Charles River Laboratories International Inc (CRL) 2006 Q4 法說會逐字稿

Good day, everyone, and welcome to today's Charles River Laboratories fourth-quarter 2006 earnings conference. Today's call is being recorded. At this time, I'd like to turn the conference over to Corporate Vice President-Investor Relations, Susan Hardy. Please go ahead.

Thank you. Good morning and welcome to Charles River Laboratories' fourth-quarter and full-year 2006 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 and full-year results and review guidance for 2007. 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 Web site at IR.criver.com. A taped replay of this call will be available beginning at noon today and can be accessed by calling 888-203-1112. The international access number is 719-457-0820. The PIN number in either case is 1934902. The replay will be available until February 27. You may also access an archived version of the webcast on our Investor Relations Web site.

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 provision 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 March 14, 2006, as well as other filings we make with the Securities and Exchange Commission.

During this call, we will be primarily discussing 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 reconciliation to those GAAP measures on the Investor Relations section of our Web site, through the Financial Reconciliations wink.

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

Good morning. I am pleased to take this opportunity to talk with you about our fourth-quarter and full-year 2006 results and reaffirm our outlook for 2007. To simplify matters and to keep the focus on the underlying metrics of our business, my financial remarks will address non-GAAP results from continuing operations.

The fourth-quarter results were right in line with our expectations. Net sales increased 5.2% to 272 million, and we closed the year with net sales of 1.06 billion, an increase of 6.5%. Foreign exchange contributed 240 basis points to the fourth-quarter growth rate but only 10 basis points to the full year. As we stated in the press release, the fourth quarter of '05 included a 14th week, so in comparison, the growth rate for the fourth quarter of '06 was reduced by approximately 3 to 5 percentage points.

Operating income for the quarter was 55.9 million, below last year's 59.3 million, due primarily to 123R stock-option expense of 2.5 million, higher corporate overhead, and lower sales of large research models. As a result of these items, the operating margin was 20.6% compared to 23% in the fourth quarter of '05. Operating income for the full year, which included $11.7 million of stock-option expense, was 232.7 million. The operating margin was 22% compared to 241.3 million and 24.3% in '05. Stock option expense accounted for 90 basis points in the fourth-quarter margin decline and 110 basis points for the full year.

At 39 million, net income was slightly lower than the 40.5 million recorded in the fourth quarter of '05, due primarily to the 2.5 million of stock-option expense. However, earnings per share were $0.58, a 5.5% increase over $0.55 per share in the fourth quarter of '05 as a result of the shares we repurchased. Similarly, for the full year, net income declined approximately 2% or 3.4 million to 154.2 million but that result included in the 11.7 million of stock-option expense. EPS increased to $2.20 per share, compared to $2.18 in '05.

The fourth quarter closed an eventful year for Charles River, a year in which we refocused and rededicated ourselves to our core competencies of laboratory animal medicine and science and regulatory-compliant preclinical services. We've sold or closed noncore businesses, invested heavily in expanding our preclinical services and RMS footprint, acquired a first-class Phase I business in Northwest Kinetics, and repurchased 6 million shares of our common stock. Our goal is to position ourselves to better support our clients and to take advantage of opportunities in both the research models and services and preclinical markets. We believe we have achieved that goal and are enthusiastic about our growth prospects in '07 and beyond.

Let's begin with our segment operating results for the quarter and year. For '06, RMS represented 49% of total revenues and preclinical was 51%. From an operating-income standpoint before unallocated corporate costs, RMS contributed 55% to profits and preclinical contributed 45%. The RMS segment grew 1.6% in the fourth quarter with foreign exchange contributing 2%. The extra week in the fourth quarter of '05 creates difficult year-over-year comparisons, reducing the fourth-quarter growth rate by approximately 3 to 5%. And as expected, lower sales of large research models also restrained growth. Production sales increased at a low single digit rate with sales to the U.S. market, the largest market for drug-discovery and development, outpacing those for the rest of the world.

As was the case earlier in the year, some of our largest customers continued to limit their purchases, while a broad spectrum of pharma and biotech customers increased theirs. For the first time since, early '05, U.S. transgenic services sales increased, and Europe and Japan also reported higher sales. In vitro sales also increased due both to sales of our core products and to the new PTS.

For the full year, RMS sales gained 2.4% with foreign exchange decreasing the growth rate by 40 basis points. Growth drivers for the year were similar to the fourth quarter, low single digit growth in models production with the U.S. increasing faster than the rest of the world and strong sales of our in vitro products.

The fourth-quarter operating margin decreased to 26.3% from 30.4% in the fourth quarter of '05, largely due to 123R stock-compensation costs, which reduced the margin by 90 basis points, lower sales of large research models and lower operating income in Japan due primarily to a one-time insurance payment received in the fourth quarter of '05. As you know, the large research model business is quite profitable, so the sales shortfall has a disproportionate impact on the quarter's operating margins. For the full year, the operating margin was 29.4% compared to 31.9% in '05 with 123R accounting for a decline of 90 basis points. The same factors which affected the quarter also affected the year, as did lower margins in the transgenic business. However, we do expect to see the '07 operating margin comparable to or slightly improved from the '06 level due to higher operating margins in the large research model in transgenics businesses and in Japan.

The Preclinical Services segment reported sales growth of 8.7% for the fourth quarter, including a benefit of 2.5% from foreign exchange and a similar benefit from the admission of Northwest Kinetics. As was the case with the RMS segment, Preclinical Sales' growth rate was negatively impacted by approximately 3 to 5%, due to the unfavorable comparisons of the fourth quarter of '05, which contain the extra week. Sales growth was also limited by capacity constraints, but with the opening of our new facility in Massachusetts and the benefit of ongoing expansions in Montreal and Edinburgh, we expect the growth rate to improve in '07. I will comment on the capacity additions in a moment.

Although sales growth was constrained in the quarter, we were very pleased with the operating margin growth. The Preclinical Segment reported a 22.7% operating margin, an increase of 130 basis points from 21.4% in the fourth quarter of '05. The fourth quarter of '06 included 1.8 million of stock-compensation expense, which reduced the margin by 120 basis points. On an apples-to-apples basis, the margin would have been 24%, an increase of 260 basis points. For the full year, the operating margin was 22.6% compared to 23.3% in '05. Stock-compensation expense account for 7.2 million or 130 basis points at the margin, so the comparable margin for '06 would have been 23.9%.

Both the quarter and the year benefited from higher sales, with improved margins at a number of our preclinical facilities. Our Six Sigma initiative has enabled us to improve our operating efficiency. And with the cost savings actions we took in the second quarter of '06, particularly in Montreal, we're making significant progress towards our goal of a 25% operating margin for the preclinical business.

The fourth quarter and full year '06 results support our confidence in our '07 guidance, which we are reaffirming today. We expect net sales growth in the range of 9 to 12%, which is a blend of mid-single-digit RMS sales and midteens preclinical sales growth and includes 2 percentage points from the Northwest Kinetics acquisition. We believe that the operating margin will be slightly below the '06 results of 22%, primarily due to higher corporate overhead, which is expected to include increased investment in Information Technology and the addition of senior staff as well as higher stock-compensation expense. Primarily as a result of the expected sales growth and the benefit of the lower share count due to our stock repurchase program, we expect earnings per share to be in the range of $2.43 to $2.53, an increase of between 10 and 15%.

I'd like to take a few minutes to discuss the growth opportunities we see in '07, but I will begin by commenting on recent developments in the pharma industry. In the past month, there have been a number of news items concerning cost reductions at Pfizer and the possibility of additional pharma consolidations. Many of you have asked how these events will impact us. Historically, pharma consolidation has been a net positive for Charles River while there may be a short-term reduction in purchases and research models, and we have made some allowance for this possibility in our '07 budget. Invariably, we see an increase in the demand by pharma for both RMS and Preclinical Outsource services. We believe these facility closures in the pharma industry also signal increased demand for services. We believe this for two reasons, first because any effort that pharma makes to improve operating efficiency must include additional outsourcing; and second, because pharma must focus their resources on drug-discovery in order to fill their pipelines with more viable drug candidates.

Charles River operates facilities dedicated to preclinical discovery and development. We test thousands of compounds for hundreds of clients. As a result, we operate more efficient facilities and develop a much higher level of expertise, particularly in specialty toxicology. For a pharma or biotech company to provide this in-house capacity and expertise, it is extremely expensive and inefficient and diverts their attention from discovery of new drugs. This is why we believe it's critical to build capacity to accommodate this growing demand and why we've been expanding our existing preclinical facilities and replacing our Massachusetts and Nevada facilities with new, larger, state-of-the-art operations.

As you know, we opened our new Shrewsbury facility on schedule in December and initiated studies there in January. We expect validation to be completed by the second quarter of '07, at which time we will begin performing GLT studies. Many customers have toured Shrewsbury and a number of them are involved in ongoing discussions with us concerning potential dedicated space agreements. We are extremely pleased with this new facility and look forward to our investor day on May 22, when we hope you will join us and see this impressive operation for yourselves.

The new Nevada facility is also progressing on schedule. Construction is well underway and we expect to begin a phased-in occupancy and validation of the facility in midsummer this year. Phase I also provides growth potential, which is why we expanded our services with the acquisition of Northwest Kinetics last October. In combination with our Edinburgh facility, we now have more than 300 beds between the two facilities. We plan to continue to invest to get opportunities to expand our global footprint, either through internal development or through strategic acquisition, should appropriate properties be available.

In addition to the significant opportunities in our preclinical and Phase I businesses, we are also working to capitalize on a number of growth opportunities in RMS. In order to better support the West Coast biotechnology corridor, which is one of the fastest-growing markets in the U.S., we're doubling the size of our Northern California facility. The new (indiscernible) is scheduled to open in the second quarter. In Maryland, we're building a facility which we will share by our research model production business and the National Cancer Institute. Last October, NCI ordered us the first dedicated capacity agreement for research models in the amount of $112 million over ten years. We will be breaking ground shortly for the Maryland facility, which is due to be completed in the third quarter of '08.

We've previously discussed preconditioning services through which we provide study-ready research models and speed our clients' research process. Preconditioning services encompasses a number of offerings, including surgery, feeding and aging studies, phenotyping and biological modification. As our customers look to improve efficiency, they are increasingly outsourcing these services because it enables them to reduce the space and man power they to have to invest in preparing research models to be used in studies. We already provide these services in North America, Europe and Japan. While the revenue base is modest today, we expect these services to drive future growth. To promote this growth, we expect to dedicate or build space in most of our major research model production facilities over the next few years.

No discussion of growth opportunities would be complete without the PTS, our portable testing systems for endotoxin detection. We are very optimistic about this device for a number of reasons. First, the PTS represents a significant advance over existing technology used in CGMP, or current good manufacturing practices (technical difficulty) the drugs and medical devices, and there has been no competitive response. Second, PTS addresses the FDA's processing analytical technologies or PAT initiative, which promotes real-time testing of in-process samples. Third, the PTS expands the market opportunity for our core products from 50 million to 200 million, and we believe there is an additional 200 million market opportunity for environmental testing and clinical diagnostics. It will take us some time to capitalize on these opportunities, but we believe that PTS will afford us double-digit growth in its markets in '07 and for years to come.

Capitalizing on all of these opportunities will require focus and execution, but we believe Charles River will meet this challenge. For the past two years, we have invested in strengthening our senior staff, adding talent and bench strength in our operating units and in finance, strategic planning, information technologies and corporate development. We expect to continue to add to our staff to enhance our ability to think creatively and execute effectively to build larger, even more successful Charles River.

It gives me great pride to say that 2007 marks our 60th anniversary. Charles River Laboratories was founded in 1947 in the belief that we could increase the success rate of drug discovery and development by providing standardized, superior research models that were free of known contaminants. Sixty years later, we have greatly expanded the breadth of our portfolio of products and services, offering the largest number of widely used rodent strains, an extensive menu of services which supports their use, preclinical services to prove efficacy and safety of new drugs, and Phase I services to support proof of concept. From a handful of people in 1947, we now employ nearly 8000 worldwide, but our mission is the same today as it was then, to accelerate research for healthier lives.

I'd like to thank our employees for their exceptional work and commitment. Our people are our greatest strength, and it is through their effort that we achieve our goals. And as always, we thank our shareholders for their continuing support.

Now, I will turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

Before I discuss our fourth-quarter financial performance, please recall that our discussion today focuses on results from continuing operations, as our Phase II to IV clinical and ISS businesses have been reclassified as discontinued operations for all periods shown.

As Jim did, I will focus my comments on non-GAAP results, which exclude all acquisition-related amortization, other items such as charges related to our cost-savings initiatives, and specifically in the fourth quarter of 2005, a deferred tax reversal related to the repatriation of 148 million of accumulated income earned outside the United States under the American jobs Creation Act of 2004.

Fourth-quarter operating income declined 5.8% to 55.9 million. Improvement in the Preclinical business was offset by lower operating income in the RMS segment, primarily due to the expected delay in shipments of large research models and the Japanese insurance settlement in the fourth quarter of 2005, as well as 2.5 million in 123R stock-option expense, and increase in unallocated corporate costs. Excluding the 123R impact, operating margins declined only 150 basis points to 21.5% in the fourth quarter of 2006.

Unallocated corporate overhead increased 3.2 million year-over-year to 10.4 million in the fourth quarter of 2006. This was a little higher than what we had previously anticipated for the fourth quarter and was the result of increased staffing, higher IT spending, and additional pension costs. For 2007, we expect unallocated corporate overhead to increase over 20% due to the investment in IT infrastructure, senior staff additions, and higher equity compensation cost. However, we expect these corporate costs to be more consistent quarter-to-quarter during 2007.

EPS increased 5.5% to $0.58 in the fourth quarter of 2006 from $0.55 in the fourth quarter of 2005. Lower shares outstanding due to repurchase and a decrease in net interest expense more than offset the slight reduction in operating income and a higher tax rate in the fourth quarter of 2006. I will discuss several of these items in more detail shortly.

123R stock-option expense reduced fourth-quarter 2006 earnings by $0.02 per share. Adjusting the fourth-quarter results to exclude 123R, EPS would have been $0.60 compared to $0.55 per share in the fourth quarter of 2005, an increase of 9% versus a 5% increase in sales. In addition to 123R stock-option expense, we also amortized cost of restricted stock grants. The table on Slide 30 shows our total equity compensation cost and the breakdown between stock-option expense and restricted stock amortization.

It is also important to note that, in 2005, prior to our adoption of FAS 123R, all of the restricted stock amortization was included in unallocated corporate overhead. In 2006, upon the adoption of 123R in January, we began allocating restricted stock grant amortization to the business units, in addition to stock-option expense. This did not change the total amortization of restricted stock for the Company but it did impact our year-over-year business segment comparisons, as there was no allocation to the business units in 2005.

As discussed on our December guidance call, our non-GAAP results have been reclassified to exclude all acquisition-related amortization expense. Following the acquisition of Northwest Kinetics, we decided we'd be more consistent to make a non-GAAP adjustment to exclude all amortization of acquired intangible assets from non-GAAP results. Previously, non-GAAP adjustments were only made for (indiscernible) related amortization, leaving amortization from earlier acquisitions in non-GAAP results. The adjustment adds approximately 3 million pretax to non-GAAP results in both 2005 and 2006, which was factored into our previous guidance. This equates to $0.03 per share annually. We expect approximately the same impact in 2007.

Net interest expense for 2006 was in line with our previous expectations at 12.6 million. Fourth-quarter net interest expense of 2.3 million decreased by 1.3 million sequentially versus the third quarter of 2006, reflecting increased capitalization of interest expense related to the Shrewsbury facility and payments made on term loans. In addition, higher interest income on cash balances and refinancing debt at lower interest rates also contributed to a year-over-year decline of 3.4 million. We continue to expect full-year 2007 net interest expense to be approximately 14 to 15 million.

Other income increased to 1.6 million in the fourth quarter of 2006, up from 0.6 million in the same period of 2005, due to an investment gain realized on the deferred compensation plan and foreign currency transaction gains. The tax rate increased to 29.1% in the fourth quarter of 2006 from 27.5% last year. During the fourth quarter, we adjusted various tax provisions based on our ongoing global tax reviews. This led to a small increase in our tax rate and also impacted discontinued operations. For the full year 2006, our tax rate was in line with our previous guidance at 29.5%, although at the high end of that range due to the fourth-quarter provisions. We maintain our current 2007 tax rate assumptions of 29 to 29.5%. As I'm sure you know, we will adopt FIN 48, which requires enhanced disclosure and review of income tax reserves in the first quarter of 2007. We do not believe the adoption of this standard will have a material impact on our financial statements.

I will quickly update you on the 3.4 million of income on discontinued operations in the fourth quarter of 2006. This income was primarily attributable to some closing adjustments related to the divestiture of our Phase II to IV clinical businesses, partially offset by a loss in our discontinued ISS Massachusetts business, which has and will continue to operate on a limited basis until the closure of the property is finalized.

Now, I will turn to balance sheet and cash flow items. At the end of the fourth quarter, we had cash and cash equivalents of 175.4 million, plus 111.4 million in short and long-term marketable securities for a total of 286.8 million compared to 134.8 million at the end of 2005. This increase was driven by the cash proceeds received from the insurance of the convertible debt offering in June and the sale of our Phase II to IV clinical business, partially offset by the repurchase of shares.

Accounts Receivable were 202.7 million at the end of the fourth quarter, up from 171.3 million in the fourth quarter of 2005, due in part to higher sales. Our DSO increased to 39 days in the fourth quarter when compared to 37 days for the third quarter of 2006 and 33 days for the fourth quarter of 2005, primarily as a result of an increase in unbilled revenue. The increase in unbilled revenue was primarily driven by the mix of studies at various stages of completion. We do not believe we have any increased credit risk as a result and are working to bring DSOs back down to historical levels.

For 2006, free cash flow was -4 million. This was below our previous guidance range due to an increase of DSOs, other changes in working capital, and slightly higher-than-expected capital expenditures. When compared to 117 million in 2005, the key drivers of the decline were an almost twofold increase of capital expenditures, tax payments made in the first quarter of 2006 for profits repatriated in 2005, and an increase of DSOs. Capital expenditures were 182 million in 2006 versus 94 million in 2005, reflecting increased investment in our preclinical and RMS facility expansions.

Our full-year 2007 guidance for free cash flow remains in a range of 25 to 50 million, with CapEx of 200 to 225 million. Depreciation increased to 45 million in 2006 and is expected to increase to approximately 54 million in 2007 as a result of the new facilities coming online. Total amortization expense decreased to 38 million in 2006 and is expected to continue to decline to approximately 31 million in 2007, primarily due to a reduction in amortization expense associated with the Inveresk acquisition.

To close, we are reiterating our 2007 guidance of non-GAAP EPS from $2.43 to $2.53 or $2.11 to $2.21 on a GAAP basis, and revenue growth in the 9% to 12% range.

That concludes our remarks. We will now take your questions.

Thank you. The question-and-answer session will be conducted electronically. (OPERATOR INSTRUCTIONS). Jon Wood, Banc of America.

Thank you very much. Is it possible to quantify what effect Northwest Kinetics had on the Preclinical operating margin in the quarter?

John, this is Tom. It would have had a diminimus impact on the Preclinical segment and on the Company as a whole, given that the margins of Northwest Kinetics are below our corporate averages. However, we only had two months of reported activity, so again, while it was negative, it wouldn't have been substantial.

Okay. Have you guys made any decisions on the timing of the Worcestershire exit?

Our activities there will be to move portions of the facility out as quickly as possible, probably sometime this year, so a portion of the work will move from Worcester to Shrewsbury as certain studies finish and new ones start. That's one of the animal-based work where the laboratory-based work we will remain there for a while and it's difficult to quantify that but I would say perhaps for another couple of years. So we will be looking two years down the road for perhaps a time where we can vacate Worcester totally.

Okay, great. Then finally, can you speak to the acquisition environment for Phase I assets?

Yes. We continue to look. As we've said before, we think there's a strategic need and benefit for Phase I, particularly in tandem geographically with some of our new preclinical assets. There's a fair number of companies out there, most of which are small and private. We're looking, as we did with Northwest Kinetics, for extremely high-quality science, reputation, some significant capacity and an ability to really hit the ground running, so we are continuing to look principally in the U.S. at the current time, and we may expand that overseas at a later date. If we are not unsuccessful, it would not be unlikely for us to do something on our own, so we're going to look for something sort of with the same quality specifications that we have in our Scottish and now Northwest Kinetics operations. If we are able to do that, great; and if not, we will create something in our own image. Now that we have something in the U.S., at least we have a foothold here and are able to take advantage of the pull-through effect, but it will be predominantly significant on the West Coast.

Okay, great. Thank you.

Derik De Bruin, UBS.

Good morning. So, you mentioned you saw some pickup in the transgenic business this quarter. Could you please elaborate on that?

We did, Derik. We had an increase in the U.S. transgenic business for the first time in a long time. We continue to see an uptick in Europe, which we've seen most of this year and actually saw a little bit of a bounce in Japan as well. We don't want to read too much into that yet, given that it has been such an unpredictable line of business and it's hard to predict what the clients are going to do.

What does appear to have happened is that customers have gone through the models that they have with us. They have rationalized them down to the strength that they want to work with that they think has the best predictive capability; they've characterize those models. What we are seeing now is we are seeing additional models being created and work coming to us. So we are adding new isolators, which are those plastic containment modules that you've seen where we house the clients' animals. So, we are obviously pleased with that. It's much too early to call that a trend. Obviously, we continue to check in with our clients continuously about the level of investments they have in Transgenics and importance that they have to them from a research point of view. We will continue to obviously watch it and report to you folks if this trend continues.

So as you recall, we were pleased with the flattening. We had projected transgenic services to be relatively flat for this year, relatively constant, so we are happy to have seen that uptick in the fourth quarter.

Great. Could you talk about the PTS endotoxin kit and just what you've seen to date in terms of launch of that product, and I guess expectations near-term?

Yes, I am very much going according to schedule. We have an aggressive marketing campaign going on worldwide. We have some new sales folks and we have somebody new heading our European operations. We have been spending a lot of time educating our clients because there is a validation timeframe that's required to get comfortable with that technology and be able to demonstrate that it's effective. We are seeing very robust demand for the PTS across the world. We're beginning to see it translate into a transition from our older technology to the newer one, as we anticipated.

We believe we're taking some share as well, and we are optimistic that we're going to see very high levels of revenue and corresponding levels of profitability in '07 as we begin to spend some time doing serious R&D work on the utilization of the basic technology for other applications, predominantly clinical diagnostics and environmental testing. So, I am very pleased with the client response that we've seen to date.

So you are expecting it to have a material impact on both the-- a material impact on the growth rate in the RMS business in '07?

You know, it's an increasingly meaningful business for us, Derik. I mean, it's still a relatively small business and we've helped you all try to figure out what the size and scope of that is. I would say that it's growing disproportionately fast to the rest of the RMS business, the market size has increased and it's more profitable. So over time, it will continue to be more meaningful. So it's a business we're quite happy with, for a whole host of competitive and financial reasons, and it will be increasingly more important as time goes on.

Great. Just one final question, Tom, what was the share count at the end of the quarter?

It was about 67 million.

Great. Thank you.

You can doublecheck if it's different.

Tycho Peterson, JPMorgan.

Could you give us a sense, on the large animal business, how you are looking at that business in particular for the coming year, whether we should think about any sort meaningful turnaround there?

Yes, just to reiterate what happened in '06, it was a very unusual year. We had some sort of slippage in quarterly shipments, which of course are unpredictable, so we've always said that we essentially sell all of the high-end large animals that we bring into this country, and we have a relatively small number of very large contracts with major corporations. Most of these animals are spoken for quite early in the year. So we had some quarter-over-quarter negative variations, and we kept saying to you folks "Don't worry; it will catch up in the fourth quarter", which we anticipated that it would have but for the CDC hold on some of the animals pending some testing results, which proved to be negative, which is a good thing. So, we have clearance to sell those animals and have been selling them readily through this first quarter. So, we will get the benefit of that this year.

So again, we would anticipate that we would sell all of the large animals to this range of clients, plus what we didn't sell in the fourth quarter of last year. We do have--we don't break it out specifically but we do have the benefit of some price increase working in there as well, because this is a relatively--it's a resource that's quite limited, and so we are quite optimistic about the sales this year and the year-over-year comparisons. Again, you have to look at it from an annual basis and not on a quarterly basis because the quarterly purchasing patterns are not predictable.

Okay. On the PTS, and this may be splitting hairs a little bit, but I noticed that you made the point of saying that you haven't seen any competition yet. Are you expecting anything in the near-term? And then, could you also give us a sense of what margins are like for that business?

So, all we've said about margins is that they are substantially higher than the corporation as a whole, and we believe we will continue to be there.

When we say we've haven't seen a competitive response, you know, we are in a business with a couple of other competitors who have had a kit similar to the kit we've been selling for the last dozen years. Our PTS device significantly sort of automates and speeds up the process and makes it more flexible and provides greater ease-of-use by our clients. We just haven't seen any of our competitors either be talking about having a device like that, announcing anything at all. We also have IP protection on our particular device, so we're not concerned that someone is going to try to do something identical to it.

So we are confident that we have fairly sizable lead. We would expect competition to respond at some point. We don't know when that will be, but since we have been in the market now for a while and have had FDA approval since July, that gives us a running start and we've had very positive customer reaction to this device with clients beginning to buy multiple devices. I think, once we have a meaningful installed base, it will be very difficult for anybody to come and take that from us.

Okay. Then finally, we've obviously seen pretty rapid expansion this year (indiscernible) market in Asia. Can you give us a sense of how you are prioritizing China and India at this point, and what we should be thinking about there?

Yes, so we've done a fair amount of investigation of in both locales. We see China primarily as a place for some chemistry work and clinical work, particularly the data-management aspects of clinical work, so India is a place that we're not really focused on at the moment.

We've spent a fair amount of time studying the China market, and given the educational base of the people, given the scientific acumen of a lot of people moving back to China, and given the fact that many of our international farmer companies are already there or are moving there, we think that directionally and strategically there's probably a need and an opportunity for us to be in most if not all of our businesses, or many of our businesses over there, certainly preclinical tox and the animal capabilities to feed that business. So, we are spending time trying to understand the market better, how they do business there, some of the IT issues and who might be the best partner, assuming we want to enter that market with a partner. Otherwise, we will be thinking about ways to do that in a greenfield fashion.

So, we think it's going to be an important market where drugs are made for the rest of the world in China by major international companies who are going to want to do work in China the way they do work in Europe and the U.S. from a quality point of view. We think we will be able to play a leadership role in helping them get those resources and to provide those services to them.

Great. Thank you very much.

Doug Tsao, Lehman Brothers.

Congratulations on the year. A question continuing on the large-animal studies, I just had a question. To what extent did the quarantine impact results in the Preclinical segment during the quarter? What I mean is that I imagine some of those animals that you sell end up in your own facilities for testing. Did it have an impact?

It really didn't impact, Doug. Most of the sort of high-end animals that we get, most of those come from the island of Mauritius--are sold to others. Mostly directly to our pharma clients for their own work, predominantly in-house. So the vast majority of the animals that we utilized for our own internal tox capabilities come from China and the supply sources were not interrupted at all. So it really only had an impact on RMS and particularly magnified in the fourth quarter.

Okay. Then on transgenic, Transgenics obviously sales were up in the U.S. Was there any particular customer segment relevant to biotech and pharma which was particularly strong, or was it just across the board, or a pick-up across the board?

Yes, it was pretty much across multiple clients, both large pharma and biotech, so there's obviously a renewed interest by some customers in investing in new models, maybe with multiple genes knocked out as opposed to a single gene knocked out or multiple genes inserted, because these animal models have always been a source of great optimism by our clients in terms of being of a predictive quality. So we've seen it across multiple clients. Again, we're going to be cautious about predicting any trends from that at this time.

Then I was wondering. I know there's been some interest in using transgenic models as a substitute for nonhuman primates, especially for testing of biologics. I was wondering if you had seen that and sort of customers ask you about that in your traditional models production business.

We really haven't. You know, I think that the primate is still the principle model for biological testing. It's hard to imagine that the transgenics certainly at this juncture (indiscernible) characterization and knowledge could be a substitute. You know, I think, as the drug (indiscernible) to do that, obviously they would use less drug and so that would be an attractive aspect of it, but we haven't heard that or seen it from our clients.

Okay. Then finally on the new capacity additions, the validation studies are underway. Are these--these are not revenue-generating or are they generate revenue-generating?

So the capacity that we have opened in Shrewsbury, we do have some studies (indiscernible) which are generating revenue. They are principally non-GLP in nature, so that's sort of early stuff, while we invalidate the facilities to get customers for GLP-quality work.

Now remember that we are using the Worcester facility and the Shrewsbury facility in tandem and all the while, while we are validating Shrewsbury, we are accepting studies that are going into Worcester and they are starting, and those are generating revenues. So you have to think of those operations fungibly and we do, and that's the way we are managing them.

I guess the one question I would have, though, as far as some of the long-term toxicology studies, are you having some hesitation from clients who, you know, before you have Shrewsbury validated yet they don't want to initiate studies at Worcester because that facility is going to be closing at some point in the near future.

I mean not really. Remember that it's exactly the same staff, so the principle draw for clients is the quality of the people they are working with, particularly the study directors. Yes, I think they would prefer to be in the new facility and will be in the new facility, but they have a need to get studies started. They are not hesitate to do them in Worcester, particularly when they've done them historically. Then as the staff that they've grown accustomed to literally moves over to the new facility when they have the next study ready to start, they'll be able to go with them. So it's actually, we think, preferable to be able to utilize these two facilities, one that's been operating for some time and one that's starting up, to effectuate a transition. I think it will actually be smoother than building a new facility from scratch. We will be able to have the same sort of structure in Reno as well when we move from the old facility to a new one. It allows us to take advantage of the older facility to satisfy clients' needs rapidly and in the short term, before the move to the new space.

Okay, thanks a lot.

Alex Alvarez, Goldman Sachs.

Good morning. If I could follow up on Doug's last question, I was just curious as to for how long do you expect that you will give customers the option of booking studies at either one of the Massachusetts facilities?

Well, it depends on the study. So a lot of our laboratory-based work, which is going to stay in Worcester for some period of time, obviously they will be able to do that for a couple of years. Probably in the second quarter, we will begin to have effective and satisfactory audits by our clients. The space will be ready and they will be comfortable booking studies in that time frame. So I would say into the second quarter, we will begin to see that, and obviously we will let the clients do that. Our goal would be to be moving out of the in-life portion of the space as rapidly as possible following validation.

Are there any plans at all to perhaps price studies differently to give customers an incentive to book new work in the new facility?

No, there's no such of that at all. You know, we are going to price the studies commensurate with the quality of the work and science and input and infrastructure that we are investing to get a fair return. I think it sort of flies in the face of logic to spend this sort of money and sort of provide incentives to clients to fill out this space at a reduced price if that's what you're saying. So we will make that transition. I think clients will actually feel that they are benefiting from having better-quality space at price points that aren't all that different.

Okay. Then in terms of the Nevada expansion, can you just remind us over what time frame you are thinking about consolidating the existing facility at that location?

Sure. So the construction is well underway. It's a very large facility; it's similar to the one that we are building out in Shrewsbury. We've learned a lot from that. That will open and will open this summer and we will slowly build up our utilization of that facility over the back half of the year, our GLP studies later. We are committed to getting out of our existing facilities, which are at leased by the end of '08.

Okay, thank you.

Eric Schmidt, Cowen & Co.

Good morning. Jim, you mentioned an operating margin target of 25% for the Preclinical business. Is it still your goal to bring RMS up to that level over time or is that unrealistic?

I was trying to follow that question. The goal--RMS is already around 30, Eric, right?

You said, historically, you've guided to total operating margins in the 25% range.

Right. So, RMS has already ramped, or the preclinical margin was 22% for the year, actually higher if you add back--if you normalize 123R.

What we've said is that combination with the G&A load on top of that, our goal is to have a corporate operating margin of 25%. We definitely think we are tracking towards that. The driver will be the preclinical business continuing to get there. So we're getting relatively close at the current time. As we finalize these new facilities and close the old ones, we will be more efficient. We think we will be able to get there. We hope we can also get the research model margins back to those sort of lower 30s from 30-ish and be able to have sort of our usual rational levels of G&A. So our corporate margin goal of 25%.

Okay, I'm with you. Then a question maybe more for Tom on the unallocated corporate costs that are going to increase 20% year-over-year in '07, could you just help us on--with a little bit more granularity on some of the initiatives? I guess I am particularly wondering about these increased benefits costs and whether that's a trend beyond 2007. I certainly can appreciate that it makes sense to invest IT and that you've got to add staff to continue to grow but I'm wondering about the other equity comps.

Sure. The biggest area of increase would be in our IT spending. We've actually allocated capital to IT, additional expenses, and of course some of the items that we'll capitalize in the early stages, until you get to a critical point in development, would always be expense. So we will see an awful lot of increase from IT; I would say that is the primary driver.

As Jim has mentioned, we've added a number of key people in staff positions and support for those people across the organization, and I think that's a driver also. We have seen some increase in benefits. I think that will continue to outpace inflation, although that's not going to increase 20-odd% on a constant-the basis, but that will continue to outpace inflation. I think those would be the key drivers, Eric.

So the general trend beyond 2007, Tom, would you expect that line to grow at a slower pace than the top line in the future?

I would, I would, because I think it's somewhat of a transitionary year in that particular area where we are probably underspent historically, particularly on IT as we've migrated to a more service platform, and really at the corporate level, we just really we don't have some of the resources that we really should have to do the work that we need to. So I think the end of 2006 and 2007 are more transitionary and I think, as we come out of 2007, we ought to be able to leverage what we have and grow more modestly.

Great. Thanks a lot.

John Sullivan, Leerink Swann.

Good morning. Can you please estimate the growth of the outsourced tox testing in 2006? Roughly?

In 2006? Yes, John, we still think that the work is being outsourced at sort of 12-plus%, maybe 12 to 14%. It's been relatively constant. It's somewhat tied to available capacity, interestingly enough. The available capacity has a lot to do with how much work we all think we can actually undertake from a people point of view. But 12-plus% looks to be sort of a continuous level for actually the last two or three years.

Thanks very much. As investors think about your CapEx needs past 2007, can you comment on how much headway you've created for yourselves with the tox testing capacity that you're putting in place between the second half of '06 and the end of 2007?

Well, clearly '06 and '07 would be probably the two watershed years for us where, in addition to expanding capacity, John, we are also replacing some facilities, as we talked about. So without providing specific guidance on the '08 numbers, we do expect that they would moderate after 2007.

Sure. Looking away from U.S. and Europe, tox testing capacity, do you--as you look past CapEx maybe past 2007, do you think about a need to set capacity in Asia or set capacity in Eastern Europe? Are those in your mind likely to the priorities in out years?

John, as I said earlier, we will continue to investigate and watch the Chinese market. It depends on the scale of operations that our international clients build there. So if they continue to build large facilities and they need their tox work done there for distribution of drugs to the rest of the world and they need high-quality capabilities, then we will certainly be there and supporting them. So we will continue to add facilities to keep pace with the market demand in whatever geographic locales are relevant to our clients.

Thanks very much. Congratulations on a good 2006.

That does conclude the question-and-answer session. At this time, I'd like to turn the conference backed over to Susan Hardy.

Thank you for joining us today for the conference call. We will look forward to seeing you in the near future, and this concludes the call. Thank you.

Again, that does conclude today's conference. Thank you for your participation.