Charles River Laboratories International Inc (CRL) 2013 Q3 法說會逐字稿

Welcome to the Charles River Laboratories third-quarter 2013 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, today's conference is being recorded.

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

Please go ahead.

Thank you.

Good morning and welcome to Charles River Laboratories' third-quarter 2013 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 2013.

Following the presentation we will respond to questions.

A slide presentation associated with today's remarks 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 304430.

The replay will be available through November 13.

You may also access an archived version of the webcast on our Investor Relations website.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, 2013, as well as other filings we make with the Securities and Exchange Commission.

During this call will be primarily discussing results from continuing operations and non-GAAP financial measures.

We believe that these non-GAAP financial measures help investors to gain a meaningful understanding of our core operating results and future prospects consistent with the manner in which management measures and forecasts the Company's performance.

The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP.

In accordance with Regulation G you can find the comparable GAAP measures and reconciliations to those GAAP measures on the Investor Relations section of our website through the financial reconciliation 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 $292 million in the third quarter of 2013, an increase of 4.8% over the previous year.

Excluding the negative impact of foreign exchange, sales increased by 5.6% with both the RMS and PCS segments reporting mid single-digit growth for the first time since 2008.

The PCS segment reported another strong quarter with 6.3% constant currency sales growth.

On a sequential basis PCS sales increased 4.2% representing the second consecutive quarter in which sequential growth exceeded 4%.

We are encouraged by the sales progression over the first three quarters of the year which certainly reflects our market share gain as well as improved demand for both large biopharmaceutical and mid-tier clients.

As was the case in the first half of 2013, the acquisitions of Vital River and Accugenix and a strong performance from the legacy EMD business drove RMS sales growth, which increased 5.1% in constant currency.

Year over year the consolidated operating margin improved by 150 basis points to 18.5% while earnings per diluted share increased 21.5% to $0.79 in the third quarter.

Several tax-related items and a limited partnership investment gain were the largest contributors to the year-over-year improvement in the margin and EPS.

These items contributed approximately 150 basis points to the consolidated margin and $0.07 to earnings per share in the third quarter.

Tom will provide additional information on these items shortly.

Excluding these items the consolidated margin was similar year over year.

Higher sales yielded a 150 basis point improvement in the PCS margin, which was effectively offset by the 30 basis point RMS margin decline and higher corporate costs.

Earnings per share were $0.79 including the $0.07 of special items.

Excluding the items higher PCS operating income was the primary driver of earnings increase.

We continued to return value to shareholders in the third quarter through our share repurchase plan with the purchase of approximately 1.4 million shares for $65.5 million.

We are narrowing our sales growth guidance for 2013 to the low end of our prior ranges or between 4% and 4.5% constant currency.

This is consistent with our year to date growth of 4.3%.

The continued success of our targeted sales efforts has reinvigorated growth in the PCS segment this year, which we expect will result in PCS growth above the consolidated range.

Because of the impact of global biopharmaceutical companies' facility rationalization on demand for research models, RMS segment sales growth is expected to fall below the consolidated range for the year.

However, the strong PCS performance, as well as our continued focus on operating efficiency and stock repurchases, is enabling us to narrow our non-GAAP EPS range to the high end of our previous range or $2.85 to $2.90.

I would like to provide you with details on the third-quarter segment performance.

RMS segment sales were $173.5 million, a 5.1% gain in constant currency.

The increase was due primarily to the acquisitions of Accugenix and Vital River which continue to exceed our original expectations.

In addition to the acquisitions, a strong performance from our legacy EMD business also contributed meaningfully to RMS sales growth in the third quarter.

Sequentially sales declined nearly 4% as expected due to normal seasonality in the small models business during the second half of the year.

The RMS operating margin was 29%, a decline of 30 basis points from the third quarter of 2012, due primarily to lower legacy sales of research models.

Pricing gains of 1% to 2%, strengthening demand from mid-tier clients and market share gains, particularly in the academic sector, did not offset reduced sales of research models for global biopharmaceutical clients.

Although lower volume can have a significant effect on the operating margin, we intend to maintain the RMS operating margin at or above 30% on an annualized basis.

Therefore we are continuing to work diligently to enhance the operating efficiency of our production business.

The consolidation of three production rooms at our facility in California, which we discussed on our second-quarter call, is one example of initiatives we are undertaking to improve the RMS operating margin.

The EMD business again delivered an outstanding performance with year-over-year sales growth of approximately 25%, including the (technical difficulty).

The PTS franchise exhibited strength across all geographic locales as we increased sales of instruments and cartridges and continue to take additional share in the conventional testing market.

We are driving growth through a number of approaches with the most significant opportunity being in the large central laboratories.

We are in the early stages of converting large pharmaceutical manufacturers' central laboratories to the PTS cartridge technology; so expect that we will be able to drive growth in this market for the foreseeable future.

Accugenix marked its one-year anniversary as part of the Charles River portfolio at the end of August and we are very pleased with the status of its integration.

One of the reasons that Accugenix is performing ahead of plan has to do with the fact that we are successfully leveraging cross-selling opportunity.

Aside from promotion of the PCS family of products to Accugenix existing clients and the Accugenix microbial identification capabilities to Charles Rivers, we are selling a combined package to all clients.

We've also expanded Accugenix global reach with new facilities in France, Korea and India either opened or scheduled to open this year.

We intend to continue investing in both product extensions and acquisitions like Accugenix, in order to drive EMD growth.

Sales of Research Models and Services declined approximately 2% in the third quarter due primarily to the expiration of two long-term contracts for certain services in Europe at the end of 2012.

As we previously noted, these contracts represented approximately $5.5 million in annual revenue.

However, a portion of this amount has been offset as some of our clients have increased their reliance on outsourcing of early in vivo research.

DRS sales have improved in each quarter in 2013 as clients increasingly chose to utilize our expertise in oncology and CNS in lieu of maintaining internal capabilities.

We have continued to win new business with both large biopharmaceutical and mid-tier clients and are working to build a flexible relationship which we believe is best suited to each client's individual needs.

Because we believe that the majority of in vivo discovery work is still done in house and the outsourcing opportunity is significant, we are enhancing our capabilities and strengthening our management bench.

I am very pleased to announce that Dr. Emily Hickey recently joined Charles River from Merck Research Labs to lead our in vivo discovery operations.

We believe that under Emily's leadership we will enhance Charles River's position as a leading provider of in vivo Discovery Research Services and encourage clients to rely on us instead of their in-house discovery capability.

Although third quarter sales for GEMS outside the US were down slightly, the US business had a strong third quarter.

US researchers are continuing to develop more complex models of human disease for use in translational research.

Given the challenges of working with these specialized models, are outsourcing services to us in order to access expertise they do not have in-house.

In addition to our scientific expertise, clients are choosing to work with us because of other competitive differentiators such as the Internet Colony Management system, or ICM, which allows clients to have real-time access to data about their colonies.

Strengthening demand for outsource services was also evident in our third-quarter PCS sales, which at $118.7 million reached their highest level since the first half of 2010.

We were very pleased with growth of 6.3% year over year and 4.2% sequentially.

Growth was driven by the continued benefit for market share gains, as well as increased study starts and overall study volume versus last year which we believe is indicative of improving demand.

Mix was also a factor in the improved sales and operating margin.

There was a notable increase in specialty services in the quarter.

This favorable study mix and increased volume led to a significant improvement in the third-quarter PCS margin.

Third-quarter margin also reflects the benefits of efforts we've undertaken to streamline operations and drive operating efficiency and best practices across the organization to enhance profitability.

In combination these factors increased the operating margin by 150 basis points year over year and 230 basis points sequentially.

The tax-related items contributed 370 basis points to the margin gain.

As a result of improved demand our capacity is continuing to be well utilized.

As industry utilization approaches more optimal levels, we are confident that pricing will eventually follow.

This will enable us to continue to increase the operating margin.

Third-quarter spot pricing was relatively stable at approximately 1% in the third quarter, consistent with our experience throughout 2013.

Furthermore, we have recently won RFPs for which we are not the lowest bidder.

As global biopharmaceutical companies reduce their infrastructure in favor of reliance on CROs they do not want to compromise on scientific expertise.

While price is an important consideration expertise and quality are most often considered more critical.

When those criteria are critical, Charles River is the preferred choice.

Our mid-tier clients increased their purchases across our broad portfolio of products and services.

And PCS sales to global biopharmaceutical companies also increased in the third quarter.

Our targeted sales efforts have been very successful, enabling us to gain market share.

Revenues from strategic relationships continue to represent approximately 25% of total sales, which gives us improved visibility and predictability.

In addition, we are also executing well on our goal to cross sell services beyond the initial scope of the RFPs.

As large clients increasingly view us as an essential element of their R&D teams and more fully understand our capabilities, working together, we're identifying additional opportunities for outsourcing.

Now that the first group of strategic relationships we won is maturing and the logistics of working together are established, the opportunities with these clients are becoming more numerous.

Discussions about these opportunities are ongoing as are discussions with other biopharmaceutical companies about new strategic relationships.

We believe that as large clients continue to rationalize capacity they will select Charles River to provide outsourced services and rely on us for the expertise that they no longer are maintaining in-house.

It is our goal to win a majority share of these opportunities.

Sales to academic and government clients increased slightly in the quarter with softness in global government sales more than offset by strong sales growth for academic clients.

In the US we don't believe that the impact of sequestration intensified, so we are maintaining our estimate that the impact in 2013 should be approximately $3 million.

We have also evaluated the extent to which the government shutdown may impact fourth-quarter sales and believe that the effect will not be significant.

In the academic sector we continue to gain market share as a result of targeted sales efforts.

Many of the more prestigious academic institutions are being funded by global biopharmaceutical companies and, recognizing the value of our expertise and the quality of our products, are choosing to work with Charles River.

For the last five years where focused on positioning Charles River to be the partner of choice for all of our clients, global biopharmaceutical companies, mid-tier biotechnology companies and academic and government institutions.

Towards that end we undertook multiple initiatives that were focused on differentiating Charles River as the preferred partner for early-stage drug development -- expanding our broad early stage portfolio through internal development and selective strategic acquisitions, maintaining and enhancing our extensive scientific expertise, improving our operating efficiency so that we could pass the savings on to our clients, providing best-in-class client service, developing state-of-the-art data systems and portals which offer clients real-time access to data, and structuring creative, flexible solutions that support each client's drug development goals.

As a result we believe we are extremely well positioned at this particular moment in time when the search for novel therapeutics is accelerating across a broad spectrum of R&D engines.

Global biopharmaceutical companies are making the critical decision to outsource larger tranches of their drug development efforts.

Mid-tier biotechnology companies are using new funding from both the public markets and global biopharmaceutical companies to advance discovery efforts.

And academic institutions are playing a more important role as the source of new molecules for global biopharmaceutical companies.

Each of these discovery engines needs a CRO like Charles River.

We have a unique and diverse early stage portfolio and the scientific expertise to support their drug development efforts and the ability to tailor a solution which meets each client's individual needs.

We believe that our market share gains are evidence that clients view us as a trusted partner.

And we were very pleased to be ranked as the best positioned CRO to provide both discovery and preclinical services by two recent surveys undertaken by analysts.

We will continue to execute our strategy and maintain our focus on driving sales, cash flow and earnings growth.

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

I will begin by providing additional details on the tax-related items and limited partnership investment gains that contributed to the significant increase in third-quarter PCS operating margin and EPS.

These items are included in our non-GAAP results, but we believe that the magnitude and timing of these items warranted more specific disclosure.

There were four tax-related items, three of which impacted the PCS operating margin as well as an investment gain that benefited other income.

In the aggregate these items benefited the PCS operating margin by 370 basis points, the consolidated operating margin by 150 basis points, and added $0.07 to EPS in the third quarter.

Regarding the tax-related items, we adopted a UK tax law change in the third quarter related to the treatment of R&D tax credits.

Under the new law existing enhanced R&D tax deductions are replaced with a refundable tax credit that is recorded as a benefit to PCS segment operating income instead of income tax expense.

In the third quarter we recorded a $1.7 million or 140 basis point benefit to PCS operating income which was largely offset by the corresponding 220 basis point increase to our tax rate.

As a result the impact to EPS was neutral.

These third-quarter amounts also include a true up for the second quarter since the law was retroactive to April 1, 2013.

Going forward the UK tax law change is expected to benefit the PCS operating margin by approximately 70 basis points per quarter and increase our tax rate by approximately 120 basis points, but have no impact on EPS.

The second item also occurred in the UK where we received a favorable property tax abatement related to our PCS Scotland site.

This resulted in a benefit of $1.1 million to PCS operating income and 90 basis points to the PCS margin in the third quarter and added approximately $0.01 to EPS.

The third tax-related item involved a multi-year settlement reached with the Canadian tax authority related to R&D tax credits associated with PCS Canada.

As a result of this favorable settlement we recognized a benefit of $1.6 million to PCS operating income and 140 basis points to the PCS margin, a reduction of approximately $700,000 in interest expense and a benefit of approximately $200,000 to income tax expense.

In total the Canadian tax settlement benefited third-quarter EPS by $0.05.

The final tax related item was associated with an ongoing tax audit related to Canada and Canadian transfer pricing.

In the third quarter we decreased a tax asset by $2 million which reduced EPS by $0.04.

However, unlike the first three tax items that I discussed, this tax adjustment did not affect operating income.

In addition to these tax items we also reported a gain of $3.5 million or $0.05 per share on a limited partnership investment.

This gain, which was reported in other income, related to our investment in a large life science venture capital fund.

Several of the portfolio companies have completed their IPOs and the gain related to their market performance in the third quarter.

In addition to the favorable performance of the portfolio investments to date we are also the preferred provider of discovery and Preclinical Services to many of the portfolio companies.

We have also entered into smaller relationships with other venture capital firms.

These relationships enable us to access a group of more than 100 emerging biotech companies at an early stage and offer us the opportunity to provide them with our products and services to fulfill their drug discovery and early development needs.

As Jim discussed, our strong third-quarter performance was largely driven by higher sales and PCS margin expansion.

I will now provide additional details on the non-operating items that affected our results.

Unallocated corporate costs increased by $1.8 million year over year to $17.7 million and were $0.6 million higher sequentially.

The year-over-year and sequential increases were primarily driven by various expense categories, including unfavorable changes to health and fringe related items and performance-based compensation expense.

We now expect unallocated corporate costs to be slightly more than the 6% of sales for the full year compared to our prior outlook of approximately 6%.

Net interest expense was $2.2 million in the third quarter, a decline of $1.6 million from the second quarter.

The significant decline reflects lower interest rates as a result of the amendment to our credit agreement and subsequent refinancing of our 2.25% convertible notes at the end of the second quarter, as well as the approximate $700,000 benefit to interest expense related to the Canadian tax settlement.

We now expect 2013 net interest expense to be approximately $13 million to $13.5 million, which below our prior outlook of $15 million to $17 million.

Other income was favorable at $4.1 million in the third quarter compared to $1 million in the second quarter.

As I mentioned earlier, $3.5 million of income was related to a gain on the limited partnership investment.

The remainder of the income was primarily related to investment gains associated with our deferred compensation program.

Since these items are principally driven by market-related returns, we do not forecast any amounts for the other income line item thus creating a sequential headwind for the fourth quarter.

Non-GAAP tax rate increased significantly on both a year-over-year and sequential basis 31.1% in the third quarter.

Excluding the items I mentioned earlier, which added 450 basis points, the non-GAAP tax rate would have been essentially in line with our expectations.

We now expect our non-GAAP tax rate to be in a range of 27% to 28% for 2013, including the third-quarter items, which are expected to have a 180 basis points impact on a full-year basis.

This compares to our previous range of 25.5% to 26.5%.

Free cash flow was robust in the third quarter largely driven by our strong operating performance.

In the third quarter we generated $58.5 million of free cash flow, an increase of nearly $8 million from last year.

As a result we now expect free cash flow to be $170 million to $175 million in 2013 which is at the high end of our previous range.

DSO's remained flat sequentially at 54 days and were two days higher than the third quarter of last year.

However, we continue to expect an improvement in DSO's by year-end.

CapEx was $9.1 million in the third quarter and $25.3 million year to date.

Despite the lower year-to-date run rate, we continue to expect CapEx of approximately $50 million in 2013 based on the anticipated timing of capital projects.

We continue to balance our capital priorities between stock repurchases and debt repayment as well as targeted acquisitions.

As we noted on our second-quarter call, we plan to repurchase more shares than our previously affected range of 1 million to 1.5 million shares in order to help offset the dilution from option exercises.

We've already repurchased approximately 1.9 million shares for $88.5 million in the first nine months of 2013 and expect to continue to moderately repurchase shares in the fourth quarter.

We expect the repurchases to result in a year-end diluted share count of slightly less than the third-quarter level of 48.4 million shares.

This would equate to a full-year average share count of approximately 48.5 million shares.

We had $66.3 million remaining on our $850 million stock repurchase authorization at the end of the third quarter.

As Jim discussed, we narrowed our 2013 sales guidance to the lower end of our previous range while non-GAAP EPS guidance was narrowed to $2.85 to $2.90, which was the high end of our previous range.

This EPS guidance range includes the $0.07 benefit from the tax-related items and investment gains in the third quarter.

You may recall that on our second-quarter conference call we announced the planned closure of three production rooms at our California research model facility.

As a result of this action we reported an accelerated depreciation charge of $6.8 million in the third quarter and expect to record a similar charge of approximately $7 million in the fourth quarter.

These charges equate to approximately $0.16 per share for the full year and are the primary driver behind the reduction in our GAAP EPS guidance range to $2.23 to $2.28.

Looking ahead to the fourth quarter we expect a modest sequential decline in both sales and EPS primarily reflecting seasonal trends in both business segments.

RMS sales are expected to be slightly lower than the third-quarter as demand for small models normally declines in the fourth quarter due to lighter holiday ordering patterns.

In the PCS segment sales are expected to be moderately lower on a sequential basis 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 preclinical work.

Given the volume sensitivity of the RMS and PCS businesses we expect that there will be some pressure on the operating margin in the fourth quarter.

Based on seasonality and the other factors I have discussed, fourth-quarter EPS is expected to be lower than the third quarter level even after excluding the $0.07 of tax-related items and the investment gain.

We are pleased with our third-quarter operating performance and the progress that we have made to return value to our shareholders.

I would like to conclude with one scheduling note; we plan to provide 2014 guidance in February when we report our fourth-quarter 2013 results.

Thank you.

That concludes our comments.

Patricia, would you please take questions now?

(Operator Instructions).

Dave Windley, Jefferies.

I wanted to ask a couple around demand.

So first of all, Jim, you called out large and mid-tier clients that are increasing their business with you.

I would be interested in your fleshing that out a little bit, but including why you seem to be specifically not saying small biotech.

And with the funding flowing to that category I am just wondering why that is not a more significant uptick in demand.

Yes, Dave, that is just a difference in nomenclature.

So we use the term mid-tier really to describe biotech clients, really sort of middle size and smaller biotech clients actually.

So we are seeing really strong demand from large pharma, first-tier biotech and smaller ones as well and actually even some academic clients.

Many large academic institutions, particularly some of the large hospitals, develop their own compounds and others are responsible for developing compounds for pharma as well.

So, yes, we are pleased with demand, we are pleased with market share gains.

We are particularly pleased with the number of study starts and the mix of studies with a slight uptick in specialty work which has always been our strength and, as we've said previously, is an area where we have less price sensitivity.

Okay, great.

And then on the broader call them strategic deals you have had one fairly high profile one in each of the last two years.

We are coming up on -- we are moving toward the end of this year and there hasn't really been that high profile announcement this year.

Maybe it has just not been announced.

But just some checks suggest that that RFI activity for broader strategic deals is a little quiet right now.

And I guess I would be interested in your comments on interest level and discussions and timing around those as well.

Sure.

We've said in prior calls that it has become increasingly more difficult for us to call these deals out because we literally can't call them out by name.

So what we have done is we have gone to a percentage of overall sales that they represent, which we identified at around 25%.

There is a fair amount of activity.

So in addition to the one that we called out by name and the one that we called previously more euphemistically, we've had several large clients like that with whom we have done deals.

Some are multi-year, some are single-year and some are almost from quarter to quarter, but clearly we've been deemed their principal provider to those clients.

And I guess that we're seeing two things happen right now.

The clients that we have large strategic deals with, regardless of the length, we are in discussions with many of them about additional services that we can provide, or products, across our entire portfolio, which are often not the initial reason that they came to us.

And they are looking to enhance the partnerships and get the benefit of the value proposition.

I would also say that we are in discussions with several other clients about additional deals.

And there has been a fair amount of activity recently in terms of responding to RFPs for both current clients and potential new ones.

So I would say that the space remains active, the interest by clients on outsourcing remains consistent and focused, and the opportunity to walk share up with current clients is becoming a reality.

Very good, thank you.

John Kreger, William Blair.

Jim, a question about the R&D restructuring trend within large pharma.

I'm sure you don't want to talk about any of these companies in particular.

But just in general when you see the type of news that we saw out of Merck a month or so ago, what other kinds of puts and takes ripple through your P&L?

And net-net, do you view that as a positive or a negative let's say over a 12- to 24-month period?

Sure.

So we are not going to comment on any particular client and certainly not the one that just reduced infrastructure, although you should presume that we do meaningful amounts of work with all the major drug companies.

So, these continue to be a fact of life for all of us, John.

The impact on us is always different depending on how much work we have done with them previously and what portion of their infrastructure they actually take off-line.

But clearly we've seen a couple of things.

We have seen an adverse impact on unit sales in our research model business, and that has reflected pretty prominently this year, certainly for the last three quarters and a bit last year as well.

So while we have gotten some share, while we have had market share gains significantly in the academic sector, and while we have had a pretty good mix in the research model business, the unit decline has been substantial enough to put some downward pressure on the growth rate of that segment for us as well as the margin.

And you have seen a bit of that this quarter as well as the prior quarters.

There is -- and that can obviously stabilize over time.

But there's certainly an initial impact.

We see an upward tick -- after some period of sorting out internal structures, we see an upward tick almost immediately in our services businesses.

And that is everything from GEMS work to non-GLP and GLP tox work.

A lot of the space that's being taken off-line by many of these companies is in classic GLP tox and some of it is in the early discovery work like early PK work, which we are doing an increasing amount of.

So net-net we see this as an opportunity to provide an increased range of services for large clients who used to do most of the work internally.

And we think they will provide some very good opportunities for us.

Great, thank you.

One quick follow-up.

In your PCS business are you seeing any hints of study start delays creeping up?

Or is there still plenty of spare capacity around the industry so programs can be started immediately?

You make me a little superstitious answering that, John.

We have seen -- in prior year's fourth quarter towards the end of the year we get nervous about that.

We didn't see any through the third quarter at all and we haven't seen any sort of to this point in time.

Nothing unusual.

We have the normal delays of a test article not being ready or formulation difficulties.

But we're not seeing the sort of, ah, we've got to put everything on hold and wait until the next fiscal year because we are either running out of money or we want to watch our expenses.

We had our antenna up for that.

But on seeing it I can't predict the balance of the year, but it feels like that is going to be unlikely.

So that is -- the fourth quarter is very difficult to call, but I would say that clients seem to be working hard, they seem to be outsourcing significantly and there seems to be culling their pipelines down relatively early in the process.

Often when we get involved it's with a compound that they have high hopes for so they tend to drive it right through all four cores.

We also are seeing clients trying to finalize and do IND filings before the end of the year, so that helps us as well.

Great, thank you.

Greg Bolan, Sterne, Agee.

I realize this is somewhat of a sensitive question, but as we think about global staffed capacity utilization for the preclinical CRO industry, I mean we kind of consistently these days are coming back with mid-60 percentage levels.

But as I've spoken to you in the past, Jim, and just kind of hearing your comments today and looking at PCS results, even excluding some of these nonrecurring items, it would appear that cost absorption is really starting to rise.

And presumably you are above the industry capacity utilization levels.

Is that fair to say?

Yes, it is.

We don't have any published information and obviously we can only garner from what our public competitors say and some of the private ones anecdotally say.

We also know a little bit about competitive capacity based upon work that we are bidding on, whether our competition seems to be able to take it in quickly or not.

But based upon the last indications of how busy the rest of the marketplace is it appears that we remain considerably above them.

Our capacity is increasingly better utilized.

Our client lists are extremely attractive.

There are a lot of big drug companies, there are a lot of big biotech, and there is a healthy amount of small biotech clients that we are doing extremely well with in part because of enhanced relationships with some of the venture capital firms that bank them.

We are being a little bit more selective, we are getting a little bit of spot pricing and we're having a better mix because the work comes to us and if the drug looks promising the studies tend to elongate.

So, yes, we are not fully utilized yet.

And from a competitive point of view, we still certainly have the issue that while we have an increasing number of clients who are loyal and have a preference for our quality.

And as we said in the prepared remarks, we have been winning some studies where we are not the lowest price.

Having said that, there are some clients that are extremely price-sensitive and also extremely time sensitive and won't wait even a relatively short period of time.

So we have to be careful about that and I think that is impairing our ability to be more aggressive with price.

But generally speaking we are really pleased with the overall trajectory of demand and how space is filling.

Thanks, that is helpful.

And then just a quick second question.

Just would be interested to hear about I guess the background as it relates to the hire of Emily Hickey.

I guess she replaces Michael Luther in Discovery Services.

She joins it sounds like from Merck.

And just would love to hear a little bit more about kind of how that went down and that would be helpful, thanks.

Emily is someone that we have known of from the client side, she is very prominent in the industry, particularly in the discovery space.

Is a sort of marquis scientist with expertise across multiple therapeutic areas and appeared to us to be a good manager.

And I think the timing just work out well in terms of our need for someone and her desire to make a move.

We very excited about having her here and very confident that her background and leadership ability will be beneficial to this part of our business.

And also she has literally been in the shoes of most of our clients and can talk to them as someone who had a corporate relationship with us.

And someone who used other suppliers as well I am sure and has some objectivity about the capabilities and expertise that exist out there.

So we think -- she has only been here a couple of weeks but has immediately enhanced our capabilities to migrate services to our clients.

Thanks, Jim.

Jeffrey Bailin, Credit Suisse.

[I noticed] that you talked a little bit about the Discovery Services market.

There's been a lot of debate about the appetite for sponsors to really actively outsource here.

Could you talk about the discussions you are having, really how you kind of see the growth of that market evolving over time?

Sure.

It has very strong parallels to the tox market.

It is a marketplace that the clients will be comfortable outsourcing when they get ready.

And by that I mean when they discern that they can't afford the internal infrastructure and/or the capability of outsized providers like Charles River are as good or better than their internal capacity.

Our capabilities are always a lower cost to them because their internal cost structures are quite significant and we move as quickly and often times faster than they do.

So it is a willingness and openness to do that.

You know, the AZ deal, which is only one we could openly talk about, was a lot of that.

It was a combination of reduced capacity and outsourcing both discovery and tox work and just getting comfortable doing that.

We end up doing the work very much like the clients did it internally.

So what we believe we will see over time is an increased necessity on the part of the client economically to outsource this work, A; B, an acknowledgment -- I'll just talk about us, acknowledgment as we continue to build out our discovery capabilities that we have significant enough science for them to be comfortable outsourcing, which we are hard at work on both organically and hopefully through additional M&A.

And that there is a partnership that has developed over time with us that gets the clients comfortable and knows that they can trust us and that will provide good science and very good transparency.

So you can actually see the market beginning to develop the way tox did.

The difference between now and 25 years ago when tox developed was that the drug companies were much different, much richer, much more internally focused and capable.

And now we see significant infrastructure reduction and a fundamental change in the way they do business and much more virtual structures.

So we do think that discovery work will pick up, it is a $4 billion to $6 billion opportunity that is 10%, maybe 15% outsourced on a very, very fragmented basis and that provides very, very good opportunities for us and others.

Great, thank you.

And then maybe just one follow-up.

Obviously the large models volume has been pressured for several quarters now and even in the face of some of the improving preclinical trends that you are seeing on the demand side.

Obviously some headwinds from facility consolidation amongst big pharma.

But you kind of mentioned that it could get to a little bit more stable place here.

What needs to happen in the marketplace maybe stabilize or evenly to some volume growth on the research model production side?

We have to have a period where we don't have multiple large pharma companies taking multiple large research facilities off-line simultaneously.

So we have had a pretty dynamic couple of years.

We do think that will benefit us nicely in our service businesses.

We are definitely being impacted by it in the research model business.

At some point the very large facility reductions should slow and at some point they will stop.

It is impossible for us to predict if, when and how they will do this or who will do it next.

So if we have some sustained period where that doesn't happen given that we will most assuredly have some price increase, as we have had every year, next year and as we're continuing to really work hard on efficiency in the research model business, even though we have been doing it for a long time.

And as we continue to take share across the board, but principally in the academic marketplace, we do think there's an opportunity to have some modest growth in that business.

And obviously if you look at RMS as a total sector, we feel that we can have at least mid single-digit growth all in.

Great, thanks so much for the question, guys.

Tycho Peterson, JPMorgan.

Maybe just following up on that last question on RMS.

As we think about the fact that you kind of restated your operating margin targets at 30% or above for that business, can you maybe just talk about whether you need to pull additional levers in light of the fact there is still some pressure on the top-line for RMS?

Yes and no, Tycho.

The levers that we will continue to pull are really looking at that business with fresh eyes with a view towards enhanced automation, less labor intensity, and sort of questioning how we have done everything.

So it is a very, very efficient and profitable business.

But we actually think there are ways to enhance it.

We have talked about our inventory management system that we have used in our GEMS business.

We are now looking to use that in other parts of our production business, which has automated a lot of our data collection of our animal models.

So do think we can get a margin in the core animal business.

And obviously other parts of research models, RMS (multiple speakers) the segment that reports, hopefully continues to report over 30%, has EMD, which has very strong margins, has a whole host of services which have strong margins as well.

And most of those businesses are growing.

So we think that the blend of products and services in that segment with an enhanced focus on driving operating efficiency in a larger research model business -- and I'm obviously talking about on a global basis -- should help us keep those margins North of 30%.

And to get back to that mid-single-digit growth in the market you talked about a minute ago, I mean restructurings aside, is there some risk that there's just a broader secular shift here, just fewer animal models because of targeted trials maybe more in silica work?

Are there other dynamics playing into the RMS volume trend beyond just restructuring?

Yes, I think that is true.

But really has had very miniscule impact on units.

But when we are talking about RMS mid single-digit we are talking about all in.

And so, if I had to give you an assessment of just research models without (technical difficulty) without EMD, without -- in our avian business, all the things that are reported in there, which I think is how you are driving the question.

I think we are sort of looking at low single-digits for that business, if we don't have additional substantial facility reductions, which we may.

So if we don't we'll probably have low single there enhanced and buttressed by much, much higher growth in the EMD business obviously.

And we have sized that for all of you in our other service businesses as well.

So we are comfortable with at least mid-single in that sector; and again, it has a lot to do with what the larger companies do with their internal capacity.

Okay, last one on your own capacity.

I know you had the question on utilization before, but as we think about the rooms that you are sitting on that are not open, Shrewsbury and other facilities, can you maybe just talk to how you think about opening up or freeing up additional capacity over time?

Very carefully.

We have just lived through a protracted period, still living through a protracted period where there was too much capacity in the overall system at a time when demand was slow related to that capacity, so it has been challenging.

Now that we see our space filling quite rapidly we obviously like that, we are still able to be responsive to our clients, both old and new.

We have some small amounts of space that we -- some of which we have opened, some of which we're in the process of opening and some of which we haven't.

That is pretty subtle and that should not have any track on anything.

Something as significant as Shrewsbury, which we obviously would love to open, and as the concentration of life sciences companies grows in the Cambridge area, it really seems an even more compelling proximity than it ever was.

But we would probably need two or three very large clients to make a significant commitment to us almost simultaneously because the running costs of that facility are not insignificant.

So directionally, we think that has great strategic opportunity for us in the future.

We also think that obviously as our space fills and everybody else fills as well that there will just be an overall need for more capacity in the system, particularly on the East Coast both would regard to Cambridge and the large pharmaceutical companies that are in New York, New Jersey, and Philly areas.

So there will be a point where we will be increasingly pleased with the fact that we already have facilities built, we have just got to be careful about how and when we open them.

Okay, thank you very much.

Rafael Tejada, Bank of America-Merrill Lynch.

Just a couple from me.

And a little bit more -- just digging in a little more on the RMS side of the business.

So as has been discussed, it appears that softening of volumes and the legacy research models business is still impacting the progress in RMS.

But can you also talk about what you are seeing in the competitive landscape?

I guess I am just trying to get a better sense of the discussed sequential decline in the business since I have to go all the way back to 2008 to see another quarter in which we saw that sort of decline?

So, our competitive position continues to strengthen.

We are continuing to take share, some in the pharmaceutical sector, some in the biotech sector, but I would say the principal share gains have been in the academic sector given the narrowing of our price points relative to the competition.

I think from a science and service and IT point of view we are way ahead of the competition.

And we are seeing our clients buy more across the larger portfolio and also they want some global consistency, certainly the large clients do.

So while we continue to have great respect for our competition, we take it seriously, we don't have any competitors in the research model business with either the scale or the scientific capacity or infrastructure that we have in proximity to our clients.

Of course we've recently enhanced all of that with our Vital River operation in Beijing which is growing very nicely, well ahead of our acquisition plan.

And, yes, we are enjoying our competitive position.

And, Tom, just had a -- wanted a clarification on the full-year EPS guidance on the non-GAAP side.

Obviously now seeing $2.85 to $2.90.

But can you help me just get a bridge for that, the change in EPS guidance just given the tax items and investment benefits this quarter?

And also, just looking at the $0.24 benefit from impairment and other items that is now seen at $0.24, before it was $0.05, so where are the $0.19 coming from?

Thanks.

Okay.

Well I think your question talks about the latter part of it, a GAAP-related item only.

And the earlier part of your question, of course, was about our non-GAAP guidance of $2.85 to $2.90.

So what we did was we narrowed our range from $2.80 to $2.90 on a non-GAAP basis to $2.85 to $2.90, which was the higher end.

And we did indicate that that included the $0.07 that we pointed out specifically in Q3, a combination of the tax items and the investment gain.

We also noted that sequentially we don't really forecast those types of things because they are more discrete and so that essentially we view those prospectively as sort of net neutral items or zero.

So that is where we are in the non-GAAP.

With respect to the impairment or the accelerated depreciation that you called out and the increase in that particular item, we lowered our GAAP range for that only.

No impact since we excluded it in our non-GAAP results.

No impact in our non-GAAP results.

And had said in earlier conversations that we expected to move through that plan by year end and expected to have a benefit going into next year as a result of the reduced capacity on the West Coast.

Basically on I guess simplified on an apples-to-apples basis as I am looking at guidance, from what it is today and what it was before, is it really just the $0.07 that is the newly introduced item?

I think the answer to that is yes if I understand the question correctly.

I mean we had the $0.07 in the third quarter; we are including it in our non-GAAP numbers for the year and basically making you aware of it specifically.

Okay.

Okay, maybe I will take a couple other off-line.

Thank you very much.

Tim Evans, Wells Fargo Securities.

Could you delve in a little bit more to the long-term guidance that you touched on with Tycho's question?

If I heard you correctly you are talking about low single-digit growth in RMS and higher growth in PCS to bring the consolidated growth in the mid single-digit range.

I guess the first part of the question is, is that all organic?

And the second part of the question is what are your long-term margin targets at this point?

I believe at one point you were hoping to reach 20% consolidated and then it was -- kind of the commentary following that was approaching 20%.

With a better margin performance this quarter do you see yourselves getting solidly back to 20% at some point?

That continues to be a long-term aspiration for us.

Without moving into 2014 guidance, which we are obviously not ready to give, I would say that we are very interested in getting preclinical to 15% kind of as the next guidepost.

We are certainly knocking on 2015 right now pretty close this quarter.

RMS we believe, and again RMS includes all the services in EMD, we believe we can keep those margins over 30%.

So certainly trending towards 20% all in.

And we think that growth rates hopefully will shake out or sort of mid single-digit for -- at least mid single-digit for both sectors.

And we are certainly in the hunt to do that.

Having done that on a consolidated basis for this quarter and having done that the first -- actually the first time having both segments perform relatively consistently in almost five years, so the economic downturn.

We feel better about the demand curve, better about our competitive position and better about additional services and products that the clients would want.

So we think it is a very -- it is a unique and competitively strong portfolio, which we are going to work hard to continue to enhance both organically, a little bit geographically and certainly through M&A upstream as we have said countless times in discovery and non-regulated area so that we can help the clients with a go and no go decision.

So the growth rate will be very much proportional to the rate of outsourcing and that is very much related to the amount of infrastructure that comes off-line and/or enhanced investments in discovery and early development by the large drug companies, we are seeing a bit of a swing back towards that also.

We are also seeing a very strong period in biotech where at least financially the wind is at their back, both from the capital markets and from the large drug companies.

And we are also seeing a real uptick in academic centers as drug discovery engines.

So, from a demand point of view the market for us is improving.

And as capacity fills and we get more pricing power we should be able to drive both the top- and the bottom-line more effectively.

Okay and just a very quick follow-on.

Should we be thinking about additional share repurchases going forward now that cash on your balance sheet is building a little bit?

I assume you are referring to 2014 and beyond?

Yes.

After you complete the current authorization.

Yes, yes.

I guess what would say to directionally.

And of course it is premature to be answering, is that one of the things that we do want to try to manage is a potential dilution from our option programs and restricted programs with our employees and whatnot.

So I would say directionally that to some level we would probably continue to be a buyer, whether we are buying incrementally above that and maybe taking our share count down, I think that depends on what we are doing in M&A and things like that.

Okay, thank you.

Ricky Goldwasser, Morgan Stanley.

Most of my questions have been asked, so just to go back to the margin question, because obviously there are a lot of moving parts.

So bottom-line, when we think about PCS margin, should we think about sustainable margins as we model it around a 15.5% level, which seems to be the normalized rate for the quarter?

And then on the RMS side I know that you have talked about this 30% target and what can get you there.

But I think with the experience that you had with PCS sometimes it takes longer, right, to turn that margin.

So when we think about it maybe if you think about what could be the headwinds, right, that will continue to pressure RMS, what are the risks of this margin for that segment that we should be thinking of?

In terms of your question on PCS, if you look back at our margins for the quarter we reported on a non-GAAP basis 18.2% and we said we had about a 370 basis point improvement as a result of the unique tax-related items.

So I think when you look at where we would have been without those and what was said about the fourth quarter, I think that is sort of the range that we should be in given the current mix of business -- it was a little bit better this quarter -- and given what we've seen from volumes.

So I think as we look forward to 2014 that certainly would be where we would target improvement from.

I think it will still continue to be challenging but that would be our goal.

I think on the research model side sort of floating around 30%, we obviously want to keep our margins up above 30% and actually try to improve them.

I think where it has been a little bit challenging is in the small research model end where we have seen some decline in the business, particularly with some of our largest clients, which creates some unused capacity.

We did take action -- or are taking action this year with respect to our facility on the West Coast where we are going to close a portion of that facility and accelerate depreciation, as we have already done and indicated.

So, I think that will continue to be the challenge on that side of the business in terms of the research models.

I think the other businesses are actually doing pretty well.

GEMS, EMD, etc.

So I think the challenges will be in the small model business.

So, just to follow up.

When you think about what is within your control, to your point, kind of like shutting down some capacity and introducing automation.

Can you quantify to us kind of like could that contribute to a 100 basis point improvement, 200 kind of like -- so kind of like -- just to think about kind of like the visibility that you have around those margins?

I think we said it would be up to a couple million in savings next year.

And of course when you look at that and the abstract, we are obviously going to have a lot of other things going the other way like merit increases and those sorts of things we have to continue to deal with.

We are obviously looking at a number of other items or areas where we can be more efficient in our research model production and things like that, inventory management and whatnot.

Some of those projects are still at a very early stage so I would be reluctant to make commitments on what we might see for savings in 2014 or thereafter or what it might do to the margin.

But I think more broadly speaking to your question, we have just taken an overted action which we are in the process of implementing and we are looking at a number of other things.

So I think we are trying to do as much as we think we can to protect and potentially improve the margin in a number of different areas.

Okay, thank you.

Shaun Rodriguez, Cowen and Company.

So first one on trends in China.

Despite maybe some industrial weakness, several of the tools companies have noted that research demand there remains pretty robust, both from the drug industry as well as academic government labs.

So just wondering if you could provide some additional detail on the Vital River performance which has exceeded your expectations.

And really just trying to understand how much is really just this robust end market dynamic versus your execution.

And more broadly, given these trends whether -- or really just your updated thoughts on plans to further increase exposure in that market?

We are seeing very good receptivity and demand for higher-quality research models, as is the case everywhere else that we do business and in the more developed drug development centers.

So as we have said several times, we are exceeding our acquisition plan, we are going to be interested in expanding our capability and reach across other parts of China.

It is a combination of internal clients, government clients, international companies who are doing work in China.

And less sophisticated competition that doesn't have the history and knowledge of the importance of really controlling viral issues, bacterial issues and also consistency among inbred strains.

So we are in a very interesting educational period with the marketplace, regardless of whatever commentary you believe, there's certainly a lot of money being put into the life sciences sector.

And one of the core elements in discovery research and also early stage development is a quality animal so you don't have impaired results.

So, we were very optimistic about our ability to continue to build a meaningful business over there.

And we don't yet see any other sort of classic commercial competitors locating in China, so we will enjoy our lead in the marketplace for as long as we have it.

Thank you.

And just on your CapEx plans for Q4, I think you expect $25 million in spending there in Q4.

I think this is roughly how much you have spent year to date and still is within the full-year guidance.

But just looking for maybe some additional details on the projects that you have lined up here in the near-term and which segments they are tailored to support, thank you.

We are finishing up a few smaller projects related to facility expansion and research models in the US, our in vitro business in Asia and a couple of other areas.

We do tend to spend a little bit more in the fourth quarter year on year, that has been really our pattern.

So while the number seems a little bit high, I mean that still is our internal estimate.

What I would say is that we do have some improvement reflected in our DSO numbers which we feel good about.

And I think the CapEx might appear to be a little conservative, so I think in terms of free cash flow overall I feel pretty good about our guidance in the event that we are unable to meet our DSO, there's probably a chance that we might under spend our CapEx.

But at this point in time those are our internal estimates and that is what we are holding to for the year.

Okay, I guess that must be it.

Thank you for joining us this morning.

If we were unable to get to your question we will follow up with you later today.

Thank you very much.

This concludes the conference call.

Thank you, ladies and gentlemen, that does conclude your call for today.

And thank you for your participation and for using AT&T executive teleconference service.

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