Charles River Laboratories International Inc (CRL) 2013 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories fourth-quarter 2013 earnings and 2014 guidance conference call.

(Operator Instructions)

As a reminder, this conference is being recorded.

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

Please go ahead.

Good morning, and welcome to Charles River Laboratories fourth-quarter 2013 and 2014 guidance 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 provide guidance for 2014.

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 315893.

The replay will be available through February 26 and you may also access an archived version of the webcast on our investor relations website.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 statement, 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, we will be primarily discussing results from continuing operations and non-GAAP financial measures.

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

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

In accordance with Regulation G, you can find the comparable GAAP measures and reconciliations to those GAAP measures on the investor relations section of our website through the financial reconciliations link.

Now, I will turn the call over to Jim Foster.

Good morning.

I'd like to begin by providing a summary of our fourth-quarter results before commenting on our 2014 guidance and business prospects.

We reported sales of $289.2 million in the fourth quarter of 2013, an increase of 3.2% over the previous year.

Excluding the negative effect of foreign exchange, sales increased 3.7%.

PCS segment was the primary driver of the increase.

At 8.2% in constant currency, the fourth quarter sales increase represented the highest growth rate we've reported in the last five years.

As expected, PCS sales declined slightly on a sequential basis, due primarily to seasonality.

We were exceptionally pleased with the PCS performance, which reflected our share gains as well as improved demand from both large biopharmaceutical and mid-tier clients.

Year-over-year, the consolidated operating margin improved by 50 basis points to 16.4%.

The UK tax law change, which shifted R&D credits to PCS segment operating income, provided a benefit of approximately 40 basis points on a consolidated margin.

Tom will provide additional information on this change shortly.

Higher PCS and EMD sales, the acquisition of Vital River, and improved operating efficiency contributed approximately 50 basis points to the operating margin increase, which was effectively offset by higher corporate costs.

Earnings per share was $0.73 in the fourth quarter, an increase of 14.1% from $0.64 in the fourth quarter of 2012.

We continued to return value to shareholders in the fourth quarter through our share repurchase plan with the purchase of approximately 1.5 million shares with $77.2 million.

In total, we repurchased nearly 3.5 million shares in 2013, which effectively enabled us to achieve our goal of offsetting dilution from stock compensation and the exercise of stock options.

We were generally very pleased with the fourth quarter results, which demonstrated the benefits of the actions we have taken to position Charles River to be the partner of choice for outsourced drug discovery and development services.

Our efforts to create a more streamlined and efficient operation, without compromising scientific expertise or client service, have enabled us to maintain and enhance Charles River's leading market position as a premier provider of essential early-stage drug discovery and development solutions, and to provide those solutions tailored to each client's specific needs.

This, in turn, has provided clients with the resources they require in lieu of in-house capabilities and supported their goal to increase their use of outsourced services with a reliable scientific partner.

I'd like to provide you with details on the fourth-quarter segment performance.

RMS segment sales were $172.3 million, a 1% gain in constant currency.

The increase was due primarily to the acquisition of Vital River, which continued to exceed our original expectation.

In addition to the acquisition, both our GEMS and EMD businesses performed well.

The main offsets to growth were research model production and the termination of the two long-term European contracts, which we have discussed in previous quarters.

Those contracts, which totaled approximately $5.5 million in annual revenues, included at the end of 2012.

As a result, they will not impact 2014 comparisons.

The RMS operating margin was 27.1% in the fourth quarter, just 20 basis points below the fourth quarter of 2012.

Lower legacy sales of research models significantly impacted the margin, which is extremely sensitive to changes in volume.

This is particularly true in the fourth quarter of the year when, as you know, normal seasonality reduces unit volume.

We mitigated some of the impact as a result of efficiency initiatives implemented earlier in the year.

Through our ongoing focus on efficiency, we are continuing to work diligently to enhance the operation of our production business, and are reaffirming our goal of maintaining an RMS operating margin at or above 30% on an annualized basis.

Excluding Vital River, sales of research models declined by approximately 5% year over year.

The continuing consolidation of the biopharmaceutical industry, the closure of biopharmaceutical facilities and the evolution of drug development to eliminate molecules earlier in the process have caused softened demand for our research models, which more than offset our market share gains.

We believe that research models will continue to be a critical component of drug research, and based on our position as a market leader, we will gain additional share with our global biopharma, mid-tier and academic clients.

We also expect that demand for our models will continue to grow in China, a market which is developing well, and in which we have established Charles River as a premier provider.

However, we also believe that the factors I mentioned will continue to impact demand in 2014.

We have a number of sales initiatives in place to enable us to gain market share, particularly in the academic sector.

As I mentioned, we implemented specific efficiency initiatives focused on research model production.

We have evaluated our production infrastructure to determine optimal capacity and determined that we could reduce capacity in North America.

This led us to the decision implemented last week, to close our Michigan facility in late 2014.

We will continue to provide our clients with research models from our other facilities without compromising either availability or on-time delivery.

Research model services were effectively flat in the fourth quarter, with gains in DRS and GEMS, offset by the impact of the European contract terminations.

We were very pleased with the solid growth in both DRS and GEMS.

Increased outsourcing, combined with our market share gains, is driving growth for these businesses, as well as for preclinical services.

In DRS, sales increased year over year and also continued the positive trajectory we saw throughout 2013, with sequential growth in the fourth quarter.

Our expertise in oncology and CNS is widely known and we intend to expand our therapeutic area expertise to other disease areas in order to enhance our value to clients.

Because we believe that the majority of discovery work is still done in-house and the outsourcing opportunity is significant, this is one of the areas for which we are pursuing acquisition opportunities.

We are focused on expanding upstream to enhance our discovery expertise as clients continue to look to partner with CROs in the earlier stages of their R&D programs.

We believe that by providing support for a larger portion of the discovery process, we can enhance the value of our portfolio to our clients.

The GEMS business also reported sales growth in the fourth quarter, predominantly in the US.

As researchers continue to develop more complex models of human disease for use in translational research, they are outsourcing services to us in order to access expertise they no longer have in-house or perhaps never established.

Genetically engineered models present a unique set of challenges in research which are not easily solved.

Given the expertise we have developed over our long history, we believe there is no CRO better able to address these challenges than Charles River.

The EMD business delivered a very good performance, highlighted by sales of testing products outside the US and Accugenix service sales.

The PCS franchise continued to exhibit strength as we sold additional instruments and cartridges and continued to take share in the conventional testing market.

Sales in the US were slightly behind our fourth-quarter plan, primarily as a result of product introductions which occurred later in the year than anticipated.

However, we expect that sales growth will be in the low double-digits in 2014, as new products are introduced and we continue our efforts to convert large pharmaceutical manufacturers' central laboratories to the PCS cartridge technology.

As I mentioned on our last conference call, Accugenix marked its one-year anniversary as part of the Charles River portfolio at the end of August.

We continue to be very pleased with the integration and our efforts to expand sales.

Cross promotion of the legacy portfolio and Accugenix Services has enabled us to take market share, as clients recognize the value of doing both microbial testing and identification with one provider.

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

Strengthening demand for outsourced services and our market share gains drove an impressive 8.2% increase in the fourth quarter PCS sales in constant currency.

At $117 million, sales were just below the third-quarter level, which was the highest level in any quarter since the first half of 2010.

As I mentioned, the slight fourth-quarter decline was expected because sponsors often delay study starts during the holidays.

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

As was the case in the third quarter, mix was also favorable.

The improvement in volume and mix, as well as the benefits of efficiency initiatives, generated a significant increase in the fourth-quarter PCS margin.

At 15.3%, the operating margin was 320 basis points higher than in the fourth quarter of the previous year.

The increase was driven primarily by operating factors which contributed 230 basis points of the improvement.

The change in R&D credits accounted for only 90 basis points of the margin gain.

As a result of improved demand, our preclinical capacity is continuing to be better utilized.

Pricing has generally remained unchanged, although intermittently there was aggressive pricing by all of our major competitors who have more unused capacity.

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

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

We have continued to win RFPs, for which we were not the lowest bidder because, as global biopharmaceutical companies reduce their infrastructure in favor of reliance on CROs, they do not want to compromise on scientific expertise.

When that criterion is critical, Charles River is the preferred choice.

We believe that the strategic relationships we have won with global biopharmaceutical companies demonstrate that as these companies increasingly choose to build strategic relationships with a smaller number of partners, our unique early-stage portfolio, our scientific expertise and our flexibility are recognized as key competitive differentiators.

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

This is been a key tenet of our strategy, that as the relationship strengthens and the clients use us as colleagues on the same side of the table, they would expand the scope of products and services they purchase from us.

The fourth-quarter results definitely bear this out.

PCS sales to our global key accounts, which comprise approximately 25 of the largest biopharmaceutical companies, increased 5%.

This is primarily the result of new agreements signed in 2012 and 2013, as well is the expansion of services under existing agreements.

In 2013, sales from strategic relationships represented slightly more than 25% of total sales.

Discussions with these clients 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 they are no longer maintaining in-house.

Furthermore, they will look to purchase products from their outsourcing partners in order to achieve their goal of reducing the number of suppliers and maximize favorable pricing.

We are focused on our goal of winning a majority share of these opportunities and based on our discussions with clients, we believe the outlook for these relationships remains bright.

The same attributes that convince large biopharmaceutical companies to partner with Charles River also resonate with mid-tier biotech companies.

As global pharma increasingly partners with these companies, it is imperative that the biotech companies choose an expert CRO which can provide the critical services they need to assure their partners can meet pharma's rigorous standards.

Many of them have chosen Charles River as their principal early development partner, which was reflected in an 11% increase in PCS sales to these companies in the fourth quarter.

In 2013, for the first time, total sales to our mid-tier biotech clients were greater than those to global key accounts.

This is the result of biotech's improved access to funding from both large pharma and the capital markets and our targeted sales efforts to win business with these companies.

Sales to academic and government clients declined slightly in the quarter, with higher sales to academic clients offset primarily by stock sales to the US government clients.

For the year, the impact of sequestration in the US remained approximately $3 million.

Although the government shutdown did not have a significant effect on fourth-quarter sales, we believe that some of our academic clients took a more conservative approach to purchases.

We also believe that the recent announcement of a $1 billion increase in NIH funding will have a positive effect in 2014 spending.

It may take some time for the funding to play out, but ultimately this should enable our clients to resume or expand research that was restrained during sequestration.

As successful as our sales strategies have been, we believe we can improve our effectiveness by coordinating the dialogue between large pharma, biotech, academia, non-governmental organizations and venture capitalists.

As these groups increasingly rely on one another, it's essential that we continue to develop deeper strategic relationships with each of these constituencies and assist them in working together.

We have already begun to make progress towards this goal, as our VC partners are now helping us to enhance our relationships with pharma, as well as with their portfolio companies, many of which are virtual and require a CRO partner for almost everything they do.

We will continue to work towards establishing ourselves as the hub for relationships between all of these groups.

With our sales strategies firmly in place, we view 2014 as the year of continuing improvement.

We expect sales growth to Charles River to be in the range of 3% to 5% and expect both business segments to deliver growth rates within the consolidated range.

We expect that almost all businesses will contribute to sales growth, although closure of pharmaceutical facilities will continue to impact our research model production business.

We expect both the RMS and PCS operating margins to improve as a result of operating leverage from higher sales and improved capacity utilization, as well as from ongoing efforts, now firmly embedded in our culture, to improve efficiencies.

As I'm sure many of you know, we made organizational changes at the beginning of December, and assigned Dr. Jorg Geller, one of our most seasoned operating executives to head our efficiency efforts.

Jorg and his dedicated team are in the process of identifying efficiencies which we expect will generate some savings in 2014 and more significant amounts in 2015 and thereafter.

We expect that the efficiency initiatives will push the RMS margin back above the 30% level in 2014, and continue to generate improvement in the PCS margin.

Corporate costs will increase slightly to approximately 6.5% of sales, but we expect that the consolidated margin will increase by up to 50 basis points.

Taking all of these factors into account, we estimate 2014 non-GAAP earnings per share will be in a range of $3 to $3.10.

Tom will give you more details about this guidance in a moment, including guidance on cash flow.

Many investors ask us if we think that the preclinical demand has turned.

We believe demand is certainly picking up, as more of our global biopharma clients make the decision to outsource in lieu of maintaining in-house infrastructure.

It's our goal to be ready to win work when it's outsourced.

Toward that end, we have undertaken targeted initiatives that are 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 can pass the savings onto our clients; providing best in class client service; developing state-of-the-art data systems and portals which offer clients realtime access to data; and structuring creative solutions that support each client's drug development goals.

We believe these actions have been crucial to our success in persuading clients to work with Charles River and will continue to drive our future growth.

But as our clients continue to evolve, we must evolve with them.

We continuously assess our organization and identify actions we can take to enhance the value we provide to clients.

Just within the past year, we have globalized and unified our RMS and PCS operations under Dr. Davide Molho; added to scientific bench strength; taken our efficiency initiatives to the next level; and continue to invest our capital and strategic acquisitions that expand our unique portfolio.

We will continue to embrace change because in doing so, we enhance our ability to support our clients, which is fundamental to our ability to drive sales, cash flow and earnings growth.

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

Now, I'd like Tom Ackerman to give you additional details on our 2014 guidance.

Thank you, Jim, and good morning.

First, let me remind you that I will speak primarily to non-GAAP results, which exclude acquisition-related amortization, charges related primarily to our global efficiency initiatives, and certain other items.

This morning, I will also focus my discussion on our 2014 financial guidance.

For 2014, we expect sales growth of 3% to 5% on both a reported and constant currency basis and non-GAAP EPS of $3 to $3.10.

We expect only a small benefit from foreign exchange at this time, despite the favorable FX movements in recent weeks.

As Jim said, we expect sales growth for both RMS and PCS to be within the 3% to 5% consolidated guidance range in 2014.

For RMS, the notable improvement in organic growth from the rate in 2013 is a result of a number of factors.

These factors include anticipated increase in average realized pricing of 2% to 3%, compared to 1% to 2% in 2013; more stable demand from large pharmaceutical and government clients; and low double-digit sales growth for the EMD business.

In addition, we have anniversaried the termination of two long-term contracts for certain services in Europe.

As we previously noted, these contracts concluded at the end of 2012 and represented approximately $5.5 million in annual revenues.

Favorable PCS sales growth trends are expected to continue in 2014.

We will anniversary several large strategic relationship wins and the corresponding sales ramp under these agreements, but expect to continue to execute on our goal of expanding the range of products and services we sell to these clients beyond the initial scope of the RFP, and enter into strategic relationships with new clients.

We also expect growth from our mid-tier clients, as we continue to benefit from a combination of market share gains and an improved funding environment for biotechnology companies.

We have also forecasted an approximate 1% increase in PCS spot pricing for 2014, which is similar to the 2013 increase.

We intend to generate consolidated operating margin expansion in 2014.

This did not occur in 2013, due primarily to the impact of biopharmaceutical facility consolidations on our research model business, which is very sensitive to unifying changes.

In 2014, we expect that the consolidated operating margin will improve by up to 50 basis points from 17.3% in 2013, with improvement in both segments.

Annual cost increases, including wages, are expected to increase 2% to 3% in 2014, but will be more than offset by the fixed-cost leverage from higher sales, price increases, primarily in RMS, and our continued focus on operating efficiency.

We remain committed to driving efficiency throughout our global organization.

We have identified $25 million to $30 million of incremental savings in 2014 which are already included in our guidance.

These savings are derived from a combination of projects that were implemented within the last year and new projects that were identified through our ongoing global efficiency initiatives.

We continue to evaluate additional initiatives, which when finalized, we expect will generate greater savings in 2015 and beyond.

In the RMS segment, the primary drivers of the margin expansion are expected to be the 2% to 3% average price increase and our global efficiency initiatives.

As Jim mentioned, we plan to close our research model production facility in Michigan by the end of the year, which will generate savings beginning in 2015.

Once this is completed, we will have consolidated approximately 8% of our global research model production capacity, including the three rooms in California last year.

Payment, severance and related charges associated with the Michigan closure are expected to total approximately $4 million to $5 million in 2014, or $0.05 to $0.07 per share, which will be excluded from non-GAAP results.

We have only included charges related to the specific action in our 2014 GAAP EPS guidance.

In 2014, we also expect to generate operating margin improvement in the PCS segment, due primarily to increased study volume, favorable study mix and the benefits of our global efficiency initiatives, similar to the trends in the third and fourth quarters of 2013.

Because it was effective for the last three quarters of 2013, the UK tax law change will only have a small 20-basis point incremental benefit to the PCS operating margin in 2014.

The 2014 PCS operating margin guidance implies that the margin on incremental sales will be higher than the segment average, as it was in the second half of 2013.

This incremental margin assumption depends on a more optimal sales mix, fixed cost leverage from increased study volume, and stable pricing, but will vary based on the strength of these factors.

It can also be affected by the addition of capacity and staff, in order to accommodate higher demand.

In line with our prior outlook, unallocated corporate costs totaled $72.1 million in 2013, was 6.2% of sales.

We expect unallocated corporate cost to be approximately 6.5% of sales in 2014, a slight increase from the 2013 level, due primarily to modest investments in IT, as well as performance-based compensation expense.

We expect higher sales and the operating margin expansion of up to 50 basis points to be the primary drivers of the 2014 EPS increase.

In total, below the line items are expected to have a minimal effect in 2014, as a higher tax rate and less favorable other income, which we do not forecast, are expected to be partially offset by a slightly lower share count.

I will now discuss these items in more detail.

Net interest expense is expected to be relatively flat in 2014, in the range of $12 million to $14 million compared $13 million in 2013.

This represents a slight increase in the second half run rate after we refinanced our convertible debt last June, in part due to our assumption that LIBOR rates will be slightly higher in 2014.

Other income totaled $7.2 million or $0.11 per share in 2013, due primarily to gains on our investment in a large, life science venture capital fund.

Several of the portfolio companies completed their IPOs and their market performance resulted in investment gains.

Since the impact of these investments is largely based on market performance, we do not forecast this item.

As a result, other income has been forecast at zero, or an $0.11 headwind to our 2014 EPS guidance.

Excluding this $0.11 from our 2013 results, our 2014 EPS guidance would represent growth of 6% to 10%.

The 2014 non-GAAP tax rate is expected to increase approximately 200 to 300 basis points, to a range of 28.5% to 29.5%.

This is an increase from 26.6% in 2013, which was lower than our prior outlook in October, due to several discrete nonrecurring items.

The 2014 tax rate increase will primarily be a result of tax law changes in Canada and the UK, which reduce the benefit of R&D tax credits.

These tax law changes will contribute approximately 120 basis points of the 2014 increase.

The UK tax law change that we discussed in detail last quarter represents only 30 basis points of the increase, because the law was effective three quarters in 2013.

The remainder of the 2014 tax rate increase is primarily related to reduced benefits from our European debt structure.

The higher tax rate and unfavorable other income are expected to be partially offset by a slightly lower share count in 2014.

Our guidance assumes an average diluted share count of approximately 47 million to 47.5 million shares in 2014, reflecting both the full-year benefit of repurchases of the second half of 2013, as well as continued stock repurchase activity in 2014.

In 2014, we expect our repurchase activity to primarily offset dilution from option exercises and equity grants.

For the full year 2013, we repurchased 3.5 million shares for a total of $165.7 million, including 2.9 million shares in the second half of the year.

At year-end, we had 139.1 million remaining on our current stock repurchase authorization of $1 billion.

In addition to stock repurchases, our capital priorities for 2014 include debt repayment and potential strategic acquisitions.

Given our favorable capital structure with a leverage ratio of approximately 2.5 times, and an expectation of continued low interest rates over the near-term, we plan to repay debt in line with, or slightly ahead of, the scheduled installments on the term loan.

We also continue to rigorously evaluate acquisition candidates and intend to pursue additional M&A opportunities in 2014.

Timing of acquisitions is always difficult to predict, but it's our strategy to continue to supplement our organic growth with disciplined strategic acquisitions that are accretive to earnings.

I will now provide an update on our cash flow.

For 2013, we generated free cash flow of $169.9 million, or $3.50 per share, compared to $160.5 million or $3.32 per share in 2012.

Capital expenditures in 2013 were lower than previously expected, at $39.2 million, due to the timing of expenditures in the fourth quarter and lower capital requirements on some smaller projects.

However, the benefit of lower CapEx to free cash flow was offset by an increase in DSOs at year-end to 56 days from 54 days at the end of the third quarter and 51 days last year.

We previously expected a slight decline in DSO from the third-quarter level, but do not anticipate any credit risk related to the two-day increase.

For 2014, we expect free cash flow to be between $175 million and $185 million, or approximately $3.75 to $3.95 per share.

We'll continue to focus on receivables and working capital management to improve our DSOs in 2014, but have not forecast a meaningful improvement in this metric.

CapEx is expected to be between $50 million and $60 million in 2014, which is slightly higher than in recent years, due in part to the carryover of projects from 2013.

Growth projects are expected to represent approximately 40% of CapEx, including further investment in our EMD business and our growing RMS operations in China.

Remaining 60% will be spent on maintenance of our global infrastructure.

In the first quarter of 2014, we expect a meaningful sequential increase in consolidated sales.

The increase primarily reflects higher sales in the RMS segment compared to the seasonally soft fourth quarter, when normal activity for small models is lighter during holiday periods.

As a result of higher sales, the RMS operating margin is expected to rebound above the 30% level in the first quarter.

PCS sales and operating margin are expected to be modestly lower in the first quarter on a sequential basis, which is consistent with seasonal trends as there are typically fewer study starts during the holidays and into January.

However, on a year-over-year basis, we expect PCS sales and operating margin to be above the first quarter of 2013.

The benefit of higher sales in the first quarter will be primarily offset by a higher tax rate, which is expected to be an approximate $0.06 headwind compared to the fourth-quarter tax rate of 22.8%.

This is expected to result in first-quarter EPS that is similar to the fourth quarter level of $0.73, which would represent a year-over-year increase of approximately 6% from the first quarter of 2013.

To conclude, we were pleased with our performance in 2013.

We achieved financial results that exceeded our original guidance range for non-GAAP EPS and were within the targets for constant currency sales growth and free cash flow.

In addition, we also continued to deliver value to our shareholders, resulting in a 50-basis improvement in our free cash flow return on invested capital to 13.1%, with further improvement expected in 2014.

We also made significant progress on many critical initiatives to strengthen client relationships and gain market share, to enhance our focus on operating efficiency, and to expand our leading early-stage portfolio.

We believe these efforts position us well for 2014 and beyond.

That concludes our comments.

We will now take questions.

(Operator Instructions)

Greg Bolan, Sterne Agee.

Looking at 2013, Jim and Tom, finished the year around 5.9% constant dollar revenue growth in PCS.

You are talking about 3% to 5% for both segment growth in 2014.

Targeting in on PCS for just two seconds.

What's assumed there?

Is it same-store sales growth from your existing strategic partnerships?

And that is the primary pillar for growth?

Is there any assumption for further market share gain?

Or acceleration in the trends that we've seen over the past six to nine months for the underlying ties for demand and for outsourced preclinical services?

If you could dig a little bit deeper, that would be great.

Thanks.

First, I would remind you that that is a range.

Correct, yes.

(laughter)

Second place, I would say that it assumes similar market metrics, which are space selling in the industry, but not full pricing, a little bit of spot pricing, but still pricing being tough.

We said in the prepared remarks that we are intermittently seeing aggressive pricing from virtually all of our key competitors.

So that may or may not continue.

We are assuming strong sales from the clients with which we have large strategic deals.

We are assuming robust sales in the mid-tiers.

Of course, the mid-tiers, there's a little bit of churn in that sector given that those companies get bought, sold, merged or go bankrupt.

We're doing very well.

You heard the 11% growth, and we actually have more revenue than large pharma.

But, it's a little bit difficult to call.

So, what we haven't built into that is a significant new strategic deal or multiple new strategic deals.

We are certainly pursuing those.

We certainly have conversations in place.

It appears that we have clients that are interested and ready, but we don't control the extent of their readiness.

And the other big driver, of course, is infrastructure reductions, which while they are a little bit tough on the core animal business, tend to be very beneficial to the service businesses.

It is virtually impossible to predict any of that.

So, I would say that we give you that range with knowledge that we will be able to perform well within that range, with the opportunities of larger deals, I suppose, to improve that.

But, it's impossible to call it, so we just think it's irresponsible to do so.

Yes, that's totally fair.

Thanks, Jim.

Just a quick follow-up.

I understand the mix -- you alluded to a mix being a little bit better in PCS in fourth quarter.

We have heard, though, from a couple of players, that there was an elevated level of non-GOP studies in the fourth quarter.

So, higher animal cost.

So, as you think about the mix, Jim, given the current capacity utilization, is the mix where you would like it to be?

Or, was maybe there a little bit of an unfavorable -- a maybe less than optimal mix than you would have liked to have seen in the fourth quarter, or no?

The study start issue is always a complex one, particularly with our large animals.

So, there can be a significantly higher cost as a result of that.

I think we had some of that in the fourth quarter.

Having said that, the mix is slightly better in terms of long- and short-term studies, there's a better balance there.

It tends to be a mix in terms of our whole portfolio, general versus specialty products as well.

Obviously, nuancing and emphasizing mix as it becomes more specialty and as there is more primate work that actually gets going as opposed to just get started, the opportunities are obviously there to drive higher top- and bottom-line growth.

We are happy with the general trend and the trajectory.

We are happy with the way the space has been filling.

We are definitely happy with the huge increase in mid-tier clients' sales and generally, our engagement with the drug companies, as a whole.

Mix is definitely something that we hope to get some benefit from.

I would just remind you that predicting that, how it's going to fall, when it's going to fall, continues to be a little bit of a challenge.

Fair.

Thanks, guys.

Appreciate it.

Douglas Tsao, Barclays.

First, curious on the Vital River acquisition, which has performed quite well.

What's the typical mix of models that you were seeing in terms of demand from China?

Is it largely on the outbred side or were you seeing demand for these specialized models?

We are very pleased with the trajectory of growth in top and bottom line from that business.

There's really opportunity to educate the marketplace, and, I think, to perform well versus mostly governmental competitors.

We have a relatively small portfolio of most of the big strains, the big outbred strains and the big inbred strains, and a little bit of immunocompromised strains.

I do think that over time, there's an opportunity to sell increasingly more complex models.

That will obviously be beneficial for the margin.

But even more than that, there's just an overall opportunity to sell significantly higher volumes to other parts of China.

So, for instance, while we have a big Shanghai sales contingent, this is a Beijing-centered facility.

So we tend to sell to that marketplace first and Shanghai second.

As we continue to build out capacity and geographically expand the reach, there's opportunities to sell both the bread-and-butter core models and in time, add the more sophisticated lines.

Okay, great.

One follow-up in terms of the PCS market.

Do you have a sense of the lag time for study starts now for clients?

Are they having to wait meaningful periods, yet?

Is that the key tripping point for any opportunity to become a little bit more aggressive on price?

We are still seeing relatively swift study starts, I would say.

A month or more, as opposed to months or more.

So, while space is filling for the industry, and starts are study next week like we have seen for the last few years, there is still enough space where clients who are not necessarily all that discerning about quality in science and just want to move quickly, will move quickly.

So, I would say we haven't reached an inflection point yet where there is a coordinated opportunity between waiting longer and paying more.

Okay, great.

Thank you very much.

Eric Coldwell, Robert W. Baird.

Talking about research models, I know you are seeing good growth in China, obviously very focused on market share gains.

But also going through a lot of efficiency programs to pare back infrastructure and maintain that strong 30% margin.

The question is, there appears to be, possibly a structural or even a secular shift in demand for the legacy core models, the rodent models.

At the same time we're seeing more evidence of a pickup in areas like fish, for example and even some comments that rabbit demand has picked up recently, other animal strains.

The question is, do you consider shifting your mix of model sales?

Do you look for targets, perhaps, in some of these other categories that appear to have more momentum in the future?

Or do you think you'll stick with your core footprint and just focus in on doing what you do better in the future?

I guess it's an acquisition or a build strategy question there, as well.

The change in the demand is nothing new.

It's been happening for a long time.

It started with a more responsible use of laboratory animals, and an effort to drive the three Rs.

I think that has continued to happen significantly and consistently, but more subtly.

The lack of subtleness has appeared in the last, I would say, three years as we have seen big R&D facilities be closed.

Last year was really dramatic.

We saw multiple facilities be reduced or shut down in Japan, multiple ones in the space.

Saw the beginnings of some infrastructure reductions in Europe, as well.

I would say that the drug companies going from, I don't know, let's say six or seven or eight R&D centers, to one or two or three, for many of them, has had the largest impact on all of this.

Some of the models that you talked about are very interesting.

I don't think they're going to be big revenue contributors.

We've looked seriously at the fish business for years.

We do a little bit of that on the service side of our business.

It's an interesting model, but it's going to be a low contributor to revenue and profitability.

Of course, we are already in the rabbit business.

I would see more likely continued increase in complex animal models, more immunocompromised models, more multi-genetic knockouts, more humanized animal models.

And some stabilization of the core models because, obviously, a lot of Discovery and basically all of safety assessment is still predicated on the use of their animals.

And I think that our market prominence, scale, profitability and this enhanced initiative to drive efficiency, should hold us in good stead.

The biggest wild card for that business, particularly predicting 2014 or 2015, is what will be the additional significant infrastructure reductions.

And the answer to that is we don't know.

We are assuming something in our plan.

There's also some noise around the edges as to who is going to do what, whether there's going to be mergers.

And the reality is that there is no way to predict it, except that the industry has to get more refined and has to do more outsourcing.

Of course, that will impact their pipelines, as well.

We do continue to think, as I think the fourth quarter really showed, the 1% increase in RMS and an over 8% increase in preclinical, the best preclinical numbers in an awfully long time, that there's a corresponding relationship between the shutdown of these big sites, a reduction in research model business and an increase in service revenues.

I don't know what the number is these days, but 70% of our revenues are service-related now.

So, at the margin or greater than the margin, that's your benefit.

Jim, thanks very much.

That was helpful.

Doug Schenkel, Cowen and Company.

This is Chris in for Doug today.

Thanks for taking the question.

On PCS margin, even excluding various one-time items.

It's fair to say PCS margin and performance is good in 2013.

Can you give an update on where you think PCS margins can go over the next few years?

How many more levers can you pull on your side, in terms of implementing various operating efficiencies?

Do you think you can get more leverage via internal controls versus improved pricing, or volume from customers?

Thanks for the question.

As you mentioned, we have improved the margin in 2013, up just over 14%.

Some of that was contributed with the tax change in the UK that we had talked about.

Even excluding that, we improved the margin going into 2013.

In our remarks, in regards to 2014, we indicated we thought the margin would also improve slightly in 2014.

While it seems like we've been really grinding and not making much progress in margin, the reality is the margins come up nicely over the last couple of years from a range of 11% to 12%.

That's an environment where we haven't seen really much, if any price increase.

We are going to keep working the efficiency initiative side of the table.

We have a number of ideas that we are looking at in 2014 to help provide lift.

The market seems to be in a little bit better spot.

I think if we can continue to drive top-line growth and volume, and have better demand from our clients overall, I think we will start getting a little bit more price than we've been talking about over the last couple of years, 2013 and 2014, where we were really talking about 1% spot pricing.

I think we will continue to look at efficiencies and as the market improves, I think we will do a little bit better on pricing, capacity utilization.

I think those things would be what would allow us to continue to improve the margin beyond mid-teens and up into the high teens over the next couple three years.

The other thing I would emphasize there, is there are some opportunities with mix.

But I do think that capacity is a big issue for us and for the industry.

Capacity utilization appears to be better.

In other words, higher, for the whole sector.

The latest estimates around 70%, were higher.

That's good for us.

It's good for everyone, as it fills.

We do need a re-balance between our available capacity and the planning metrics of our clients.

We have to get back to a time where they plan better with a little less last-minute stuff.

That ought to get a little bit more price.

Obviously, none of us are going to run out and build new space or a whole lot of new space anytime soon.

We are all very focused on filling our space, but also using it well for the highest margin business that we can generate.

So, I would say that all the factors are lining up well.

We are very pleased with the margin pop in the fourth quarter.

But, to have it get up to the high teens, which is certainly a goal of ours, we are going to have to see some price, and we are going to have to see better capacity utilization.

All right, great.

Thanks for taking the question.

(Operator Instructions)

Tim Evans, Wells Fargo Securities.

I wanted to talk a little bit about the corporate overhead.

Over the past seven years or so, that's gone up from levels of 3.5%, now it's going to be this 6.5%.

Is that increase permanent?

Is it going to go higher?

Is there opportunities to bring it back down in the future?

Some long-term commentary there would help a little bit.

Thanks, Tim.

I think the seven-year historical reference and that increase has a lot to do with how we have aligned some things in IT, for example, where we've expanded globally, but have done that through the corporate group, and therefore bearing a little bit more of that burden at the corporate number versus in the divisional number.

It's an area where we've looked at keeping costs in line with our sales growth and in relation to our sales, which I think over the last couple three years, it's been a little bit more in the 6% range.

IT continues to be an area that we need to invest in for competitive reasons, as well as for our back office systems and whatnot.

So that continues to put a little bit of pressure on the number.

Our global efficiency initiatives that we've talked about today, corporate overhead is a focus of that, as are all of our business segments.

So, that's an area where we will look to try to get more efficient growth in services that we buy.

And, how we manage ourselves globally in SG&A.

The idea going forward would be to try to at least have that number remain constant, but ideally, generate some leverage from it.

It will continue to be a focus of ours.

Okay.

Thank you.

John Krieger, William Blair.

Jim, just to go back to Eric's question a bit.

You talked about some of the longer-term downward demand trends within the models business.

But I thought I heard, when you talked about guidance for 2014, that you assume there's at least some stabilization.

Could you clarify that a little bit?

Are you expecting demand to bottom out in 2014?

What drives that confidence?

Give a view of where that underlying unit growth goes longer term.

We would say that all things being equal, for 2014 we should have more stable demand.

We should get more pricing.

So we should get maybe 2% to 3% net price, than the 1% to 2% that we had in 2013.

That would be just the core research models.

Of course, if you look at the whole sector, you've got EMD on top of that and Discovery, et cetera.

But you're talking just about the model space?

Yes.

I would say, all things being equal, that there's likely to be some stability.

But the wild card continues to be what is the extent of infrastructure reduction?

We had an awful lot in 2013.

We have to expect something in 2014.

That has an undue impact on driving units down.

The good news is, we have the primary share and the big pharmaceutical companies.

The bad news is, when they shut facilities, that has an undue adverse impact upon us.

It feels irresponsible to assume that there will be none of that.

Obviously, if it was less or more subtle, or less pronounced or they took a year off, whatever, we could have better numbers.

But for now, we are assuming overall stability, a little better price and some inevitability of additional infrastructure reduction.

Longer-term, do you view that as a flattish business?

Or do think it can have underlying growth?

If and when the infrastructure reductions stop, we think that's a business where we can continue to get price.

We can continue to build share, for sure, in the academic marketplace where we are doing a lot better, I'd say, the last three or four years.

Given the lack of substantial premium of our price versus the competition.

We've actually been picking up a little bit of share in big pharma in places in the few clients where we don't have that much share, and new biotech companies, as well.

Having said that, thinking about that globally for a moment, it's probably the core road business is going to be low single-digit grower.

I do think that we are going to spend these significant efficiency initiatives we have in place, while they will focus on the entire company, will focus more directly on RMS.

So we do think there's an opportunity to actually expand operating margin in what is already an extremely high operating margin business.

Great.

Thank you.

Sean Dodge, Jefferies.

It's Dave Windley.

I wanted to try to get into your growth assumptions here on top line.

If I understood correctly, you are saying that your mid-tier client base is driving greater amount of revenue now than your strategic clients would.

So greater than 25%, I presume.

You've talked about that number being, in the fourth quarter, 11%.

If I extend that out and assume that growth rate continues, that alone, that mid-tier client base alone, gets me to the low end of your revenue growth assumption.

What about that framework is incorrect?

Follow me?

I'm saying greater than 25%, maybe 30% of your business growing at 11% gets me to 3%, gets me to the bottom end.

So, seems like the 3% to 5% is pretty conservative.

We are not going to acknowledge conservative or not, we are going to acknowledge we have a range.

We have certain uncertainty from clients.

Could be better than we think, sure, I suppose, could not.

We had an uptick in the fourth quarter in the big global accounts, of which we have about 25 that we are all over, about 5%.

In mid-tier about 11, talking about preclinical, now.

Those are obviously very good metrics.

We have big strategic relationships and several that we are in discussions with now.

Again, we don't control the decision making timeframe, but we like the way those are moving.

There's just so much inherent uncertainty related to continued availability of space.

There is periodic very low-price metrics that we see from everyone all of a sudden.

Then it stops for a while, then it starts again.

It's directly related to competitive desire and need to fill the space.

So, David, if you think the numbers are conservative, fine.

We are not going to use that parlance because we've been doing this for too long and the predictability is too difficult.

Although, all we can say is demand is definitely better.

It's more consistent.

It's likely to be -- it could be very well accelerated by the multiple facilities being closed, or clients at the same time saying, yes, we are ready to outsource.

The conversations are great.

But we've learned from several of them in the past, that sometimes they're a matter of months, or sometimes it takes a year or two.

So, it just doesn't -- it's not in our best interest to predict that.

Having said that, we are obviously very pleased with the fourth quarter, both margin and top line.

There is a lot more work out there.

We don't mean to be difficult or evasive at all.

You know us too well.

We just want to give as much clarity as we can to how the world and the business occurs to us, the demand occurs to us.

While we are doing really well, it's still -- I would say that bidding on large pieces of work is still highly competitive and a challenging environment.

If I could follow on to that, quickly.

When I think about your commentary on the mid-tier, I'm thinking about companies that are maybe increasing their activity, more because their pipelines have grown or their funding situation has improved, a la the recent IPO window.

That demand would be a reflection of organic demand or activity increase as opposed to just a shift in venue, say insourced versus outsourced.

If I'm right on that, should that also have a knock on benefit to models demand?

That will be all.

Thanks.

I think that is sort of right.

The difference is this.

As we talk to our big pharma clients, it's clear that an increasing number of the molecules they are working on are coming from outside of their companies, principally from biotech.

So, a lot of our increase in biotech is, yes, definitely a very frothy marketplace.

There is a lot of money coming in from the capital markets.

So, maybe a compound is they couldn't afford to develop, they are.

A lot of it's coming in from big pharma, as it always did.

I do think to some extent, there is a shift in work that would have historically been done by big pharma, on the Discovery side.

Now, since their biotech colleagues or partners are doing the discovery for them, we are seeing a big uptick there.

So the animals that would have been utilized by big pharma are now being utilized by biotech.

I think it's unlikely that there is a net add-on effect, although it's possible that you could have both with certain clients.

But depending on who you talk to, between 40% and 70% of these drugs that they're working on are licensed and maybe the average is 50%.

That's a lot and I think it's growing substantially.

So we would expect biotech to be up, it was.

There's a real serious rationale for that.

Okay.

Thank you.

Jeff Bailin, Credit Suisse.

Jim, with the benefit of another year in the rear view mirror, following some of the key strategic partnerships that Charles River disclosed, can you offer any high-level commentary on how these performed relative to expectations, maybe in terms of volume and profitability?

Looking forward, how meaningful the potential up-sell or overall share opportunity is?

As we've said many, many times, they take a multiplicity of sizes and shapes and forms.

Some are long-term contracts and some are short-term.

We get a printout weekly of margin by clients.

There's a fair amount of variability, although most are moving in the right direction.

I would say that by and large, we are pleased with the quality of the relationships, with our strategic deals, regardless of the contractual nature.

We are pleased with the sense of true partnership, their respect for our science, them, sooner than later, treating us like they were themselves and not as a third party.

As the volume increases, and our productivity improves, in many of them, I won't tell you all of them, in many of them, the margins have improved significantly.

I can think of one or two where we've been disappointed with the revenue contribution vis-a-vis what we were told, not that they contracted for it, but vis-a-vis what we were told.

I do think we know how to do these deals, and we do really listen closely to the clients, We try to design a structural relationship that works for them.

We have several very large pharma companies that we are talking to now about enhanced deals.

As we did say, I believe in the prepared remarks, but it may have been lost in there, one of the strongest aspects of these deals is regardless of how the conversation initially starts, we tend to almost always inevitably get additional business that wasn't contemplated by the first conversation, which increases the size and scope and often the profitability of those relationships.

So, a little bit higher than 25% of total sales.

That's not an insignificant number in terms of predictability of top and bottom line.

We're going to continue to drive as many of those as clients are interested in talking to us about.

But it appears that an increasing number are seeing their way to wanting to work on that basis.

They definitely want to reduce the number of research partners that they have.

Great.

Thanks very much.

Ross Muken, ISI group.

I just wanted to touch again on the labor piece of PCS, just in terms of where staffing is.

Should we see this inflection point?

What needs to occur in order to make sure you can sufficiently meet any incremental change in demand that could happen as this biotech environment continues to be robust?

That is a constant issue for us.

We feel that our facilities are in good shape in terms of having excess space and we actually could bring on more as necessary with some advanced planning, which of course we are doing.

I would say the senior scientific staff is quite deep, as our study directors are quite strong across most sites and our pathologists are as well.

So, as we continue to take on additional work, we will have to add direct labor, which we do all the time.

We did it in 2013.

We will certainly do it again this year.

We are thrilled to be hiring people back.

Some of our market places are easier recruit in than others.

All of our jobs, no matter how, I don't want to say menial, but no matter how basic, require fair amounts of training.

We have to hire people slightly in advance of when we need them, but not a year in advance of when we need them.

We think we are all over that.

We are in a good place to work and our business model, certainly on the preclinical side, is more stable than it has been historically.

We feel that we will be able to manage our headcount in a way that we are able to do great work for our clients and stay slightly ahead of the demand curve.

You had such a great experience with the two recent acquisitions.

As you look at that environment, obviously you're still generating a fair amount of cash flow.

How would you characterize the tuck-in M&A activity out there and the tertiary spaces that you may look to to supplement what you already have?

Deal flow is particularly good at the moment.

It's a combination of, I think, we are doing a better job at it and more assets are available, particularly from venture firms that have owned them, invested in them for a while.

We've been pretty clear, but let me reemphasize the fact that we are looking primarily upstream.

So closer to when the drugs are approved.

We want to engage with our clients as early on in the process as possible and help them with multiple steps, some of which are earlier than what we do now.

We are looking at several companies with several technologies and service businesses that would incorporate that description.

We are also looking at expansion of our current therapeutic areas, as well as expanding into additional therapeutic areas for in vivo pharmacology.

And I would say thirdly, we are looking at some geographic expansion or moves.

I would list them and prioritize them the way that I just described them.

As we continue to say on our calls, we can't promise that we can deliver any of these deals, because they are not done until they are done.

But we have both the interest, the finances and the strategic need and opportunity to broaden our portfolio and engage with our clients in ways that we don't think our competitors can.

So it's an important focus of us at the moment.

Very helpful.

Thanks, guys.

Ricky Goldwasser, Morgan Stanley.

This is [Sarv Singh] for Ricky Goldwasser.

My questions have actually already been answered.

I will go back to the queue.

Tycho Peterson with JPMorgan.

This is Paj Esson for Tycho this morning.

Thanks for taking the question.

I have one quick one on PCS margins.

Can you share any color on how you see them trending sequentially in 2014?

Should we expect more of a back-end loaded year?

Or is that just quarter-to-quarter variation that is hard to predict?

This is Tom.

My comments said that, as is typical in the first quarter, we expected to see it seasonally down a little bit.

But beyond that, I think it should be somewhat steady.

I don't think it will be dramatically back-end loaded or whatever.

So I think a little bit slows on in the beginning and a little bit steadier for the remainder of the year.

Okay.

Can you comment quickly on your outlook for the Genetically Engineered Models business within RMS for 2014 and what you are seeing there?

We are optimistic about our GEMS business.

It had a very good fourth quarter.

The demand for these models continues to increase.

More are being made by our clients in academic institutions.

They continue to be an important translational vehicle for drug discovery.

So we would expect to see an increase again in 2014.

Great, thank you.

Steven Valiquette, UBS.

Congratulations on the results.

I also wanted to quickly touch on that seasonality pattern in the tox of the PCS side of the business.

In this call overall you sound optimistic around PCS, overall, for overall 2014.

Again, you just mentioned for 1Q you are guiding for PCS sales and margins to be down sequentially.

While it is consistent with your historical pattern, so probably nothing to get you worried about.

But it does seem one of your peers does have a more optimistic sequential outlook for their comparable business.

Trying to triangulate all those data points.

The main question might be, is your guidance for PCS in 1Q based on what you are seeing in the first half of the quarter through mid-february?

Or is it based more on previously-established budgets and historical patterns?

Thanks.

We are going to stay away from what we are seeing so far in the quarter, because it's often misleading.

And January has become increasingly funky and complex month with clients not getting back to work and taking a lot of time to figure out what drugs they were going to work on and what drugs they're going to outsource.

It's possible that different commentaries from us and other people in the field, both public and private, just have to do with specific our client footprint.

So that wouldn't necessarily jive.

I would say that, on a positive, if you roll up everybody's comments, the demand is generally better across both big pharma and biotech.

Pricing is challenging but basically stable.

Margins have been improving and we are optimistic about that business for next year.

It's a little bit difficult to call the quarters.

Some of our commentary does have to do with the history, which is that Q1 is usually little bit slower.

Qs 2 and 3 are stronger in the preclinical business.

Q4 usually is slower because of the holidays, but not always.

So, some of those historical seasonal factors are pretty much a certainty.

Hope that was helpful.

Yes, that's great.

Thanks.

Sung Ji Nam, Cantor.

I just have a quick one.

Was wondering if you might be able to comment on what percent of your research model production revenues came from pharma as you exited 2013?

Thank you.

Large pharma.

We don't really spend time anymore parsing it that way.

Sorry.

It's a very large percentage.

Probably, a slight majority, I would guess.

But, where pharma starts, biotech starts and pharma ends, is sort of blurred for us.

I would say the last five years, because they work so closely together.

It's not -- I mean, if you think it's important, it's important.

We're just saying it's a distinction we spend less time on.

So, if you take those, as a whole, so take pharma and biotech, our not-for-profit footprint is 24%, 25% of sales and the rest is industrial.

The other's a little medical device and ag farm in there.

The vast majority of that is pharma and biotech, with biotech going up faster.

Thank you.

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