Charles River Laboratories International Inc (CRL) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories third quarter 2011 conference call.

At this time, all participants are in a listen-only mode, and later we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded.

I would now like to turn the conference over to our host, Miss Susan Hardy, Corporate Vice President of Investor Relations.

Please go ahead.

Thank you.

Good morning, and welcome to Charles River Laboratories third quarter 2011 earnings conference call and webcast.

This morning, Jim Foster, Chairman, President, and Chief Executive Officer, and Tom Ackerman, Executive Vice President and Chief Financial Officer, will comment on our third-quarter results and review guidance for 2011.

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 taped 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 219596.

The replay will be available through November 16.

You may also access an archived version of the webcast on our investor relations website.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 23, 2011, as well as other filings we make with the Securities and Exchange Commission.

During this call, we will be primarily discussing results from continuing operations 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 to be superior to or a substitute for results from 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.

Good morning.

I'd like to begin by providing a summary of our third-quarter results and commentary on our business prospects.

We reported sales of $277.6 million in the third quarter of 2011, an increase of 2.5% from the same period in 2010.

Foreign exchange represented a 3.7% benefit.

On a constant dollar basis, the RMS business performed very well, with sales gaining 3.1% year-over-year.

Sales for the pre-clinical services segment declined 7.3% from the same period a year ago.

I'll speak more about the relative segment performance shortly, but we view these results as evidence of the continuing evolution in large pharmaceutical companies' drug development models that I've spoken about before, which increasingly emphasize short-term studies aimed at washing out non-viable molecules earlier, and taking a more limited number through the regulated safety assessment process.

We believe this thesis is confirmed by the fact that this week, we were awarded a significant expansion of an existing preferred provider agreement with a leading global pharma company.

Under the expanded agreement, Charles River is the client's primary in vivo biology partner, providing non-GLP pharmacology for multiple therapeutic areas -- drug metabolism and pharmacokinetics, or DMPK services, and GLP safety assessment.

Under the original agreement, we were the client's primary provider for GLP safety assessment, and also provided DMPK services.

We were able to demonstrate to this client that we could offer a flexible service model, which supports their goal of more efficient and cost-effective drug development.

We believe this value proposition will resonate with other large biopharmaceutical clients, particularly as they increasingly choose to outsource as a viable alternative to more costly in-house infrastructure.

The operating margin declined 10 basis points from the third quarter of 2010, and 300 basis points sequentially, 16.2%.

The sequential RMS margin decline was expected, due to normal seasonality which occurs in both the third and fourth quarters of the year.

The pre-clinical services margin decline was the result of lower sales volume due to softer demand for regulated safety assessment services and weaker demand for mid-tier pharmaceutical and biotechnology companies which were affected by reduced availability of funding.

Earnings per diluted share were $0.57 in the third quarter of 2011, compared to $0.46 in the third quarter of 2010, a 24% increase.

The lower number of shares outstanding was the primary driver of the EPS increase.

We continue to return value to shareholders in the third quarter through our share repurchase plan, through the purchase of approximately 1.8 million shares for approximately $64 million, which brings our cumulative total repurchases from August 2010 to the end of the third quarter of 2011 to approximately 17.3 million shares, or more than 26% of our outstanding shares.

Third-quarter repurchases were funded primarily through the $40 million of free cash flow generated in the third quarter.

For 2011, we continue to expect sales to be slightly higher than 2010, due to favorable foreign exchange rates.

We are narrowing the guidance range for earnings per share to between $2.40 and $2.45 from our earlier range of $2.38 to $2.48.

Given our expectations for continuing softness in pre-clinical sales, we do not believe the upper end of our previous range is attainable.

However, we continue to generate strong free cash flow and reaffirm our guidance of $165 million to $175 million.

Based on our expectations for stable sales performance, our ongoing efforts to improve operating efficiencies, and our stock repurchase plan, we are confident that we can achieve free cash flow from earnings in these ranges.

Before reviewing the segment results, I'd like to discuss our view of the evolution of our large biopharmaceutical clients' drug development models.

We are all very aware of the fact that our clients are grappling with two significant challenges -- pipelines, which have yielded very little in recent years, and overly large and unwieldy infrastructures which add cost and suppress innovation.

In the past few years we have all witnessed the significant efforts to improve operating efficiency and reduce costs.

Elimination of therapeutic areas, reduction of molecules in the pipeline, business reorganization, and capacity and headcount reduction have all been geared toward streamlining infrastructure.

Concurrent with these actions, we're also seeing efforts to construct better approaches to drug development.

The most notable change has been our large clients' increasing focus on eliminating molecules at the earliest pages of in vivo work.

If they can't prove the efficacy of a compound or biologic early in the process, they eliminate it and move on.

This has resulted in an increased focus on DMPK and in vivo pharmacology, which are primarily non-GLP efficacy testing, and a reduction in the number of molecules that progress the safety assessment, which includes toxicology.

It is for this reason that we don't expect a significant improvement in demand for safety assessment in the near term.

However, we are beginning to see significant opportunities emerging in outsourced efficacy testing.

We believe the market for DMPK and in vivo pharmacology, which represent only a portion of efficacy testing, to represent more than $2 billion.

Estimates place the market for in vivo mark pharmacology, which is the larger of the two, at $1.5 billion, of which less than 20% is currently out-sourced.

DMPK is a smaller market, estimated at $750 million, and outsourcing penetration is believed to be higher.

These services were historically considered poor by our clients, and were not available to CROs.

As they continue to evaluate the benefits of outsourcing, we estimate that as much as 75% to 80% of these services could be outsourced.

We continue to discuss these opportunities with our large biopharmaceutical clients, who believe that through outsourcing, they can have access to scientific expertise on a flexible basis, and at a lower cost they could do so by maintaining the infrastructure internally.

And as biopharmaceutical companies limit the number of providers with whom they do business, the opportunities for a top tier company like Charles River increase.

The expanded agreement I just discussed demonstrates this trend exactly.

We already had a preferred-provider agreement in place with this large client, and we're their primary provider for DMPK and GLP safety assessments.

The expanded agreement, which extends for a period of five years, now encompasses all of the products and services we currently provide to this client, and establishes us as their primary in vivo biology partner.

It is expected to double the volume of business we do with this client, and when the programs are fully up and running in 2013, total revenue from this client is likely to represent more than 5% of our projected total sales.

New business, which will be outsourced to us, includes non-GLP pharmacology for multiple therapeutic areas.

These services are pivotal to the client's ability to screen large numbers of molecules and determine which of these are viable, enabling them to make informed decisions earlier about which models should progress to regulated safety assessment studies.

The client chose to partner with Charles River for its entry into large-scale outsourcing of in vivo biology services because of our broad portfolio of products and services, scientific expertise, and our willingness to develop a customized in vivo biology program which supports a more flexible and cost-effective drug development model.

We believe that this agreement is a leading indicator of the evolution of drug development industry, that large biopharmaceutical companies will increasingly turn to outsourcing as the means to improve the drug development process.

We are in the earlier stages of similar discussions with other large clients and believe that the expanded agreement will serve as a template for those who want to establish this type of strategic partnership.

We are beginning to see our large biopharmaceutical clients increase outsourcing of non-GLP services for both RMS and PCS, although the contribution to PCS revenues is being overshadowed by a continuing decline in demand for GLP safety assessments.

RMS service businesses are focused on the earlier stages of drug development, which is why we believe we are seeing growth in all of them.

We were very pleased with the performance of the research model services businesses, which include genetically engineered model services, or GEMS, research animal diagnostic services, or RADS, discovery services, and consulting and staffing services, or CSS.

In total, and excluding foreign exchange, sales in services increased 4.3% from the third quarter of 2010.

The strongest performance was in our global GEMS business, which grew nearly 10% in the quarter.

GEMS benefited from our clients' development of new, more complex, genetically engineered models, and the expansion of functional genomics, and their willingness to outsource colony management to us.

These models are particularly challenging to produce and validate, so our expertise in this area makes us the logical choice as our clients decide what is core to their process, and what can dependably be outsourced.

In October, we were very pleased to announce that the DTCC, a consortium formed by Charles River GEMS, the University of California Davis, Toronto Center for Phenogenomics, and Children's Hospital Oakland Research Institute, was awarded a grant by the NIH for $34 million over five years to participate in the second phase of the Knockout Mouse Project, known as KOMP2.

Charles River's well-known expertise in large-scale production made us an excellent partner in this effort, which has generally been the domain of academic institutions.

We look forward to working with the scientific thought leaders in the DTCC and to utilizing our expertise to support the effort to develop better models against human disease.

The grant was not a factor in our third-quarter RMS results but academic and government clients overall were strong contributors to year-over-year RMS sales gains.

Sales to these clients increased nearly 10% in the quarter.

As it has throughout the year, the in vitro business again delivered very strong results in the third quarter.

The portable testing system, or PTS, continues to drive growth, as more readers are deployed in the field, and cartridge sales increased.

Because the portability and speed of the PTS accelerates the testing process for clients, we continue to identify growth opportunities outside of the core pharmaceutical market, such as nuclear pharmacies, dialysis clinics, and small drug and device manufacturers.

We expect these markets to continue to generate growth, and also believe that we will increase sales to large biopharmaceutical clients.

On our second-quarter conference call, I mentioned that we had filed with the FDA for approval of the multi-cartridge pack, which would enable us to increase our sales to central testing laboratories.

The FDA has recently released our first three validation batches, so we have actively begun to sell the multi-cartridge pack to these high-volume users.

Combined with the automated MCFs, which we anticipate launching at the end of the first quarter of 2012, we expect to be able to drive continued growth through conversion of our large client Central Testing Laboratories.

The seasonal impact was most visible in sales of research models, which declined sequentially in all geographic locales except Japan.

We expected sales in Japan to be higher, despite seasonality, because of the impact of the earthquake on the second-quarter results.

In addition to seasonality, sales were also affected by pricing.

As preferred-provider agreements are put in place, and our large biopharmaceutical clients bring more of their sales under those umbrellas, increased sales volume resulted in lower pricing.

We expect this trend to continue, although it will be offset in part by price increases, which we continue to implement annually and enhance service revenues.

Price sensitivity has been a constant factor since late 2008.

We don't expect this to change, as long as there is a significant excess capacity for services in both the biopharmaceutical and CRO industries.

Being an efficient provider who can price its products and services competitively makes us a more attractive partner, which is why our efficiency programs are so vital to our success.

These initiatives are directed at refining processes and workflows to improve our speed and efficiency, so that we can pass on those savings to our clients in the form of enhanced service and lower costs.

I'd like to share an example of this with you.

Through an efficiency initiative designed to improve deliverables to our clients, we have recently completed a project intended to reduce reporting timelines by approximately 10%, for a large proportion of our GLP studies.

To further enhance report delivery, we're working on a proof-of-concept project with a specific client.

We were able to reduce delivery time by approximately 35%.

We and the client were extremely pleased with the outcome of this initiative, which we believe can be used to reduce delivery times for all clients.

In 2012, we will implement the next phase of this project, the goal of which will be to extrapolate the improvement across our client base.

We are continuing to identify and pursue other initiatives which will further our goal of maintaining the high quality of our science and customer service at a lower cost.

In reference to my earlier point that our business needs to evolve in order to support our clients' changing needs, I'd like to comment on the business alignment we announced in August.

As many of you understood, this action was the culmination of other actions we have taken in the last three years to enhance our ability to sell across our early-stage portfolio.

We reorganized PCS into a global network of sites, and thereby improved the standardization and harmonization of the facilities.

This enabled our customers to work at multiple sites with the confidence that their studies would be consistently performed, regardless of location.

We re-aligned the sales force to increase the number of customer touch points, and educated our personnel to view the portfolio as a continuum of products and services which could be packaged flexibly in order to support each client's specific needs.

We raised our visibility with our large biopharmaceutical clients, forging strong relationships which are evolving into larger strategic partnerships, as is the case with the agreement we announced today.

Combining the RMS and PCS businesses was the logical step because it aligns the businesses in the way that our clients view us, as the premier provider of in vivo biology expertise.

Our clients are increasingly viewing our broad portfolio of essential products and services and our scientific expertise as tools they can use to further their goal to bring more drugs to market sooner, and at a lower cost.

It's our goal to ensure that we maintain and enhance our role as a premium provider of in vivo biology, and the strategic partner of choice.

In conclusion, I'd like to thank our employees for their exceptional work, commitment, and resilience, and our shareholders for their support.

Now I'll turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

Before I recap our financial performance, let me remind you that I'll be speaking primarily to non-GAAP results from continuing operations.

A reconciliation of non-GAAP items can be found in our press release and on our website.

Our third-quarter performance was a balance of the favorable performance in our RMS business with lower PCS results.

The strong RMS sales growth of 7.7%, or a 3.1% constant dollar increase, the highest RMS growth rate this year, reflects the segment services focus in early in vivo biology, in addition to continued strength in other products.

The 4.9% decline in PCS sales reflects continued soft demand for GLP safety assessment services.

The third-quarter operating margin declined 10 basis points year-over-year, to 16.2%, as the drop-through of the PCS sales decline offset both the benefit from last year's cost saving actions and the improvement in RMS.

Stock repurchases offset this operating performance, driving robust EPS growth of 23.9% in the third quarter, the fourth consecutive quarter of year-over-year EPS growth above 20%.

On a sequential basis, the anticipated seasonal decline in RMS sales and operating margin was amplified by softer PCS results.

The cumulative impact of these factors resulted in a 300-basis-point decline in the consolidated operating margin, and a 19% EPS decline.

Because of the high-fixed-cost nature of our business, a significant portion of the $4 million sequential decline in PCS sales dropped through to operating income.

To right-size our infrastructure to match anticipated future demand, we are implementing a cost-savings action in the fourth quarter to reduce our global headcount by approximately 2%, predominately in the PCS segment.

While we expect the expanded in vivo biology partnership to enhance utilization at both RMS and PCS facilities, we will selectively reduce headcount in certain areas where we see an opportunity to improve operating efficiency while continuing to accommodate the anticipated client demand.

This action is expected to result in annual cost savings of approximately $7.5 million, beginning in 2012.

Given the timing, we expect the impact to be minimal this year.

As a result of this action, we expect to record approximately $3.5 million of severance and other costs, primarily in the fourth quarter.

These charges will be excluded from non-GAAP results.

Third-quarter unallocated corporate costs were more favorable than our prior outlook.

These costs were $14.6 million, essentially unchanged versus the prior year, but down $3.6 million sequentially.

The sequential decline was driven primarily by lower health and fringe-related costs, which were more favorable than anticipated in the third quarter.

Lower performance-based bonus accruals in the quarter and tighter discretionary spending also contributed to the decline.

We did incur consulting fees in the third quarter, as expected, related to our program to enhance process efficiency.

We've already started many of these projects and plan to update you on the progress of these initiatives on our guidance call in December.

Looking ahead to the fourth quarter, we expect unallocated corporate costs to be higher than the third quarter level, due primarily to the 53rd week, which will add nearly a full week of corporate costs.

Net interest expense of $6.9 million was essentially flat from the second quarter, however, we expect a moderate reduction in interest expense for approximately $6 million in the fourth quarter, due to the benefits from the amended credit agreement that I will outline shortly.

Other expense, which we do not forecast, as it relates primarily to investment gains or losses, associated with our deferred compensation program, was $0.7 million, and reduced EPS by $0.01 in the third quarter.

To take advantage of the attractive credit markets, we amended our credit agreement on September 23, to effectively reduce the interest rates.

The margin on the term loans in drawn amounts on the revolver decreased by 75 basis points, and our current leverage ratio to LIBOR plus 175 basis points, which is expected to reduce our interest expense beginning in the fourth quarter.

This amendment did not change the amount of outstanding debt or available credit under the facility, but did extend the maturity to September, 2016.

We wrote off approximately $1.5 million in deferred financing costs related to the amendment, which was excluded from our non-GAAP results in the third quarter.

The non-GAAP tax rate declined 220 basis points sequentially, and 280 basis points year-over-year, to 22.9% in the third quarter of 2011.

The lower tax rate was primarily related to the favorable settlement of a tax audit in a foreign jurisdiction.

We now expect our 2011 non-GAAP tax rate to be slightly greater than 25%, which is slightly below our prior outlook.

Free cash flow improved slightly in the third quarter to $40 million, up from $37.7 million last year, when excluding the $30 million acquisition termination fee.

With year-to-date free cash flow at $113 million and slightly lower expectations for capital expenditures for the year of approximately $40 million, we continue to expect free cash flow to be $165 million to $175 million for 2011.

DSOs remained relatively stable at 50 days, unchanged from the second quarter, and a slight improvement from 52 days in the third quarter of last year.

Our cash and marketable securities balance declined to slightly below $100 million at the end of the third order, due in part to the repayment of approximately $58 million on our euro-denominated term loan and cash used for stock repurchases.

We are comfortable with our current liquidity position, including our strong cash-flow generation, and over $300 million available under our revolver.

Our capital priorities continue to be focused on stock repurchases, debt repayment, and potential smaller acquisitions, the timing of which is difficult to predict.

Our stock repurchase activity was slightly more aggressive in the third quarter than initially planned, due to the compelling valuation of our shares.

We repurchased 1.8 million shares in the third quarter for $63.8 million.

At the end of the quarter, we had approximately $141 million remaining on our current stock repurchase authorization.

Stock repurchases continue to be an integral method that we utilize to return value to shareholders.

Since August 2010, we have invested $609 million in stock repurchases, reducing shares outstanding by more than 26%.

We anticipate a moderate level of stock repurchases continuing in the fourth quarter.

Our total debt balance decreased by approximately $49 million during the third quarter to $740 million at quarter end.

This was consistent with our goal to de-lever below three times debt to EBITDA, which we accomplished.

As I mentioned earlier, we re-paid EUR40.9 million, or approximately $58 million, at the beginning of the third quarter, in conjunction with the restructuring of our international subsidiaries.

We also borrowed $22 million on the revolver to supplement our US capital needs.

Based on US free cash flow expectations for the fourth quarter, we plan modest debt repayment in addition to stock repurchases.

We have narrowed our 2011 EPS guidance to a range of $2.40 to $2.45, to reflect our third-quarter performance and expectations for the fourth quarter.

We continue to expect that sales will be slightly higher than the $1.13 billion reported last year, including an approximate 2.5% benefit from foreign exchange in 2011.

This guidance assumes that soft free clinical market conditions will persist.

Guidance also reflects the fourth-quarter impact of normal seasonality and the addition of the 53rd week.

The expanded in vivo biology partnership with a leading global pharmaceutical company is not expected to have a material impact on fourth-quarter results, given anticipated ramp-up through the second quarter of next year.

The addition of a 53rd week is required periodically in order to true-up to a December 31 fiscal year end.

Coming during the holidays, the 53rd week is characterized by light sales, which is expected to be the primary driver behind an anticipated moderate increase in RMS sales from the third quarter level, and also lead to flat sequential sales in the PCS segment.

The 53rd week is also characterized by normal costs, so in conjunction with seasonality, we expect it will cause additional margin pressure on both segments in the fourth quarter, resulting in flat to slightly lower EPS from the third-quarter level.

Historically, the PCS segment had experienced only a limited impact at year-end, because the study mix included more long-term studies.

These studies continued over holiday periods, generating a relatively steady stream of revenue.

Under the current conditions, with more short-term studies in the sales mix, we expect lighter order activity and fewer study starts during the holiday period, which will negatively affect PCS sales.

This will be offset by the sales contribution of the 53rd week, which is expected to lead to flat sequential PCS sales in the fourth quarter.

To close, our third-quarter results reflect the challenges that our business continues to face, as well as the progress that we have made to enhance shareholder returns.

We believe the expanded in vivo biology partnership we discussed today positions us extremely well for additional partnership opportunities with other large biopharmaceutical clients.

As they increase their focus on outsourcing earlier stages of their drug development activities, partnering with us can enhance the flexibility and cost-effectiveness of their R&D programs.

We'll speak more about our expectations when we provide 2012 financial guidance on December 14.

Thank you.

That concludes our comments.

Operator, would you please take questions now?

(Operator Instructions) Our first question comes from line of Tycho Peterson with JPMorgan.

Please go ahead.

Hi, good morning.

Maybe first question for Jim, on the large strategic partnership you highlighted with pharma.

Since you've been a little bit later than maybe some of your peers to embrace the strategic deals, and obviously this doesn't involve a facility transfer, but can you talk about the margin profile from this type of deal for you?

Is any part of this agreement exclusive?

And maybe if you can also comment on your bandwidth to take on other similar strategic deals.

I know you talked about exploring other opportunities.

Sure.

The work that has been outsourced to us, we believe, is exclusive.

So they selected us as their principal in vivo partner across a whole host of therapeutic areas.

This is work that historically was done internally by this large client, sort of a sea change for them to outsource this work, and allows them to rationalize their own infrastructure and utilize ours.

We feel that we have sufficient capacity, both in terms of people and space, to accommodate for this work, and we suspect we would have people and space to continue to not only crank this one up, but take on additional clients, although to some extent, depending on the size and scale of the deal, additional direct labor could be required.

But I don't think -- I think we have sufficient senior scientific staff.

This is a deal that gives the client enormous flexibility to use our space instead of owning the assets themselves, and as we said on the call, I think it's a very important template for other deals to come.

We've never had a negative view of these deals.

We've been skeptical about doing deals where we had to take on large amounts of capacity from a client, particularly since we have an abundance of capacity in the free clinical space, but certainly long-term, large, strategic deals with our large clients is exactly what we're looking for, because strategic relationships are critical.

Our anticipated margin is that they will be sort of competitive and acceptable, where we see the pre-clinical margins going.

It depends obviously on capacity utilization, how quickly they scale up, and how big this actually gets.

We have an anticipated size, which we've tried to size for you in our comments.

We actually think there's upside to that, both within these specific therapeutic areas, but also other work we're doing with them.

The power in this is the collective partnership and in working closely together.

Okay.

Then my follow-up is just on pricing dynamics in the market.

As you mentioned, obviously there's still a bias toward short-term contracts.

Has the pricing dynamic remain irrational, or is it fairly stable?

I guess, what gives you confidence that it doesn't drop off for RMS?

I didn't quite get the dynamic.

You talked about capacity utilization being relatively low, therefore RMS pricing would hold up.

I didn't quite get that.

Right.

In the pre-clinical business, we feel that pricing has stabilized substantially, except for periodic very aggressive pricing bites -- actually more of the smaller players.

We certainly try not to respond in kind.

And our price flexibility has gone -- closely linked to volume, and we like to keep it that way.

So we certainly think we continue to be cost and price effective, particularly as the volume increases.

We're certainly seeing a shift to more short-term studies from the regulators work, but as we tried to really carve out clearly in this call, we're seeing a significant increase in demand by clients who want to do work earlier on to cull down their portfolios.

We size this market opportunity at more than a couple of billion dollars, and we pointed out the fact that it is essentially done internally by the drug companies, and so this big deal that we just announced is, I think, a leading indicator of other deals like this to come, as the drug industries sort out what drugs they really want to drive all the way through safety assessment.

What was your RMS question?

Sorry.

Well, just your comments on seasonality for RMS.

I think you're implying that it will remain relatively stable, and I guess, what gives you the confidence?

I guess years of history, conversations with clients, their feedback about future purchases.

We continue to see obviously some slowness in our [per RAD] sales, but a corresponding significant increase in service revenue.

Service revenue has very significant operating margins, and so we're not seeing any margin drain as a result of that.

We also feel that we'll continue to price in our core animal business, which should offset any slowdown.

So we think there's a high degree of predictability in that business model going forward.

Okay.

Thank you.

Our next question comes from the line of Ricky Goldwasser with Morgan Stanley.

Please go ahead.

Good morning, thank you.

A couple of questions.

First of all, on your margin expectations for the future, obviously margins for PCS were quite low this quarter.

Given the industry dynamics and the fact that we're seeing more preferred provider agreements, that do come at a lower price tag, structurally, margins in the future, stable -- it's more kind of like the low double-digit range?

Ricky, it was a little bit hard to hear parts of your question.

You did comment on some of the different pressures that we're seeing.

Did you conclude by saying, is low double-digit, realistically where we should be?

Is that --

Yes.

Well, I wouldn't comment too precisely on that.

What I would say is that for all the things that we've talked about with fairly experienced pressures on the margin, notwithstanding a lot of the cost actions we've taken and continue to take.

We did talk about some actions that we're implementing as we speak with headcount, which is predominately in the PCS, but will obviously provide some relief to margin, so what I would say is that we're working hard to improve our margin.

Pricing is more stable at this particular point in time, so I don't see that as a meaningful issue today, unless that were to change.

Looking at where we've been during 2011, it's really been the movement in volume and change in mix that's affected the margin principally.

So we're doing a lot of things to improve it.

I don't want to characterize too much where we think we can get it to at this early point.

We will talk more about that in December, so hopefully you can kind of hold off a little bit until we get to that point.

Okay.

Then as far as your customer composition, what percent of your book today is biotech that's kind of at the mid-size pharma that are more impacted by the financing environment, versus large pharma in academic centers?

It's been a while since we broke it out that way, Ricky.

Obviously the vast preponderance of our clients are big pharma.

I know the last time we did it was probably 55%-ish.

Academics was another 22%, so the balance is sort of what we call our mid-tier clients.

We continue to feel that mid-tier is principally financed by pharma.

And while beleaguered somewhat this quarter by slowness in money flowing into that segment by the capital markets, we do think that over time that the difference between large pharma and biotech pretty much blurs.

It ought to be the same pool of capital driving those businesses.

So while there seems to be more stability with the larger clients recently, I think long-term it's likely we'll see stability across that whole segment.

Okay.

And then --

Thank you.

Our next question comes from the line of Douglas Tsao with Barclays Capital.

Hi, thanks, good morning.

Just given the cost-reduction actions that you're taking in the PCS business and the persistence of softness.

I'm just curious, have you considered additional facility closures or rationalization of the footprint?

Yes, we've certainly considered it.

We constantly look at our infrastructure to make sure it's appropriate, in line with demand that we're seeing globally, and given the geographic footprints of our clients.

We like the size and scope and diversity and geographic dispersion of our footprint right now, and also the specialty capabilities that we have in several locales.

So we think this is a very good footprint to service the market on a forward-going basis.

While it's something that we look at periodically, we're happy with the footprint we have now.

Okay.

And --

Thank you.

Once again, we ask you to limit your questions to one.

Our next question comes from line of Dave Windley with Jefferies and Company.

Please go ahead.

Okay.

I wondered, Jim, if you could talk about the cycle time on this broader strategic deal that you talked about, how long did the discussions go on?

How many discussions, subsequent to that, are you engaging in with other clients?

Then if you could give us a sense of the profile of the late discovery work in vivo pharmacology DMPK?

In terms of revenue value, what's the average ticket there?

And what do the margins of that business look like relative to more traditional safety testing?

That would be great, thanks.

Sure.

This is a very large client who we have a strong relationship with.

I would say that our relationship has been building, and our interface has been with increasingly with more senior people over the last three years.

I would say that the specific work that we reported on today that was recently signed, that conversation negotiation system has probably been going on in earnest six to 12 months.

It was a competitive process, and one that we feel very good about.

We certainly think that this signals, just given the size and scale and financial strength of this company, that this signals that other deals should follow.

We have several conversations going on right now, albeit earlier, but clients who are open to discussing this, who are thinking about it, and since this deal was recently signed, and we really haven't had the opportunity to discuss with other clients, even though we're not going to name the specific client, I do think that will generate additional business and actually speed up the process.

We know there's a lot of work.

We know it's historically been done internally.

We watched with our discussions with this client, how they got comfortable outsourcing it across multiple therapeutic areas, how we're going to work together, and sharing protocols and enhancing protocols and driving efficiency, and the movement from the work done internally at the client site to multiple Charles River sites, and now with the IT interface is going to be, et cetera.

This is going to be a great one to sort of use as a model.

We think there's considerably more work.

The work is shorter term, lower-priced than long-term studies, but still should be at good margin.

We haven't -- we're not going to give a lot of detail on the margin or the pricing, except to say that as with all clients, we were flexible with our pricing given the substantial volume that we have here and will continue to be.

We're quite confident that we will be able to drive efficiency through this work stream.

We've been doing DMPK with this client now for probably a year and a half or two years.

That operation has got increasingly more efficient as we work closer together, and frankly, as the volumes have increased, and we're quite confident we'll be able to do the same thing here.

Some of the slowness and shortfall we're seeing in the regulated safety assessment studies we ought to see offset and picked up by this shorter-term earlier work, and there ought to be, even though the studies are shorter in duration, there's probably a lot more of them, just in terms of the specific studies themselves.

So we ought to see a better balance now between early stage and the later-stage regulated work.

Okay, thank you.

Thank you.

Our next question comes from the line of John Kreger with William Blair.

Please go ahead.

Hi, thanks very much.

Jim, you commented back, I think on slide 16, about some lower pricing dynamics within RMS for your preferred-client relationships.

I don't recall that coming up before.

Can you just talk about that?

Is that a new dynamic that you're seeing?

What sort of magnitude of discounts are you giving?

And what percentage of your RMS business would you say these type of arrangements apply to?

I think we probably have discussed it earlier, but if we haven't, it's just simply the notion -- it's what I was referring to earlier.

So just to be clear about this, the notion that as we have larger, longer-term relationships with clients, and the volume increases under those contracts, they will invariably get the benefit of better prices from us.

That's been our strategy forever.

We try really only to be price-flexible in situations where we have substantially more volume.

So I suspect it will come to play in many of these large agreements.

We think that the volume is very important, particularly in the free clinical business as we fill up space, but also in RMS as well.

It's incumbent upon us to hold and hopefully improve margins over time through driving efficiency, which we believe that we can with most of these situations, particularly as the volume increases.

I think we're probably not going to give any greater specificity than that.

Okay, thanks.

Thank you.

Our next question comes from the line of Garen Sarafian with Citigroup.

Good morning, and thank you for taking my question.

I wanted to just ask for some more details around what you're seeing in the market.

You mentioned some softer demand from your smaller end of the client base, which you're actually seeing the softer demand, whereas one of your peers recently mentioned that they're anticipating softer demand due to lack of funding.

If you could just discuss the timing in which, when you started seeing the lack in funding of your clients, versus the lag to when you actually saw the decline in demand?

Also, on the larger end, I believe last quarter you mentioned that you were seeing some softness from your larger biopharmaceutical clients, so if you could update us on that, as well?

Thank you very much.

I guess in the large pharma clients, we would characterize demand right now is much more stable.

Obviously, signing this new large contract is quite positive.

As we look at that client base, not only with the revenue that particular deal would generate, but the potential for others as well.

As you know, as we've talked about for many quarters, there's a lot of work locked up inside of our clients that we believe will be outsourced, whether it's classic regulated safety assessment work, or some of this early drug efficacy work.

Pharma as a general proposition seems more stable, although there's variability amongst the players in the large pharma universe.

In terms of the smaller players, as I said earlier, we've done pretty well with them.

We haven't seen much volatility -- A, because we do work with virtually all of them, and B, so much money has come directly from the big pharmaceutical companies to use them as their discovery tools.

I don't know, I would say that we've only seen the softness maybe a month before the beginning of the third quarter and through the third quarter.

This has been a relatively recent phenomenon tied to access of funding in the capital markets, probably something that will ameliorate with time, particularly as direct funding continues to be strong by the large drug companies.

Thank you.

Our next question comes from the line of Todd Van Fleet with First Analysis.

Good morning, guys.

Two-part question if I could.

First, if the current environment persists in PCS versus same period of time, that is, with respect to the funding for certain clients, the mix between GLP and non-GLP, how long is it before you think we could once again see organic revenue growth within the PCS segment?

Secondly, Jim, I'd be interested in any more qualitative comments you might have surrounding that phenomenon of there being less safety-related toxicology work; more non-GLP types of activities.

What is it that's driving the decision-making on the part of your large pharma customers to kind of shift their activities in that way?

We understand being quick to kill, and that sort of thing, and being efficient, but are there any other aspects of kind of the broader macro environment that's causing large pharma customers in particular to behave that way?

The pressures on their P&Ls are causing the shift.

As the drugs are rolling off patent there are insufficient numbers of drugs to fill that gap.

I think everybody anticipates -- there's obviously concerted pressure on all of these companies to reduce their infrastructure, and they're looking at things that they've never done before, but our conversations with all of them are about how we all should do what we do best.

We're an in vivo biology Company, and we have a very large footprint in all of these animal-related activities, and both regulated and non-regulated tox studies.

The knowledge that they can get the work done as well -- I'd like to think better, but certainly as well -- and as quickly at favorable price points and not have to own the people and the space, is becoming very intriguing and energizing to them.

I think we're going to see that accelerate, A, because I do think this deal that we've announced is sort of a seminal deal and is going to get a lot of attention from the other drug companies.

Also, they're all looking at similar pressures on their internal cost structures.

I think it's important, as we all look at what we've called toxicology or free clinical services, you have to parse it differently.

There's safety assessment, which are regulated studies, and then there are non-regulated studies, which entails principally DMPK and in vivo pharmacology and a few other things.

There's going to be a greater -- there's becoming a greater shift in that available work for us.

A trivial amount of the non-GLP stuff is currently outsourced, and so we believe a lot more of it will come outside.

We believe that the value proposition will be similar or perhaps better, depending on the volume.

It really allows us to have a much more strategic relationship, so I do think that one needs to look at the pre-clinical universe differently than we have been, historically.

We, and I think our shareholders in particular, have only been talking about the billed and regulated studies.

It's clear that clients are being much more value critical earlier on.

And while that has an adverse impact on the scale of the safety studies later on, it has a beneficial impact on the volume of business earlier on in the process.

And our goal will be to stay focused on principally large pharma and large biotech to try to get the lion's share of this businesses that they outsource.

Thanks.

And then the second part regarding the timeframe to return to organic growth?

That's a certainly more difficult question to answer.

Certainly, we should see greater stabilization at balancing in the value proposition than we've seen for the last two or three years.

We've actually had a decline in the revenue base, and would like to think that the mix is shifting to the point where we ought to see some increases going forward.

I would be reluctant, particularly since we're a month away from our guidance call, to be any more specific than that.

Thanks.

Thank you.

Our next question comes from the line of Ross Muken with Deutsche Bank.

Can you talk quickly about your comfort with your leverage levels, just in the context that you noted you'll pay down a bit in 4Q, and you continue to buy back stock.

Just given the end-market environment from an uncertainty perspective, and given just some of the recent data points we've seen in leveraged markets, where we've seen spreads come out--

Ross, I missed the last part of your question, so I'll try to answer it as best as I could based on what I heard before that.

We're clearly comfortable with our leverage as it is today.

I do think we would be comfortable with a somewhat higher leverage, but in our view, we have a split investment grade rating.

We are investment grade rated by Standard & Poor's, and a notch or two below that for Moody's, and we do like that split rating.

In order for us to keep that, we have to maintain appropriate leverage, probably slightly below where we are today.

So we're actually working toward that.

As I mentioned, our capital deployment would be in stock repurchases, debt pay-down, and smaller acquisitions, so I think the balancing between the three of them will be what we do on the M&A front.

That will sort of dictate our flexibility on both that and share repurchases.

But in the nearer term, as I said, I would anticipate we would continue to buy moderate levels of stock, and would probably continue to pay down some debt.

That will be a little bit dependent on whether or not there's any M&A activity in the near term.

Hopefully that answered the rest of your question.

If not, we can always follow-up later.

No, that's perfect.

Okay, good.

Thank you.

(Operator Instructions) We want to remind you that you try to limit your questions to one.

Our next question comes from the line of Robert Jones with Goldman Sachs.

Please go ahead.

Hi, this is [Redel Walker] in for Robert today.

Just really quickly on the first part, just in terms of the $7.5 million head count reduction cost, where should we think about that primarily coming from in PCS, the COGS or the SG&A portion?

Principally in the cost area -- COGS.

Perfect.

You kind of touched on this earlier, but really trying to get a better sense of how should we think about the margin ramp in PCS?

Understand you may want to wait to the 14th to delve more deeply into it, but just looking at least qualitatively, just how you think about getting back to that normal range on the margins in that segment?

Thanks.

Well, I think some of the factors that are important, as I said a little bit earlier, is pricing.

We do think pricing has stabilized, so I don't see in the nearer term pricing adding instability, either on the downside or unfortunately on the upside.

So I think we've been in a stable mode for a while.

So it's a little bit about volume.

Jim talked about some of the difficulties in the regulated GLP safety assessment work that we've been seeing, but on the bright side we've been getting more inquiries and actually been seeing more work on the non-GLP side, referencing our recent partnership and other activity that we've actually had with other clients currently, and discussions that we're having with larger clients more prospectively.

We do look at that as a little bit of a shift and hopefully, we can accelerate that beyond what we've seen in GLP safety assessment.

While the GLP safety assessment outlook hasn't been great recently, we do think ultimately there'll be more activity on that as companies refocus their energies away from late-stage clinical trials and get more on molecules, notwithstanding the fact that the paradigm has probably changed from what it was a couple, three years ago.

We do think that ultimately that market will get a little bit better in the GLP area.

We just don't see it in the very near term, so we're looking at more work on some of the partnerships that we talked about.

If we can continue to push the volume there, in conjunction with efficiencies and actions that we're taking, we hopefully can continue to improve the margin, but it's difficult at this time to A, set an expectation for 2012, and probably even give you a realistic target of where we think we could be in a couple of years, as an example.

So hopefully that helps.

Okay.

Thanks for the question.

Thank you.

Our next question comes from line of Tim Evans with Wells Fargo.

Hi, thanks.

I'd like to get an update on how expected cost savings this year have played out.

I think you were expecting something like $40 million in cost savings in 2011, after the 2010 charges in fourth quarter of last year.

It looks like total cost in 2011 are going to be about $10 million lower, rather than $40 million, and I imagine the difference there probably comes in the relative segment performance.

But I'd just like to understand that better.

And I guess the main question is, how do we have confidence that we'll see the benefit, the cost savings announced today in 2012?

Thanks.

It's a good question, but unfortunately, it's also very complicated.

I do think we're making good progress on our cost reductions.

We do have some businesses that are growing, so we're actually spending some money in businesses that are growing, as you would expect us to do, I think I've alluded to that.

We also had some increases outside of the cost reductions in terms of merit increases in 2011, some level of incremental bonuses, although there'll be lower than we expected at the beginning of the year.

So we continue to make cost reductions, and I think we're doing well against our target.

It's being masked a little bit by the erosion, in some cases, in the PCS volume, where we're cutting costs, but at the same time sales is eroding, and therefore it appears that we're not making inroads against costs, certainly from a margin perspective.

As I said, we did provide merit increases earlier in the year and some level of increasing bonuses, so I think a lot of the cost savings that we're making are being masked, but I do think that we're actually making good progress against our stated goals, and will continue to do that.

Thank you.

Our last question comes from line of James Kumpel with BB&T Capital Markets.

Please go ahead.

Thank you very much, good morning.

Can you characterize as you did in the year-ago, your sense of capacity utilization on the toxicology side?

Would you characterize PCS operating margins today at trough levels, or do you see potentially more deterioration?

I think we can both answer this.

I think capacity utilization is improving slowly.

We have some locations where capacity utilization is actually quite good.

We have others where it's not quite as good as we'd like it to be.

It's a little difficult to tell what the industry's doing because a lot of our competitors are private.

Of course the big issue is, what are the clients doing in terms of reducing or taking their space out of operation?

I think that has the biggest discernible impact.

We certainly would like to believe that the margins that we're seeing now are certainly at a trough.

We think on a going-forward basis, particularly if this early business continues to pick up as we anticipate, we should get some benefits in margin.

Yeas.

I mean, I would essentially echo what Jim said.

We did talk a little bit about the fourth quarter in terms of volume in pre-clinical sequentially.

I think at this particular volume level, I would say the margins are pretty much trough.

There could be a little variability depending on mix and things like that, but I would characterize that in a small range of variants as opposed to a wide.

Hopefully, we'll see volume pick up and we can leverage the margins, but I think based on where we are for volume, and unfortunately Q3 was lower than we thought it might be at the beginning of the year, that's really what's put pressure on the margins for 2011, has really been the change in volume and, to probably a lesser extent, the change in study mix.

Okay, thank you.

We have no further questions in queue.

Please continue.

Thank you for joining us this morning.

We look forward to speaking with you soon, and this concludes the conference call.