Charles River Laboratories International, Inc.
Q3 2012 Earnings Call Transcript

Published: 31 Oct 2012

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Charles River Laboratories Third Quarter 2012 Earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session. Instructions will be given at that time. If you should require assistance during the call, please press star then zero. As a reminder, this conference is being recorded. I’d now like to turn the conference over to your host, Ms. Susan Hardy, Corporate Vice President of Investor Relations. Please go ahead.

[Susan Hardy:]

Thank you. Good morning and welcome to Charles River Laboratories Third Quarter 2012 conference call and webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer, and Tom Ackerman, Executive Vice President and Chief Financial Officer will comment on our third quarter results and review guidance for 2012. Following the presentation, we will respond to questions. There is a slide presentation associated with today’s remarks which is posted on the Investor Relations section of our website at ir.criver.com. A taped replay of this call will be available beginning at noon today and can be accessed by calling 800-475-6701. The international access number is 320-365-3844. The access code in either case is 265998. The replay will be available through November 14. You may also access an archived version of the webcast on our investor relations website. I’d like to remind you of our Safe Harbor. Any remarks that we may make about future expectations, plans and prospects for the company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors, including but not limited to those discussed in our annual report on Form 10-K which was filed on February 27, 2012, as well as other filings we make with the Securities and Exchange Commission. During this call, we will be primarily discussing results from continuing operations and non-GAAP financial measures. We believe that these non-GAAP financial measures help investors to gain a meaningful understanding of our core operating results and future prospects consistent with the manner in which management measures and 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’ll turn the call over to Jim Foster.

[James Foster:]

Good morning. I’d like to begin by providing a summary of our third quarter results before commenting on our business prospects. We reported sales of 279 million in the third quarter of 2012, about 40 basis points better than the previous year. Excluding the negative effect of foreign exchange, net sales were 3.6% higher than in the third quarter of 2011. We were very pleased that for the second consecutive quarter, PCS business reported higher sales on both a year-over-year and sequential basis. We were particularly pleased to see the year-over-year improvement in PCS sales up 8 million or 7.5% on a constant currency basis. PCS sales also gained 1% sequentially, the first time since 2007 that third quarter PCS sales have exceeded the second quarter level. We believe this is a further indication of market stability as well as the fact that we are gaining market share. RMS segment sales increased 1.2% year-over-year on a constant currency basis, but due to normal seasonality we’re sequentially lower than in the second quarter. The operating margin increased 80 basis points to 17% from the third quarter of 2011, driven primarily by the PCS business. The sequential decline was due primarily to the RMS business. Normal seasonality results in lower sales of research models which are extremely sensitive to changes in volume. Earnings per diluted share increased by 14% in the third quarter of 2012 to $0.65 per share from $0.57 in the third quarter of 2011. The EPS increase was driven primarily by the lower number of shares outstanding but also by higher operating income. We continued to return value to shareholders in the third quarter through our share repurchase plan with the purchase of approximately 416,000 shares for $15 million. We estimate that we will purchase between 1.4 and 1.6 million shares this year, approximately the middle of the 1 to 2 million share range we noted when we gave our 2012 guidance last December. As you know, we are updating our guidance for 2012. We now expect that constant currency sales will be approximately 1%, at the low end of our previous guidance of 1 to 3%. Despite the continuing positive sales effort to strengthen relationships with all of our clients which have enabled us to gain market share, the large biopharma market remains volatile and with limited visibility. Furthermore, we believe that these clients will restrain spending in the fourth quarter as they focus on meeting year-end financial targets. Although sales growth will be at the low end of the expected range, our continued efficiency initiatives and share repurchases are enabling us to maintain our non-GAAP EPS guidance and to narrow the range to 2.68 to 2.73, the mid to high end of our previous guidance range. We accomplished a number of significant expansion objectives in the past three months

[Thomas Ackerman:]

Thank you, Jim, and good morning. Before I recap our financial performance, let me remind you that I’ll be speaking primarily to non-GAAP results from continuing operations. A reconciliation of non-GAAP items can be found in our press release and on our website. We were pleased with our third quarter growth, which included a constant currency sales increase of 3.6%, operating margin expansion of 80 basis points, and an EPS increase of 14% when compared to last year. While third quarter sales and EPS were below the first two quarters, this is consistent with the seasonal trend in the third quarter, particularly for RMS. The favorable PCS performance in the third quarter, highlighted by 7.5% constant currency sales growth and a 13% operating margin, represents improvement in demand across both the large biopharmaceutical and mid-tier client segments for both our safety assessment and non-GLP discovery services. We were also pleased that trends in this business were relatively stable compared to the strong second quarter performance. The strategic partnership with AstraZeneca provided only a minimal benefit to the PCS performance in the third quarter under an interim agreement that had been in place since May. We are working diligently with AstraZeneca to transfer protocols and perform validation and pilot studies. Since these validation and pilot studies generate little revenue, we do not expect a more meaningful benefit from the partnership until early 2013 when the transition has been completed. This is consistent with the progress on our strategic partnership that we announced last November, which took several quarters to transition before meaningfully contributing to our results. Start-up costs related to the AstraZeneca partnership were expected to be marginal as incremental hiring is expected to be limited. RMS sales increased 1.2% on a constant currency basis in the third quarter. In addition to the consolidation within large biopharmaceutical clients, RMS sales were pressured by our large model business. This business has been a headwind throughout 2012, but the impact was more pronounced in the third quarter, reducing RMS sales growth by nearly 200 basis points year-over-year. This was partially offset by the August acquisition of Accugenix. Continued strong EPS growth in the third quarter was driven by a balance of operating margin expansion and stock repurchases. I will now walk you through the non-operating line items in more detail. Unallocated corporate costs were relatively stable in the third quarter at 16 million. This was slightly lower than the second quarter as health and print-related costs remained favorable. We expect fourth quarter unallocated corporate costs to be similar to the third quarter level and total approximately 6% of sales for the full year. Net interest expense was relatively stable at 4.6 million in the third quarter. We do not anticipate any meaningful changes to interest expense in the fourth quarter, so net interest expense should be approximately 18 to 19 million for 2012. Primarily as a result of a Canadian tax settlement related to R&D tax credits, our non-GAAP tax rate decreased 40 basis points sequentially in the third quarter to 25.7%. We expect that the tax rate will increase in the fourth quarter due to both an anticipated tax law change in a foreign jurisdiction that would increase the effective tax rate, and the fact that the Canadian item will not recur; however, we believe our non-GAAP tax rate for the full year will now be at the low end of our prior 26.5% to 27.5% range due to the favorable tax rates in the second and third quarters. We have continued to make progress on our four key initiatives in 2012. New projects are continually implemented under our profit improvement program with a goal to further drive operating margin improvement. In the third quarter, we began the process of consolidating two small RMS facilities in Europe as part of the ongoing evaluation of our global footprint and efforts to improve efficiency and profitability. We can provide the same products and services from our other facilities in the region and reduce the overhead for the smaller facilities. In the third quarter, we incurred nearly 1 million in severance costs and a 3.5 million asset impairment charge related to this action. We have also continued to generate strong free cash flow. In the third quarter, free cash flow was 50.8 million, an increase of approximately 11 million over last year. Year-to-date free cash flow totaled 109.9 million. We continue to expect to achieve free cash flow in the range of 160 to 170 million for 2012. This was a robust quarter for free cash generation despite an unfavorable change in DSOs. DSOs increased to 52 days in the third quarter from 48 days in the second quarter due to client mix and non-credit related receivables fluctuations. We have also continued to make disciplined investments in our growth businesses. Year-to-date capital expenditures totaled 33.8 million and we remain on track to spend approximately 50 million in 2012. One example of these investments is our new diagnostic laboratory in Wilmington which we opened during the third quarter to support our growing RADS business. We also acquired Accugenix in the third quarter for approximately 17 million. As Jim mentioned, Accugenix expands the capabilities of our fast-growing EMD business by adding premier microbial identification services to our portfolio. In the fourth quarter, Accugenix is expected to represent approximately 1% of our total sales and be neutral to earnings per share. In conjunction with our third quarter release, we also announced that we have signed an agreement to acquire a 75% stake in Vital River, a leading commercial provider of research models and related services in China, for approximately 27 million subject to certain closing adjustments. The transaction is expected to close in the first quarter subject to customary closing conditions, including Chinese regulatory approvals. The acquisition is expected to add more than 1% to 2013 total net sales on a full-year basis and be slightly accretive to 2013 EPS. Both of these acquisitions demonstrate our commitment to disciplined investments. We have performed thorough due diligence, a rigorous financial analysis, and extensive integration planning to evaluate these acquisition candidates and ensure their successful integration into the Charles River portfolio. In addition to capital expenditures and acquisitions, we continue to balance our capital priorities between stock repurchases and debt repayment. Our stock repurchases totaled 1.2 million shares for the first nine months of 2012 at a cost of 42.8 million. As of December 29, we had 73.5 million outstanding under our stock repurchase authorization. We expect to repurchase between 1.4 and 1.6 million shares in 2012, or near the middle of our previous range of 1 to 2 million shares. We also reduced our total debt by 17.5 million in the third quarter as we continued to repay debt modestly ahead of the scheduled installments on the term loan. As Jim discussed, we have reduced our constant currency sales guidance to an increase of approximately 1% for 2012, which reflects slightly lower than expected sales in the RMS segment. We continue to expect that foreign exchange will reduce reported sales by approximately 2% for the year. We have also narrowed our EPS guidance to 2.68 to 2.73, or the high end of our previous range, to reflect the strong year-to-date performance. Our updated 2012 guidance includes a small benefit to sales from both the AstraZeneca partnership and Accugenix acquisition, but the earnings impact from each is not expected to be significant in 2012. Our narrowed guidance range assumes a meaningful decline in fourth quarter EPS as we are maintaining a cautious outlook toward the end of the year. Our outlook assumes that normal seasonal trends will pressure fourth quarter results. Although we did experience increased spending late in the fourth quarter of 2011 as our clients utilized remaining budgetary funds before the end of the year, we are not forecasting a budget flush this year. Many of our clients have indicated that they expect to restrain spending in the fourth quarter in order to meet financial targets. We believe our outlook is prudent given client commentary and the current macro economic and political environment in the U.S. and globally. Sequentially for the fourth quarter of 2012, RMS sales are expected to improve moderately, in large part because we will record a full quarter benefit from the Accugenix acquisition as well as from robust organic growth in the base EMD business. PCS sales are expected to be moderately lower due to fewer study starts during the holidays, which has become a more significant factor in recent years due to the shorter term nature of preclinical work. Our clients’ budgetary concerns are also expected to cause some studies to be delayed at year-end. The non-GAAP operating margin is expected to climb moderately in both segments from the third quarter level due to the normal seasonal trends. As I mentioned earlier, the tax rate is expected to increase in the fourth quarter primarily due to an anticipated tax law change in a foreign jurisdiction. I would also like to remind you that the fourth quarter of last year benefited from the addition of the 53rd week. Since 2012 is a normal 52-week fiscal year, we expect the year-over-year sales growth comparison to be negatively affected in the fourth quarter of 2012. You may recall that the 53rd week benefited the fourth quarter sales growth rate by approximately 450 basis points in 2011 or approximately 12 million, and we would expect it to reduce sales growth by a similar amount in the fourth quarter of this year. We are focused on a strong finish to the year through the continued execution on our four key initiatives, our efforts to take market share and provide customized solutions to our global clients, and our programs to drive efficiency and profitability across our businesses. We also look forward to providing you with our outlook for 2013 in December. Thank you.

[Susan Hardy:]

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

[Operator:]

Certainly. [Operator instructions] We’ll go to David Windley with Jefferies. Please go ahead.

[David Windley:]

Hi, good morning. Wondering if I can ask a two-parter. I guess the question I’ll ask is around the broader deals that you’ve been able to bring under the umbrella, I’m curious about how that has catalyzed other conversations, Jim. You’ve talked over the course of the last year about other clients engaging you in conversations around those types of deals, so if you could talk about how those conversations are going. And then if you could also talk about the embedded pricing in these deals and how that looks relative to what spot business might look like. Thank you.

[James Foster:]

Hi Dave. We’ve been saying for an awfully long time – several years, at least – that drugs are going to be rolling off patent, the whole drug development process would have to change, that we would all have to do what we do best and that the drug companies would inevitably outsource this work. And not that we’re great sages; it was just sort of clear from looking at the cost structures and looking at how we had built out our business and the things that we could do for them that it’s been a little bit frustrating over the last few years the rate at which this hasn’t happened as quickly as we had anticipated. But be that as it may, it’s clear now that we are in the midst of a significant change in the way the clients are operating. We have these two large deals – one that we can name the client and one that we aren’t able to. We have several other conversations in various stages of that sort of process, but it’s clear that as the drugs roll off and as they re-look at their infrastructure, and of course we’re seeing—and I’m not saying that we’re literally the catalyst for this, but we’re seeing facilities being closed as we said they would – several years ago, we pointed to this – and staff being reduced, at least in the areas where we can help them. So we’ve got this wonderful symbiotic relationship where we’re doing the work for them, we believe, scientifically as well as fast or faster and at a beneficial value proposition. The other thing that’s important is that we’re utilizing the whole portfolio and so clients who have bought from us historically sort of on a transactional but non-strategic basis across our portfolio are being much more strategic about those purchases, and as we pointed to in the prepared remarks, we sign these large deals but we become very much the partner of choice, the scientific partner of choice, and we’re finding that very quickly there is additional work beyond the confines of that deal and beyond the confines of what we had done with these clients previously that we’re more apt to get and in fact are getting. So we’re very pleased with our ability to essentially take share and do so principally on a scientific basis. In terms of the embedded prices, it sort of depends on the nature of the work; but I would say that we’re pleased in most cases with the prices that we’re getting. You said how do they compare to spot prices? You know, again, that depends. For most of the deals that we’re doing, and some aren’t large strategic deals but they are large relationships that we’ve had, we’re obviously seeing that with the transfer of protocols and those smoothing out over time and the increase in volume that the value proposition improves, we often bid knowing that we will be able to improve the profitability as the volume increases and we’re quite confident that we’ll be able to do that. We’ve also indicated our capacity is filling, so we’re being very thoughtful about how we fill it from here on in and what the relationship is between large clients and small ones, between long-term deals and short-term deals, and between specialty talks and general talks and also between GLP and non-GLP. So it’s a very interesting patchwork right now and one that we think will continue to if not accelerate, continue at this rate where we find more clients. And yes to your question – I think that the announcement of a specific client has gotten the interest of others, and in the previous deal where we couldn’t announce it publicly, we have said in our conversations with the Street that we have used that client as a reference with other potential clients, and that’s obviously gone quite well. So the notion that our clients will increasingly become our advocates and help us with kind of the sales and validation process, we think is a very, very powerful one.

[David Windley:]

Great, thank you.

[Operator:]

We’ll go to Eric Coldwell with Baird. Please go ahead.

[Eric Coldwell:]

Thanks. I don’t know if I can restrain myself either. First off, I’m curious about the impact of the fungal meningitis outbreak for your EMD segment. I don’t believe you do point-of-use fungal testing, but Accugenix brings in some capabilities there. I’m just curious what you think the derivative impact of the fungal meningitis outbreak will be for your business.

[James Foster:]

It’s hard to say. I would say that with a lot of these pharmacies that weren’t testing as they had our technology available to them, it’s likely that some of this stuff could have been prevented. So you know, we’re talking about very early detection of these things, and yeah, we’re quite cognizant of the potential for us. I couldn’t begin to quantify the value to the business, but it’s exemplary of the type of expansion capabilities we now have with rapid microbe testing in addition to the rapid endotoxin testing.

[Eric Coldwell:]

That’s fair. And if you’ll allow me one more – I did a quick search of the Biocon website as you were speaking. It’s a pretty interesting website, but I can’t actually find any data immediately available on the total R&D budgets of their membership base. But it’s some very large companies, so I’m curious if you can give us some sense as you displace Harlan there, if you can give us some sense of the incremental opportunity to grow that business over time.

[James Foster:]

Sure. This is a piece of work that we have wanted to secure for a long period of time. You’ve got this huge concentration of some of the best biotech companies and other institutions in the world in southern California, and obviously we have a significant west coast operation there so it makes a lot of sense that we would be their provider. As we’ve said, the rate of adoption is sort of unknown – we think it will be modest at the beginning and accelerate. All we can say is it’s a several million dollar opportunity, assuming that the majority of it comes to fruition; but it’s sort of difficult to pinpoint how quickly that will happen. But the opportunity is there and the clients are certainly well aware of that, and it would be financially advantageous of them to take advantage of our relationship with a size of contract.

[Eric Coldwell:]

That’s great. Thanks very much.

[Operator:]

We’ll go to John Kreger with William Blair. Please go ahead.

[John Kreger:]

Hi, thanks very much. Jim, can you just remind us the portion of your business that comes from academia and government across the two segments? And in this period of cutbacks, are you seeing any pullbacks by that customer base and do you think that is a trend that you might see as we move into ’13?

[James Foster:]

So the global number is 24%. As we’ve indicated for the last few years, that’s up dramatically. It used to be in the mid-teens, so by focusing our sales force globally on this sector and by the fact that our price points versus the competition have been—the premium has been reduced dramatically, we’ve gotten a lot more traction in the academic marketplace. And by the way, I believe that we can continue to do so going forward. As we indicated in the prepared remarks, the increase in the academic and government sector has slowed somewhat over ’11 – it’s sort of flat, actually. The academic piece is up a bit more than the government piece. We did have a couple of government contracts which we actually rebid on and did not win for a variety of reasons, principally price; but yeah, around the edges there’s probably a subtle reduction in demand but not as much as you would anticipate. As we’ve indicated previously, the research model business in particular is not particularly price sensitive. It’s a relatively low volume purchase or low ticket purchase for our clients. If you’re doing basic research, you’re going to use animals, and so we don’t see the sort of severe impact that perhaps some people that are selling larger, more expensive pieces of equipment might. We also have a lot of embedded government contracts with multiple year durations which are in good stead, and we’ve always had a very big piece of the government business in Europe where it’s actually a bigger percentage of the whole than it is in the States. So if we’re seeing anything, it’s subtle, slight slowdown versus the prior year; but really, nothing dramatic that concerns us, and we would anticipate that we would continue at least on the pure academic piece of this, through this concerted sales effort be able to continue to have at least a slight uptick in that going forward.

[John Kreger:]

That’s very helpful, thanks. And just to clarify – the 24% was across your total revenue base, right, or just RMS?

[James Foster:]

No, it’s total government and academic across the total revenue base.

[John Kreger:]

Great, thank you.

[Operator:]

And we’ll go to Greg Bolan with Sterne Agee. Please go ahead.

[Greg Bolan:]

Hey, thanks. Tom, just some back-of-the-envelope math here, but is it safe to assume the year-over-year headwind from large models was about a $0.02 drag on EPS this quarter?

[Thomas Ackerman:]

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

[Greg Bolan:]

Okay, great. Thanks. And then just real quickly, Jim, I’m assuming that non-discovery services is something on the table for discussion with your latest in vivo biology partner, and I know you guys characterize this still as 1% incremental to calendar ’13, but do you believe the potential discovery business there to be larger, smaller, or kind of in line with what you’ve already won, just kind of hypothetically?

[James Foster:]

Yeah, hypothetically as we have these large relationships and we get closer scientifically with clients and they kind of look at us as really an extension of themselves, the potential to expand that to the non-GLP area, for instance, is certainly there. I wouldn’t want to say with any certainty that we can make that happen. I’m sure we will. I continue to have those conversations with this client and with others. Our footprint is quite strong scientifically, as we said, particularly in the CNS and oncology areas where lots of clients, including that particular one, are spending a lot of dollars. So we’ll certainly continue to have the dialogue. It all depends on the client’s readiness to outsource that type of work, and their readiness is somewhat enhanced by the knowledge that we have the capability for them.

[Greg Bolan:]

Thank you.

[Operator:]

We’ll go to Douglas Tsao with Barclays. Please go ahead.

[Douglas Tsao:]

Hi, good morning. Just in terms of the deal with AstraZeneca, I think in the original press release you indicated that it was expected to grow or contribute about 1% to revenues, or an incremental 1% to revenues. Would you expect there to be incremental growth off of that base as we move into 2014?

[James Foster:]

As we said with the last question, we would hope that through our relationship that we would be able to expand our service offering to them and they would be interested in that as well. It’s a better value proposition for them, and through these deals you really get to understand the expectations of the client in terms of service and time frame and IT interface, and we understand their expectations better as well. So there’s a more comfortable basis upon which to do that sort of work, so yes, we would hope so but it’s not built into the contract. I mean, I want to be clear about that.

[Douglas Tsao:]

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

[James Foster:]

I don’t think we have that number at the tip of our fingers, Doug. We certainly have some relationships and some sales to some of those clients, but a lot of the opportunity is incremental and we weren’t able to do work with those clients previously because they had this preexisting relationship with one of our competitors at more attractive price points. So we do think this will be beneficial, notwithstanding the fact that we had some of these clients already.

[Douglas Tsao:]

Okay, great. Thank you very much.

[Operator:]

And we’ll go to Tycho Peterson with JP Morgan. Please go ahead.

[Tycho Peterson:]

Hey, good morning. I’m going to ask a two-parter on RMS. First, on just the Vital River deal, you had previously obviously moved out of China, understanding that this is a different business you’re going back in with. But can you just talk about whether or not it’s really just to gain access to the market, or do they bring any new capabilities?

[James Foster:]

So Tycho, it’s pretty straightforward. This is becoming a major life sciences center with large local companies, a growing cadre of biotech companies, and a whole bunch of international companies that are going to do work to develop drugs de novo in China, and they’re absolutely going to want to use the same quality animals they’re using elsewhere. As we’ve said actually for a few years now, we continually assessed the opportunity to be in the research model business in China and up to this point haven’t felt that the market opportunity was significant enough for us. We do think the opportunity is significant enough now, and we think the growth rate will be impressive for us. It’s a good-sized market. The research models that are available now are primarily from government-based production operations at very low price points and at very low quality points as well, so they don’t have this sort of virulogical and bacteriological and genetic sort of consistency that our animal models have. So this is a licensee of ours, so they have our breed stock. It’s sort of a derivative facility; it’s very Charles River-like. It’s a very good opportunity for us. We intend to set the quality standards and eventually the pricing standards for laboratory animal production and research in China, and we will increasingly expand our presence into other areas in which we operate. So with this acquisition, we get a RADS laboratory and a GEMS capability. As I think you know, we also have a small endotoxin company in China. We source our non-human primates from there, and so increasingly we will do more and more of our work there. But it feels very good to have a strong research model business as the hub and the center of our activities going forward.

[Tycho Peterson:]

And then just to follow up on RMS, the guide down there, I’m just wondering how concentrated it is by customer and how much visibility you now have in those markets, and I think you also mentioned some impact to the GEMS business so I’m wondering if you could elaborate on that.

[James Foster:]

You’re just talking about the overall—

[Tycho Peterson:]

Yeah, the guide down for RMS.

[James Foster:]

Well, we’re seeing that decline in the third quarter really for two reasons. One is the normal seasonality, which we have every third quarter. The other is we’ve had a continuous decline in small animal sales for a while now. Some of that’s related to tox and some of that’s related to the low spending in the discovery area, and some of it is for sure related to the continued concentration of our client base, reduction of facilities. We’ve had multiple big pharma site closures either happen or announced in this fiscal year, and we anticipate there probably will be more of those. Obviously, at some point that will level off. That over time should be offset somewhat by the sort of mix issues with more highly valued models or genetically based models, and any uptick obviously in the tox business would be an improvement as well. So it’s been in a decline but somewhat leveled off.

[Tycho Peterson:]

Okay, thank you.

[Operator:]

And we’ll go to Doug Schenkel with Cowen & Company. Please go ahead.

[Doug Schenkel:]

Hi, good morning. In recent quarters, you guys have talked about a higher mix of shorter term, less complex studies within PCS. Given the strength that you’ve demonstrated within PCS the last couple quarters, I’m just wondering if there is any update there, whether that’s evolving right now. Thank you.

[James Foster:]

Yeah, a couple things – number one and interestingly enough, a lot of those short-term studies are actually pretty complicated, so we find ourselves doing very complex work for our clients; and again, I think our scientific holds us in very good stead vis-à-vis the competition. We’re going to continue to focus there. We have had an increase in longer term GLP work, sort of not the great balance that we’ve seen historically but it is improving, so you’ve got obviously some of the molecules are moving through short-term studies to longer term ones. I’d say that the mix—you didn’t ask this, but the mix between specialty work and general tox is okay, somewhat better than it has been previously. Again, we’ve had periods where that was almost 50/50 or better. So I’d say that the mix of business is subtly improving with more long-term studies and extremely complex ones as well.

[Operator:]

And we’ll go to Tim Evans with Wells Fargo Securities. Please go ahead.

[Tim Evans:]

Hi, thanks. I was hoping to get a little bit more color on the long-term margin guidance, specifically how would you characterize the trend in RMS margin versus PCS margin? I’m particularly interested in how the recent changes in the business would impact that, namely the acquisitions you’ve done as well as the two strategic partnerships.

[Thomas Ackerman:]

Well, obviously we have different historical data points in both segments. In RMS, we have an extremely high margin that we’re obviously protective of, while at the same time we’re trying to improve it. So I do think there’s potentially some opportunities to improve it, but certainly we’re trying to safeguard it where it is as well. Preclinical, we’ve obviously struggled over the last few years given the changes in the marketplace in terms of demand, pricing, et cetera, where we have seen it erode. We have made a lot of cost and structural changes over the last few years. We’ve actually improved it quite nicely against headwinds like historical price changes that we’ve seen, so I think we’re probably a little bit more optimistic on improvements in the preclinical side. The strategic deals, while they add an element of pricing in terms of pressure and a larger competitive process, they do allow for incremental business in most cases and steadier demand, so notwithstanding any price pressures it will allow us to actually do the work in a more steady, consistent fashion as we have demonstrated from our last partnership, improve our efficiencies and work knowledge so that we can actually continue to drive the margins up. So I think going forward, as Jim had said, we’re still targeting 20% over the next few years. I don’t think it will be that easy to get there, and I think the opportunities are probably larger in, say, preclinical but nonetheless in some of our grow RMS businesses as well where we do have EMD, as an example, and a couple of other areas where we are still experiencing growth in RMS.

[Tim Evans:]

Great. The RMS acquisitions don’t create too much of a headwind there on margin?

[Thomas Ackerman:]

Well, Accugenix of course—our in vitro business is quite profitable, so Accugenix from purely an EMD standpoint creates a little bit of pressure, but we’re obviously working to improve the margins going forward. The margins there are not creating a drag on the corporate margins, so I should be clear about that; and China, it’s really the same. We do think we have good opportunities to improve the margin by bringing more of our knowledge to that process locally, both production and sales; but again, from a corporate standpoint, those margins are not creating any pressure on the corporate margin rate.

[Tim Evans:]

Great, thank you.

[Operator:]

We’ll go to the line of Ricky Goldwasser with Morgan Stanley. Please go ahead.

[Andy:]

Hey, this is Andy in for Ricky. How are you guys doing?

[Susan Hardy:]

Good, how are you?

[Andy:]

Good. So just real quick – your guidance implies a step-down sequentially in 4Q earnings. On the 2Q call, you guided that 3Q would be the low point for the year. I was just wondering what changed since the 2Q call, and are there any implications heading into 2013?

[James Foster:]

I think I’m going to ask you to repeat the question. I know you were talking about what’s different from what we said after our Q2 call going into Q3—

[Andy:]

Yeah, sorry about that. I’m going to have to try again. So I was just saying on the 2Q call, you guided that 3Q would be the low point for the year. Clearly, the new guidance has 4Q sequentially stepping down. I was just curious what has changed since the 2Q call and are there any implications from that heading into 2013?

[James Foster:]

Well, what I would say about Q4 specifically is that we talked about the 53rd week, which I think was a little bit of difference in some of the analyst call; but also, we had the benefit of the quote-unquote budget flush last year, and while we didn’t necessarily expect that this year, we expect things to be a little bit more normal and I think now we’re a little bit cautious about some of our clients actually restraining spending, so I thin that’s a little bit more maybe on the preclinical side but as well on the RMS side. We probably have seen a little bit more softening in our large biopharmaceutical accounts in the research model side, and I think other than that, I don’t know that I would add anything else.

[Andy:]

Okay. So just a follow-up on that – there was just a little softening versus where you guys where when you reported 2Q. Do you think that trend is going to continue into next year, or it’s really just some cautiousness turning to the end of the year and you expect things to rebound?

[James Foster:]

Well, year-end is always a little bit of a seminal moment. We are putting our plans together as we speak, and we’ll be providing guidance in mid-December so that’s probably a data point or a point in time where we could give you a little bit more clarity on that.

[Andy:]

Okay, thank you.

[Operator:]

And we’ll go to Ross Muken with ISI Group. Please go ahead.

[Ross Muken- ISI Group:]

I just have two quick follow-ups. Just one on the China business – I mean, my understanding, having been over there, is the models market is pretty price sensitive and there’s a lot of local competitors, large academic and government-based institutions that sort of have their own. How do you see sort of the landscape in terms of the addressable market of the asset you purchased? Is it mainly western companies based over there, or is it sort of broader base of Chinese companies as well?

[James Foster:]

It’s going to be both, Ross. I mean, obviously we’re going to have—it’s going to be a much more straightforward proposition to sell higher quality and higher value models to international companies that are our clients in other parts of the world, but obviously we’re going to have a focus on educating the local user, both government and commercial start-ups in this sector, to the value of high quality animals. You know, we’ve done this for almost 70 years throughout the world, and the research results will be better. So it will take some time but as that market grows, we will have a central role in this, both geographically and in terms of the scientific quality of the animals, and through seminars and other things we’ll educate this marketplace as we’ve educated other marketplaces throughout the world, so we’re quite confident in our ability to drive growth. By the way, this business that we’re buying, while we haven’t broken it out, it has very good operating margins so we’re really happy with the value proposition. We’ve got very high quality facilities with our own animals, and with our direct participation now and expansion, we’re really going to be able to educate the marketplace. We’re hitting it just at a time where there’s a lot of increased investment, both internally by the government and externally through these global pharmaceutical companies. We’re really excited to be there in a significant way, and we think that we timed it quite well.

[Ross Muken:]

And just secondarily from a COGS perspective, you guys have done a really good job at managing COGS and SG&A despite some of the volatility you’ve seen in the business. As you look going forward and sort of the margin targets where are we in terms of your ability to sort of deliver that 20% goal in the context of top line? I mean, how much is coming just from volume versus how much is coming from management of just sort of efficiencies and other pieces on the OPEX side? And if we see some choppiness, where are you getting the most flex in your cost structure to continue to be able to deliver the bottom line?

[Thomas Ackerman:]

Yeah. Well, I would say – and it’s not getting any easier – most of our flex in our cost structure would really come from efficiencies. We have rung out concessions from our suppliers and we’ll continue to do that, but we have mainstreamed sort of our merit increases a couple years ago, holding merit increases flat and things like that. We can’t afford to do that forever, so I think you look at an environment where you have to increase wages each year at an appropriate rate. We’ll continue to work with our suppliers, but it gets harder and harder, and so we’ll continue to look at efficiencies as well, although you get sort of the easy efficiencies out of the way earlier and then that gets harder and harder. So I do think we’ll continue to do all those things. I think they’ll contribute, but we also need to see an uptick in volume – you know, Jim talked about mid-single digits. We need to kind of see those type of numbers, continue to get price increases in the research model business, and gradually start to get price increases in the preclinical business. And I think if all those things don’t come together, it will obviously be hard to get to a 20%-ish margin in a few years.

[Ross Muken:]

Thanks, guys.

[Operator:]

And at this time, there are no questions in queue. Please continue.

[Susan Hardy:]

Thank you for joining us this morning. We look forward to talking to you all in the near future, and this concludes the conference call.

[Operator:]

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