According to Citi Research analyst Garen Sarafian, the contract was worth between $11-$12m per year, and is now set to expire in September, though it was supposed to expire in Sept. 2016. Upon its expiration, Charles River will be forced to compete with other commercial vendors as well as the NCI directly, which said it could potentially insource some of the rodent breeding.
“As a result of this change, the NCI will discontinue its research model production contract at Charles River’s Frederick, Maryland, site,” CRL spokesman told us. “Charles River is evaluating the option to operate this site as a commercial business, by working directly with the NCI’s clients to provide research models.”
Seventy-six of the Frederick office’s 94 employees currently have roles that primarily support NCI, though the company would not say how many of those jobs might be impacted by the contract’s end. “At this point, it is too early to determine if there will be a workforce reduction,” a company spokesman told us.
Sarafian added: “While we think insourcing of models where the vast majority of the industry is outsourced is unlikely, we are concerned losing a government contract and competing commercially will lower margins on the business it does retain.”
He estimates that for CRL, the NCI contract represents $0.04-$0.06 of annual EPS (earnings per share), though the analyst maintained his “Neutral” view of the company’s shares, noting, “We continue to favor clinical over pre-clinical, driven by improving trends in the former and more aggressive pricing and competition in the latter.”
Citi analysts also estimate Charles River will have received about $89m over the contract’s eight year life when it formally ends.
Operating Margin Pressure?
In February, Charles River announced that it expects non-GAAP operating margins in its RMS (research models and services) business, which buoyed its Q2 results , to increase by more than 30% in 2014, driven by both price increases and global efficiency.
But Sarafian said he believes reaching this goal of 30% margins may prove difficult with this contract loss, even if the company is able to retain a substantial portion of its business. “Additionally, the RMS segment’s margins are three times higher than its Pre-Clinical segment, which could pressure consolidated margins,” Sarafian said.
Thus far, NCI’s decision seems steeped in a change of policy rather than budget cuts or other politically motivated events, according to Sarafian.
The recent merger of two of the largest players in the pre-clinical space -- Harlan Labs and Huntingdon Life Sciences -- may also alter the competition as NCI grantees select vendors.