Charles River Laboratories International Inc (CRL) 2012 Q1 法說會逐字稿

Welcome to the Charles River Laboratories first-quarter 2012 conference call.

At this time all participants are in a listen-only mode.

Later we'll conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions).

As a reminder, today's conference call will be recorded.

I would like to turn the conference over to your hostess and conference facilitator, as well as your Corporate Vice President of Investor Relations, Miss Susan Hardy.

Please go ahead, ma'am.

Thank you.

Good morning, and welcome to Charles River Laboratories' first-quarter 2012 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 first-quarter results and review guidance for 2012.

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 243-794.

The replay will be available through May 17.

You may also access an archived version of the webcast on our Investor Relations website.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 on our annual report on Form 10-K which was filed on February 27, 2012, 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 superior to or a substitute for results of operations prepared in accordance with GAAP.

In accordance with Regulation G you can find the comparable GAAP measures and reconciliations to those GAAP measures on the Investor Relations section of our website through the Financial Reconciliations link.

Now I'd like to turn the call over to Jim Foster.

Good morning.

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

We reported sales of $286 million in the first quarter of 2012, unchanged from the same period in 2011.

The RMS business delivered an exceptionally strong performance in the first quarter.

As was the case in the fourth quarter of 2011, both businesses in the segment reported higher year-over-year sales on both a reported and constant currency basis, driving the best quarterly results since the end of 2008 and better than the fourth quarter.

The majority of these businesses also reported higher operating margins.

The PCS segment was moderately weaker than expected, although the in-life business was in line with our expectations.

Our biopharmaceutical, or BPS, business performed significantly less well than expected.

The operating margin declined 30 basis points from the first quarter of 2011 but improved 60 basis points sequentially to 17.7%.

The increase was due primarily to the RMS margin which improved on both a year-over-year and a sequential basis to 33.3%.

Higher sales volume and process efficiency initiatives were the primary driver of the improvement.

Earnings per diluted share increased 14.8% in the first quarter of 2012 to $0.70 per share from $0.61 in the first quarter of 2011.

The increase in earnings per share was driven primarily by the lower number of shares outstanding.

We continued to return value to shareholders in the first quarter through our share repurchase plan with the purchase of approximately 348,000 shares for $12.5 million.

We are reaffirming our sales and EPS guidance for 2012.

Although we have yet to see sustained signs of improvement from our large biopharma client base, we believe that demand for regulated safety assessment continues to remain relatively stable.

Furthermore, the growth drivers we discussed on our conference call, Discovery Researchers Services, GEMS, Insourcing Solutions and In Vitro, are enabling us to generate higher sales.

Based on the first-quarter sales increase, combined with our ongoing efforts to reprove operating efficiency and the benefit of our stock repurchases, we maintain confidence in the guidance we gave on December 14.

I'd like to provide some details on the segment performance.

In the first quarter the RMS segment delivered an outstanding performance, the best since 2008.

Sales were $183.2 million, 6.5% higher in constant currency than the first quarter of 2011 and approximately 5% higher sequentially when adjusting for the 53rd week.

The largest sales contribution came from our In Vitro business followed by our Discovery Research Services business.

These are two of the businesses which we have identified as growth drivers in 2012 and, with double-digit gains from both, they surpassed our expectations.

The In Vitro business delivered an outstanding performance in the first quarter.

Sales growth exceeded 10% due primarily to the PTS family of products, but also in part to timing.

Though perhaps not as high as the first-quarter rate, we expect this business to continue to deliver growth in the 10% range in 2012.

As has been the case in the last few years, the PTS franchise, including the new multi-cartridge system, or MCS, is performing extremely well.

As biopharmaceutical companies focus more on efficiency and cost and the PTS establishes a longer track record in the field, our clients are becoming more open to conversion to the PTS technology.

The results are faster and testing with the PTS requires fewer trained personnel to execute than the older methods do.

With the advent of the MCS and the expected launch of the automated MCS at midyear, we believe we will be able to increase the uptake in manufacturers' central labs and convert a larger portion of the test market to our product.

We are the market leader in number of tests performed each year, but to date have only converted about 10% of tests to the PTS family.

We continue to work with clients to facilitate conversion and are very optimistic that the PTS franchise will continue to drive growth.

As was the case in the fourth quarter, sales for our Research Models Services businesses, which include Discovery Research Services, or DRS, GEMS, RADS and Insourcing Solutions, or IS, again gained more than 9%.

DRS contributed the fastest growth rate benefiting both from the expanded preferred provider agreement we signed in the fourth quarter with a major global pharma company and the focus on oncology by many of our clients.

We have one of the largest in vivo pharmacology franchises in oncology and, because of our expertise, many of our clients choose to utilize our services rather than maintain or expand in-house infrastructure.

As the volume of Research Models Services increase the operating margin also improves which was one of the drivers of the segment margin increase.

Our clients, particularly large pharma, are focusing more attention on discovery in order to eliminate molecules earlier in the drug development process, advancing only the most promising through the pipeline.

The growth of our Discovery Research Services is evidence of this trend and confirmation of our thesis that biopharmaceutical companies are increasingly choosing to outsource services which they no longer consider core to their drug discovery and development process.

Utilizing our personnel and facilities enables our clients to create flexible drug discovery and development operational models which are pivotal to their ability to increase efficiency and reduce costs.

As a recognized expert in in vivo biology, we believe we are able to support their efforts in a manner that no other CRO can.

Sales of research models increased in the first quarter of 2012 compared to the first quarter of 2011 and were up significantly on a sequential basis.

The sequential increase is not surprising given the seasonal softness in the fourth quarter.

However, first-quarter sales were better than we expected with Europe and Japan driving growth.

As you know, Europe has consistently performed well over the last few years.

We continue to believe this is due to two factors -- the client mix in Europe, which includes more private pharma and government funded research; and the fact that we believe we are taking market share from our largest competitor.

Japan also performed extremely well in part because of the comparison to the first quarter of last year which was affected by the earthquake, and in part because of volume increases and market share gains.

North America was up slightly as a result of higher sales to mid-tier and academic clients.

The RMS operating margin was 33.3% in the first quarter compared to 31.2% in the first quarter of 2011 and 28.8% in the fourth quarter of last year.

We were very pleased with this result which was driven by higher sales volume and the benefit of process efficiency initiatives.

The table on slide 13 summarizes the first-quarter sales performance for the RMS segment compared to the first quarter of 2011.

On a constant currency basis Research Model sales increased 1.4% to $94 million, Services increased 9.2% to $56.3 million, and other products increased 19.1% to $32.8 million.

I will also point out that Discovery Services in total increased slightly less than 10% of total Charles River sales; about one-third of this amount is reflected in RMS and the other two-thirds in PCS.

At $108.2 million, PCS sales in the first quarter declined 8.6% from the first quarter of 2011 and 7.6% in constant currency.

As I mentioned, this was below our expectations due primarily to the BPS business.

This business, which provides cell banking, process development, validation and manufacturing scale up for Biologics is predominately comprised of short-term projects with short lead times.

We believe that the first-quarter decline was due to clients starting off the year slowly as they prioritized projects and allocated new budgets multiple project delays and low sample volumes related to certain preferred provider agreements.

Because sales volume was very low its impact on the PCS margin was significant.

However, we expect the BPS business, which represents approximately 5% of total sales, to improve in the second quarter of 2012 due to the absence of some of the first-quarter factors as well as new business booked.

When looking at the In-Life business, first-quarter sales were consistent with the third and fourth quarters of 2011 when adjusted for the 53rd week and increased by approximately $1 million from the adjusted fourth-quarter.

Based on this performance and our outlook for 2012 we continue to believe that overall demand for our in-life services will remain stable with the expected decline in regulated services partially offset by increasing demand for non-regulated services.

The sales mix is still characterized by a greater proportion of shorter-term non-regulated Discovery Services.

This was expected given the shift in our clients' processes to eliminate molecules early in the drug development process as well as the expanded preferred provider agreement.

Interestingly, non-regulated studies are increasingly becoming more complex as clients attempt to gain a better understanding of how their molecules perform sooner.

The increase in non-regulated studies is visible in our capacity utilization, which improved in the first quarter.

In addition, we have begun to see strengthening demand for reproductive toxicology.

This is likely due to molecules which are advancing through the clinical trials and are at the stage where they require contemporaneous safety assessment work.

The PCS operating margin declined to 8.9% in the first quarter.

While clearly not the outcome we wanted, most of the year-over-year sequential decline was due to BPS which reduced the first-quarter margin by approximately 180 basis points.

Furthermore, as we mentioned on our February call, the fourth-quarter margin benefited from a non-income-based tax adjustment which represented approximately 160 basis points.

When adjusting for both of these items the fourth-quarter margin would have been approximately 11.4% and the first-quarter margin would have been approximately 10.7% or a decline of approximately 70 basis points.

We attribute this decline to the transfer of protocols under the expanded preferred provider agreement.

Much of the work which transferred in the fourth quarter went to facilities that had already been providing non-GLP services to the client and were staffed to do so.

In the first quarter the client began transferring more protocols to facilities that had not performed a significant volume of these services, necessitating more start-up costs.

We expect these costs to moderate in the second quarter as revenue begins to increase.

I'd like to give you a brief update on the status of the expanded preferred provider agreement we signed with a leading global pharma company for its DMPK and in vivo pharmacology work.

We have been working collaboratively with the client at every step to ensure a smooth transition of the work and both we and they are very pleased with our progress to date.

As the client becomes increasingly comfortable with our capabilities, together we are identifying more opportunities to expand the services we can provide outside the parameters of the recently added work.

As the relationship solidifies we truly believe that the client is viewing its colleagues at Charles River as critical partners on the same side of the table, not us and them, but one seamless discovery and development team.

We are continuing discussions with other large biopharmaceutical clients.

We are confident that they are moving towards a shift to a more variable cost modeling through outsourcing.

They recognize that outsourcing will enable them to access scientific expertise on a flexible basis and at a lower cost than they could by maintaining the infrastructure internally.

As biopharmaceutical companies limit the number of providers with whom they do business, the opportunities for a top-tier partner like Charles River increase and we are aggressively pursuing them.

We believe that the expanded preferred provider agreement is a template that we can use to assist other clients in their efforts to improve the efficiency and cost effectiveness of their drug development models.

And senior management from our partner has served as a reference for Charles River.

I want to take a moment to discuss sales by client type.

As you know, we segment our clients into three categories -- global biopharma, mid-tier biopharma, and together academic and government.

In the first quarter of 2012 we saw growth in the mid-tier and academic sectors, but sales to large biopharma companies declined.

Let me start by discussing the large clients.

We are seeing a continuation of the trends which we have experienced for the last few years -- large biopharmaceutical companies have reduced therapeutic areas, leaned out their pipelines and changed their models to eliminate molecules earlier in the discovery process, investing only in those molecules with the greatest commercial potential.

This has led to a significant reduction in the amount of work clients outsource and in some cases to retention of work in-house while they make decisions about capacity reduction.

In the first quarter, as expected, we saw a continued stabilization in many of these clients.

However, a small number continued to steadily reduce the amount of work they outsourced.

We believe this is a function of their pipeline and the stage of development.

We did see some positive sales indicators in the global biopharma segment in the first quarter, including the award of some longer-term regulated studies in both North America and Europe.

Consistent with the increased demand for reproductive toxicology, we believe these awards are indicators that some of our large biopharma clients are moving molecules through the clinical development process.

The sales force realignment and related allocation of additional resources to the mid-tier and academic sectors is enabling us to enhance our visibility with clients and increase market share in both sectors.

We were pleased that sales to our mid-tier biopharma client increased approximately 5% year over year and were up sequentially when adjusting for the 53rd week.

Our focused sales efforts in the mid-tier are resulting in new business and we intend to maintain our outreach to these clients, many of which are benefiting from funding by large pharma.

Sales to the academic sector increased in the high-single-digits year over year and the low-single-digits on a sequential basis.

The powerful combination of our premium products and services at competitive prices has served us very well, particularly at this time when academic and government clients have been spending on basic research tools and services.

We continue to believe that the breadth of our integrated portfolio, our deep scientific expertise in in vivo biology, rigorous management of our business and intensive focus on our four key initiatives have enabled and will continue to enable us to manage our performance during this period when our clients are undergoing rapid and extensive change.

As they change it's incumbent upon us to do the same.

Throughout this period we have focused on improving our operational efficiency through the implementation of financial operations and scientific systems, all of which have increased our access to information and enhanced our ability to support our clients.

We have added to our capabilities through internal development of new products and services and hope to further expand our early-stage portfolio through strategic acquisitions.

We have strengthened our balance sheet through management of capital and the early payment of debt, reducing our leverage to below 2.75 times.

We've returned value to shareholders through the cumulative repurchase of 18.5 million shares or 28% of the total outstanding shares when we began the program in August 2010.

All of these actions have positioned us extremely well to provide clients with the support they need to achieve their goals of more efficient, cost effective and productive drug development.

At the same time we believe our actions have positioned the Company for profitable growth as demand for our broad portfolio of essential products and services strengthens.

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.

Looking at the first-quarter results, we experienced a continuation of the stable to improving trends across most of our businesses.

Pressure from a limited number of business restrained sales growth and operating margins resulting in sales growth of approximately 1% on a constant currency basis and a 30 basis point decline in our consolidated operating margin to 17.7% when compared to the first quarter of last year.

RMS had a tremendous quarter with 6.5% constant currency sales growth and a 210 basis improvement in the operating margin to 33.3%.

Most RMS businesses posted higher sales and margins when compared to the first quarter of last year.

On a sequential basis the RMS margin improved by 450 basis points, about half of which was due to the inclusion of a $4 million inventory write-down of a large model business which we recorded in the fourth quarter of 2011.

At first glance it appears that PCS had a difficult quarter.

PCS sales were done approximately 1% sequentially when adjusted for the 53rd week last year and the segment reported an 8.9% operating margin.

But as Jim said, our in-life business, which includes both GLP safety assessment and non-GLP Discovery Services, continued to be stable posting a $1 million first-quarter sales increase on a sequential basis when excluding the impact of the 53rd week.

This was more than offset by softness in Biopharmaceutical Services, or BPS, which posted lower sales and reduced the overall PCS operating margin by approximately 180 basis points in the first quarter.

Normalizing for the BPS margin and the non-income-based tax adjustment in the fourth quarter, the PCS operating margin would have declined 70 basis points on a sequential basis.

This more modest margin decline reflects the impact of the initial ramp up of non-GLP discovery activities under our expanded client agreement which Jim has already discussed.

We were quite pleased to deliver robust double-digit EPS growth for the sixth consecutive quarter.

Year-over-year EPS growth of 14.8% in the first quarter was driven principally by stock repurchases as well as lower-than-expected interest expense.

Stock repurchases contributed approximately $0.07 while interest expense contributed an additional $0.02.

I will now discuss some of the non-operating items that contributed to our first-quarter results.

Unallocated corporate costs increased by $1 million year over year to $19.6 million, primarily reflecting annual cost increases across several expense categories including compensation, health and fringe, and consulting services.

Historically unallocated corporate costs trend higher in the first half of the year before moderating in the second half.

We expect unallocated corporate cost to be at or slightly above 6% of sales for the full year.

As I mentioned earlier, net interest expense was favorable during the first quarter, declining $1.6 million year over year and $1.2 million sequentially to $4.8 million.

This primarily reflects lower average debt balances as well as a lower interest rate.

LIBOR was slightly favorable in the quarter and we also benefited from a reduction of the interest-rate spread on our credit facility by 25 basis points to LIBOR plus 150 basis points, as a result of an improvement in our leverage ratio.

As a result we currently expect net interest expense to be slightly favorable for 2012 at approximately $20 million to $22 million.

Our non-GAAP tax rate of 26.6% in the first quarter was within our guidance range for the year and equates to just a 30 basis point increase from the first quarter of 2011.

I will now provide an update on cash flow and capital priorities.

Free cash flow in the first quarter was $11.2 million compared to $14.6 million last year.

The first-quarter is typically the weakest for cash flow generation, so we remain on track to achieve free cash flow of $160 million to $170 million this year.

We were also encouraged by our operating performance as demonstrated by operating cash flow improvement of $4 million to $25.3 million in the first quarter.

This improvement was offset by a $7 million increase in capital expenditures to $14.1 million.

As you may recall, we are continuing to invest in existing growth businesses on projects such as the new RADS laboratory in Wilmington, a new discovery facility in Finland, and a new in vitro facility in China all of which will open for business during 2012.

Our CapEx guidance of approximately $50 million in 2012 remains unchanged.

We have continued to make progress on our capital priorities, which include a balance of stock repurchases, debt repayment and potential smaller acquisitions.

In the first quarter we repurchased approximately 348,000 shares for $12.5 million.

As of March 31 we had $103.8 million outstanding under our stock repurchase authorization and continue to anticipate repurchasing 1 million to 2 million shares in 2012.

Our total debt declined by approximately $14 million in the first quarter from the December 31 level as we repaid debt modestly ahead of the scheduled installment of the term loan.

We expect accelerated repayment activity to continue over the course of the year.

As I mentioned earlier, as a result of achieving a leverage ratio below the 2.75 times threshold for the fourth quarter, we reduced the interest rate spread on our credit facility and generated some interest savings in the first quarter.

As Jim discussed, we are reaffirming our 2012 guidance for constant currency sales growth in a range of 1% to 3% and non-GAAP EPS in a range of $2.60 to $2.70.

We currently forecast that the first-quarter EPS of $0.70 will be the highest level for 2012 as our outlook for the remainder of the year assumes normal seasonal trends in RMS for the second half and relatively stable trends in PCS going forward.

This leads me to our outlook for the second quarter.

We expect sales and EPS to be slightly lower on a sequential basis driven by a modest decline in RMS sales and operating margin from the exceptional first-quarter performance.

The RMS outlook assumes moderately lower sales in the European and Japanese small models businesses.

Japan had a strong first quarter due to year-end budgeting spending for Japanese clients whose fiscal year ends on March 31.

In addition, they had particularly high distribution sales and we believe both of these trends will moderate in the second quarter.

In Europe sales typically decline slightly in the second quarter reflecting a seasonal pattern.

We expect PCS sales to be slightly higher with some improvement in the PCS operating margin as a result of the actions we have taken to reinvigorate sales growth and profitability in the BPS business, as well as the continued ramp up of our non-GLP discovery activities.

Other income also contributed $0.01 to first-quarter results, but we do not forecast this line item since it is primarily tied to market-based returns on certain investments.

To conclude, we are pleased with our strong EPS growth in the first quarter and with the stable to improving underlying trends across most of our businesses.

Thank you.

That concludes our comments.

Operator, would you please take questions now?

(Operator Instructions).

Dave Windley, Jefferies.

Jim, you've talked for a few quarters now about strategic acquisitions in the RMS part of the business.

I was hoping you could dig into that a little bit more, give us a sense of the pipeline for that and perhaps what the cycle times are on those or what -- why we haven't heard anything about acquisitions closing yet.

The pipeline's improving I would say nicely; we have a full-time staff dedicated to really ramping it up.

There's a fair amount of properties available for sale.

They're not always in our wheelhouse and some of the price expectations are a little unreasonable -- unrealistic I would say and disappointing.

Having said that, there are several things that we're seriously looking at and talking to sellers about and they would improve both the portfolio and our capabilities to support clients in ways that they want and we currently perhaps fall short in a couple of areas.

So we're pretty optimistic about that.

We're quite focused on what we're looking at.

I would say the deal flow is improving to the point where we're actually looking at several things a week, at least superficially, and then drilling down on a bunch of them.

So we are interested.

We are looking carefully.

I think we have the funding and the management capability to absorb and integrate these businesses.

We're very, very focused on remaining upstream and having something that's accretive to both operating margins and particularly the EPS.

Sometimes these things just take longer than one would like and particularly in instances where we're dealing with smaller private enterprises where due diligence is sometimes a little more complicated.

But the lack of announcements is not an indication of lack of involvement or looking.

Super, thanks.

If they'll let me sneak one more in, I'll just ask real quickly if you could comment on the change in the Canadian SR&ED tax credit potentially on the Montreal operation.

Thanks.

Hi, Dave, it's Tom.

The change that's proposed in Canada at the federal level, which is actually a smaller part of the credit than we receive -- the bulk of that is at the provincial level.

So it's something that we're obviously looking at closely.

I don't remember exactly if it will take effect in a couple of years.

And while it would be a negative indicator, as I said, it's really a smaller portion of all the credits we receive in Canada.

Okay, thanks.

As a reminder, please limit yourself to one question.

Eric Coldwell, Robert W.

Baird.

Looking back now on your closure of the Shrewsbury facility, in your experience since then, I'm curious if you have any initial thoughts on what impact you could see from the large capacity reduction announced at your largest peer last night.

Thanks very much.

We got on with our capacity reductions much earlier obviously and pretty aggressively given the current market conditions, which to some extent have continued.

I think additional capacity reductions, either by our large competitor who's gone ahead and done so and clients themselves, will continue to be beneficial to the value proposition here.

While it's not necessarily evident in the operating results, the conversations with clients about outsourcing and/or shutting space and reducing people, and particularly these days in some of the discovery applications, are certainly increasing.

The timing around that is never something we can predict with certainty, but just the nature and the increase in the number of conversations I think is quite interesting and probably telling.

So this is an industry that, for reasons that we've all talked about previously, structurally ended up with too much capacity.

And I think that alone in combination with these pipeline reductions has had a dramatically adverse impact on pricing.

And so any opportunity -- anytime anybody takes out a significant amount of space I think that's directionally good for all of us as a whole.

And as if you've heard us say before, the continued reduction in capacity, particularly by our clients, I do think is critical.

We have seen capacity utilization improvement steadily throughout the last, I don't know, two or three years.

And while it's not optimal yet, it's certainly moving in that direction and we do have a couple of sites where capacity utilization actually is optimal.

So less space, I think, improves the value proposition for all of the CROs.

Great.

If I could just sneak in one quick follow-up.

You mentioned some large clients looking at their own resources and infrastructure.

I think we all know that there are at least a couple or a few large pharmas considering making bigger outsourcing moves.

I'm just curious what you think those moves might look like.

Are there specific geographies or services?

Are you thinking that the new deals coming out would the sole source or multi-source in nature?

And also, do you consider even a remote possibility of any asset transfers in the industry over the next year or two?

Thanks.

So we have several conversations going on right now, they're all slightly different and they're all at various stages of development.

So some I think are potentially much more near-term than others, but you can see a change -- you can see sort of an inflection point in the marketplace commensurate with drugs rolling off patent.

We have a situation or two where people are looking at asset transfers.

We have looked; facilities are often very nice, they're often in geographic locales where we are not.

The sort of simple fundamental response -- kind of visceral response that we have to all of them is those are great and maybe five or six years ago would we would be all over them, but it just doesn't seem to make any rational sense either to us or the industry or, in fact, to the client because they tend not to be overly productive.

So we would hope that they would get on with their own business of shutting and repurposing the site and dealing with the social issues related to their internal staff.

I think that we're seeing all of the large pharma companies aggressively reduce the number of research partners that they have.

I don't know one pharma company that isn't doing that right now.

They want to have a small number of partners that they can depend on who will provide a better value proposition and there's a close working relationship as if we, we the CRO, was the client.

In a couple of conversations we have going on there are some anecdotal -- apparent anecdotal interest in sole sourcing.

I would be surprised if that happens, but I think it's likely that big drug companies -- I'm just talking about on the tox side now -- will have a predominant provider, 70% to 80% of their work, and a minority provider that provides 20% to 30% of their work and that gives the client the sleep factor of knowing that they're non sole sourced and also the ability, I'm sure, to get that better value proposition.

But we're really not seeing clients want to have five or six or seven or 10 pre-clinical providers.

In some of the very small ones -- we've had conversations recently with clients who have said some of these small players actually have good science, but it's not a working relationship that we want to bet the future on, so we're uncomfortable with it.

We've actually had some clients recommend and suggests that we look at these companies for acquisition purposes.

And by the way, we typically do look when requested or suggested by clients because I can't think of a better way to get M&A targets than through our clients who use and are happy with some of these small players but think they're too fragile to have any long term success.

Thanks again.

As a reminder, please limit yourself to one question.

Greg Bolan, Sterne, Agee.

Just looking at the year-over-year decremental margin for PCS, it looks like only about 28%.

So it would just appear to me that the PCS infrastructure has been reduced to absorb some fairly significant shocks like this quarter.

I mean, Tom, how should we be thinking about incremental margins on incremental pre-clinical sales these days?

Thank you, Greg, and good morning.

We have, as you've said, taken on a number of costs that have helped mitigate a lot of the activities we're seeing such as changes in volume and of course changes in study mix and composition, which ultimately affect revenue.

So I do think we're better positioned.

As I said and I think Jim said in his comments, we do expect a slight uptick in activity, in part from improvements in BPS as well as some of our non-GLP activity and we do expect that to bring revenue to the top line.

I think in a broader sense if revenue were to reintegrate more dramatically, I still think that we would see a good flow through on operating margin depending on the nature and mix of that type of work.

Okay, thanks, guys.

John Kreger, William Blair.

This is Beth Rose in for John Kreger.

We had a quick question on the status of strategic partnerships.

Are those trending as expected?

And then also to follow on that, how do these compare with the demand you're seeing in nonstrategic clients?

So as I said before, there's a fair number of conversations that certainly directionally -- that are about strategic partnerships and I think directionally are probable, where we have clients who are looking to outsource the more routine assays in their development capabilities, both GLP and non-GLP, in favor of keeping the very complex assays as part of their core.

So we're seeing that as a dialog.

And whether they end up as a large strategic deal where there's a commitment to a certain amount of time and/or volume, we can see most of the clients moving that way.

Obviously that's happening at the same time as clients are reducing their infrastructures and being quite sensitive about cost, which is reflected in the P&L.

So, look, I think strategic deals are a good thing -- are potentially a good thing if you get the value proposition right and it's a strong client who will adhere to the relationship.

The other really positive things about them that we've seen with a big deal that we did recently is that we have signed up a fair amount of additional work with that client aside from the four corners of the big strategic deal that we did because they have confidence in us, respect for us, work closely with us and, of course, the value proposition benefits them and is attributable to the discount as they increase their volume.

So you can't paint them all with the same brush; the clients are all totally different.

I think it's nice to have them when you start a quarter to know that X amounts of sales are there.

It's nice to exclude competition if you get a deal for multiple years.

It's nice to be closer to the client, but it only works if the value proposition works.

And they're sensitive to the needs of the CRO to make an appropriate level of profit.

Great, thanks.

Timothy Evans, Wells Fargo.

Tom, would you be willing to talk about the options that are on the table for dealing with the convertible debt that comes new next year, and maybe how we should be thinking about interest expense in 2013 and beyond?

Sure, I can give you a little bit of color at this moment, and we are obviously continuing to work that.

We do have $350 million for available on our credit facility.

A little bit of it is -- the revolver, a little bit of it is actually drawn or committed to letters of credit but not really that much, because we do have an accordion feature.

So at the moment we have an ability to maintain a portion of our converts as a long-term status, so we are looking at that.

Beyond that, we are looking at what the market is doing in senior notes and converts as well, and the rates do continue to be low.

If we could write the script, we would obviously wait longer to do something.

But I think in the meantime we will continue to look at current market trends and look at activity.

And I think the positive thing is we do have good credit ratings, we do have good cash flow.

And so I think it affords us a good ability to pick and choose what we think is in the best interest of the Company.

Okay, thanks.

Tycho Peterson, JPMorgan.

Question on RMS.

It seems like a lot of the upside relative to your expectations there was on the model side, and obviously you called out Europe and Japan as being points of strength.

Can you maybe just talk about what you are thinking about in terms of the underlying growth rate for RMS going forward?

I know you talked about some of that European and Japanese business rolling off a little bit in the second quarter.

But are you seeing a bit of an inflection here, and can you also talk about how price is factoring into the dynamic?

Sure.

I'm not sure it's an inflection point.

It's a strong business where we continue to be the prominent player in the industry.

On the model side at the moment, Europe and Japan are a bit stronger than the US.

Europe, we have a totally different mix of clients, sort of small drug companies, government, and we are definitely taking share.

We're also taking share in Japan, we've been in that business in Japan since 1975 and I would say this is -- while we've always held our own, this is the first time where we are aggressively taking share and improving operating margins and we're certainly holding our own in the US.

So I'd say the models business is solid.

The service businesses are the most, in some ways a positive surprise if I were to go back a decade and think about it.

We're getting very large service lines of business with very, very good operating margins and good growth rates.

We told you in the prepared remarks that we're growing that, the service entity around 9%.

We told you that in vitro, which is reported in the RMS business, is performing at above 10%.

So really good mix, you can see it in the operating margin which is the best since 2008 and I believe the 2008 number was actually the best ever.

So it's probably the best operating margin that we've ever seen.

We have said directionally that we believe that, assuming you just take the current portfolio of products and services, RMS is tracking towards high-single-digit.

FX adjusted it's sort of 6.5%.

There's no reason why that can't continue to gravitate upward.

Okay, and then if I can just ask a quick follow-up on BPS.

You talked about you think that business will pick up a little bit in the second quarter.

What gives you the confidence?

And as you think about your portfolio of services there, do you have everything you need?

And also, are there things you can do to improve the margin profile of the biopharma services business?

Yes, I mean, look, it's strategically an important business.

It's all about Biologics, you've got large molecule services, testing process development, validation and scale up.

We have quite a large business in it, we have four locations, we have new GMs, we have enhanced facilities and we have much more of a complementary service offering where we offer this in addition with other products and services that we can offer to the client.

The first quarter was definitely a sorting out quarter for our clients, definitely a reprioritization process.

A little bit of slippage and the confidence that we have is based primarily on feedback from clients as we see the demand strengthening as we move into the second quarter.

It has to strategically increasingly be an important business given the intensified investment in large molecules that we're seeing by our clinics and a reluctance by virtually all of them except very big drug companies to bring this sort of expertise which is very complex in house.

So we remain really optimistic about it as a service line.

Okay, thank you.

Douglas Tsao, Barclays.

Jim, just could you provide some perspective on how much of your PCS capacity is now utilized in strategic deals?

And do you have a sense of where you would like to take that and what's a reasonable target in the near term?

Hey, Doug.

I think that's actually a really good question, not necessarily one I know the answer to.

I think as a general proposition, as I said earlier, it would certainly be good to have some meaningful portion of your preclinical revenue booked and visible as you go into a quarter.

I don't know what that is.

If there's not a margin trade off I like to have as much as possible.

You want to have some flexibility to be able to use your space for others, so you don't want all of it -- I'm trying to think back when we first bought [Inveress], we had a take on that.

I think in those days we were saying, what was it, like kind of 30% would be --?

20% to 30%, yes.

Yes, 25% to 30% would be kind of good, you have that cooked as a stable base.

So that's probably an okay number to resurrect.

I would say it's modest now, but directionally and potentially improving if and as we continue to do deals with larger companies.

Yes, I would just add, and I would echo what Jim said, that because the largest biopharm has been our weakest sector, that's traditionally we've had the stability in those types of agreements.

So I do think it's trended down.

But with the activity that we're looking at hopefully it will trend back up.

And then just in terms of the your current capacity and your study rooms, what percent are being used in DMPK and non-GLP -- other non-GLP studies right now versus the standard regulated studies?

Well, I think rather than give you runs of capacity what we've said is that that business is looking to be, what, 10%?

That's looking to be about 10% of our revenue.

So it's a -- it's definitely a meaningful portion of our business, it's growing way faster than -- it's continuing to grow quite quickly.

We have some really strong therapeutic area capabilities particularly in oncology and CNS.

Certainly on the oncology side that's at a time where so many drug companies are focusing in on that.

It requires and utilizes exactly the same space as the regulated study, albeit you can have multiple studies in the same room so you actually have a little more flexibility and it's helping with the process of enhancing capacity utilization.

So I think we will see that increasingly constitute a larger proportion both of our revenue and capacity utilization.

And just one really quick follow-up.

That 10% number, where is that relative to where you would have been say three or four years ago?

Without specifically quantifying it, dramatically higher.

It's certainly an area that clients are beginning to focus on and let go of these things that they've embraced as core (inaudible) [sourceable].

So much more significant and growing pretty much faster than many other things that we do.

Okay, great.

Thank you very much.

John Sullivan, Leerink Swann.

Just a quick question about the way the tox testing services business flowed over the quarter.

First quarter is often difficult to figure as drug companies are slow to get out of the gates.

Any meaningful difference between the third month of the quarter and the first in that business?

Not really.

The good news about tox, we're starting to use the term in-life, the real classic regulated tox study has been really consistent for about three quarters in a row.

And as you've heard in our prepared remarks, we're actually up $1 million if you normalize the 53rd week.

And while that's not -- certainly not dramatic growth, it's stable growth.

So it does seem like the regulated studies have reached a point of some stability and the non-regulated stuff has reached a point of potentially consistent increased outsourcing.

There should be some balance there, some offsets in terms of growth rate and hopefully margin.

And as I said a few moments ago, both of them will continue to utilize our excess capacity.

Thank you.

Garen Sarafian, Citigroup.

I wanted to just draw down a little bit on the market share comments in RMS.

Just trying to find out, has the demand from the market shifted in your favor, is that these market share gains are occurring in the Europe and Japan?

Or is it more of some of your competitors stumbling and Charles River not -- where it could be more temporary in nature?

I think there's a combination of both.

We have competitors in both locales -- I wouldn't say stumbling -- I wouldn't say stumbling and then temporary, I would say sort of consistent underperformance, a lack of consistent service, often irrational pricing policies, lack of investment in facilities, lack of scientific depth, on and on and on.

So I think a lot of things we're seeing are systemic.

The Japanese one is a bit unusual because that's a culture that historically has been egalitarian with the way it's provided business to its suppliers and sort of liked everyone to be -- have the same percentage and we're not seeing that anymore.

So I think the worldwide phenomenon is have less partners, go to the best quality provider who can provide you -- also provide you with attractive pricing.

So I think it's the quality of the work, the science, the turnaround time, a more flexible pricing strategy at a time where competitors are just not executing as well as they used to.

Got it.

And just a follow up question.

In terms of toxicology, when capacity utilization goes down in an industry, do prices adjust in a linear fashion or does it -- is it more of a hockey stick where until the industry reaches its optimal or near optimal utilization levels pricing is sort of sub optimal?

I would say -- this is Tom, I would say that it's not necessarily linear and also it's not really just about capacity but also about demand as well from our clients that has also affected -- could affect pricing.

Got it, great.

Thank you very much.

Todd Van Fleet, First Analysis.

Just a quick follow-on to that market share question.

Just thinking about the timing of which you can really push to make those inroads in gaining the share.

Is there -- as you guys think about it internally, is there kind of a push to get new contracts signed for the beginning of year or is it possible to see really gains from a marketshare perspective over the course of a year as well?

Just trying to understand kind of timing wise is it more of kind of a bulge at the beginning of the year versus kind of spread ratably over the year?

Thanks.

I'd say we're always pushing.

Though not necessarily pushing in any one quarter or at the beginning of the year.

Nor can we necessarily push clients away from the competition.

I think it's continuous and concerted.

On the RMS side it's been several years, it's not a quarter phenomenon.

We said the Japan thing is a little bit new, so that's kind of the back half of '11 and also -- I'm sorry -- '11.

And also remember that we had this oddity where most fiscal years -- the fiscal year most Japanese companies, particularly our clients, is April 1 when ours is January 1.

So we had a little bit of a push, expenditure push at the end of their fiscal year in Japan, which was helpful to us.

So we're always pushing on it hard.

We are making significant progress.

We've made progress on the RMS side both in the US over the last few years and in Europe over the last two or three.

I'd like to think that we can continue to gain share in Japan as that marketplace begins to attempt to act like the rest of the world, both in terms of relationships between clients and supplier and the Japanese pharma companies' desire to sell internationally.

Thanks.

[Zach Soscick], Morgan Stanley.

In for Ricky.

And I had a question about your client mix actually.

When you look at the big global biopharma mid-tier, it sounds like throughout the year you're expecting to see a continued mix shift away from the big biopharma towards the mid-tier.

I was wondering if you see that trend continuing throughout the year.

And then also with your sales force location to line up with that, do you believe there's any chance that you'll miss perhaps some of the turnaround in big pharma if you have less sales resources allocated towards it?

We have a very good structure for the big global accounts.

We have very senior people with responsibility for a very small number of the global accounts and we have multiple touch points with every account.

So we're quite happy with our interface, they're really big companies who are taking a lot of work off-line and refining their pipelines, a couple have temporarily kept work in-house.

So there's not a whole lot we can do except continue to distinguish ourselves from our clients and periodically sign up a big strategic deal.

So no, I don't think anything we do elsewhere will steal from the big pharma.

We definitely have more people on the mid-tier accounts, which I told you was up 5% and in the academic and government accounts which are up high-single-digit, those are definitely areas of growth for this Company.

For us to be the scientific provider at rational price points is definitely winning share for us in the academic sector where we historically were not that strong.

Mid-tier is an awful -- there's a lot of different types of companies covered by that description, but lots of them are growing nicely and many of them don't have any internal capacity.

So I think we have the right sales component, I think we are flexible and thoughtful about our pricing.

I'd be disappointed if we didn't continue to grow both of those sectors in a meaningful way without having to steal people from the big drug companies to work on them.

Operator?

There are no further questions in queue at this time.

I would like to turn the call back over to Miss Hardy and the panelists for any closing remarks.

Thank you for joining us this morning.

We will be presenting at a number of conferences in May and June and look forward to meeting with you then.

This concludes the conference call.

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