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Albany Molecular Research, Inc. (NASDAQ:AMRI)

Q3 2013 Earnings Conference Call

November 6, 2013 10:00 ET

Executives

Dr. Thomas D’Ambra - President and Chief Executive Officer

Michael Nolan - Chief Financial Officer, Vice President and Treasurer

Analysts

Greg Bolan - Sterne, Agee

Andrew Weinberger - Private Investor

Operator

Good day and welcome to the AMRI Third Quarter Earnings Release Conference Call. As a reminder, this call is being recorded. At this time, I would like to turn the call over to your host Dr. Thomas D’Ambra, President and Chief Executive Officer. Please go ahead, sir.

Dr. Thomas D’Ambra - President and Chief Executive Officer

Thank you, Shannon. Good morning, ladies and gentlemen. Welcome to the conference call segment of AMRI’s 2013 third quarter announcement. This call is a follow-up to our press release issued earlier this morning over PR Newswire.

On September 9, I announced my retirement as CEO of AMRI effective on December 31, 2013. We were pleased to simultaneously report that Bill Marth will take over as President and CEO on January 1, 2014. Bill is joining us remotely on the call today and will be available to speak during the Q&A session immediately following our prepared remarks. Also with me on the call today is Michael Nolan, AMRI’s Chief Financial Officer, Vice President and Treasurer.

It has been a positive and busy period for AMRI highlighted by a number of changes that I believe positioned the company more strongly for greater growth, creating value for our customers, our employees, our shareholders and the communities in which we reside. AMRI’s contract services continued the recent pattern delivering year-over-year growth with all segments, Discovery Services, Development and Small Scale Manufacturing and Large Scale Manufacturing delivering double-digit contract revenue growth in the mid-teens or greater. This performance more than offset an anticipated double-digit year-over-year decline in royalty revenue with adjusted net income of $4.2 million, or $0.13 per share. We remain on track to meet our guidance for the full year. And as you will have noted in this morning’s press release, have tightened and raised full year guidance.

AMRI’s performance in 2013 reflects the turnaround built through a number of actions around rightsizing operations coupled with a strong performance from our large scale operations and modest gains in discovery and early development. As we entered the home stretch on 2013, we are confident that AMRI is well-positioned for continued positive growth for our services business in 2014.

I am going to stop here and turn the phone over to Mike Nolan for his comments after which I will have additional remarks. Go ahead, Mike.

Michael Nolan - Chief Financial Officer, Vice President and Treasurer

Thank you, Tom. Good morning everyone. Before we begin, I’d like to note that much of our discussion today might be termed forward-looking. Other than historical facts, our statements may contain projections, estimates and other forward-looking statements that involve a number of risks and uncertainties including those discussed in the company’s Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission on March 18, 2013 and the company’s other SEC filings.

While these statements represent managements’ current judgment on the future direction of the company’s business, such risks and uncertainties could cause actual results to differ materially from any future performance suggested herein. The company undertakes no obligation to release publicly the results of any revisions to these forward-looking statements to reflect events or circumstances arising after the date here.

I am now going to present financial results for the third quarter and financial guidance for the fourth quarter and full year 2013. Further details are included in our press release issued this morning over PR Newswire. I would like to underscore some highlights on a year-over-year basis for third quarter 2013. These include contract revenue growth of 16% at the top end of our guidance and then adjusted EPS of $0.13 compared with $0.00 in third quarter of 2012 and above the top end of our guidance. Royalties for the third quarter of $7.7 million were at the midpoint of our guidance and were below last year principally driven by lower Actavis royalties due to third quarter 2012 including the benefit of launch quantities.

Contract margins finished the quarter above our guidance at 16% helping our adjusted EPS performance finish above the top end of our guidance for the third quarter even with midpoint royalty results. We are pleased with the improving trends in our contract business performance with adjusted operating margin, excluding royalties and milestones, on pace to be profitable by the fourth quarter. And finally, we continue to generate cash as we grow the business with third quarter cash flow of $4.2 million for $2.8 million of capital expenditures resulting in an unrestricted cash position of $39.7 million.

Turning to the financial details for third quarter 2013, all comparisons are on a year-over-year basis. To begin with adjusted operating income in the third quarter, excluding a few one-time items, was $6.4 million. This compares to $1.5 million in the third quarter of the prior year with a strong pull-through on our increased contract revenue. Excluding royalties and milestones, adjusted operating income increased $7.3 million and incremental contract revenue of $7.4 million, reflecting a pull-through of 99%.

Total revenue was $60.8 million, up 9%. Total contract revenue was $53 million, an increase of 16%. Total contract revenue encompasses revenue from AMRI’s Discovery Services, Development and Small Scale Manufacturing and Large Scale Manufacturing business components. Contract revenue from Discovery Services was $10.4 million, an increase of 17%. The increase reflects growth in our medicinal chemistry business primarily driven by increased revenue from our in-sourcing relationship at Lilly along with a significant growth in our revenue for India Discovery Services.

Contract revenue from Development and Small Scale Manufacturing consistent with our expectation was $9 million, an increase of 22% with all segments domestically and overseas contributing to the strong growth. Contract revenue for Large Scale Manufacturing was $33.6 million, an increase of 15%. We saw an increase across the board at all our large scale operations. Our compounds in Phase 1 and Phase 2 development programs now total 54 as of the end of third quarter 2013. The number of compounds in Phase 3 on which we are working with clients was 22 as of the end of third quarter 2013.

Overall, third quarter 2013 royalties was $7.7 million, down $1.7 million. Royalty revenue for third quarter 2013 includes royalties from Allegra as well as $2 million earned by the company on net sales of generic product sold by Actavis for which the company also manufactures the active pharmaceutical ingredient at our Rensselaer, New York facility. The decrease was primarily due to the third quarter of 2012 Actavis royalties of $3.3 million, including large quantities.

Selling, general and administrative costs excluding some one-time executive transition charges were $9.1 million, which are 17% of contract revenue. Adjusted year-to-date SG&A costs as a percentage of contract revenue are 19%, which is down from 23% for the first nine months in 2012. Adjusted earnings per share in the third quarter of 2013 were $0.13 per diluted share compared to third quarter 2012 of $0.00 per diluted share. Adjusted earnings per share exclude restructuring and effective transition costs.

Cash generated from operations was $8 million before payments of $3.8 million for lease termination and settlement costs, which were charged in previous quarters for a net increase of $4.2 million and before capital expenditures of $2.8 million. Our cash, cash equivalents and restricted cash increased approximately $44.4 million by the end of Q3 2013.

I will now provide our full year and fourth quarter 2013 financial guidance. Looking at full year 2013, we are reconfirming the top end of our contract revenue guidance to $213 million, an increase of up to 12% from 2012 and increasing the bottom end of the range to $210.5 million reflecting our stronger first nine months 2013 results. For fourth quarter 2013, we see this coming in around $60 million to $62.5 million, an increase of up to 6% over 2012 excluding estimated royalties of $6 million to $7.5 million.

Breaking down revenue for the year, at the top end, we are projecting Discovery Services to grow 11%, Development and Small Scale to grow 2% and Large Scale to grow 16% versus 2012. The contract gross margins we are guiding to improve our contract margins from11.5% in 2012 to a midpoint of 17.3% in 2013, slightly up from our previous midpoint of 16.8% for the year. We will see some margin benefit resulting from the closure of our Bothell facility through the balance of the year along with increased volume leverage in the fourth quarter.

R&D investment is expected to decrease slightly to less than $1 million focused on improved process efficiencies in the plants and also furthering our out-licensing opportunities. We project adjusted SG&A costs to be slightly down versus 2012 based on ongoing cost savings and targeted investments more than offsetting inflation. As a percent of the contract revenue, adjusted SG&A will approximate 18%, which is down 3% versus 2012. Adjusted SG&A excludes one-time litigation settlement charges and executive transition costs.

As we have stated in our last call and the last few announcements issued, we have undertaken cost steps to ensure we reach profitability excluding royalties by the end of 2013 on a run rate basis. The cost steps of realigning our Discovery Services as well as managing down our SG&A and R&D spend are reducing our annual cost structure to move us toward our goal of being profitable excluding royalties and milestones by the end of the year.

Projected adjusted operating income, excluding royalties, milestones, restructuring charges and executive transition costs for the fourth quarter is estimated to be around $1 million at the midpoint of our guidance. For the full year 2013, we are projecting royalties to range from $35 million to $37 million including $8 million and $9 million from Actavis royalties. However, due to continued strength in our contract manufacturing business, we are able to increase and tighten the range for adjusted EPS guidance to the new range of $0.60 to $0.67, up from our previous guidance of $0.54 to $0.65. At the midpoint, our adjusted earnings per share guidance represents a 250% increase over our adjusted earnings per share of $0.25 in 2012. Our adjusted earnings per share guidance for 2013 excludes the impact of a litigation settlement, executive transition costs, impairment and restructuring charges from our previously announced closure of our Bothell and Hungary operations.

As a result of our increased operating performance, ongoing working capital management and disciplined capital program, we predict a strong cash flow in 2013. Operating cash flow has been increased from our last forecast and will now range from $23 million $28 million before CapEx between $12 million and $14 million. For the fourth quarter, we expect contract revenue growth compared to prior year to range from 2% to 6%. Broken down to segment, fourth quarter contract revenue growth versus prior year is estimated as follows, $9.2 million to $9.7 million for Discovery Services, down 8.5% at the top end. $9.0 million to $9.5 million for Development and Small Scale down 8.4% at the top end. And $42 million to $43.5 million for Large Scale, up 14% at the top end. We project total royalty revenue in the fourth quarter to range from $6 million to $7.5 million including $2 million to $2.5 million from Actavis royalties. We expect contract gross margins in the fourth quarter of around 18%. SG&A and R&D for the fourth quarter of 2013 will approximate fourth quarter 2012. For the fourth quarter, we expect adjusted earnings per share to range from $0.12 to $0.19.

Before I turn the call back over to Tom, I would like to emphasize how pleased we are with the progress toward our objectives so far this year. The momentum has been positive and we are confident with the outlook for 2014 where we see low-double digit growth rates in our contract business. We will of course, discuss this in more detail during our fourth quarter earnings call and look forward to giving you more color for 2014 at that time.

I will now turn the call over to Dr. D’Ambra, who will continue concluding marks.

Dr. Thomas D’Ambra - President and Chief Executive Officer

Thank you, Mike. Although market demand for discovery and early development has remained soft for the last several years, we continue to see early signs of a strengthening of the demand for these services. As contract revenues grow for discovery and early development, we are able to recognize a disproportionate pull through to contract margins as we are able to fill excess capacity. At the same time, we continue to have capacity to meet projected growth for the foreseeable future.

Discovery Services contract revenue increased 17% on a year-over-year comparison, benefiting as we have all the year by being at full scale for both Lilly insourcing and NIH contracts relative to the prior year as well as on the cost side, benefiting from closing and consolidating operations from both Hungary and Bothell into our Hyderabad and Singapore operations respectively. While lowering fixed cost structure, these decisions have allowed us to retain capabilities and existing customer relationships. As mentioned previously, our ability to create custom libraries of synthetic compounds in Hyderabad now enhanced in vitro biology operations in Singapore continued to perform notably well. Hyderabad in particular delivered a strong quarter with contract revenues increasing more than 50% for Q3 versus the prior year.

During the second half of this year, we have also begun to see a modest increase in interest and demand for U.S. based Discovery Services with a number of small FTE relationships being established for U.S. based medicinal chemistry. Although the aggregate value of these newer relationships is small relative to total contract revenues for the Discovery segment, some of these small opportunities may be pilots for potential expansion in the future. Overall, I believe the trend of interest in U.S. Discovery capabilities bodes well for the future.

On October 16 we announced the appointment of Dr. Michael Luther as Senior Vice President for Discovery Services. Mike officially joined AMRI on October 28, replacing Dr. Bruce Sargent who was retiring at the end of the calendar year. Dr. Luther has a distinguished and accomplished track record and joins AMRI from Charles River Laboratories where he was Corporate Vice President of Global Discovery Research Services serving as the General Manager of the firm’s Discovery business unit including developing and implementing strategic and operating plans. Prior to his role at Charles River, Mike was President and a member of the Board of Directors of the David H. Murdock Research Institute in Kannapolis, North Carolina. And before that he held the position of Vice President and Site Head at Merck Frosst, Montreal, Canada site. Before joining Merck, Mike also held positions of increasing responsibility at GlaxoSmithKline culminating in his appointment as Vice President, High Throughput Biology.

Mike’s strong biology background and accomplishment as well as his experience in both large pharma and the CRO world bring to his role the experience and network to strengthen AMRI’s position as a leading Discovery partner to the industry. I am confident that Dr. Luther is the right person to lead AMRI’s strong Global Discovery brand to the next level as we expand the breadth and depth of our biology capabilities in line with movement by our customers seeking greater and more integrated discovery offerings by the service providers. We thank and are grateful to Dr. Bruce Sargent for his long and successful career at AMRI. Notably under Bruce’s leadership several of our internal R&D programs achieved successful milestones some of which have been successfully out-licensed to other parties. I will have a few additional comments about our R&D programs later in these remarks.

Turning to our Large Scale business segment, as Mike mentioned contract revenue for Large Scale Manufacturing was $33.6 million, an increase of 15% resulting from an increase across the board at all of our Large Scale operations, Rensselaer, Holywell, Wales, India and Burlington. As in past, quarters Large Scale performance was led by our Rensselaer operations which delivered 15% in contract revenue growth and a very large increase to the bottom line driven by improved capacity utilization and greater margin and the mix of business this quarter. It should be noted that Rensselaer had a record fourth quarter in 2012 and is forecasting to beat those results this year. In addition to continued improvement in Rensselaer, all of our other Large Scale operations delivered improvement over the prior year. With investments and GMP upgrades coming to completion in Holywell, Wales, and in Aurangabad, India, these facilities are poised to deliver continued growth in 2014.

On September 30 we announced that our Holywell subsidiary was awarded a seven-year contract for the development and manufacture of an active ingredient under clinical evaluation. The active ingredient is for a potential antidote to chemical poisoning. The contract was awarded by Defense Science and Technology Laboratory acting on behalf of the United Kingdom’s Secretary of State for Defence, the Department of National Defense of Canada and Minister of Defence of the Kingdom of the Netherlands. AMRI is working on the development and scale of the investigational drug and subsequently the manufacture and supply for use during the Phase 1 clinical trials. If the trials are successful, AMRI will be in a strong position to become the commercial manufacturer in the product for distribution to the government – government partners of this contract, including the U.K., Netherlands and Canada.

Government contracts and related collaborations outside of our typical outsourcing contracts with biopharmaceutical companies are part of our strategies to diversify our revenue base while making our high quality services available to all industries, sectors and organizations that can benefit from strength and discovery development and manufacturing. This includes work as both a contractor and sub-contractor for various agencies of the U.S. government. AMRI has been a sub-contract in the manufacturing arena for the U.S. Department of Defense for more than a decade. In August of 2011, AMRI was awarded a five-year, up to $43 million federal contract from the NIH, National Institute of Neurological Disorders and Stroke to provide chemistry and other drug discovery technologies in support of the Institute’s Medicinal Chemistry for Neurotherapeutics Program, part of the NIH Blueprint Neurotherapeutics Network. AMRI’s Burlington parenteral dosage form subsidiary also a component of AMRI’s Large Scale segment continues to benefit from growth and the number of customers at early stage projects.

Yesterday, we were pleased to report that on Monday November 4, we received a letter dated October 30 from the New England District Office of the Food and Drug Administration stating that the FDA has completed an evaluation of Burlington’s corrective actions in response to the warning letter dated August 17, 2010. The letter further stated that “Based on our evaluation, it appears that you have addressed the violation contained in this warning letter. Future FDA inspections and regulatory activity will further assess the adequacy and sustainability of these corrections.” This language is accepted in the industry as confirmation that the FDA is closing out the 2010 warning letter, and we expect the letter to be posted on the FDA website in the ordinary course of business.

As a result, AMRI’s Burlington, Massachusetts facility may receive approval for products manufactured at Burlington, in addition to continuing the work with customers’ development program. In addition, Burlington has been audited by a growing number of customers throughout 2013, with every audit concluding successful and a large majority resulting in new business relationships for the operation. We believe that the lifting and the warning letter will lead to greater opportunities in business for our Burlington operations and remain committed to the high level of diligence and obligations to high quality required to sustain this momentum.

I want to acknowledge and thank my many colleagues at AMRI for their dedication and efforts to bring this chapter in the history of the Burlington facility to a successful outcome. At a time when the FDA is raising the quality bar across the industry for injectable dosage from manufacturers, AMRI has successfully demonstrated the ability to meet these tough standards and is now well positioned to support our customers and the many patients they serve. Quality is a core value to our business so it’s gratifying, but no surprise that AMRI was awarded a 2013 CMO Leadership Award for distinction in Quality from Life Science Leader in an industry-focused news publication. The award acknowledges a survey result of more than 10,000 pharmaceutical and biotechnology executives based on research conducted by Nice Insight. The survey covered more than 100 contract-manufacturing organizations.

To be recognized by our industry peers and customers as a leading CMO in the area of quality, it is a great honor and testament to the dedication of my colleagues at AMRI to each and every customer. We are grateful that our customers recognize AMRI’s SMARTSOURCING as a high quality global brand and we will continue to search for ways to improve our offerings and performance.

I would next like to turn my remarks to discuss one of our partner programs, our CNS program that AMRI licensed to Bristol-Myers Squibb in 2005. The lead compound, BMS-820836 completed two Phase 2 clinical trials during the first half of this year. On August 12, we filed an 8-K with the Securities and Exchange Commission indicated they had recently been informed that BMS had made a decision to terminate development of 820836 against treatment-resistant depression. And BMS announced that decision on August 12 to the various clinical investigators who had enrolled patients in Phase 2 studies. A third ongoing clinical study is being discontinued. According to BMS, this decision was made based on the drug’s failure to achieve the primary end point in two Phase 2b studies, which is superiority over duloxetine and SNRI or escitalopram and SSRI in patients with treatment resistant depression. BMS intends to share further data from the two Phase 2b studies at an appropriate scientific forum and/or in a scientific publication at a future date.

AMRI expects to have continued discussions with BMS regarding their plans for this compound and other development compounds and Discovery leads previously identified for potential development against treatment resistant depression or other CNS indications. We believe there may be opportunities for BMS 820836 and other compounds in the series and look forward to working with BMS to define a strategy to seek continued development of this important technology. Although AMRI is no longer investing significant resources in advancing any new compound R&D program we continue to seek to unlock the value for shareholders of past investments in this CNS and other programs and believe the changing licensing environment is more conducive for potential partnering than it has been for several years.

As I wrap up my prepared remarks this morning I’d like to summarize several points that we want to leave with you today. First and foremost AMRI continues to deliver significant growth and revenue and substantial improvement in financial performance in this quarter and year-to-date relative to the year ago period. These results reflect an improvement in business driven by all of our contract operations and importantly also reflect the disciplined spending decisions we have taken in prior periods which have not impacted our ability to grow. These results are anchored by a number of long-term supply contracts and strategic relationships across our Discovery and Manufacturing business and represent a long-term revenue base and backlog with visibility for the next several years.

Secondly, we continued to be proactive in strengthening our leadership team and strategic plan. The appointment of Dr. Michael Luther as Senior Vice President for Discovery Services brings to our Discovery leadership a world-class and accomplished biology leader with Big Pharma and CRO experience. As I retire at the end of this year and William Marth takes over as CEO of AMRI I believe Bill is inheriting a strong leadership team bolstered by several appointments over the past couple of years.

Third, the Burlington operations continue to strengthen and the team will only have more opportunities available to pursue based on the close-out of the warning letter. This reaffirms and demonstrates AMRI’s commitment to the highest standards with regard to quality, execution, scientific activities and customer service. Our brand is growing and AMRI’s smart sourcing options provide the market with services and capabilities beyond what our competitors can offer. We continue to implement best in class practices, services and technologies and we remain committed to making AMRI a premier provider across the range of technologies and services of our business.

As I conclude my last remarks as the CEO of AMRI I want to sincerely thank my colleagues at AMRI for making the company what it is today and putting us in position for even greater things in our future. As AMRI enters a new chapter, I believe the company will grow and prosper as a successful global pharmaceutical and biotech services company with Bill Marth at the helm and I look forward to working with him and the leadership team when I reassume my role as Chairman. I’m very proud of what we’ve accomplished over the more than 22 years and continue to believe that the best still lies ahead.

Thank you also for your interest in AMRI. At this point, we will be happy to answer any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question does come from Greg Bolan with Sterne, Agee.

Greg Bolan - Sterne, Agee

Hey, thanks guys and congrats on a very strong pull through in your Contracts Service margin this quarter. In fact, I guess if I look at the last five quarters, I’m kind of coming up with about an average of 99% pull-through for incremental contract service margins, which I don’t think has happened in a very long time, maybe even seven years. And I know that Rensselaer obviously is a big contributor here and I was just maybe wondering if you could maybe give us an update, Mike, on your Rensselaer is probably fair to say that you guys are running probably, or maybe even exceeding optimal utilization. But how does utilization kind of look across the board as you go out to your – as you kind of look out at your more global, Large Scale assets?

Michael Nolan

Yes, thanks Greg. We appreciate you being on the call and asking the question today. So a couple of things, first of all I want to touch base on your comment on the incremental pull through for our business. You’ve indicated 99% pull-through. It was kind of a number. If you do the math, it’s actually 74%. I just wanted to clarify that for everybody on the phone versus prior year, so year-to-date September versus year-to-date September last year.

Greg Bolan - Sterne, Agee

Got it.

Michael Nolan

Second, in terms of capacity utilization, I think that’s your question, Greg?

Greg Bolan - Sterne, Agee

Yes.

Michael Nolan

Yes. So, certainly as we’ve mentioned on previous calls, Rensselaer is operating kind of in that 80% to 85% range in terms of its capacity, whereas we have other facilities in our Large Scale particularly where we’re not up to that level of utilization. And then if I move to our discovery business, we are also not kind of actual capacity. And it varies depending on the various parts of our business there. But fair to say in the foreseeable future that similar to Thomas comments that we have the ability to expand the business without any major capital investment on the growth rates that we gave you, particularly for 2014 as an example.

Dr. Thomas D’Ambra

Great, Greg. With regard to Rensselaer, there are clearly certain areas where there are bottlenecks for capacity bumps up against – and we have mentioned before, not only for Rensselaer but in Wales and India as well, we’re making targeted capital investments to clear these bottlenecks, so that allows us – for example earlier steps we don’t have capacity limitations in many of the reactor trains in Rensselaer, but as you make an API, your final step goes through a finishing suite that has controlled air and a clean room type of environment. That can be a bottleneck, so there are targeted investments in that area as well as other equipment that will allow us to increase the total pull-through or capacity we can put into that facility without major investment.

Greg Bolan - Sterne, Agee

Okay then. That’s very helpful. And then as I think about the announcement of a very large pharma company here as of late, how are you thinking about this pharma company’s direction as it relates to outsource. Say for example chemistry work as you think about for example your single floor facility and just thinking about what this large Pharma-company as well as the general mindset out there. And Bill or Tom, you could take a crack at this. It seems to me that we are kind of at a tipping point as it relates to the outsource manufacturing. We’ve seen outsourcing penetration really rise for the services side of the equation. On the manufacturing side I feel like we are still kind of behind, and still very low penetrated market place. If you could, maybe give me an update on what’s the mindset out there as you guide the meeting with the Executive types at Big Pharma.

Dr. Thomas D’Ambra

I will jump in first. I think it’s a great question Greg and it goes across, it’s not just manufacturing as well, but during the quarter or just subsequent to the quarter we noted a number of additional layoffs from Big Pharma and I think that part of the restructurings is kind of right sizing these organizations to where they need to be, and we think that going forward you are going to see a lot more variable costs in both R&D and manufacturing. I don’t think pharma is going to start hiring thousands of people again as their R&D spend picks up. Really they’re looking for strategic partners. And we’ve seen that interest from a number of these large companies.

We think that bodes well for AMRI because we positioned ourselves as a science-driven organization where we can help our customers innovate, solve problems and not just low-cost commodity type of outsourcing support. So I think that is a good barometer for the future. And on the manufacturing side, as you know, that’s been farther behind. But we know that a number of these companies have begun to shed their facilities and are really looking for more strategic relationships. As Bill has said before, these companies are starting to realize they don’t have to own everything, but there are high quality providers out there than can support them. And we’re seeing a lot of interest in that direction.

Greg Bolan - Sterne, Agee

That’s helpful. Great. And then as I think about the commentary regarding low double digit contract service revenue growth next year, if I look at the third quarter, DDS definitely beat me by quite a lot, especially on the Discovery side. What’s the mix just in terms of the triggers here? And I know it’s probably a little early to get into this, but just qualitatively, what’s the thinking going into next year because as we speak to large pharma types, we speak to early development, late stage development CROs, it seems as though there’s maybe an indication that there might be more dollars devoted to early development pipelines next year. And I guess I just wanted to get a sense as to your thinking as it relates to the drivers for 2014 contract service revenue growth.

Dr. Thomas D’Ambra

Sure. And we’re hearing the same things. I think we’ve talked in past calls that we’ve had a number of R&D leaders in pharma talking about their budgets for 2013 being tight because of all the late-stage compounds and Phase 2 trials really chewing up a lot of R&D dollars. But the expectation was that 2014 money would start to get freed up for early discovery efforts, in part because these expensive trials may be drawing to a conclusion. There’s a need to refill pipelines. And then you have the launch of the FDA approval of a number of new drugs, both last year and continuing into this year, that fuel sales. So it’s not across the board. You know every company is different, but we are seeing signs that many companies are looking at picking up their R&D spending again. And I think the experience over the last decade, they’ve learned a lot. We know one big pharma we’re working with is really beginning to recalibrate their metrics for their partner’s performance. And as part of that recalibration, it’s really about their ability to innovate, provide higher quality support and really refocusing on their outsourcing to I guess help drive the success of their pipelines.

Greg Bolan - Sterne, Agee

That’s great. And I apologize. Okay so that was me. So gross profit dollars for DDS, or gross profit margin for DDS and Large Scale, Mike, I apologize, I think I missed that.

Michael Nolan

So for Q3?

Greg Bolan - Sterne, Agee

Yes.

Michael Nolan

Yes, I just want to quickly jump to Q3 gross profit for Discovery Services for Q3 was 20%. And then if I move down to Development, it’s 13%. And if you go to Large Scale, it’s 18%.

Greg Bolan - Sterne, Agee

Okay. And I guess just kind of going back to your response as it relates to kind of what you’re hearing out there as it relates to dollars being devoted to more Early Development next year. And as I think about the gross margin profile of DDS versus Large Scale, Mike, could you maybe give us an update on maybe what those margins could look like in a more optimal fashion? I think historically we’ve talked about, I could be off here, but maybe 30% plus gross margins for DDS kind of at more optimal levels and gross profit margin for Large Scale maybe in the low to mid-20% range. Is that still kind of how we’re thinking about it? That’d be helpful.

Michael Nolan

Yes, sure. Is your time horizon kind of out for the next year or so?

Greg Bolan - Sterne, Agee

Yes. I mean over the next, say, three years actually.

Michael Nolan

Three years. Okay. Well, what we’ll probably have is a bit of convergence similar to our Investor Presentation, I believe we put out there what 2015 looks like. So in line with those kind of numbers, you’ve really got all segments growing in terms of Contract margin because of the continued leverage we get with every incremental dollar revenue. So there’s no real added cost in a lot of cases. And so what I anticipate is when we think of our Discovery and perhaps Development business, those margins should be migrating towards 25% levels, right. And then the Large Scale business are north of 25% level type of margins. They tend to be particular rent, so there where we can command a higher margin. So – but again, I don’t want to get into too much color because it is somewhat competitive too, but those would be orientation-wise kind of what I would expect.

Greg Bolan - Sterne, Agee

That’s helpful. And then actually just on the competitive comment, if you think about your competition it would appear to me that not only is there kind of a shift going on as it relates to more outsourcing dollars or more dollars being outsourced in your neck of the woods as it relates to your specialty, but it also feels as though all the things like this gaining share, I don’t know how you actually would gauge that but just anecdotally, Tom, is that the impression you’re getting as well?

Dr. Thomas D’Ambra

I do think so, Greg. You might talk about our pipeline of compounds we’re working on for customers and the API and still finished area of being 54 compounds Phase 1 and Phase 2, another 22 in Phase 3. That’s a large chunk of the specialty pharma smaller companies. I don’t think many of those compounds are from Big Pharma so if you carve out all the development programs that Big Pharma’s working on I think we have a large piece of the other part of the pie. Part of our strategy is to get more of the Big Pharma piece going forward and that goes to that question you asked earlier about their move to manufacturing more outsourcing, and I think we’re well-positioned for that in part because of the reason we’ve got all these specialty pharma compounds, because of our ability to deliver high quality not only on a manufacturing scale but helping them in those early batches where a lot of – they’re still research until you get through a validated process and things can go wrong. And it’s a challenging effort for our development colleagues to do but they perform very well.

And I think the same thing on the discover side where I mentioned before a lot of the, particularly the larger companies, are starting to re-look at their outsourcing strategy and really asking what they’ve been getting for their dollars and what they need to refill those pipelines. And it’s in a sense a return to quality, looking for outside partners that can add more value than just being commodity providers to their internal resources but taking advantage of the scientific minds and the problem-solving ability of the partners they work with. So I think AMRI is very well positioned going forward as the industry looks for more strategic partnering type relationships with outsourcing service providers much as they’ve done on the clinical side.

Greg Bolan - Sterne, Agee

That’s great. And then, Mike, could you give me an update on PhDs as a percentage of total head count?

Michael Nolan

I certainly can. If I look at where we are as at September we’re around 33% overall, the it varies depending upon operations so you may have particular parts of our business where that ratio is quite a bit higher, for instance in Singapore as an example and as well if you look at our U.S. Discovery business. So that’s an aggregate number but you can imagine it peaks above that in certain other parts of our population.

Greg Bolan - Sterne, Agee

Sure. And to me it seems that number is kind of three to five x some of your competitors, so that’s very helpful. Okay, so I’ll stop here. Thanks for the questions.

Michael Nolan

Thanks, Greg.

Operator

And next we go to Andrew Weinberger, Private Investor.

Andrew Weinberger - Private Investor

Hi, guys. Thanks for letting me get in with a question here. First obviously, Tom, congrats again on your semi-retirement and clearly thank you for making sure the company was on the right track going forward before sort of semi moving on. But a quick question about the fourth quarter and as we move into 2014 is there any sort of expectation in some sort of macro acceleration from the 4% to 6% growth in the fourth quarter and the sort of low double digits in 2014? Or is that really just a factor of how strong the fourth quarter was last year?

Michael Nolan

Yes, that’s a great question.

Andrew Weinberger - Private Investor

I think it was like 50% or so right, plus the 50% revenue growth last year in the fourth quarter?

Michael Nolan

That’s right.

Andrew Weinberger - Private Investor

So if you kind of look at the aggregate it seems like, am I looking at it the right way? So you don’t have any sort of aggressive anticipation of any major acceleration necessary to (indiscernible) growth that you had for the majority of this year? It’s just sort of how the numbers lined up?

Michael Nolan

Well, that’s right. And you may recall we had a very strong Q4 last year particularly in our Large Scale and Rensselaer business. And the growth expectation this year is that we’ll still have some impressive growth at Rensselaer so when you add it all up it’s still as a company growing on what was a record quarter in Q4 2012. So and we’re very pleased that we can still grow particularly on our Large Scale business at Rensselaer even when last year was such an impressive growth rate.

Andrew Weinberger - Private Investor

So it’s really just a very tough comp in the fourth quarter, and these numbers sort of more normalized for your higher revenue growth. I mean you expect sort of continual 10% revenue growth going forward, and that’s sort of what you see the business doing for, I guess, the foreseeable future?

Michael Nolan

Yes. So, it’s actually north of 10% we’re expecting next year in terms of overall growth for the company. And a quarter-to-quarter can very because you get some lumpiness sometimes in some of your large commercial orders, which we have pretty good visibility to at this point, to be quite honest, for 2014.

Andrew Weinberger - Private Investor

Okay, perfect. Thanks so much.

Dr. Thomas D’Ambra

Thanks, Andrew.

Operator

And it appears there are no further questions in the queue. I would like to turn the conference over to Dr. D’Ambra for closing remarks.

Dr. Thomas D’Ambra - President and Chief Executive Officer

Thank you, Shannon. This concludes today’s Q3 earnings call. Thank you again for your interest in the company.

Operator

And that does conclude today’s conference. We do thank you for your participation. You may now disconnect.

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