anywhere for the remainder of the year that's unique, such as last year we had the expansion of the Transgenic Services, which of course was a big fitting.

There's a lot of infrastructure related things in the Research Model business.

We are starting a Transgenic Services type operation in our French facility.

Jim talked about the globalization of that, so we're actually starting to put up something additional on our site there.

We're expanding at our large animal facility, so it's a smattering across all areas, Larry.

And with respect 2004, we haven't finalized our capital plans yet, so we're still evaluating it at this point, but I can probably provide more color in January.

Okay.

Thank you.

The next question comes from Jim Rice with Oppenheimer.

Please state your question.

Hi, guys.

I just wonder if you could comment a little bit on what you are seeing in terms of volumes and customer orders in October?

I think all we can we say about October is that we're seeing volumes that are consistent with our full year guidance, what we expected to see.

Okay.

And then again on the use of the cash, if you end up not finding good M&A targets during '04, have you guys considered other uses of the cash in terms of buying back shares?

That is a continuing, and I guess appropriate line of questioning.

Yes we have considered, we have discussed it.

We continue to really be committed to important meaningful strategic acquisitions and we're hopeful that at the right time in the right space we will be successful in doing that.

We really would like to stay focused on that as opposed to contemplate other alternatives.

Okay.

Thanks.

The next question comes from Meirav Chovav of UBS.

Please state your question.

Hi, this is Derik DeBruin.

A couple of questions.

First looking at your SG&A it was 13.9% of sales in the third quarter.

Is this a level that you're comfortable with going forward?

Is that the rate, Derik, is that what you said?

Yes.

I would think on a percentage basis that we will see some moderation as it kind of shows in the numbers, but I don't think there's going to be any "dynamic shift" in that number either, up or down, if you would.

Okay, so -- I mean because it's going to be a little bit lower than which you have historically, are you concerned that if you cut it back as much that you are going to be able to compete as effectively in the pre-clinical business when the outsourcing returns later this year?

I don't think that we have any great plans to cut back in that respect.

I think the fact that it's moderated a little bit is just really a fluctuation in some of the discretionary spending, that sort of thing.

But in terms of sales and marketing and those particular areas, we continue to maintain an active full force, if you would, and don't have any plans to curtail in things like that, for instance.

Okay.

Looking at the Proteomics business, you mentioned in September that it was taking a little bit longer to ramp up than anticipated.

Is it going to be contributing to net income in '04?

It's still taking longer to ramp up than we anticipated, although the feedback continues to be positive.

I think it's unlikely that it will contribute to net income in '04.

I think in any meaningful way it certainly would not, Derik.

Okay.

And I guess the final question is on the margins.

Certainly the animal margin is down a little bit this quarter.

Where do you see the gross margins for the different businesses going in 2004?

Well we didn't want to dig down too much into 2004.

I guess I would say, with respect to our guidance for '03 and looking forward, typically the Research Models is down in the fourth quarter because of seasonality and what not.

But based on what we see, and as I said earlier, I don't think the Research Models will be down as much in the fourth quarter for instance as the third quarter.

And if you look at the Biomedical we've seen a nice little improvement, slight but steady, in the margins there.

And I think we should continue to see that.

Right.

Thank you very much.

Thank you, Derik.

(Caller Instructions).

The next question comes from Steven Rossman of Burn Capital Management.

Please state your question.

The information you provide is very helpful.

In your guidance for 2004 you broke down the growth expectations for the Research Models area and the Biomedical Products and Services.

In the past you've talked generally about where growth would come from, price increase, units volumes, and if you would go with that I would appreciate it.

It sounds like acquisitions you're assuming 0% increases, and also 0% from FX, if you could review that as well that would be great.

I think just to clarify.

Last year on our fourth quarter call we actually gave some additional color on the guidance that we provided at this particular time last year.

So I think we will do the same thing, you know, hold that same pattern, if you would.

I think the comments that Jim has made in his script and to an earlier were essentially that our guidance as it's stated so far for next year, does not include any acquisitions because we haven't made any recently, so we wouldn't project any.

But merely pointed out what the effect was this year.

And the FX rates are slightly ahead of where we are this year, and without knowing whether the dollar will remain weak, which some folks think, or strengthen a little, which other folks think, basically if you look at where the rates have traded this year and where they are today, our guidance essentially doesn't have any meaningful impact on FX either.

And what about on -- you've had in the animal Research Model area, you've had about a 4% price increase over many year - I think.

Yes, I think what we tried to state a little bit earlier is that with respect to those types of specifics we will wait until fourth quarter conference call to provide a little bit more color in this areas, if you would.

But generally you are not expecting a significant change, because the market hasn't changed dramatically in the Research Model area?

I can't comment at this time.

And then on the Biomedical Products and Services, since you had a 4% benefit from acquisitions in 2003, that means you think that it's getting more than 8% this year you're seeing certain catalysts that would provide at least an incremental 4% to 5% in '04 organically?

I just want to make sure I'm listening correctly on that.

We couldn't hear that question could you repeat it.

Sure.

If you look at the 8% to 10% growth rate in Biomedical Products and Services in '03, at least 4% of that benefit is from acquisitions - from what I understand.

So with your guidance for '04 having a higher growth rate, you expect some benefit leading to an incremental 4% to 5% organic growth rate in the Biomedical Products and Services.

I just want to make sure that I understand that correctly.

We do see Biomedical Products and Services having a higher growth rate than this year, because the number -- the '04 guidance is obviously not assuming any acquisitions.

And we've been talking a lot about the Discovery business continuing to grow at double-digit rates and the Development business continuing to grow back and strengthen.

So yes, we expect that business to have higher growth rates next year.

Okay.

I will follow up later.

Thanks.

The next question comes from Terry Tower with Nuberger Berman.

Please state your question.

Hi, guys.

My question is around the Research Models business.

Jim, you made a comment that there growth coming from the disease models and the immuno-deficient models.

I'm wondering with respect to acquisitions, will you be looking in those areas to acquire additional disease model, since that's part of the business that appears to be the strongest?

And then as a second question, can you give us an update on discussion with Jackson laboratories and the potential of you guys becoming their distributor in the US?

And an update on how it's going overseas?

Sure, Terry.

Disease models is an areas that we are consistently speaking to people about.

Typically it's academic researchers develop these models and then want to commercialize them.

And at the time they decide to commercialize them they want to maximize the distribution.

They usually come to us.

So we get to see multiple models a week, most of which we obviously pass on.

Sometimes we see them from the government.

Both cases that would be a licensed in activity, so we're always in discussion and always looking for those models in the US and overseas.

Every once in a while we find what's typically a spin-off of an academic institutions that sets up a for-profit company, that's what we did when be bought GMI, which is a diabetic rat model business that we bought which has been quite successful.

So yes, we continue to look.

Determining the commercial viability of these models is everything because most of them are quite interesting from a scientific point of view.

So you spend a lot of time trying to sort that out.

And when we find ones that we think we can validate and get commercial traction on, we pursue them.

With regard to Jackson, the relationship continues to blossom and progress.

We are increasing the production of Jackson animals at one of our European facilities, and also at one of our facilities in Tokyo.

You may recall that in situations where we simply distribute their animals we get a royalty, and in situation where we actually produce them in the country, they get the royalty.

So we have a slightly larger contribution when we produce in country.

And we continue to talk about ways that we can work together domestically, although we have nothing definitive to report at the current time.

Okay.

And if I can just follow up one more question.

With respect to the large animal business, I recall on the last call that there was [shortage] of some sort.

Has that rectified as of yet, or do you have any plans to somehow take that into your own production?

Yes, it's unlikely that those are models that will produce ourselves.

We've done that previously and it's a difficult and time consuming business, so we wouldn't be able to satisfy the market needs.

I would say the was a supply situation is still challenging and we have some modest impact from it next year.

We're assuming it's going to stay challenging.

I would that we are in discussion over the last month or two to try to secure incremental but high quality supply source.

If that happens we will be able to rectify the shortage, but it's hard to say with any certainty at the moment.

We can probably comment on that in greater depth and with greater exactitude and specificity at our fourth quarter call.

Okay, thanks.

The next question comes from Larry Neibor with Robert W Baird.

Please state your question.

Thank you.

You mentioned that the academic market was becoming more accessible for you.

What type of incremental sales potential could that have in the US for you?

Also you mentioned that you are not going to be lowering prices in the US for the academic market.

Does the same hold true internationally?

Thanks.

Yes.

We do better internationally in the academic markets Larry, it's just really the market dynamics and sort of share that they have overseas.

So we've always had a slightly larger proportion in the academic sector there.

So no, we wouldn't have to moderate our prices at all.

In Japan for instance we have a third party selling for us into the academic marketplace, so that's helped us over there.

And in Europe it's always been a slightly larger piece of our customer base.

Trying to break it out, in the States I suspect that the academic customers over the last couple of years has grown from low double-digit to mid double-digit.

And I suppose the prospects are that we can continue to grow.

And so it has the potential to be meaningful for us.

In North America obviously there's a large academic base that gets a lot of its funding from big pharma, so it's just another outlet to do research.

And I think that's what's caused the shift to quality and paying up for it over the last couple of year, where historically those academic institutions were much more prices sensitive.

And so we are going to continue to focus on that.

We've been very focused on it in the US over the last 24 months, and we will put more resources on it in 2004 and hope to be able to grow our share continuously over the next few years.

Thank you.

The next question comes again from Jim Rice with Oppenheimer.

Please state your questions.

Hey guys, just one more question.

Curious if you can just talk a little bit about the sales and marketing side, what you guys are doing to really try and get out there and assess what you can do to start growing revenues faster?

And on the SG&A side, if there are any areas where you can trim back?

On sales and marketing, sure it's a strong people add, which we don't intend to do, although we'll have some modest adds on our sales force around the world.

What we did this year in North America was we took a centralized sales organization and we broke it into four pieces.

So there's the sales manager and sales representatives report directly into the relevant operating division.

So the people are focused in a certain product line and much better trained in a specific product line.

Obviously they communicate amongst those four sales organizations because there is a fair amount of cross-selling opportunity.

But we feel we're getting a lot more leverage by having specialized sales organizations where the general manager of the business both drives who they see and where they put their focus and can direct them in certain areas.

We've also begun to beef up -- and we also had the sales and marketing organization, one organization, we've split that and we have a marketing organization that's separate and it’s a strategic marketing organization, spending a lot more time on really understanding our market generally, but our markets specifically, particularly in this rapidly changing pharmaceutical world of mergers and consolidations.

So I guess the general comment is, we think we have a much more focused and hopefully highly effective strategy.

Tom can comment on SG&A.

Yes, I think directionally the benefits that we'd like to get out of SG&A would be volume related.

I'm not sure that you implied that, but as opposed to efficiency or something else like that.

Does that answer your question?

Yes it does.

Just one other question.

Someone mentioned to me that at the University of Wisconsin the scientists had developed a knockout rat.

And I was curious, I know you guys work with, or have worked with them in the past.

Is there any chance that that would increase your hotel business at all in the future as customers are able to use knockout rats?

I think directionally it could.

It's been scientifically challenging for knockout rats to be developed, and I think there are a lot of researchers that would prefer a larger animal model for ease of use actually.

And in some cases better results.

So yes, I think directionally it's essentially the same service for both species, it's just about general market acceptance and more people being able to create them.

Okay.

Thank you.

Our final question comes from Dave Windley with Jeffries & Co. Please state your question.

Hi, Jim, a question for you again, going back to the broader view of demand.

I got the sense from the last conference call that the softness that you were seeing in research models was coming mostly from buyers of those products that would be using them for research uses as opposed to development or toxicology type uses.

Is that correct?

And then how does that correlate with specialty models being the faster growing part of research models?

Thanks.

I think it is correct, Dave, that a lot of these animal models they use for very early discovery.

And as I said it's been a gradual shift to development because these drug companies now need to get these drugs developed and into the clinic and into the market.

And that has had an impact.

Conversely the specialty animals have the potential -- obviously there's still a fair amount of discovery going on, specialty animals are hopefully and directionally better discovery tools where the drug companies feel that they can hopefully accelerate the process because it would give them better information faster.

So while those may sound like they're contradictory explanations they're really not.

We fully expect to continue to see an increase in these specialty models because they are one of the solutions to accelerating the drug discovery process.

Then - this may be taking the statement too far and correct me if I'm wrong - but does that then suggest that standard model use in the research setting is a declining business?

Is that becoming somewhat obsolete as we move forward, given scientific advance?

It probably does take it a bit too far, Dave.

The specialty or disease models are becoming an increasingly larger percentage of the whole, although still not the majority.

The basic standard models are essential because at some point, both in the discovery phase and particularly in the development phase you want to use an animal model that somehow mirrors a regular person, a non sick person, as it were.

So those standard models are very important controls to some degree, and also they give you a comparison to the disease model.

So no, we don't see -- we certainly don't see a decline at the current time.

I think it's incremental.

I think over time there will be a larger use of disease models, but as we've said previously the ASPs are so significant that we think it will offset any decline that might occur.

Great.

Thank you.

Thanks a lot, Dave.

At this time I will now turn the conference back to Susan Hardy for final remarks.

That concludes our conference call today, thank you all for joining us and we will see you in the future.

Ladies and gentlemen, if you wish to access the replay for this call you may do so by dialing 1-800-428-6051 or 973-709-2089 with an ID number of 308187.

This concludes our conference for today.

Thank you all for participating and have a nice day.

All parties may now disconnect.