Charles River Laboratories International Inc (CRL) 2012 Q3 法說會逐字稿

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

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

Later we will conduct a question-and-answer session.

Instructions will be given at that time.

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to your 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 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 third-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 265-998.

The replay will be available through November 14.

You may also access an archived version of the webcast on our Investor Relations website.

I would like to remind you of our Safe Harbor.

Any remarks that we may make about future expectations, plans and prospects for the Company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors including, but not limited to, those discussed in our annual report on Form 10-K which was filed on February 27, 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 forecast the Company's performance.

The non-GAAP financial measures are not meant to be considered superior to or 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 will turn the call over to Jim Foster.

Good morning.

I would like to begin by providing a summary of our third-quarter results before commenting on our business prospects.

We reported sales of $279 million in the third quarter of 2012, about 40 basis points better than the previous year.

Excluding the negative effect of foreign exchange, net sales were 3.6% higher than in the third quarter of 2011.

We were very pleased that for the second consecutive quarter the PCS business reported higher sales on both a year-over-year and sequential basis.

We were particularly pleased to see the year-over-year improvement in PCS sales up $8 million or 7.5% on a constant currency basis.

PCS sales also gained 1% sequentially, the first time since 2007.

The third-quarter PCS sales have exceeded the second-quarter level.

We believe this is a further indication of market stability as well as the fact that we are gaining market share.

RMS segment sales increased 1.2% year over year on a constant currency basis, but, due to normal seasonality, was sequentially lower than in the second quarter.

The operating margin increased 80 basis points to 17% from the third quarter of 2011 driven primarily by the PCS business.

The sequential decline was due primarily to the RMS business.

Normal seasonality results in lower sales of research models, which are extremely sensitive to changes in volume.

Earnings per diluted share increased by 14% in the third quarter of 2012 to $0.65 per share from $0.57 in the third quarter of 2011.

The EPS increase was driven primarily by the lower the number of shares outstanding, but also by higher operating income.

We continued to return value to shareholders in the third quarter through our share repurchase plan with the purchase of approximately 416,000 shares or $15 million.

We estimate that we will purchase between 1.4 million shares and 1.6 million shares this year, approximately the middle of the 1 million to 2 million share range we noted when we gave our 2012 guidance last December.

As you know, we are updating our guidance for 2012.

We now expect that constant currency sales will be approximately 1%, at the low end of our previous guidance of 1% to 3%.

Despite the continuing targeted sales efforts to strengthen relationships with all of our clients, which have enabled us to gain market share, the large biopharma market remains volatile and with limited visibility.

Furthermore, we believe that these clients will restrain spending in the fourth quarter as they focus on meeting yearend financial targets.

Although sales growth will be at the low end of the expected range, our continued efficiency initiatives and share repurchases are enabling us to maintain our non-GAAP EPS guidance and to narrow the range to $2.68 to $2.73, the mid- to high-end of our previous guidance range.

We accomplished a number of significant expansion objectives in the past three months, the acquisitions of Accugenix and Vital River, the partnership with AstraZeneca and a partnership with BioCon in which we were named the premier supplier of research models for the Southern California Purchasing Consortium.

I will provide more details on these events as I discuss the segment's performance.

The RMS segment delivered sales of $166.5 million; the year-over-year decline was due in part to foreign exchange which reduced sales by 4.1%.

As was the case in both the first and second quarters, the largest RMS sales contributions came from our endotoxin and microbial detection, or EMD business, followed by our discovery research services, or DRS business.

Excluding foreign exchange these two businesses continue to drive growth at a double-digit rate.

This growth was offset primarily by the large model businesses which continued to decline as we said it would when we gave guidance in 2012.

In total sales of research models declined 4.1% on a constant currency basis, but the majority of the decline was attributable to the large model business.

When excluding large models on a constant currency basis sales of small research models decreased only about 1%.

There were two primary factors which affected these sales, seasonality and a decline in sales to our large biopharma clients.

As some of our clients close facilities and consolidate research it reduces the number of research models they require.

This trend has been visible particularly in North America where it has also affected our GEMS business.

To a lesser extent we have experienced the trend in Europe where our business has been relatively resilient.

As Tom mentioned last quarter, we have less exposure to the more economically unstable countries in Europe.

Discovery Research Services, or DRS, was a growth driver for both RMS and PCS in the third quarter, primarily as a result of the strategic partnership we initiated in 2011.

As you know, our North Carolina and Finland businesses are recorded in RMS and all other non-GLP Discovery Services are reported in PCS.

Our DRS business is benefiting on three fronts -- first, from the decision by many of our large clients to outsource these services, as evidenced by our recent major strategic partnerships with large global pharma companies.

Second, from the shift in R&D to eliminate more molecules earlier in the process.

And third, from the focus on oncology and CNS diseases.

Our DRS business provides the non-GLP services which our clients need to make go/no go decisions on which molecules should advance with a pipeline.

And our greatest therapeutic areas of expertise are oncology and CNS to which the largest percentage of research dollars is directed.

We believe our expertise in these two therapeutic areas is a key differentiator between us and our competitors because the depth of our expertise is currently unmatched by other CROs.

We believe this positions us very well to gain market share in outsourced Discovery Services at this pivotal time when so many of our large biopharmaceutical clients are making the critical decision to outsource.

The EMD business delivered an outstanding performance in the third quarter with sales growth again exceeding 10% before the addition of Accugenix September sales.

The PTS franchise performed extremely well enabling us to take market share as clients recognize the value and efficiency that the devices can bring to the manufacturing process.

The multi-cartridge system, or MCS, is enabling us to improve our penetration of the high-volume lab and we expect the robotic MCS, branded Nexus, to be another tool in our arsenal to drive high cartridge sales.

Nexus made its debut at the Global PDA Micro Biology Conference last week and from there it will move to one of our large global pharmaceutical clients for beta testing.

We expect to begin shipping the Nexus in the first half of 2013.

We were very pleased to announce the acquisition of Accugenix at the end of August.

We paid approximately $17 million in cash to acquire the premier global provider of cGMP compliant contract microbial identification testing.

This acquisition strengthens the EMD portfolio of products and services by providing clients with state-of-the-art microbial detection services for manufacturing in the biopharmaceutical, medical device, nutraceutical and consumer care industries.

The Company has invested in proprietary library databases which allow it to identify over 5,000 species of organisms.

As a result Accugenix is an acknowledged industry leader in species level identification and strain typing of bacteria and fungi that are recovered from manufacturing facilities.

This acquisition is an important step in our broader strategy to become the premier provider of rapid microbial and endotoxin detection products and services to the biopharmaceutical industry.

Over the next several years we intend to enhance our capability through both product extensions and acquisition.

We believe that execution of this strategy will advance our position as the market leader in endotoxin and microbial detection and enable us to continue to drive growth to the EMD business.

The table on slide 14 summarizes the third-quarter sales performance for the RMS segment compared to the third quarter of 2011.

On a constant currency basis research model sales declined 4.1% to $79.6 million.

But as I said, the majority of the decline was due to large model business.

Services increased 1.8% to $53.6 million and other products increased 14.8% to $33.3 million.

For the first nine months of 2012 DRS represented approximately 10% of total Charles River sales; about one-third of this amount is reflected in RMS and the other two-thirds in PCS.

Both of the businesses in other products, EMD and Avian, contributed to this significant increase in the third quarter.

The RMS operating margin was 29.3% in the third quarter compared to 29% in the third quarter of 2011.

The 30 basis point increase, despite lower year-over-year sales, is the result of leverage from higher sales of other products as well as operating efficiencies and continued management of our cost structure.

The sequential decline of 350 basis points was due primarily to seasonality and also to the insurance payment related to our Japan operation that we received in the second quarter of 2012.

That payment increased the second-quarter margin by approximately 100 basis points.

Establishing an RMS footprint in China has been one of our key objectives as we focus on gaining market share in emerging markets.

Acquiring a 75% ownership of Vital River, one of the largest commercial providers of research models and related services in China, will enable us to provide high-quality research models and associated services, such as RADS and GEMS, to the emerging China market for drug discovery and development.

We expect demand for research models in China to significantly increase over the next several years as drug development initiatives in academia, government and biopharmaceutical companies expand.

Charles River intends to step the scientific quality standards for research models in China, the third largest pharmaceutical market in the world.

We will also gain market share through a new partnership with BioCon, the largest regional life science associations in the world representing more than 550 member companies in Southern California.

Through this partnership we are the preferred provider of research models to the members and we hope to expand partnership to include other RMS products and services in our portfolio.

This was a competitive bidding process where we unseated a long-standing research model competitor.

We won the business on the basis of scientific expertise, product availability, breadth of services and customer service, characteristics which were extremely important to the consortium.

We have already received early orders from some of the BioCon members and expect to launch a full on sales effort on November 1. Sales are initially expected to be modest but should increase as the members transition to Charles River from the former supplier.

At $112.2 million PCS sales in the third quarter increased 5.7% from the third quarter of 2011 and 7.5% in constant currency.

This was the largest year-over-year increase since the third quarter of 2008 and the first third quarter which has increased from second-quarter levels since 2007.

Sales increased approximately at 1% sequentially following the outstanding 8.1% sequential increase in the second quarter.

Higher sales, improved operating efficiency and increased capacity utilization resulted in a 370 basis points year-over-year improvement in the PCS operating margin to 13% in the third quarter.

The AstraZeneca partnership has had a small short-term margin impact, as was the case with last year's major partnership.

The initial transfer protocols and other start-up measures do not contribute meaningfully to sales and, as a result, the associated costs create a temporary drag on the margin.

This is likely to be the case with any partnership we do.

Although the start-up costs are not as significant as clinical partnerships, the protocol transfer process usually requires hiring and training of both new and existing personnel as we learn the client's procedures and establish the working relationship.

Revenue is low during this period, but then typically increases over a six- to 12-month period.

As I mentioned earlier, the year-over-year increase in non-GLP Discovery Services is being driven primarily by the strategic partnership with a major global pharma client that we initiated in the fourth quarter of 2011.

That partnership is progressing very well with the transfer of the remaining protocols nearing completion.

Through accurate and timely execution, structured governance and regular communication we have created a strong working relationship which is already encouraging the client to place other work streams with Charles River.

We were very pleased to see another modest increase in GLP safety assessment studies in the third quarter given the volatility of the large biopharma market and the limited visibility of demand in general, we're still not calling a sustained improvement in the safety assessment market.

However, I will say we believe we are taking market share because as clients make the critical decision to outsource the studies that will determine whether a drug can be delivered to patients they recognize that they can do so only with a partner who can support the same level of scientific expertise that our clients have historically maintained in-house.

We have said previously that our scientific expertise, accessible client data and flexibility in structuring arrangements that address each client's individual needs were what enabled us to win the partnership last year.

Those same characteristics are the reason AstraZeneca chose Charles River through a highly competitive bidding process as its trusted strategic partner for toxicology, safety pharmacology and development DMPK.

This partnership is the culmination of months of work with a long-standing client whose goal is to create a flexible research capability without compromising scientific excellence.

I can't over emphasize how important our scientific expertise has been in winning these partnerships.

At the day our global biopharma clients want to partner with a reliable CRO who can deliver the scientific expertise necessary to evaluate the efficacy and safety of new drugs.

Price has its place in these discussions, but we believe that science is a key criterion.

We have no doubt that we are at an inflection point with regard to outsourcing by large biopharmaceutical companies.

Discussions concerning additional strategic partnerships are ongoing as our clients grapple with the logistics of how and what to outsource.

Our continuing focus on scientific expertise, operating efficiency and information technology platforms and our willingness to provide the structure which best meets each client's individual needs position us extremely well to compete for new business.

We are utilizing these characteristics in our entire portfolio to differentiate Charles River from the competition.

We believe that our year-to-date results are demonstrating our success with this strategy.

I would like to point out that our success at winning new business has not been limited to global accounts.

The targeted selling strategies that we implemented three years ago with our mid-tier and academic clients have also yielded returns.

Sales to our mid-tier clients have increased approximately 5% both for the third quarter and year to date.

Sales growth for academic and government clients has slowed from the levels we achieved in 2011, particularly in Europe.

However, this is mostly due to the loss of government revenue rather than academic clients where increased sales to current accounts and market share gains are continuing to drive sales growth.

For the last few years we have had a dual focus, internally on our four key initiatives and externally on assisting our clients with their goals of reducing the cost and improving the productivity of drug development.

We have made tremendous progress on our four key initiatives, improving the operating margin through identification and implementation of process efficiency, generating higher free cash flow, investing in businesses with the greatest potential for growth and returning value to shareholders through share repurchases.

We have invested in a number of information technology initiatives and believe that our new client data portal is one of many capabilities which differentiate us from the competition.

At the same time we have invested significantly in strengthening our relationships with our clients and in the process have actually become a catalyst for outsourcing.

Many of our clients have utilized our knowledge of outsourced drug research to help identify and structure their outsourcing programs.

The resulting RFPs are competitive because price has its place, but we believe that investing in these relationships and structuring them to suit the individual client's needs is a winning proposition.

We are experiencing a pivotal moment in time when global pharmaceutical companies are reinventing the drug discovery and development model.

With so many drugs coming off patent and an acknowledgment that the current model is not successful our clients have taken and continue to take major actions to improve the pipeline productivity.

We've witnessed significant reductions in therapeutic areas, faster elimination of molecules at earlier stages, staff reductions and closure of facilities and, most importantly for Charles River, a willingness to evaluate an increasing number of research work streams as candidates for outsourcing.

It is not a decision that can be made quickly given the ramification of reducing in-house expertise and relying on a contract research organization for expertise and flexibility.

With our broad early-stage portfolio, scientific expertise, data access capabilities and unique working methodology for each client, our goal is to win a majority of the work that will be outsourced over the next few years.

As a result we believe that the preliminary three-year strategic plan, which we first discussed at our investor meeting in August, is achievable.

From 2013 to 2015 and we expect to reach mid-single-digit organic sales growth and mid- to high-single-digit growth including acquisitions, an operating margin approaching 20%, earnings per share growth at a faster rate than sales, strong and improving free cash flow generation and steady improvement in returns on invested capital.

We are dedicating ourselves to executing this plan and to continuing to return value to shareholders.

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

Now I would like Tom Ackerman to give you the third-quarter financial details.

Thank you, Jim, and good morning.

Before I recap our financial performance let me remind you that I will 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.

We were pleased with our third-quarter growth, which included a constant currency sales increase of 3.6%, operating margin expansion of 80 basis points and an EPS increase of 14% when compared to last year.

While third-quarter sales and EPS were below the first two quarters, this is consistent with the seasonal trend in the third quarter, particularly for RMS.

The favorable PCS performance in the third quarter, highlighted by 7.5% constant currency sales growth and a 13% operating margin, represents improvement in demand across both the large biopharmaceutical and mid-tier client segments for both our safety assessment and non-GLP Discovery Services.

We were also pleased that trends in this business were relatively stable compared to the strong second-quarter performance.

The strategic partnership with AstraZeneca provided only a minimal benefit to the PCS performance in the third quarter under an interim agreement that had been in place since May.

We are working diligently with AstraZeneca to transfer protocols and perform validation and pilot studies.

Since these validation and pilot studies generate little revenue we do not expect a more meaningful benefit from the partnership until early 2013 when the transition has been completed.

This is consistent with the progress on our strategic partnership that we announced last November which took several quarters to transition before meaningfully contributing to our results.

Start-up costs related to the AstraZeneca partnership were expected to be marginal as incremental hiring is expected to be limited.

RMS sales increased 1.2% on a constant currency basis in the third quarter.

In addition to the consolidation within large biopharmaceutical clients RMS sales were pressured by our large model business.

This business has been a headwind throughout 2012, but the impact was more pronounced in the third quarter reducing RMS sales growth by nearly 200 basis points year over year.

This was partially offset by the August acquisition of Accugenix.

Continued strong EPS growth in the third quarter was driven by a balance of operating margin expansion and stock repurchases.

I will now walk you through the non-operating line -- items in more detail.

Unallocated corporate costs were relatively stable in the third quarter at $16 million.

This was slightly lower than the second quarter as health and print-related costs remained favorable.

We expect fourth-quarter unallocated corporate costs to be similar to the third-quarter level and total approximately 6% of sales for the full year.

Net interest expense was relatively stable at $4.6 million in the third quarter.

We do not anticipate any meaningful changes to interest expense in the fourth quarter, so net interest expense should be approximately $18 million to $19 million for 2012.

Primarily as a result of a Canadian tax settlement related to R&D tax credits, are non-GAAP tax rate decreased 40 basis points sequentially in the third quarter to 25.7%.

We expect that the tax rate will increase in the fourth quarter due to both an anticipated tax law change in a foreign jurisdiction that would increase the effective tax rate and the fact that the Canadian item will not recur.

However, we believe our non-GAAP tax rate for the full year will now be at the low end of our prior 26.5% to 27.5% range due to the favorable tax rates in the second and third quarters.

We have continued to make progress on our four key initiatives in 2012.

New projects are continually implemented under our profit improvement program with a goal to further drive operating margin improvement.

In the third quarter we began the process of consolidating two small RMS facilities in Europe as part of the ongoing evaluation of our global footprint and efforts to improve efficiency and profitability.

We can provide the same products and services from our other facilities in the region and reduce the overhead for the smaller facilities.

In the third quarter we incurred nearly $1 million in severance cost and a $3.5 million asset impairment charge related to this action.

We have also continued to generate strong free cash flow.

In the third quarter free cash flow was $50.8 million, an increase of approximately $11 million over last year.

Year-to-date free cash flow totaled $109.9 million.

We continue to expect to achieve free cash flow in a range of $160 million to $170 million for 2012.

This was a robust quarter for free cash generation despite an unfavorable change in DSOs.

DSOs increased to 52 days in the third quarter from 48 days in the second quarter due to client mix and non-credit-related receivables fluctuations.

We have also continued to make disciplined investments in our growth businesses.

Year-to-date capital expenditures totaled $33.8 million and we remain on track to spend approximately $50 million in 2012.

One example of these investments is our new diagnostic laboratory in Wilmington which we opened during the third quarter to support our growing RADS business.

We also acquired Accugenix in the third quarter for approximately $17 million.

As Jim mentioned, Accugenix expands the capabilities of our fast-growing EMD business by adding premiere microbial identification services to our portfolio.

In the fourth quarter Accugenix is expected to represent approximately 1% of our total sales and be neutral to earnings per share.

In conjunction with our third-quarter release, we also announced that we have signed an agreement to acquire a 75% stake in Vital River, a leading commercial provider of research models and related services in China for approximately $27 million subject to certain closing adjustments.

The transaction is expected to close in the first quarter subject to customary closing conditions including Chinese regulatory approvals.

The acquisition is expected to add more than 1% to 2013 total net sales on a full-year basis and be slightly accretive to 2013 EPS.

Both of these acquisitions demonstrate our commitment to disciplined investments.

We have performed thorough due diligence, a rigorous financial analysis and extensive integration planning to evaluate these acquisition candidates and ensure their successful integration into the Charles River portfolio.

In addition to capital expenditures and acquisitions we continue to balance our capital priorities between stock repurchases and debt repayment.

Our stock repurchases totaled 1.2 million shares for the first nine months of 2012 at a cost of $42.8 million.

As of December 29 we had $73.5 million outstanding under our stock repurchase authorization.

We expect to repurchase between 1.4 million and 1.6 million shares in 2012 or near the middle of our previous range of 1 million to 2 million shares.

We also reduced our total debt by $17.5 million in the third quarter as we continue to repay debt modestly ahead of the scheduled installments on the term loan.

As Jim discussed, we have reduced our constant currency sales guidance to an increase of approximately 1% for 2012, which reflects slightly lower than expected sales in the RMS segment.

We continue to expect that foreign exchange will reduce reported sales by approximately 2% for the year.

We've also narrowed our EPS guidance to $2.68 to $2.73 or the high end of our previous range to reflect the strong year-to-date performance.

Our updated 2012 guidance includes a small benefit to sales from both the AstraZeneca partnership and Accugenix acquisition, but the earnings impact from each is not expected to be significant in 2012.

Our narrow guidance range assumes a meaningful decline in fourth-quarter EPS as we are maintaining a cautious outlook towards the end of the year.

Our outlook assumes that normal seasonal trends will pressure fourth-quarter results.

Although we did experience increased spending late in the fourth quarter of 2011 as our clients utilized remaining budgetary funds before the end of the year, we are not forecasting a budget flush this year.

Many of our clients have indicated that they expect to restrain spending in the fourth quarter in order to meet financial targets.

We believe our outlook is prudent given client commentary and the current macro economic and political environment in the US and globally.

Sequentially for the fourth quarter of 2012 RMS sales were expected to improve moderately in large part because we record a full quarter benefit from the acquisition Accugenix acquisition as well as from robust organic growth in the base EMD business.

PCS sales are expected to be moderately lower due to fewer study starts during the holidays, which has become a more significant factor in recent years due to the shorter-term nature of pre-clinical work.

Our clients' budgetary concerns are also expected to cause some studies to be delayed at year end.

The non-GAAP operating margin is expected to decline moderately in both segments for the third-quarter level due to the normal seasonal trends.

As I mentioned earlier, the tax rate is expected to increase in the fourth quarter primarily due to an anticipated tax law change in a foreign jurisdiction.

I would also like to remind you that the fourth quarter of last year benefited from the addition of a 53rd week.

Since 2012 is a normal 52 week fiscal year we expect the year-over-year sales growth comparison to be negatively affected in the fourth quarter of 2012.

You may recall that the 53rd week benefited the fourth-quarter sales growth rate by approximately 450 basis points in 2011 or approximately $12 million and we would expect it to reduce sales growth by a similar amount in the fourth quarter of this year.

We are focused on a strong finish to the year through the continued execution on our four key initiatives, our efforts to take market share and provide customized solutions to our global clients and our programs to drive efficiency and profitability across our businesses.

We also look forward to providing you with our outlook for 2013 in December.

Thank you.

That concludes our comments.

Stacy, would you please take questions now?

(Operator Instructions).

David Windley, Jefferies.

I'm wondering if I can ask a two-parter.

I guess the question I will ask is around the broader deals that you have been able to bring under the umbrella, I am curious about how that has catalyzed other conversations, Jim.

You have talked over the course of the last year about other clients engaging you in conversations around those types of deals.

So if you could talk about how those conversations are going.

And then if you could also talk about kind of the -- I guess the embedded pricing in these deals and how that looks relative to what spot business might look like.

Thank you.

We have been saying for an awfully long time, several years at least, that drugs are going to be rolling off patent, that the whole drug development process would have to change, that we would all have to do what we do best and the drug companies would inevitably outsource this work.

And not that we are great stages, it was just sort of clear from looking at their cost structures and looking at how we had built out our business and the things that we could do for them.

And it has been a little bit frustrating over the last few years the rate at which this hasn't happened as quickly as we had anticipated.

But, be that as it may, it is clear now that we are in the midst of a significant change in the way the clients are operating.

We have these two large deals, one that we could name the client and one we aren't able to.

We have several other conversations in various stages of that sort of process.

But it is clear that as the drugs roll off and as they relook at their infrastructure and of course we are seeing, and I'm not saying that we are literally the catalyst for this, but we are seeing facilities being closed, as we said they would several years ago, and we pointed to that, and staff being reduced, at least in the areas where we can help them.

And so we've got this wonderful symbiotic relationship where we are doing the work for them, we believe scientifically as well as fast or faster and at a beneficial value proposition.

The other thing that is important is that we are utilizing the whole portfolio and so clients who have bought from us historically sort of on a transactional but non strategic basis across our portfolio are being much more strategic about those purchases.

And as we pointed to in the prepared remarks, we sign these large deals but we become very much the partner of choice, the scientific partner of choice.

And we are finding that very quickly there's additional work beyond the confines of that deal and beyond the confines of what we have done with these clients previously that we are more apt to get and in fact are getting.

So we are very pleased with our ability to essentially take share and do so principally on a scientific basis.

In terms of the embedded prices, it sort of depends on the nature of the work, but I would say we are pleased in most cases with the prices that we are getting.

You said how do they compare to spot prices.

Again that depends.

For most of the deals that we are doing, and some aren't large strategic deals but they are larger relationships that we've had, we're obviously seeing that with the transfer of protocols and those smoothing out over time and the increase in volume that the value proposition improves, we often bid knowing that we will be able to improve the profitability as the volume increases.

And we are quite confident that we will be able to do that.

As we have also indicated, our capacity is filling.

So we are being very thoughtful about how we fill it from here on in and what the relationship is between large clients and small ones, between long-term deals and short-term deals and between specialty tox and general tox and also between GLP and non-GLP.

So very interesting patchwork right now and one that we think will continue to -- if not accelerate continue at this rate where we find more clients.

And, yes, to your question, I think that the announcement of a specific client has gotten the interest of others and in the previous deal where we couldn't announce it publicly we have said in our conversations with the Street that we had used that client as a reference with other potential clients and that has obviously gone quite well.

So the notion that our clients will increasingly become our advocates and help us with kind of the sales and validation process we think is a very, very powerful one.

Great, thank you.

Eric Coldwell, Baird.

First off, I'm curious about the impact of the fungal meningitis outbreak for your EMD segment.

I don't believe you do point of use fungal testing, but Accugenix brings in some capabilities there.

I am just curious what you think the derivative impact of the fungal meningitis outbreak will be for your business.

It's hard to say.

I would say that with a lot of these pharmacies that weren't testing, had they had our technology available to them it is likely that some of the stuff could have been prevented.

So we are talking about very early detection of these things.

And, yes, we are quite cognizant of the potential for us.

I couldn't begin to quantify the value to the business.

But it is exemplary of the type of expansion capabilities we now have with map and micro-testing in addition to the rapid endotoxin testing.

That's fair and if you will allow me one more.

Did a quick search of the BioCon website.

As you were speaking, it's a pretty interesting website, but I can't actually find any data immediately available on the total R&D budgets of their membership base.

But it is some very large companies.

So I am curious if you can give us some sense as you displace Harlan there, if you can give us some sense of the incremental opportunity to grow that business over time.

Sure.

This is a piece of work that we have wanted to secure for a long period of time.

You've got this huge concentration of some of the best biotech companies and other institutions in the world in Southern California.

And obviously we have a significant West Coast operation there, so it makes a lot of sense that we would be their provider.

As we said, the rate of adoption is sort of unknown, we think it will be modest at the beginning and accelerate.

All we can say is that it is a several million dollar opportunity assuming that the majority of it comes to fruition.

But it's sort of difficult to pinpoint how quickly that will happen.

But the opportunity is there and the clients are certainly well aware of that and it would be financially advantageous of them to take advantage of our relationship with that size of contract.

That's great.

Thanks very much.

John Kreger, William Blair.

Jim, can you just remind us the portion of your business that comes from academia and government across the two segments?

And in this period of cutbacks are you seeing any pullbacks by that customer base and do you think that is a trend you might see as we move into 2013?

So the global number is 24%.

As we have indicated for the last few years, that is up dramatically.

It used to be in the mid-teens, so by focusing our sales force globally on this sector and by the fact that our price points versus the competition have been -- the premium has been reduced dramatically we've gotten a lot more traction in the academic market place.

And, by the way, I believe that we can continue to do so going forward.

As we indicated in the prepared remarks, the increase in the academic and government sector has slowed somewhat over 2011, it is sort of flat actually.

The academic piece is up a bit more than the government piece.

We did have a couple of government contracts which we actually rebid on and did not win for a variety of reasons, principally price.

But, yes, around the edges there's probably a subtle reduction in demand, but not as much as you would anticipate.

And as we have indicated previously, the research model business in particular is not particularly price-sensitive, relatively low -- it's a relatively low volume purchase or low ticket purchase for our clients.

If you are doing basic research you are going to use animals.

And so we don't to see this sort of severe impact that perhaps some people that are selling larger more expensive pieces of equipment might.

We also have a lot of embedded government contracts with multiple-year durations which are in good stead.

And we have always had a very big piece of the government business in Europe where it is actually a bigger percentage of the whole than it is in the states.

So if we are seeing anything, it is subtle, slight slowdown versus the prior year but really nothing dramatic that concerns us.

And we would anticipate that we would continue, at least on the pure academic piece of this through this concerted sales effort, be able to continue to have at least a slight uptick in that going forward.

That's very helpful, thanks.

And just to clarify, the 24% was your total -- across your total revenue base, right, or just RMS?

It's total government and academic across the total revenue base.

Great, thank you.

Greg Bolan, Sterne, Agee.

Tom, just some back-of-the-envelope math here.

But is it safe to assume that year-over-year headwind from large models was about a $0.02 drag on EPS this quarter?

Well, we said a couple of hundred basis points on sales, so that would be a good estimation, Greg.

Okay, great.

Thanks.

And then just real quickly, Jim, I am assuming that non Discovery Services is something on the table for discussion with your latest in vivo biology partner.

And I know you guys characterize this deal as a 1% increment [on] calendar 2013.

But do you believe the potential discovery business there to be larger, smaller or kind of in line with what you have already won, just kind of hypothetically?

Yes, hypothetically as we have these large relationships and we get closer scientifically with clients and they kind of look at us as really an extension of themselves, the potential to expand that to the non-GLP area, for instance, is certainly there.

I wouldn't want to say with any certainty that we could make that happen; I am sure we will.

I continue to have those conversations with this client and with others.

Our footprint is quite strong scientifically, as we said, particularly in the CNS and oncology areas where lots of clients, including that particular one, are spending a lot of dollars.

So we will certainly continue to have the dialogue.

And it all depends on the client's readiness to outsource that type of work and their readiness is somewhat enhanced by the knowledge that we have the capability for them.

Thank you.

Douglas Tsao, Barclays.

Just in terms of the deal with AstraZeneca, I think in the original press release you indicated that it was expected to grow or contributed about 1% to revenues or an incremental 1% to revenues.

Would you expect there to be incremental growth off of that base as we move into 2014?

We would -- yes, I mean, we would hope, as we said with the last question, we would hope that through our relationship we would be able to expand our service offering to them and they would be interested in that as well.

It's a better value proposition for them and through these deals you really get to understand the expectations of the clients in terms of service and time frame and IT interface and we understand their expectations better as well.

So there is a more comfortable basis upon which to do that sort of work.

So, yes, we would hope so, but it is not built into the contract, I mean I want to be clear about that.

Okay.

And then the deal with Biocon, that is not -- what percent of those customers were you already selling to?

I don't think we have that number at the tip of our fingers, Doug.

We certainly have some relationships and some sales with some of those clients.

But a lot of the opportunity is incremental and we weren't able to do work with those clients previously because they had this pre-existing relationship with one of our competitors at more attractive price points.

So we do think this will be beneficial notwithstanding the fact that we had some of these clients already.

Okay, great.

Thank you very much.

Tycho Peterson, JPMorgan.

I'm going to ask a two-parter on RMS.

First on just the Vital River deal -- I mean, you had previously obviously moved out of China understanding that this is a different business you are going to back in with.

But can you just talk about whether that is really just to gain access to the market or do they bring any new capabilities?

So, Tycho, it is pretty straightforward.

This is becoming a major life sciences center with large local companies, a growing cadre of biotech companies and a whole bunch of international companies that are going to do work to develop drugs de novo in China and are absolutely going to want to use the same quality animals they are using elsewhere.

As we've said actually for a few years now, we continually assess the opportunity to be in the research model business in China and up to this point haven't felt that the market opportunity was significant enough for us.

We do think the opportunity is significant enough now and we think the growth rate will be impressive for us, it's a good-sized market.

The research models that are available now are primarily from government-based production operations, at very low price points and at very low quality points as well, so they don't have the sort of virological and bacteriological and genetic sort of consistency that our animal models have.

So this is a licensee of ours, so they have our breed stock, it is sort of a derivative facility, it is very Charles River like.

It is a very good opportunity for us.

We intend to set the quality standards and eventually the pricing standards for laboratory animal production and research in China and we will increasingly expand our presence into other areas in which we operate.

So with this acquisition we get a RADS laboratory and a GEMS capability.

As I think you know, we also have a small endotoxin company in China, we source our nonhuman primates from there.

And so increasingly we will do more and more of our work there.

But it feels very good to have a strong research model business as the sort of hub and the center of our activities going forward.

And then just to follow up on RMS.

The guide down there, just wondering how concentrated it is by customer and how much visibility you now have in those markets?

And I think you also mentioned some impact to the GEMS business, I'm wondering if you can elaborate on that?

Just talk about the overall --?

Yes, the (inaudible) for RMS, yes.

The decline.

Well, I mean we are seeing that decline in the third quarter really for two reasons.

One is it's the normal seasonality which we have every third quarter.

The other is we've had a continuous decline in small animal sales for a while now, some of that is related to tox and some of that is related to the low spending in the discovery area.

And some of it is for sure related to the continued concentration of our client base, reduction of facilities -- we have had multiple big pharma site closures either happen or announced in this fiscal year and we anticipate there probably will be more of those.

Obviously at some point that will level off.

That over time should be offset somewhat by the sort of mix issues with more highly valued models, more genetically-based models.

And any uptick obviously in the tox business would be an improvement as well.

So it has been in a decline but somewhat leveled off.

Okay, thank you.

Doug Schenkel, Cowen and Company.

In recent quarters you guys have talked about a higher mix of shorter-term, less complex studies within PCS.

Given the strength that you have demonstrated within PCS the last couple quarters I was just wondering if there is any update there, whether that is evolving right now.

Thank you.

Yes, a couple of things.

Number one and interestingly enough, a lot of those short-term studies are actually pretty complicated.

So we find ourselves doing very complex work for our clients.

And again, I think our scientific strength pulls us in very good stead vis-a-vis the competition; we are going to continue to focus there.

We have had an increase in longer-term GLP work, sort of not the great balance that we have seen historically but it is improving.

So you've got obviously some of the molecules are moving through short-term studies to longer-term ones.

I would say that the mix -- you didn't ask this, but the mix between specialty work and general tox is okay, somewhat better than it has been previously.

Again we've had periods where that was almost 50-50 or better.

So I would say that the mix of business is steadily improving with more long-term studies and extremely complex ones as well.

Tim Evans, Wells Fargo Securities.

I was hoping to get a little bit more color on the long-term margin guidance, specifically how would you characterize the trend in RMS margin versus PCS margin?

I'm particularly interested in how the recent changes in the business would impact that, namely the acquisitions you have done as well as the two strategic partnerships?

Well, obviously we have different historical data points in both segments.

RMS we have an extremely high margin that we are obviously protective but while at the same time we are trying to improve it.

So I do think there is potentially some opportunities to improve it, but certainly we are trying to safeguard it where it is as well.

Preclinical we have obviously struggled over the last few years given the changes in the marketplace in terms of demand, pricing, et cetera, where we have seen it erode.

We have made a lot of cost and structural changes over the last few years; we have actually improved it quite nicely against headwinds alike historical price changes that we've seen.

So I think we are probably a little bit more optimistic on improvements in the pre-clinical side.

The strategic deals, while they add an element of pricing in terms of pressure and a larger competitive process, they do allow for incremental business in most cases and steadier demand so that notwithstanding any price pressures it will allow us to actually do the work in a more steady, consistent fashion; as we have demonstrated from our last partnership, improve our efficiencies and work knowledge so that we can actually continue to drive the margins up.

So I think going forward, as Jim had said, we are still targeting 20% over the next few years.

I don't think it will be that easy to get there and I think the opportunities are probably larger in say preclinical.

But nonetheless in some of our growth RMS businesses as well where we do have EMD, as an example, and a couple of other areas where we are still experiencing growth in RMS.

Great.

The RMS acquisitions don't create too much of a headwind there on margin?

Well Accugenix -- of course our in vitro business is quite profitable.

So Accugenix from purely an EMD standpoint creates a little bit of pressure, but we are obviously looking to improve the margins going forward.

The margins there are not creating a drag on the corporate margin, so I should be clear about that.

And China it is really the same.

We do think we have good opportunities to improve the margin by bringing more of our knowledge to that process locally, both production and sales.

But again, from a corporate standpoint, those margins are not creating any pressure on the corporate margin rate.

Great, thank you.

Ricky Goldwasser, Morgan Stanley.

This is Andy in for Ricky.

Just real quick, your guidance implies a step-down sequentially in 4Q earnings.

On the 2Q call you guided that 3Q would be the low point for the year.

I was just wondering what changed since the 2Q call and are there any implications heading into 2013?

I think I'm going to have to ask you to repeat the question.

So I know you were talking about what is deference different from what we said after our Q2 call going into (multiple speakers).

Sorry about that, let me try again.

So I was just saying on the 2Q call you guided that 3Q would be the low point for the year.

Clearly your new guidance has 4Q as sequentially stepping down.

I was just curious what has changed since the 2Q call and are there any implications from that heading into 2013?

Well, what I would say about Q4 specifically is that we talked about our -- the 53rd week, which I think was a little bit of difference in some of the analyst call.

But also we had the benefit of quote/unquote the budget flush last year.

And while we didn't necessarily expect that this year, we expect things to be a little bit more normal and I think now we are a little bit cautious about some of our clients actually restraining spending.

So, I think that is a little bit more maybe on the pre-clinical side, but as well on the RMS side.

We probably have seen a little bit more softening in our large biopharmaceutical accounts in the research model side.

And I think other than that I don't know that I would add anything else.

Okay, so just to follow up on that.

So there was a little softening versus where you guys were when you reported 2Q.

Do you think that trend is going to continue into next year or it is really just some causes that are heading into the end of the year and you expect those to rebound?

Well, year end is always a little bit of a seminal moment; we are putting our plans together as we speak and we will be providing guidance in mid December.

So that is probably a data point or a point in time where we can give you a little bit more clarity on that.

That's it.

Thank you.

Ross Muken, ISI Group.

I just have two quick follow-ups, just one on the China business.

I mean my understanding having been over there is the models market is pretty price-sensitive and there's a lot of local competitors, large academic and government based institutions that sort of have their own.

I mean how do you see sort of the landscape in terms of the addressable market for the asset you purchase?

Is it mainly Western companies based over there or is it sort of a broader base sort of Chinese companies as well?

It's going to be both, Ross, I mean obviously we are going to have -- it is going to be a much more straightforward proposition to sell higher quality, higher value models to international companies that are our clients in other parts of the world.

But obviously we are going to have a focus on educating the local user, both government and commercial start-ups in this sector, to the value of high-quality animals.

We have done this for almost 70 years throughout the world and the research results will be better.

So it will take some time, but as that market grows we will have a central role in this both geographically and in terms of the scientific quality of the animals and through seminars and other things we will educate this marketplace as we have educated other marketplaces throughout the world.

So we are quite confident in our ability to drive growth.

By the way, business that we are buying, while we haven't broken out, has very good operating margins, so we are really happy with the value proposition.

We have got very high-quality facilities with our own animals and with our participation -- direct participation now and expansion we are really going to be able to educate the marketplace.

And we are hitting it just at a time where there is a lot of increased investment both internally by the government and externally through these global pharmaceutical companies.

And we are really excited to be there in a significant way and we think that we timed it quite well.

And just secondarily from a cost perspective, I mean you guys have done a really good job of sort of managing COGS and SG&A despite some of the volatility you have seen in the business.

As you look going forward at sort of the margin targets, where are we in terms of your ability to deliver that 20% goal in the context of top-line?

I mean, how much is coming just from volume versus how much is coming from management of just efficiencies and other pieces on the OpEx side?

And if we see some choppiness where are you getting the most flex in your cost structure to continue to be able to deliver the bottom line?

Yes, well I would say it is not getting any easier.

Most of our flex and our cost structure would really come from efficiencies.

We have wrung out concessions from our suppliers and we will continue to do that.

But with mainstream sort of our merit increases after a couple years ago holding merit increases flat and things like that, we can't afford to do that forever.

So I think you're looking at an environment where you have to increase wages each year at an appropriate rate.

We will continue to work with our suppliers but it gets harder and harder.

So we will continue to look at efficiencies as well, although you get sort of the easy efficiencies out of the way earlier and then that gets harder and harder.

So I do think we will continue to do all those things, I think they will contribute, but we also need to see an uptick in volume.

Jim talked about mid-single-digits, we need to see those types of numbers, continue to get price increases in the research model business and gradually start to get the price increases in the pre-clinical business.

And I think if all those things don't come together it will obviously be hard to get to a 20%-ish margin in a few years.

Thanks, guys.

And at this time there are no questions in queue.

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Thank you for joining us this morning.

We look forward to talking to you all in the near future.

And this concludes the conference call.

Thank you.

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