Charles River Laboratories International Inc (CRL) 2012 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the Charles River Laboratories fourth-quarter 2012 earnings conference call. At this time, all lines are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given to you at that time. (Operator Instructions). As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Susan Hardy, Corporate Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, and welcome to Charles River Laboratories fourth-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 fourth-quarter results and review guidance for 2013. Following the presentation, we will respond to questions.

There is a slide presentation associated with today's remarks which is posted on the Investor Relations section of our website at IR.CRiver.com. A replay of this call will be available beginning at noon today and can be accessed by calling 800-475-6701. The international access number is 320-365-3844. The access code in either case is 278709. The replay will be available through February 23. You may also access an archived version of the webcast on our Investor Relations website.

I'd like to remind you of our safe harbor. Any remarks that we may make about future expectations, plans and prospects for the Company constitute forward-looking statements for purposes of the safe harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors, including, but not limited to, those discussed in our annual report on Form 10-K, which was filed on February 27, 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 a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations to those GAAP measures on the Investor Relations section of our website through the Financial Reconciliations link. Now I'll turn the call over to Jim Foster.

Good morning. I'd like to begin by providing a summary of fourth-quarter results before commenting on our business prospects. We reported sales of $280 million in the fourth quarter of 2012. Although this was 3.7% below the previous year, the decline was due to the inclusion of a 53rd week in the fourth quarter of 2011, which added 4.3% to sales growth, and also to the effect of foreign exchange, which reduced sales by 70 basis points. When adjusting for the 53rd week on a constant currency basis, total sales increased by 1.3% in the fourth quarter, with RMS sales declining less than half a percentage and PCS sales increasing approximately 4%.

We were quite pleased with these results, especially in view of the fact that the fourth quarter of 2011 benefited from strong year-end spending by clients as compared to this year's fourth quarter, when clients restrained spending. These results underline our confidence that our market remains stable, as well as the fact that we are gaining market share.

Lower sales volume in RMS was the primary driver of the 120 basis point year-over-year consolidated operating margin decline to 15.9% from 17.1% in the fourth quarter of 2011. Normal seasonality results in lower sales of research models and operating income is extremely sensitive to changes in volume. Restrained client spending in this year's fourth quarter increased the impact on both sales and the operating margin. We have continued to focus on our process improvement initiatives, which are enabling us to partially offset the impact of higher compensation costs, inflation, lower RMS volumes and costs associated with the startup of new and expanded strategic relationships.

Earnings per diluted share were $0.64 in the fourth quarter of 2012 compared to $0.69 in the fourth quarter of 2011. We generated less operating income as a result of lower sales, although this was partially offset by a lower tax rate and stock repurchases. We continued to return value to shareholders in the fourth quarter through our share repurchase plan with the purchase of approximately 483,000 shares for $18.6 million. We repurchased approximately 1.7 million shares in 2012, slightly higher than our last estimate of between 1.4 million and 1.6 million shares.

As you know, we updated our sales guidance for 2013 in January, when we completed the acquisition of Vital River, to a range between 4% and 6%. With our update for foreign exchange, we now expect that both reported and constant currency sales growth will be in the same range. We believe this anticipated growth will be driven by successful, targeted sales efforts, which are enabling us to gain market share, as well as the acquisitions of Accugenix and Vital River.

On a non-GAAP EPS guidance -- our non-GAAP EPS guidance remains in a range of $2.80 to $2.90, or about 4% growth at the midpoint. As we discussed when we gave guidance in December, compensation costs and inflation, as well as costs incurred in relation to new strategic relationships, are expected to offset our cost savings and moderate earnings growth in 2013.

Our fourth-quarter results reflect the number of puts and takes, which are illustrative of the significant changes taking place in the biopharmaceutical industries. As they told us they would, many of our large clients, most of which are public companies, restrained their spending as they endeavored to meet financial goals for the year. At the same time, other clients increased their outsourcing efforts as they moved forward with initiatives to gain efficiencies and cost effectiveness.

We continued to win market share in all three of our client segments, but some of the studies we expected to begin in the fourth quarter were postponed until 2013. However, taken as a whole, the fourth-quarter performance was as expected, and we remain confident in our guidance for 2013. Continuing discussions with our global biopharmaceutical clients reinforced our view that they will increase the amount of outsourcing, and we intend to win the majority of the available work.

We believe we achieved this goal in 2012, as demonstrated by the announced strategic partnership with Astra Zeneca, as well as the other strategic relationships which we won or renewed. In addition, we remain focused on our mid-tier and academic clients, and expect to continue to take market share in 2013.

The investment community has asked repeatedly whether we believe our clients are refocusing their spending on early development activities. It is difficult to assess the overall marketplace and to separate our market share gains from increases in functional volume. But at least with regard to our global biopharmaceutical clients, we believe that some of them are beginning to re-emphasize early-stage work. We base this belief on discussions with our clients about where they are focusing their research, as well as the types of studies they are placing with us and the volume of work.

This is particularly true of regulated safety assessments. Revenues increased in each of the first three quarters of the year, and we believe the moderate fourth-quarter decline was the result of restrained spending rather than a change in direction.

One thing is certain. These global biopharmaceutical companies have accepted the fact that outsourcing will enable them to bring new therapies to market faster and at a lower cost. The challenge for them now is to determine how they want to outsource and to choose the partner who can best support them with superior scientific expertise, best-in-class service and the flexibility to provide solutions that are tailored to each client's unique requirements.

We believe we are extremely well-positioned to be that partner, and our market share gains suggest that our clients agree.

I'd like to provide you with details on the fourth-quarter segment results. The RMS segment delivered sales of $171.8 million. As I mentioned, the year-over-year decline was due primarily to the 53rd week and foreign exchange. In constant currency and excluding the impact of the 53rd week, sales decline was approximately 30 basis points. And on a sequential basis, RMS sales increased by 3.2%, approximately 1% of which came from Accugenix.

The table on slide 11 provides RMS sales by product and service line. You should note that going forward from 2012, we are realigning this disclosure in our 10-Ks and 10-Qs to show EMD as a separate business category. Avian Vaccine, which was formerly reported with EMD in other products, will now be reported in research model production. This affects only the RMS sales disclosure. It does not change what is reported in the RMS and PCS segments.

The largest RMS sales contribution in the fourth quarter came from our Endotoxin and Microbial Detection, or EMD business. Higher EMD sales were offset primarily by the models businesses, both small and large. The large models business has continued to decline, as we said it would when we gave guidance for 2012.

The EMD business delivered an outstanding performance in the fourth quarter, with sales growth just over 20%, including the addition of Accugenix. We are extremely pleased with the ongoing exceptional performance of the PTS franchise. We continue to identify and penetrate new niche markets within PTS, which is increasing the number of units we are placing.

The larger MCS is also selling well, so between the two product lines, we are generating higher sales of cartridges. And with the expected launch later this year of the automated MCS, or Nexus, we also hope to improve penetration of manufacturing central laboratories. Successful penetration of that market will drive even higher cartridge use and continued EMD growth.

We are very pleased with the Accugenix acquisition, which is performing ahead of our plan. In addition to the existing facilities in the US, we are in the process of establishing satellite testing facilities in France, Korea and India. This will expand our clients' access to the Accugenix database and enable us to promote our services more broadly. Over the next several years, we intend to enhance our capabilities through both product extensions and acquisitions like Accugenix.

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 for the EMD business.

On an adjusted basis, excluding the 53rd week and foreign exchange, sales of research models decreased by 5.8%. As you know, the fourth quarter is seasonally weak, but the comparison to last year was compounded by the strong December we had in 2011 versus the softer December in 2012, as well as the expected continuing decline of sales of large models this year. Our large biopharmaceutical clients continue to rationalize capacity which is no longer needed due to industry consolidation, elimination of therapeutic areas, rationalization of pipelines or a combination of all three. As a result, they are using fewer research models. We have experienced this trend in North America for the last few years, and have recently observed it in Europe and Japan. However, as this consolidation is occurring, we are seeing the corresponding increase in outsourcing, as our clients replace internal capabilities with more flexible outsourced resources.

We believe this is visible in our PCS results for 2012 and also in higher bookings in the fourth quarter of the year. As I mentioned on our December call, when clients outsource to us in lieu of in-house research, the associated sales of research models are recorded as intercompany revenue rather than commercial sales.

Despite the softness in research model sales in the fourth quarter, we continue to expect that sales will increase in 2013. We base this outlook on information from our clients concerning their anticipated spending and our continuing market share gains across all geographies.

Adjusted sales of research model services, including GEMS, RADS, DRS and IS, were down 70 basis points year over year against challenging fourth-quarter comparisons. However, sales increased sequentially for each of those businesses as a result of increased outsourcing, market share gains or both.

The growth rate for Discovery Research Services, or DRS, slowed in the fourth quarter as a result of our clients' restrained spending. As is the case with research model sales, based on indications from clients and potential new business opportunities, we believe that the growth rate for services will also reaccelerate in 2013. As the patent cliff continues to erode sales, biopharmaceutical companies will rationalize additional capacity and take further actions to implement a more flexible cost structure. We believe that they will increasingly outsource their early-stage testing to a partner like Charles River because they can achieve the flexibility they need without sacrificing science or quality.

We believe there are two primary reasons that our clients choose to outsource the discovery testing to us, scientific expertise and breadth of our early-stage portfolio, which enables them to outsource a broader segment of the discovery processes to a single partner. Expertise is critical to our client as they eliminate their internal capabilities and rely solely on a CRO. Our expertise in the key therapeutic areas in oncology and CNS is a key differentiator between us and our competitors because the depth of our expertise is currently unmatched by other CROs.

And because our portfolio is so focused on early-stage research processes, our clients can outsource more to us, taking advantage of time savings as a result of fewer handoffs, as well as attractive pricing, as they expand the volume of work they do with us.

We believe these two factors position 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.

In total, our DRS business represented just over 10% of total Charles River sales in 2012. I will remind you that approximately one third of our DRS revenues is reported in RMS, and the other two thirds is reported in PCS.

When adjusted for the 53rd week and foreign currency, at $108.3 million, PCS fourth-quarter sales increased 4% from the fourth quarter in 2011 and 1.6% for the full year. As a result of our clients' restrained spending, sales declined sequentially from the third quarter, but were down only 3.5%. We are very pleased with the improvement in our PCS sales this year, the first year since 2008 that we have reported growth. We attribute the growth in part to our market share gains, including new and renewed strategic relationships, and also to the fact that some of our clients are appearing to refocus resources on early-stage projects.

The marketplace, while still challenging, is more predictable, and visibility has improved somewhat. The strategic relationships in which we are now engaged represent approximately 25% of total Company revenues, which provides us better visibility than we have had in the past, and because of the strength of these relationships, better insight into our clients' planning processes.

Our facilities are operating at higher capacity utilization than the previous year, and we are seeing some increased spot pricing. We have no doubt that we are at an inflection point with regard to outsourcing by large biopharmaceutical companies. Discussions concerning additional strategic relationships are continuing 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 the fact the we will provide the structure which best meets each client's individual needs positions us extremely well to compete for new business. We believe that our 2012 results are demonstrating our success with this strategy. Our success at winning new business extends to our mid-tier and academic clients, as well. Through our targeted selling strategies, we have forged stronger relationships with these clients that have yielded returns.

Sales to our mid-tier clients increased approximately 4% in 2012. Sales growth for academic and government clients declined 1% for the year, with a 1% increase in academic sales, offset by lower sales to government clients. We have experienced slower spending in this group globally as the effect of economic uncertainty worldwide has restrained expenditures. There has been less impact on our sales to academic clients, where market share gains are continuing to drive sales growth. We have been particularly successful with larger academic institutions in the US, which in general are the beneficiaries of better and more consistent funding.

Our focus on our four key initiatives, improving profitability, increasing cash flow, investment in growth businesses and returning value to shareholders, has been the foundation of our business strategy for the last two years and will continue to be. Our profit improvement program generated $25 million of benefits in 2012, and we have targeted annualized benefits of $20 million in 2013.

As operating profit increases, so does cash flow. And at $3.32 per share, we generated one of the highest yields in the CRO universe in 2012. We have used that cash flow to repurchase stock and repay debt, as well as to invest in our businesses which have the greatest potential for growth. In 2012, we added new facilities for our EMD, RADS, DRS and BPS businesses and made strategic bolt-on acquisitions that extended our capabilities or expanded our global footprint.

Accugenix is an example of the former, and the Vital River acquisition, which we closed in early January, is an example of the latter. We believe that Vital River will enable us to be a leader in setting the standards for research models and associated services in China, a fast-growing market for pharmaceutical research.

We are experiencing a pivotal moment in time when global biopharmaceutical companies are reinventing the drug discovery and development model. We believe it is critical to participate in that process now, so our strategy is focused on positioning Charles River as the preferred provider for outsourced early-stage drug discovery and development products and services. We differentiate ourselves by our broad, early-stage portfolio, which is unique in the CRO universe, and our extensive scientific expertise, our attention to client service, our best-in-class data systems and portals and our ability to structure creative, flexible solutions that support our clients' goals of reducing the cost and improving the productivity of drug development.

We are dedicating ourselves to executing this strategy 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 fourth-quarter financial details.

Thank you, Jim, and good morning. Before I recap our financial performance, let me remind you that I'll be speaking primarily to non-GAAP results from continuing operations. A reconciliation of non-GAAP items can be found in our press release and on our website.

Our fourth-quarter performance was largely in line with our prior outlook, with the exception of the favorable tax rate. Operational trends tracked closely to the expectations that we discussed on our December guidance call. Jim has already discussed the sales performance, so I'll begin my comments with the operating margin.

Our consolidated operating margin declined by 120 basis points year-over-year to 15.9% in the fourth quarter, but essentially in line with our expectations. Low margins in both segments were partially offset by a decline in unallocated corporate costs.

The PCS operating margin declined by 90 basis points year-over-year to 12.1%. The fourth-quarter 2011 operating margin benefited from a $1.7 million non-income-based tax adjustment. Excluding this adjustment, the PCS operating margin would have increased year-over-year due to improved capacity utilization and prior cost savings initiatives.

In the RMS segment, the operating margin declined by 150 basis points year-over-year to 27.3%. This decline reflects the sensitivity of the RMS operating margin to changes in sales volume, which was caused by the stronger client spending in 2011 as compared to restrained spending in 2012, particularly for small models. You may recall that we reported a $4 million inventory write-down in the large models business that negatively impacted the RMS operating margin in the fourth quarter of 2011.

Unallocated corporate costs decreased by $1.6 million year-over-year and $0.6 million sequentially to $15.4 million in the fourth quarter. The year-over-year decline was primarily driven by the absence of a 53rd week, as well as lower costs related to consulting services and performance-based bonuses. Unallocated corporate costs represented approximately 6% of sales for 2012, and we continue to expect that we will maintain this level in 2013.

At $0.64 for the fourth quarter and $2.74 for the year, we exceeded our EPS guidance for 2012, primarily driven by a favorable tax rate in the fourth quarter. Our fourth-quarter tax rate was 20.6%, 360 basis points below the fourth quarter of 2011 and 510 basis points lower sequentially. Discrete tax benefits, as well as higher-than-expected R&D tax credits in Canada, reduced our tax rate, which was the primary driver of the EPS upside. These discrete benefits are not expected to repeat, so we continue to forecast a non-GAAP tax rate between 26.5% and 27.5% in 2013.

As expected, net interest expense of $4.4 million remained relatively stable on a sequential basis in the fourth quarter and declined approximately $1.5 million year-over-year. For 2013, we continue to expect net interest expense of $17 million to $19 million. We are working to finalize plans to refinance the convert and intend to keep interest rates low under any refinancing alternative.

Our 2013 guidance assumes that our cost of debt remains at relatively consistent levels for 2012.

Our four key initiatives to improve shareholder value remain intact and continue to guide our overall strategy. Our progress in 2012 was focused on growing a stable base of larger clients that is integral to achieving our longer-term financial goals, while continuing efforts internally to improve operating efficiency. We believe our commercial efforts were successful, as demonstrated by the strategic partnership with Astra Zeneca, business awarded from several other large clients and market share gains in mid-tier and academic accounts. This led to adjusted sales growth of 1.9% for 2012, when excluding foreign exchange and the 53rd week.

We also made progress on improving operating efficiency through our profit improvement program, for which we met our goal of more than $25 million in incremental cost savings in 2012. These savings do not always drop to the bottom line. In 2012, normal annual cost increases, coupled with headwinds from new strategic client relationships, resulted in a consolidated operating margin that was relatively stable at 17.5%.

We continued to generate strong free cash flow in 2012. Free cash flow increased by $6 million to $50.6 million in the fourth quarter of 2012, driven by lower capital expenditures. For the year, we generated free cash flow of $160.5 million or $3.32 per share, which was an increase of $3 million over 2011 and within our guidance range. We continue to expect free cash flow of $165 million to $175 million in 2013.

We also continue to focus on disciplined capital allocation. 2012 capital expenditures totaled $47.5 million, and we expect to spend approximately $50 million in 2013. In 2012, we completed a new diagnostic laboratory in Wilmington to support growth in our RADS business and moved to a larger discovery facility in Finland to support our growth in the CNS therapeutic area, among other projects.

We continue to evaluate acquisition candidates, and, as you know, completed the acquisitions of Accugenix and Vital River within the last six months. Accugenix contributed nearly 2% to the RMS year-over-year sales growth in the fourth quarter, which was slightly ahead of our acquisition plan. The integration of Vital River has progressed well in the first month post-closing, and we are confident that this is the appropriate time to enter the research models and services market in China.

In addition to capital expenditures and acquisitions, our capital priorities were balanced in 2012 between stock repurchases and debt repayment. For the year, we repurchased a total of 1.7 million shares for $61.4 million, including 483,000 shares in the fourth quarter. Since the inception of our stock repurchase program in 2010, we have bought back 30% of our outstanding shares and expect to repurchase another 1 million to 1.5 million shares in 2013.

At the end of 2012, we had $54.8 million outstanding under our current stock repurchase authorization.

We also reduced our total debt balance by $51.4 million in 2012 as we repaid debt modestly ahead of the scheduled installments on the term loan. We are comfortable with our leverage of $666.5 million at the end of 2012, or approximately 2.5 times EBITDA. Our goal is to maintain our leverage ratio at approximately this level in 2013.

Our debt activities in 2013 will include refinancing the $350 million 2.25% convert and scheduled payments on the term loan.

Overall, we believe our accomplishments in 2012 continue to position us for sustainable growth and long-term shareholder value creation. One example is our free cash flow-to-invested capital return, which increased 90 basis points to 12.6% in 2012.

As Jim discussed, we are updating our sales and reaffirming our EPS guidance for 2013. We increased our sales guidance by approximately 1% in January to reflect the completion of the Vital River acquisition, and expect constant currency sales growth to be 4% to 6% in 2013. We have also updated the foreign exchange impact to mirror current rates. We now expect the FX impact to be negligible compared to the previous 50 basis point headwind. As a result, reported sales growth is expected to be the same as constant currency growth of 4% to 6%.

Our 2013 EPS guidance range of $2.80 to $2.90 remains unchanged from December.

Our sales expectations for the first quarter are in line with the outlook that we provided on our December guidance call. At that time, we said that we expected a slow start to 2013 as a result of the same trends that caused clients to restrain spending ahead of year-end, as well as our clients' usual first-quarter budget allocation process.

Since the beginning of 2013, we have experienced continued slow spending globally. However, we still expect RMS sales to increase significantly from fourth-quarter levels, which is consistent with the seasonal trend, and for PCS sales to be slightly higher sequentially.

The first-quarter tax rate is now expected to be at the higher end of our forecasted range of between 26.5% and 27.5%. This is due primarily to a retroactive tax law change that was recently enacted in a foreign jurisdiction. The tax rate is expected to normalize for the remaining three quarters in 2013.

To conclude, we are pleased with our performance in 2012 and remain confident about our outlook for accelerating sales growth and higher earnings per share in 2013.

That concludes our comments. Cynthia, would you please take the questions now?

(Operator Instructions) Tim Evans, Wells Fargo.

Thanks for taking the question. Jim, could you maybe tell us what's going on with small models? There was a statement about that in the press release. And then I would also be curious as to if you could give us an update on conversations you're having with potential new strategic partners.

Sure. Small models continue. In the fourth quarter, we had a slowdown pretty much across the board, with -- globally, we had restrained spending by our clients, who told us that would be the case, and it was. So that impacts small models, as has site closures and therapeutic area realignments. We also obviously had difficult comps, given we had an unusually strong fourth quarter of last year, particularly December.

We indicated that the first quarter of this year would be a little bit slow, as well, although we did indicate that research model sales would be up meaningfully in the first quarter. The quarter seems to have started as we thought. January sales, like December these days, takes people a long time to get back to work, researchers, and the budgets to be finished, and there is always this allocation of studies internally and externally. But we are getting a sense that things are beginning to pick up.

Our sense going forward is that we'll continue to get price, probably 1% to 2%, that we will continue to get market share worldwide. I would say the emphasis in market share gains would be academic gains in the US, gains in Europe, particularly in the UK, and continue to take share in Japan, which we've been doing for the last two or three years.

Our clients are talking to us about more spending in early development and also in early discovery. Obviously, if that happens, this generates additional research model sales.

And I guess the last thing that we said in our prepared remarks and also in our last call, which is important to note, is that as we win additional large deals, whether they are multiyear or individual year or even month-to-month, the work that we were doing with external clients in providing them with the animals -- are now doing ourselves, providing ourselves with the animals, so those sales now are intercompany based.

So we continue to feel that we will have at least low single-digit growth in the basic research models business. That is without the services affiliated with it.

On the strategic deals, we've been very clear recently to try to describe those in a more comprehensive way. So we have several multiyear deals that are signed and several that we are talked about. We also have annual deals; in other words, that we have relationships with a client's contract with us an annual basis and then we re-up those. And we have some clients who work with us from study to study. In the aggregate, those are about 25% of total sales, which is improving our visibility.

I believe we will continue to sign deals like this. We won't be able to announce them all because the clients won't let us, and it is going to get a bit tedious. But I would say it is a continuous process. We've had several wins recently. Some of those were just re-ups of work that we had that was being rebid. One of those was incremental work. But we had thought that we got that; it's already planning through our guidance. But I would say it is a continual process and a continued emphasis of us, and that we are continuing to prevail in many of these conversations.

Thank you.

Douglas Tsao, Barclays.

Hi, Jim. Thanks for taking the questions. As your business increasingly turns towards discovery services, which is often, or generally, I would argue, a more dynamic segment in terms of technological advances, I was just curious how you were thinking about keeping Charles River at the forefront in that segment in terms of potentially your own internal R&D efforts. Or is this something in which you will largely remain acquisitive and on the hunt for small, innovative companies and bring technology and sort of services that way?

Doug, historically our R&D, our pure R&D has been principally in the EMD space. We are innovating there all the time, and we have strong IP in that space, and it's important to have new generations of products.

I'd say in the rest of our business, both the discovery and the research model space, while we've had some pure R&D expenditures, that is really not the way that we have kept up technologically, which, as you say, we of course have to.

I would say that a lot of our acquisitions, particularly some of the small ones, are specifically to gain those sorts of technologies. So we are either buying in those technologies or licensing them in.

I would say that Accugenix is a technology deal. I'd say that our M&A activities right now, which are pretty robust in terms of the types of businesses that we are looking at, most of which are upstream, are very much technology-based. And I think that going forward, you will see sort of a greater combination of efforts between our DRS business, where we branch out both further in CNS and oncology, but also other therapeutic areas, and our core laboratory business, where we do more biomarker work in our model and also in our quest to have model creation abilities. And yes, I think the vast majority of that will be externally sourced and acquired.

Okay. And then just I might have missed it in your answer to Tim's question, but can you talk about the trends you are seeing in terms of -- in the productions business between outbred rats and the inbred models?

I didn't address that specifically. Outbred rats continues to be very much tied, obviously, to toxicology. I did emphasize in my answer the fact that a lot of the strategic deals that we are getting, both multiyear and single-year, where we are selling those animals essentially to ourselves, are showing up in intercompany and are part of our overall sales effort. And outbred rat sales have definitely stabilized for a while now. I'd say some of the inbred rat strains continue to increase on a unit basis, similarly with some of the inbred mouse strains. We're also getting a little bit of mix.

Okay. And then, Tom, just in terms of -- so the Vital River acquisition is going to add about 1% to the sales guidance?

Right.

So why didn't we get a full percentage increase to the overall consolidated revenue guidance?

We did that in December, Doug -- January -- excuse me. I think at JPMorgan, we did that. That's right.

Okay, thank you.

It was originally 3% to 5% constant currency, and at JPMorgan we bumped that up to 4% to 6%.

Okay.

Tycho Peterson, JPMorgan.

Good morning. Just wanted to follow up on some of the trends for RMS that you highlighted. Can you just talk about whether all the drop-off was volume-related? I know you talked about expectations for 1% to 2% price increases, so can you also talk about whether you've been able to implement them at the beginning of this year?

Yes, I mean, our price increases go into effect, I think we inform our clients in December. We give them a month's notice. Obviously, some of that is -- those price increases are impacted by larger deals that we have with clients, where they are either price protected or they don't pay the full discount, and that is why we haven't been reporting the full discount.

But we are going to get sort of 1% to 2% this year in RMS. We will have some share gains. Obviously, some of that share gains. that will be fewer units, and that will be unit mix. I would say that some of the strains, we have had some unit declines, which is a result of just overall pullback in spending that we saw, particularly in the fourth quarter.

Okay, and then your expectations for a rebound in that business this quarter, how much of that is predicated on things getting better in Europe and Japan versus just normal seasonality?

It is very much a combination of normal seasonality and absolutely global spending pullback by the big pharma companies. Our clients tend to move as a group. And similarly, we saw unusually high spending in the fourth quarter pretty much across the board globally by our clients. We feel that will pick up meaningfully for both reasons in the first quarter.

Then can you just talk a little bit about expectations for Endosafe? I mean, you talked about the Nexus launch later this year. How should we think about that ramping in the back half of the year, and what is kind of baked into your expectations?

I would be careful to overanalyze those. As we introduce new products -- and this is an automated product which will increase throughput in the central laboratories -- it will enhance that whole product line, particularly from a cartridge unit basis.

The best way to look at that whole business is that it is going to be double-digit growth for the next few years, at least. Combination of growing share, introducing new technologies and essentially staying ahead of the market. Also, as we've moved into microbial detection with our Accugenix acquisition, we've opened up larger market opportunities, which will clearly benefit that business.

Lastly, to clarify, you had talked about spot pricing increases in December. You mentioned it again today. Is there any kind of meaningful underlying trends here that looks like it is improving as we start out the year, or is it just very sporadic at this point?

It's hard to tell. We don't want to overstate it. In situations where we don't have very large deals that are locked in, particularly as capacity has continued to get tighter, we are testing pricing and are periodically getting it. If that periodically turns into something more consistent, that will obviously be terrific.

But there is obviously going to be some correlation between available capacity and our ability to get greater price. So we will continue to test that and hopefully continue to have pricing be more of a part of this business going forward.

Thank you.

Dave Windley, Jefferies.

Good morning. Thank you for taking the questions. I wanted to follow-up on Tycho's question there. Jim, it seems to me from your descriptions that the real opportunity for growth in this business is going to be share gains, but particularly through broader strategic relationships. Those relationships bring with them, I think as we saw with Astra Zeneca, some amount of price concession for the volume that the client is bringing to you.

I guess I'm interested in your drilling in just a little deeper to help us to understand the puts and takes on pricing. Is it net positive because utilization and spot is improving, or is it going to be net negative because the mix of your volume is shifting more toward these protected-price strategic relationships?

So these strategic deals are -- again, whether they are multiyear or single-year or even shorter periods of time -- sometimes we're just the preferred provider. And one of our top five clients doesn't want a multiyear deal, but we get virtually all of their work. And obviously, that's fine.

Look, we've always given better prices for volume, and I suspect that we always will, and that is across the board in all of our products and services. So that is really nothing new.

In these strategic relationships, as we've indicated, particularly for the very large, complex ones, we are probably going to have some startup drag in margin, and the revenue will come more slowly as we are learning to run the protocols and assays.

In the very earliest deal that we announced, we bid that work at very aggressive margins, and it has proven out over the last year to have very attractive margins, given the total volume and mix of studies and other work that we are doing for these clients. So at the margin, we still think that they are very positive in terms of getting share, having closer partnership, definitely invigorating the top line. And if we are good and if we execute well and if we drive efficiency, which we are definitely committed to, while we hope to get price, and we just talked a little bit about it, we can't guarantee that. So it is going to be volume and efficiency. We do continue to think that we cannot just drive the top line, but continue to improve our margin.

So it all conspires. I wouldn't -- if your inference is we should -- we just would never back off of pursuing these deals. The client base, particularly with the very, very large clients, is relatively small, there is a small number of clients left. There will probably be further consolidation. There will be certainly be significant, dramatic additional outsourcing. And to be the beneficiary of that outsourcing is extremely powerful and positive.

And then it is up to us to drive home the value proposition. I can just tell you that every business in this Company is spending a significant amount of time driving productivity and driving efficiency and doing everything they can to contribute to pushing margins going forward, given our basic assumption that pricing is possible but will be a challenge.

I would just add a couple of things to that. In addition to the efficiencies, either because of our familiarity with a specific client or general efficiencies across the board and more work in the parameters of the arrangement, the partnerships or agreements themselves tend to be more narrowly defined along a certain patent of studies, as you might imagine. And so as we move outside of those particularly defined studies, we have additional benefits to price those a little bit more aggressively.

In addition to that, Jim talked about more volume. A lot of these are master agreements where they provide for incremental discounts across all of their buying. So it does provide for an ability to actually pull in more work in other areas of the Company, as opposed to just, for instance, in life work.

Okay. And switching gears then, as I look back through my notes, I think the automated MCS, or Nexus, I believe you are calling that now, so -- was at the investor day in the late summer, was expected to launch in the second half of 2012. At JPMorgan, you talked about the first half of 2013. And today, you said later in 2013.

I don't know if that means just later here in the first half or if you mean the second half of 2013. I was hoping you could kind of describe what is going on there. Is there an approval that you are waiting on externally or something like that that is impacting the launch date of that product?

These products have very -- they are complicated. There is lots of hardware and complex and innovative software. We like to alpha and beta test these thoroughly, obviously, before they go out. We often get really good ideas from our clients on additional enhancements.

So we still think it will be in the first half. It slid a quarter or so. It is fine. As I tried to indicate when I was answering the last question, these additional products will have a subtle impact on the overall volume this year, mostly on cartridges. And obviously, we will always delay a product to make sure it is as perfect as possible before we launch it. And I think it is all part of the wonderful world of software, trying to call the launch dates properly.

Got it, okay. Thank you. I'll stick to the two. Thank you very much.

Himanshu Rastogi.

Good morning, and thanks for taking my question. Staying with the DCS segment and thinking about the evolution of EBIT margins in that segment, if [you win even one] after the (inaudible) partnership every year, is the midteens target attainable over the next few years? And for my follow-up, how is that partnership evolving? Thank you.

Just to clarify, the question is, as an example, on the AZ partnership, are midteens margins achievable? Obviously, which would be beneficial to the overall margin. I would go back to some of the points that both Jim and I just raised, based on one of Dave's question, where these things are priced aggressively, as you might imagine. That's probably the genesis of your question.

We do, as Jim said, believe in participating with our clients, particularly in these multiyear deals. It does increase our capacity utilization, it does provide stability and visibility over an extended period of time. So I think it is really important to participate.

The RFP process is aggressive, as you said. So we are pricing these to make good margin, margins somewhere in the range of where we are. And as we both pointed out, I think the opportunities to improve that lie with higher volume, gaining an understanding of that work -- and in some cases these clients' work is a little bit different to us from some of our other work -- doing it better. General efficiencies across the board, looking to extend this master services type agreement into other areas of business in the Company, where we can provide incremental work in say other areas of the Company, products and services.

And also, as I mentioned, these profiles of competitive RFPs are somewhat narrowly defined along certain study bands because each study is, while similar, different in many regards. So it's nearly impossible to provide an RFP that considers every type of possible study that might be done in the agreement. So once you sort of start moving away from that band, pricing is less defined, and therefore, we have an opportunity to improve that.

So I think the long answer to your question is I do think that we can continue to improve our margin in deals like AZ and across preclinical. And part of that depends more broadly speaking on pricing trends and capacity utilization and things like that as well, for which over the long haul we do think will improve.

And how is the partnership with Astra Zeneca evolving?

The status of AZ?

How is the partnership going? The partnership is going extremely well. We have very, very close scientific ties with AZ, and we are kind of using each other interchangeably. I think they look at us as AZ folks. So communications is very close. We have people working together and discussing transfer of work daily. We continue to be very enthused with long-term prospects for the relationship.

Thank you very much.

John Kreger, William Blair.

Thanks very much. Jim, could you just expand upon a comment you made earlier that you are seeing some signs of clients reemphasizing early-stage work? That is a very intriguing comment. Maybe expand upon what are the sort of things you are seeing.

I mean, we constantly ask them what the allocation is of spending between the clinic and earlier development work and even early discovery work. We've had a significant number of clients indicate that their emphasis was shifting and had shifted.

We can also tell a little bit about the shift, if you look at early development, based upon the increase in regulated preclinical studies, the nature of those studies. And also, to a lesser extent, I suppose, how some of the discovery work is coming. So we are a pretty good mirror image of client spending, particularly on a global basis, because we do so much work with so many of them.

So that would obviously be quite positive for us, if we had a better realignment of spending between the clinic and some of the earlier activities.

Great. Thanks. And then as a follow-up, if you look across both your businesses, are you seeing any change in model usage per compound? Is that going up or down or pretty stable?

I wouldn't say we've had any discernible changes in model usage.

Great. Thank you.

Ross Muken, ISI Group.

This is Vijay for Ross. Thanks for taking my question. Jim, I just want to dig in a little bit on RMS and the comment that you made, saying volumes were down and that this is -- you were beginning to see this trend in Europe and Asia, while US has been weak for several years now. I am just trying to put that in perspective. Are we saying that volumes will be -- that Europe and Asia will sort of mimic what we have seen in the US for the next few years?

It is difficult to predict that. Sometimes, Europe and Asia follows the US. But I think the phenomenon we saw in the fourth quarter was pretty much just a pullback in spending by all the drug companies on a global basis.

We would be surprised if we don't continue to get competitor wins -- continue to get competitive wins and share gains in both of those locales, as we have been for the last few years, given the weakness of some of the competition there. We are also getting price in those locales as well.

I don't know -- I think those locations, albeit smaller, are still in some ways a little bit stronger in their growth rates versus the US. And I wouldn't expect that we have any sort of dramatic change in the slope at the current time.

Got it. Could you just walk us again through the sequestration assumption? If we do have a sequestration now, sort of what would be the impact or what do you guys think could be the impact?

We have a relatively small amount of our sales specifically to the government. We have sales to the NIH, like everybody else has, and then we have a lot of government contracts. But again, in the aggregate, that is a relatively small number.

I think it is unlikely that they are going to slash ongoing contracts, particularly for -- most of those are for basic animal models, use of basic research, which I think is a pretty important part of structured research within the government. So we think that is unlikely. It is more likely to have a greater impact on things that -- new contracts being let. It could have some modest impact, I suppose, on work directly from the NIH.

But our total sales to the -- we don't break it out for US. I was going to say, our total sales for academic and government are probably about 24%, but that is worldwide, and we have a lot of government sales in Europe. So I don't have the number at my fingertips, but the impact, if any, will be very modest on that.

Thank you.

Robert Jones, Goldman Sachs.

It's Adam calling it for Bob. Just wanted to get a little more color on strategic partnerships. You spoke to 25% of your total revenue coming from strategic partnerships. What do you think -- not assuming any further partnerships, what do you think the number could get to with regards to expanding your current footprint with existing partners?

That is a bit of an imponderable. Obviously, we will work hard to have as many strategic relationships as possible. Again, whether they are multiyear or not is not particularly relevant. The point is that if you have a relationship with a client and you are either the sole source of providing the work for them or the primary source of providing work for them, I would say in a lot of cases we have that. We just got word actually this week of re-upping with a [lost] client that we already had; and the work went out to RFP and we're getting that on a sole source basis. That gives you very -- increasingly better visibility and predictability of our business model. It also gives you a better opportunity to work on pricing and also to plan for future capacity utilization.

So I don't know what that number is going to be. We would like it to be as large as possible because that means that we have enhanced relationships with our clients.

Okay, great. That's very helpful. Just also to ask around to the RMS margins, definitely somewhat disappointing relative to our numbers and the Street numbers for 4Q. How do you look at those going forward? And was this just more completely volume and seasonal-based?

In specific? Specific as to what? I'm sorry.

Were the 4Q margins -- I believe the non-GAAP was at 27.3%, which was the lowest since 2008. So do you see those re-accelerating up to 30%, or is that possibly in the high 20%s is the kind of new normal?

We do. What we said in our December guidance call is that we expected our margin to be really in-line year-over-year. I know it was a little bit lower than normal in the fourth quarter, but of course the fourth quarter is typically low, which I'm sure you are aware of; this fourth quarter was a little bit lower. We did talk about that in December, and a little bit earlier, about seeing a little bit of pullback due to clients trying to meet their budgets at year-end and what not.

So I do think other than what we said about a little bit of smoothness out of the gate in the first quarter, we do expect to see margins be pretty normal and stable overall in RMS year-over-year.

Okay, great. Thanks for the questions.

Ricky Goldwasser, Morgan Stanley.

This is Andrew Schenker in for Ricky. How are you guys doing? Just to follow-up on the margin discussion. I know you guys did discuss this in the December call, but you are expecting margins to be flat, even with benefits from the profit improvement program and increased sales.

So maybe a way to word this a little differently is what do you guys think it will take to see margins expand going forward? Is it strictly a volume issue, and kind of what is that magic point where volumes kind of exceed annual cost increases maybe?

I think it is a combination of continued volume growth. We have to work hard -- continue to work hard on efficiencies. But even with the efficiencies, we do have cost increases every year, so that is -- given the limited volume increases that we've had, it makes it very difficult to improve margin when you're not getting substantial volume or pricing.

So I do think we need some pricing. I think that environment will get a little bit better as we get more volume and the industry gets more volume. I think really it is a combination of considering to be diligent on efficiencies, continuing to improve the top line via volume, ultimately as capacity gets better, we need to start seeing some price increases.

Okay. And just following up on that, you did highlight another $20 million on the profit improvement program. Kind of where -- in which buckets is that $20 million going to fall? And then thinking forward, is there more upside to that going forward as you increase your attention on efficiency or continue your attention on efficiency?

Yes, there is. Obviously, we talked about that for 2013 in our original guidance and talked about some of the offsets to that, like normal merit increases and some inflation from some of our vendors and things like that. So I think that is the kind of thing we're going to have to do every year just to offset merit increases and things like that.

A lot of that would be in PCS. I think that is probably the number one area. We obviously have a number of savings in RMS, as well as corporate. But I think in terms of ranking them, PCS would be the rank order number one and then RMS and corporate.

Okay. Thank you.

Garen Sarafian, Citigroup.

Good morning. A couple follow-ups. One is on your strategic partnerships. You mentioned the headwinds as you invest in the relationship with these strategic partnerships. I'm just wondering, are there -- do you have anything contractually stating some sort of a volume minimum or dollar minimum so that down the road that you are assured that these investments are going to pay off?

We actually don't have dollar minimum. I can just tell you going back to the first big one we announced, we were negotiating a dollar minimum right up to the last moment. The client was very resistant to that, and I think that given the dynamism in the pharmaceutical industry, just the massive changes that they have constantly of management and drugs failing and changes in therapeutic areas, that they just hate that. It is not comfortable for them.

I remember in the last day, they said, we -- you can be confident that you will get the volume that you are asking for. We just can't contractually commit to it. I know that sounds odd. And I think the only sort of euphemistic -- or the only example I can give you is that actually on the anniversary of that deal, the dollar amount came out exactly as we had requested and that they had confirmed, albeit not in writing.

So yes, I suppose it would be better, but not if the client was uncomfortable by that and not if the client wouldn't contract with us. So I think we get a lot of these deals because we are flexible and because we are thoughtful and because we don't push those things too hard.

I understand the essence of your question is there needs be a payoff at some point for taking on this work, and obviously, we agree with that. And so far, the progression of these relationships has been quite positive. There is an opportunity for us, as I said earlier, through driving efficiency and also through the mix of studies and/or other work across our products and services portfolio that do have an opportunity to enhance both the top line and the bottom line. So we continue to feel really good about our ability to impact the contribution that these large deals will make almost as much as the clients do.

Okay. Sort of related to the strategic partnerships, with nearly 25%, you are fortunate that these relationships bring in business. But could you just perhaps talk about the competitive environment, maybe from your smaller competitors that do not have these partnerships? And with the volumes still into 2013 not yet picking up, how are your competitors reacting to fill their capacity? Are you seeing any sort of -- just overall pricing pressure, are you seeing anything change?

Not really. We have smaller competitors whose capacity is definitely not very full who are very aggressive on price. Here is an anecdotal example for you. We just won some work this week from a large client that we already had, but it was competitively bid, and we were not the lowest price. And so as we say every time we talk to you folks, science is the most important thing to our clients, and in the final analysis, it really is.

So we know what our walkaway point is. We know how much we are willing to be aggressive with pricing on the downside. We also know at what locations the volumes would be most beneficial. But we've been able to compete very effectively for the last year or two with very large comparers and very small ones, almost regardless of the pricing that they throw at us.

As I said, with this anecdotal example, we (inaudible) because the client wanted great science. We knew that at the price point we were giving them, we could deliver that great science. And we got the work, even though we weren't the lowest price. So lowest price doesn't always prevail in this market. Sometimes it does. Sometimes we are the lowest-priced. But we do that always with our eyes open.

Thanks for the questions.

Todd Van Fleet, First Analysis.

Thanks for hanging on. Jim, the free cash flow yield of the Company is pretty attractive. The growth profile for the Company overall is relatively steady. Acquisition appetite you guys have seems to be more kind of of the bite-size than something that is more significantly sized these days. So I'm wondering at what -- what would the circumstances have to be before Charles River would consider paying out a cash dividend to investors? Thanks.

Sure. We take a look at use of cash all the time. We actually have a Board committee that looks at that, along with Tom and I. It is hard to characterize acquisitions because they are -- I think our acquisitions flow is quite good, and we could have a larger number of small deals. We could have a more modest-sized deal. We have no intentions of doing anything gigantic. But we could upsize the deals a little bit. Again, that would always be the best use of our cash for strategic, accretive acquisitions, which help us to grow and service our clients.

If for some reason we were sitting here and had gone -- I don't know -- a couple or three years without doing any acquisitions and cash was mounting and we thought our leverage was where we wanted it to be, I suppose we could determine that a dividend would be the best use of the cash at the time. So -- and/or buying back stock.

So it is always circumstantial. We always look at all of the possibilities pretty much on a continuum. You know what our preference is, but we have a responsibility to utilize our cash responsibly and to give shareholders the best return. And so I would never say we would never do anything.

And so we will continue to watch it, although I would have to say that our M&A pipeline is unusually strong because we've been working on it very, very hard and we are seeing some things now that are of significant strategic merit.

Thanks.

With that, speakers, I'd like to turn it back over to you for any closing comments.

Thank you for joining us this morning. This concludes the conference call.

Ladies and gentlemen, that does conclude your conference call for today. Thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.