Charles River Laboratories International Inc (CRL) 2007 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Charles River Laboratories' fourth-quarter and full-year 2007 earnings call.

At this time, all participants are in a listen-only mode.

Later, we will conduct a question-and-answer session and instructions will be given at that time.

(OPERATOR INSTRUCTIONS).

Starting off today, we have Corporate Vice President of Investor Relations, Susan Hardy.

Please go ahead.

Thank you.

Good morning and welcome to Charles River Laboratories' fourth-quarter and full-year 2007 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 2008.

Following the presentation, we will respond to questions.

There is a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our website at IR.CRiver.com.

A taped replay of this call will be available beginning at noon today and can be accessed by calling 800-475-6701.

The international access number is 320-365-3844.

The access code in either case is 905524.

The replay will be available through February 26.

You may also access an archived version of the webcast on our Investor Relations website.

I would 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 February 27, 2007, 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 reconciliations to those GAAP measures on the Investor Relations section of our website through the Financial Reconciliations link.

Now I'll turn the call over to Jim Foster.

Good morning.

I am very pleased to speak with you today about our outstanding fourth-quarter and full-year results, which demonstrates the effectiveness of our organization and validates the investments we made and continue to make as we correctly anticipated the paradigm shift that has taken place in the global pharmaceutical industry.

Let's begin with a review of the fourth-quarter and full-year highlights.

Strong sales growth of 17% in the fourth quarter contributed to full-year sales growth of 16.3%, including $318 million for the fourth quarter.

Our full-year sales reached $1.23 billion, the result of robust growth in both the Research Models and Services or RMS and Preclinical Services or PCS segments.

The acquisition of Northwest Kinetics contributed 2.4% for the year and foreign exchange added 2.9% to the annual sales growth rate.

For the fourth quarter, operating income was $65.8 million and the operating margin was 20.7% compared to $55.9 million and 20.6% reported in the fourth quarter of '06.

For '07, operating income rose 14.3% to $265.9 million and the operating margin was 21.6%.

As we expected, the operating margin declined year-over-year due primarily to the costs associated with the transition of our new preclinical facility in Massachusetts and because of higher corporate costs as we invested in information technology and scientific and operational staff to support our growing business.

However, we were very pleased that the operating margin declined just 40 basis points compared to last year, the result of higher sales and improved operating efficiency.

At $45.9 million, net income from continuing operations was up 17.6% higher than the $39 million reported in the fourth quarter of '06.

Earnings per share increased 12.1% to $0.65.

For the full year, net income from continuing operations was $180.2 million, an increase of 16.9% from $154.2 million in '06 and earnings per share increased 19.1% to $2.62 from $2.20.

As a result of strong sales and operating efficiencies, we generated operating cash flow of $285 million, which is above the top of our estimated range.

And even though capital expenditures of $227 million slightly exceeded our estimate, we generated free cash flow of $58 million, $8 million above the high end of our range.

I will speak more about our capital investment shortly, but I am very pleased to say that all projects are moving along on schedule and on budget.

As you know from our press release, we are reaffirming our '08 guidance of sales growth in the range of 10% to 13% and non-GAAP earnings per share in the range of $2.87 to $2.97.

Given the strength of our organization and the opportunities we see in our marketplace, we believe that these targets are achievable.

I would like to review the highlights of the segment operating results.

For '07, PCS represented 53% of total revenues and RMS was 47%.

From an operating income standpoint before unallocated corporate overhead, RMS contributed 56% to operating income and PCS contributed 44%.

While the PCS segment is growing at a faster rate than the RMS segment, the RMS operating margin is significantly higher, generating a greater percentage of our earnings and cash flow.

As a more mature business, the RMS segment enjoys a higher return on invested capital.

We believe that once the replacement space in Massachusetts and Nevada has been completed, the capital intensity of the PCS business will moderate and its returns will improve.

Notwithstanding my comments that the PCS segment sales growth rate is higher, the RMS segment had an outstanding fourth quarter and one of its best years.

Sales rose 13.7% in the quarter to $145.2 million.

For the year, sales were $577.2 million, a growth rate of 12.1%.

Excluding the impact of foreign exchange, the organic growth rate was an impressive 9%.

We were extremely pleased with the growth, which was a result of robust pharma and biotech spending on our broad portfolio of Research Model products and services, a trend which was consistent throughout the year.

Higher sales and improved operating efficiencies generated significant improvement in the operating margin with the fourth-quarter margin increasing 130 basis points to 27.6% and the full-year margin increasing 160 basis points to 31%.

The largest contributors to both the fourth quarter and annual sales gains were US research models, worldwide transgenic sales and the in vitro business.

This was a very strong year for research models in the United States, which is the bellwether for the industry.

Annual sales grew above 10% as pharmaceutical and biotechnology companies continued to use these critical research tools to drive the discovery of new drugs and push existing compounds through the development pipeline.

Sales to US academic institutions and government agencies also increased due to both higher spending and marketshare gains.

We view the increased sales of research models as an indicator that researchers are focusing on filling their pipelines with new therapies.

Sales of most of our strains benefited from our customers and pre-spending, particularly immunodeficient mice, used extensively for discovery of drugs for oncology and infectious diseases, inbred and outbred mice used for both efficacy and safety testing and outbred rats used for safety tests.

Sales of worldwide transgenic services increased again in the fourth quarter.

As expected, the growth rate was lower than the first nine months of the year as the fourth quarter of '06 marked the beginning of the improvement in the U.S.

business.

On a global basis, researchers continued to focus on the use of genetically-engineered models of discovery tools and to outsource to Charles River the housing of these models and other value-added services to support their use in research.

The same goals of faster and more efficient drug development, which are driving the use of preclinical outsourcing, are leading our clients to outsource discovery services as well.

As researchers develop more complicated models, they have an increased need for the scientific expertise in defined breeding and ancillary laboratory services we offer.

And given the depth of our expertise and the breadth of our services, Charles River is the partner of choice to support the use of these models in research.

In the fourth quarter and full year, our in vitro business delivered exceptional results with sales growth above 20%.

The PTS is the right device at the right time, a portable, easy to use, endotoxin testing device, which provides timely and accurate results.

It is tailor-made to support current FDA initiatives to improve quality control in injectable drugs and medical devices.

Both the process analytical technologies or PAT initiative and the pending regulation of nuclear pharmacy are aimed at reducing the risk of contamination by increasing the frequency of testing during the manufacturing process and shortening the time between sampling of finished lots and obtaining test results.

These are goals which the PTS supports exactly and as a result, we are experiencing robust adoption of the technology.

In order to better support our clients and maintain our first-to-market advantage, we are adding to the PTS product family.

Our latest innovation, the multi-cartridge system or MCS, is set to debut in the second quarter of '08.

It is aimed at supporting central [QC] laboratories, which perform a higher volume of tests and require higher throughput.

We believe that our investment in the PTS technology will continue to drive the in vitro business' growth for the foreseeable future.

The Preclinical Services segment reported very strong sales of $172.9 million in the fourth quarter, a growth rate of 20% over the fourth quarter of '06 and the seventh straight quarter of sequential growth.

For '07, net sales were $653.4 million, a year-over-year growth rate of 20.2%.

Excluding the impact of Northwest Kinetics and foreign exchange, the organic growth rate was a robust 14% for the fourth quarter and nearly 13% for the year.

In both the quarter and the year, our toxicology facilities delivered very strong performance and for the full year, each of our facilities delivered sales growth in double digits.

We attribute this growth to strong demand from our pharmaceutical and biotechnology clients for the breadth of services we provide, our scientific expertise and the advantage of outsourcing to Charles River rather than investing in facilities and developing in-house expertise.

By relying on the expertise from a partner like Charles River, our clients can utilize their assets more effectively by focusing on what they do best -- the discovery of novel compounds.

As you know, we transitioned to our new, state-of-the-art, preclinical facility in Massachusetts throughout '07.

We are now located solely in the new facility and the old facility has been closed.

Expenses associated with operating two facilities were significant in the fourth quarter, especially when compared to the fourth quarter of '06 when we had only the operating costs of the old facility.

In addition, we began the transition to our new Nevada facility in the fourth quarter of '07, which further increased our operating costs.

Partially as a result of these transitions, the PCS operating margin declined 210 basis points to 20.6% from 22.7% in the fourth quarter of 06.

Our Phase I business in the UK also depressed the operating margin as the facility has continued to be affected by the issues surrounding the regulation of Phase I clinics in the UK.

Those issues, which arose two years ago following an incident at a clinic in London, have caused sponsors to perform their first-in-human trials outside of the UK.

This resulted in weakness in our UK clinic in '07.

The strength of the Canadian dollar created additional margin pressure in the fourth quarter as did start-up and operating costs in our China facilities.

However, robust sales and operating efficiencies enabled us to deliver a full-year '07 operating margin of 21.5%, only 110 basis points below the '06 margin and we expect to maintain a similar margin in '08.

Our results for '07 represent the intersection of two very important factors.

The first is our business strategy and the second is the inflection point at which pharmaceutical companies find themselves with regard to outsourcing.

It is our business strategy to provide a unique continuum of products and services from the point at which researchers begin to use research models in discovery through proof of concept and new therapies.

We are the only company with the expertise to support such a broad portion of the drug development pipeline and we can do so because we have focused on, invested in and continue to invest in our core competencies of laboratory animal medicine and science and regulatory-compliant preclinical services.

We offer these extensive services and the capacity to provide them at a time when pharmaceutical companies have reached an inflection point in their adoption of strategic outsourcing.

From drugs coming off patent to pipeline rationalization to spending constraints and facility closures, there are many factors driving the need to improve efficiency.

Increasingly, these companies are using outsourcing, whether by investing in biotechnology companies to provide discovery of new compounds or utilizing preclinical contract research organizations like Charles River to accelerate the discovery and development process.

We see it in the increasing numbers of requests for proposals and the outsourcing of compound development programs rather than just individual studies and in the request for Charles River dedicated resources or CRDR where we provide staff or space or both, flexible combinations designed to fit specific needs.

Our relationships with our clients already close are becoming even closer as we work side by side to support their drug development efforts.

Understanding the pressure that our pharmaceutical clients are facing and believing that strategic outsourcing would be one of the only ways they could be addressed, in '05, we undertook the most ambitious expansion program in our history, the goal of which was to build capacity to accommodate the growing demand for preclinical drug development services and to support our growth.

As you know, we made a strategic decision to establish state-of-the-art, multi-service, multi-species facilities on both the East and West Coast of the U.S., specifically situated to be proximate to the largest concentration of pharma and biotech companies and exit our less efficient legacy facilities in Massachusetts and Nevada.

Almost three years later, we have made tremendous progress.

With the transition to our new facility in Shrewsbury, Mass.

completed at our old Worcester facility closed, we are now focused on improving the sales mix.

As you know, the Worcester facility was better known for its discovery services, which generally involved shorter-term studies.

PCS Massachusetts with its larger, more experienced scientific staff and greater capabilities is making the transition to a sales mix richer in toxicology studies, which increased more than 50% over the previous year.

As we have said previously, the facilities' operating margin goals are predicated on improved mix.

We are pleased to say that great progress was made in '07 and expect continued progress in '08.

We are very pleased to announce that the new facility in Reno, Nevada opened on schedule in January.

I am also pleased to say that clients are very enthusiastic about working with our scientific staff in such a state-of-the-art environment.

Half of our major clients have already qualified the facility and we have additional audits scheduled over the next several weeks.

As you know, we will commission and validate progressively more space for the first half of the year until approximately 80% of the facility is opened by this summer.

As we did in Massachusetts in '07, we will be transitioning out of the older facility throughout '08 and expect to be fully located in the new facility by the end of the year.

Unlike Massachusetts, we will retain a significant portion of the old Reno facility for quarantine space rather than utilizing the new, more expensive facility for that purpose.

While Massachusetts and Nevada are our largest expansion projects, we are also expanding existing facilities and developing new locations.

With only one facility in the UK to service European clients, we add capacity in Edinburgh nearly every year to meet client demand.

In the fourth quarter of '07, we completed a uniquely designed specialty toxicology facility and are already working on additional space to be completed in '09.

To meet demand for our services in Montreal, we broke ground in the third quarter of '07 for a 75,000 square foot facility in Sherbrooke, Quebec.

This facility will be open for business in early '09 and could be expanded modularly as demand requires to as much as 300,000 square feet.

We are doubling the size of our smaller Ohio higher facility and expect that expansion project to be completed in '09.

We are continuing to make progress on the facility in China and due to robust client demand, are accelerating the schedule in order to provide GLP services in the second half of '08 rather than the first quarter of '09.

Some of these facilities, such as Sherbrooke and China, will provide capacity for CRDRs, as well as 180,000 square feet of expansion space we have in Massachusetts and the 100,000, square feet in Nevada.

We continue to have extensive discussions with clients concerning CRDRs for those facilities.

As we said on our guidance call in December, we expect CRDRs to account for approximately 10% of PCS revenue in '08 and we expect that percentage to increase over time.

As you know, we signed our first CRDR for research models at the end of '06, a 10-year, $112 million agreement with the National Cancer Institute.

We have been managing the NCI colonies under a previous agreement, but the importance of the new agreement is that, for the first time, we will provide those services in dedicated space at a Charles River facility.

The new facility in Maryland is progressing on schedule and we expect the building to be open in the third quarter of '08.

A portion of the new Maryland facility will ultimately be used to support the increasing demand for commercial production and services, as will the expansion at our California facility where we have just begun to shift from the first two new production runs.

Demand from our West Coast clients continues to be robust and we are still on track to open a third production room in the first quarter of this year.

It is our belief that the trend towards outsourcing among our clients will continue.

The goals of faster and more efficient drug development have led pharma and biotech companies to outsource as much as an estimated 25% to preclinical development in '07.

The expertise of partners like Charles River who have the capacity to support drug discovery and development have enabled this trend and will continue to allow pharma and biotech companies to outsource, perhaps to as much as 50% to preclinical development over the next eight to ten years.

We believe we are currently seeing the virtualization of big pharma.

So at Charles River, we are continuing to invest in scientific expertise, capacity and strategic bolt-on phone acquisitions.

We are building our clients facilities and hiring staff for them.

In fact, we are becoming our clients' infrastructure, working with them to accomplish their goals of bringing new therapies to market faster and more efficiently.

Our investments in capacity to support our clients and to promote our future growth are significant, as are the investment in additional personnel required to accommodate the demand for our products and services and the information technology systems to support our data requirements.

In '08, we expect to hire approximately 800 new employees or nearly 10% of our existing employee base.

These new employees will work at facilities around the world to provide the high-quality products and services for which Charles River is known and we will continue the IT projects we began in '07, which we believe will position us on the leading edge of information management, both internally and to support our clients' requirements.

Charles River today is a vibrant growing company with a unique continuum of products and services that supports and accelerates our clients' drug development efforts as no other provider can.

Our strong financial performance in '07 clearly demonstrates the strength of our business model and the value that we provide to our global client base.

By adhering to our core competencies of laboratorial medicine and science and regulatory-compliant preclinical services and investing aggressively to expand and strengthen our infrastructure, we have positioned ourselves to partner with our clients at this critical inflection point when they are increasingly adopting strategic outsourcing as a means to improve the efficiency and cost-effectiveness of their drug development efforts.

And increasingly, they have selected Charles River to play an integral role in accelerating these efforts.

With robust demand for our products and services, we see significant opportunities for continued growth in both the RMS and PCS businesses.

In order to capitalize on these opportunities, we are turning our attention to our corporate brands and to our sales and marketing functions.

These are extremely valuable assets to the Company and are intrinsic to effective communication with our clients about the products and services we provide, the support we can offer and the value we bring to their drug development efforts.

To enhance our visibility, we have realigned our salesforce, assigned senior management to key client accounts, trained every salesperson on our full portfolio and established cross-selling initiatives.

Given the brand equity we have in the Charles River name, you will now see our name coupled with a new, overarching brand message, clearly focused on supporting our customers' critical needs.

Over the course of '08, much you will see message on our new website, marketing materials and programs, all of which are focused on extending our support for and visibility in the research community.

You will see it in our new refreshed logo, which builds on our recognized and well-regarded brand equity.

And although much of this messaging will be new, we are still Charles River, a company our clients can continue to rely on to help accelerate their drug development efforts.

That is why our new tagline is -- accelerating drug development exactly.

It is what we do, it's who we are and who we will continue to be -- exactly.

In closing, I would like to thank our more than 8500 employees for their exceptional work and commitment and our shareholders for their continuing support.

Now I will turn the call over to Tom Ackerman.

Thank you, Jim and good morning.

First, let me remind you that our discussion today focuses on results from continuing operations.

In addition, I'll be speaking primarily to non-GAAP results, which exclude all acquisition-related amortization and other items.

Sales and operating income continued to grow at strong double-digit rates in the fourth quarter of 2007, which drove our 12.1% increase year-over-year in EPS to $0.65.

Consolidated operating margins improved slightly year-over-year to 20.7%.

The RMS operating margin improvement was largely offset by a decline in the PCS margin, the result of operating two facilities in Massachusetts in 2007 compared to only one in 2006, incurring some operating costs at the new Nevada facility and the negative impact of foreign exchange in Canada.

As I emphasized on our third-quarter conference call, we expected foreign exchange to cause a meaningful drag on the PCS margin in the fourth quarter just as it did in the third quarter.

Due to the impact of the strengthening Canadian dollar, foreign exchange reduced the PCS operating margin in the fourth quarter by 150 basis points.

Throughout 2008, we will be working to mitigate the impact of foreign exchange on operating margins by invoicing a larger percentage of our Montreal clients in Canadian dollars, reducing Montreal's U.S.-denominated sales to slightly more than half of total sales.

Foreign exchange did not have a material impact on the RMS operating margin in the fourth quarter and it typically does not.

In the fourth quarter, we were pleased to generate sales growth on a sequential basis for the fifth consecutive quarter.

As expected, the consolidated operating margin declined by nearly 200 basis points and EPS also declined sequentially versus the third quarter of 2007, primarily reflecting normal seasonality in the RMS segment and the higher share count related to dilution from the convertible debt.

Reduced [line] orders around the holidays negatively impacts fourth-quarter sales volume and operating margins, particularly in the Research Model production business.

The seasonal impact is most visible in the RMS operating margin because the effect of lower sales volume and the high margin, high fixed cost production business drops straight through to the operating income line.

Unallocated corporate overhead declined by $600,000 year-over-year and approximately $2 million sequentially to $9.8 million in the fourth quarter of 2007.

For the full year, unallocated corporate expense was $53 million or 4.3% of sales.

This was below our previous expectations due to lower health, fringe and related costs, partially offset by the expected increase in IT costs.

Including the initiation of a multi-year ERP project, we continue to invest in our information infrastructure to support our clients' growing requirements and to conduct our operations in a more integrated and efficient manner.

Part of the initial investment has required us to hire key staff and consultants to help manage and ensure a successful implementation of our global IT initiatives.

Net interest expense decreased by $1 million, both year-over-year and sequentially, to $1.3 million in the fourth quarter of 2007, driven by lower interest rates, as well as debt repayment activities.

We have prepaid the remaining balance on our Canadian term loan at the end of the third quarter and have made scheduled payments on our U.S.

credit facility.

Other income declined by $1.3 million in the fourth quarter as prior year investment gains related to the deferred compensation plan and foreign exchange transaction gains did not recur in the fourth quarter of 2007.

The tax rate of 29.2% in the fourth quarter was nearly unchanged year-over-year, lower than the third-quarter level.

For the year, our tax rate of 29.4% was in line with prior guidance.

In the fourth quarter, we excluded a $2.1 million benefit from our non-GAAP results related to a deferred tax revaluation.

The revaluation was driven by tax law changes in foreign jurisdictions, primarily Canada and the adjustment was attributable to the impact on acquisition, intangibles and amortization.

As Jim said, we completed the transition into the new Shrewsbury facility on schedule in December.

We also closed the Worcester facility, primarily as a result of the related lease impairment, recorded charges of approximately $4.6 million or $0.04 per share in the fourth quarter.

This brings the total charges related to the accelerated exit of the Worcester facility to $6.2 million for 2007 or $0.06 per share, which we excluded from our non-GAAP results.

We have not yet disposed of the Worcester real estate and when we do, we could incur additional charges.

However, we would not expect the amounts of any such charges to be material.

Now I'll turn to some balance sheet and cash flow items.

At the end of the fourth quarter, we had cash and cash equivalents of $225 million, plus $63 million in short and long-term marketable securities for a total of $289 million compared to $287 million at the end of 2006.

Accounts receivable improved significantly to $214 million at the end of the fourth quarter, down almost $20 million from the third-quarter level.

Our finance team's continuing focus on collections paid off in the fourth quarter and we are very pleased to see our DSO meaningfully improve to 35 days at the end of the year compared to 43 days at the end of the third quarter and 39 days at the end of last year.

We continue to actively manage our DSOs and monitor our collections and receivables.

Free cash flow for 2007 was $58 million, exceeding the high end of our expected range by $8 million.

We achieved this level as a result of strong operating cash flow generation of $285 million, due primarily to higher net income and the improvement in DSO.

We generated more than enough cash to fund our 2007 capital expenditures, which came in above the high end of our expected range at $227 million.

For 2008, we continue to expect free cash flow to be in the range of $50 million to $75 million and capital expenditures to be in the range of $220 million to $240 million.

Depreciation in the fourth quarter increased approximately $2 million year-over-year to $14 million, primarily as a result of the new Shrewsbury facility.

In the quarter, we also began to book a small amount of depreciation related to our new Reno facility as we opened the new building and transitioned in some management and administrative personnel.

For 2007, depreciation grew by nearly $8 million to $53 million due to new space coming online.

Total amortization expense declined $700,000 to $9 million in the fourth quarter and decreased approximately $4 million to $33.5 million for the year due to a reduction in Inveresk-related amortization expense.

A portion of the intangible assets from the Inveresk acquisition were amortized over a shorter, three-year period, which ended in 2007.

In the fourth quarter, we repurchased nearly 200,000 shares at a cost of approximately $12 million, which brings our total purchases to 724,000 shares for the year at a cost of $39 million.

We had approximately 96 million remaining on our current buyback authorization at the end of the year, which we expect to help offset the share dilution from option exercises and equity compensation awards.

2007 was a tremendous year for Charles River, driven by a robust client demand and excellent execution.

Nearly all of the businesses in our portfolio met or exceeded the operating plans that we laid out for them over a year ago.

We believe that the robust market trends, which supported our growth in 2007, will continue to drive many of our businesses in 2008.

As a result, we are reiterating our 2000 guidance of sales growth in a range of 10% to 13%, GAAP earnings per share in a range of $2.59 to $2.69 and non-GAAP earnings per share in a range of $2.87 to $2.97.

We do expect our average diluted share count in 2008 to increase from the guidance that we have provided in December, reflecting a higher stock price, which drives incremental dilution from our convertible debt.

However, this incremental dilution is expected to be offset by lower than expected net interest expense and other operating items.

We have seen interest rates drop on our floating rate debt as a result of the Federal Reserve January reductions of the Fed fund rate and the correlated impact on LIBOR.

As we noted in our December guidance call, we expect the costs from Nevada to step up significantly in the first quarter of 2008 as we commence studies at the new facility.

Operating costs at the new Nevada facility are significantly higher than both the legacy facility and the new Massachusetts facility since we are opening more space in the initial phase in Nevada than we did in Massachusetts.

We also expect the PCS margin to continue to be pressured by foreign exchange in Canada.

As a result, we expect the first-quarter PCS operating margin to be sequentially lower than the fourth quarter of 2007.

This is consistent with our December guidance, as is our expectation that the full-year 2008 operating margin will be comparable to the 2007 level.

We are quite pleased with our 2007 results, but have already put the successful year behind us to focus keenly on delivering another strong year of performance in 2008.

That concludes our remarks.

We will now take your questions.

(OPERATOR INSTRUCTIONS).

David Windley, Jefferies & Co.

Hi, good morning.

Thanks for taking the question.

I wanted to focus on the Preclinical segment margins.

Tom, you have outlined down first quarter, flat for the full-year comparison.

There were several qualitative items that, Jim, you described -- the Phase I clinic in the UK, China facility start-up, Canadian dollar strength.

I guess it sounds like you are going to take some steps to mitigate the Canadian dollar issue.

What about the Phase I clinic and the China facility start-up costs.

Are those addressable?

Obviously, you're going to continue to spend in China, but are those addressable in a way that that impact will be mitigated as we move through 2008?

We think, as we move forward, Dave, that both of those issues will be much less of an issue.

The China operation we don't anticipate will have costs increasing any higher than the current year and we intend to build that operation up and open it, so it shouldn't be -- it shouldn't be any more of a significant drag at all.

And Phase I is -- we believe that the -- while the regulatory issues to persist to some extent, they are beginning to soften somewhat.

We are also really initiating a more aggressive business development campaign over there to really sell these services and show the linkage between our preclinical and (inaudible) operations.

So we would actually anticipate the sales being much less of an issue going forward.

Okay.

And on the Canadian dollar, Tom, you mentioned that you are going to start billing half of that revenue or so in Canadian dollars for Montreal, but you did say Canadian dollar will pressure the first quarter.

Is that something that is not going to start until later in the year?

No, if you just look back to 2007, Dave, to put it in perspective, we began the year at about an exchange rate of 0.85 and in the fourth quarter, the Canadian dollar was actually between C$1.05 and C$1.10, so that was obviously exacerbated in the fourth quarter.

It has improved in the first quarter.

I don't what it will do for the rest of the quarter, but it has come down somewhat to be almost one-for-one, so it will still be a difficult quarter for foreign exchange, but it should be a little bit better than the fourth quarter.

We have begun already to build some additional clients in the first quarter and we'll continue to look at that during the year.

So I think both of those factors will provide a little bit of relief in the first quarter.

As you look year-over-year, it is still a lot of pressure in the Canadian dollar versus the first quarter of '07.

Okay, I will jump out of the queue and let somebody else ask questions.

Thanks.

Good luck.

Douglas Tsao, Lehman Brothers.

Hi, good morning.

I was just wondering if you could provide a little more color on the sequential decrease in the operating margin for the RMS segment.

Certainly there has historically been some seasonality there.

I was wondering if there was any other moving parts since it seems to be a little greater than it has been in the past?

The biggest thing, which I mentioned to in my remarks, is that we do see the models themselves decline noticeably from Q3 to Q4 and that is really associated with activity around the holiday period from Thanksgiving right through to New Year's and it is a global phenomenon, so we look at our big geographic areas -- North America, Europe and Japan.

We do see that trend off.

As I mentioned, it is a very high-margin business and given the high fixed cost, it pretty much drops straight through to the bottom line.

When you look sequentially a total RMS sales activity from Q3 to Q4, I think we essentially moved sideways so we were able to pick up in sequential growth in most of our services business, but we just don't have the same margin flow-through as on the model business, so we do see a net overall drop in our margins from Q3 to Q4.

Okay.

And then thinking about -- sticking to RMS, when you think about the models business, is this a function where the volumes of the outbred rats and mice for the toxicology studies are sort of growing at low single digits and the immunodeficient and other sort of disease models are growing at a faster rate?

No, not really.

As we have said, Doug, we have been really pleased that that sector has been growing as quickly as it has.

It grew 10% in the fourth quarter, which was pretty much its growth rate for the year.

And we have been seeing increased unit growth pretty much across all of the productlines that we delineated in our prepared remarks, driven both by increased research in the oncology and infectious disease area, but also a significant pick-up in toxicology work, as well as basic discovery work.

So it is pretty much across the board in all of those models.

So all of the models are growing at comparable rates in terms of volume?

I can't say that exactly, but the ones that we culled out -- the ones that we reported out are growing at significant increases over the prior year.

Okay.

And then one final quick question on PCS, you referred to a lot of client demand for services in China.

I was just wondering if you could provide some comments on the source of that.

I mean are these large, multi-national pharmaceutical companies and where would the potential work -- would this be coming from their discovery operations based in China or is this the question of taking molecules discovered in the U.S.

and bringing them to China for toxicology work?

They are all large, international or multi-national companies that have discovery efforts, either their own or on some contract basis in China and specifically in Shanghai frankly.

So this is not to support local Chinese companies; it is to support the clients who we have elsewhere in the world for whom we do work both in North America and Europe and this is for discoveries that are made locally where they are going to want preclinical tox work done locally as well.

So it is not for molecules to be shipped from the U.S.

to Europe to China.

John Kreger, William Blair.

Jim, a question, given the economic weakening that we have seen at least in the U.S.

and the difficult year that pharma had in '07, are you seeing any changes in behavior of your clients both at large company and small?

We really haven't.

It has been quite consistent throughout '07 pretty much quarter to quarter with significant increases and certainly versus the prior year.

We've seemed to see just the continual virtualization of these companies and because of some of the economic pressures and also some of the pipeline pressures that they've been facing, almost an accelerating interest and desire to outsource and of course, we are not just seeing outsourcing in the Preclinical sector, but the service components of the RMS business are also sort of the direct legacy of that demand as well.

So I think as more work as these clients can do externally that they feel can be done as well as work done internally to allow them to focus their attention elsewhere, the more they are going to continue to do that.

That will require continued investment in facilities and staff for us to really show them the quality of our work and of course, a fair number of the people that we have been getting to work in our business, particularly at the highest levels, the senior scientific levels, are coming directly from big pharmas.

So to some extent, it is kind of the same quality of work that is overseen.

So we haven't seen any diminution in demand.

We wouldn't expect it to.

We would expect that outsourcing would continue as sort of a safety valve to alleviate some of the pressure that these clients are feeling and I think as long as we have the infrastructure in place, it will continue.

Thanks and just a second question.

You talked about the fact that you expect Reno expenses to ramp significantly in the first quarter.

Can you just expand about what is really driving that?

Is that the lack of capitalizing some of those costs or is it really a spike in staffing and as we look through the rest of the year, should we expect that to continue to ramp or sort of plateau at first-quarter levels?

So remember that Reno -- yes, Reno's certainly ramping up the first quarter.

We are going to continue to open that -- about 80% of the space that we have renovated over the next two quarters and then finally have that space finished by the summer.

So we will have increased costs during that time and duplicate costs indeed over the prior year.

Commensurate with that, we will be filling up that space as quickly as we can.

As I reported to you earlier, we have had more than half of our clients already audit the facility and are quite pleased with it and we have additional clients coming back soon.

So we think the uptake is going to be considerable and consistent.

By the same token, the costs are considerably higher than the prior year.

Hari Sambasivam, Merrill Lynch.

Yes, thank you very much.

Jim, just a quick question on the Endosafe PTS.

Could you give us maybe a quantification of how big this opportunity might be just in terms of where you have penetrated your possible or probable accounts and how much actually you can expand on it?

And the second question I am wondering is, on the PCS side, you were talking about a mix improvement going forward in Shrewsbury and I'm just wondering what kind of studies you may be talking about that might be actually contributing to that improvement in mix.

The PCS mix is -- historically, the Massachusetts operation has been more discovery work or short-term work, which tends to have a lower margin.

They did that very well and the size and scale of the facility and the staff were more commensurate with that type of work.

As we have cranked up the physical plant and considerably improved the depth and quality of the staff, we are able to do much more sophisticated and long-term studies.

So we saw that mix actually change nicely during '07, but we anticipate that that will continue to shift dramatically so that we are relying less and less on discovery work and more on more, longer-term, higher value studies.

On the PTS side, we are extremely pleased with this productline and we have a very strong IP situation.

We have very good uptake clients.

There is some validation time required, whether they are actually switching from our old technology to the new one or from a competitor's technology to our new one, but that is happening consistently throughout the world.

Additionally, we are watching the increase in the numbers of cartridges sold along with the machines and those seem to be increasing nicely as well.

So I think the only metric that would be appropriate to give you, which we have given historically, is that, by virtue of this device, we increased the size of the market four or fivefold from its historical norm and we think that we are playing in an endotoxin testing market with a couple of hundred million dollars in total revenue and we anticipate that we will have the majority of that going forward, but the conversion time -- there is no way to short-circuit that or to actually speed it up.

We are doing the best we can from a technical service point of view.

The response has really been rewarding and positive from clients who we anticipate that we will continue to build share and convert both our own clients, but in particular the competition's clients.

Thank you.

One additional question on the RMS side.

As you sort of see -- I guess I'm just wondering about the condition of the economy, pressures on government budgets, etc.

How do you sort of mitigate the impact on RMS or do you think that business is more vulnerable to government cutbacks, institute cutbacks, etc., and how do you sort of go about sort of mitigating that risk?

Well, we don't really think it is more vulnerable.

The NIH budget has been beleaguered for the last three or four years and so we are certainly in for another year of that.

We have got 15% or less of our revenues dependent on the academic and government marketplace and a lot of our government contracts are already in place, so it is a de minimis impact on us from that point of view.

As I said earlier, while I think the large pharmaceutical and certainly several of the large biotech companies have a lot of pressure on them to invigorate their pipeline, the principal and primary way to do that is to invest more in research, not less in research.

So we are seeing continued increases in research spending, combined with continued increases in outsourced research spending and development spending and so that gives us a level of comfort, particularly off of our strength in '07, that we should see similar trends this year, which you can see in our guidance of 10% to 13% growth for '08.

Randall Stanicky, Goldman Sachs.

Good morning, it's Adriana Kalova on behalf of Randall Stanicky.

We actually have two questions.

The first one is you guys have been talking about attracting new customers.

Do you provide some information on your breakdown of your customers by biotech and pharma?

And my second question is regarding your toxicology business.

It has been growing very strongly.

Do you provide some information, how much of the organic growth in the quarter was attributed to your tox services?

So on the biotech and pharma, we haven't done that recently and the majority of our sales are the big pharma.

I think that's probably the best way to answer that and a significant portion and a significantly growing portion are the biotech.

One of the reasons we don't -- that is the best answer, but one of the reasons we don't think that the distinction is all that useful is because a fair amount of the funding from biotech comes directly from big pharma and there tends to be some sort of a blurring between the two sectors.

There is sort of an area that is gray and so much of the biotech work is for the big pharmaceutical companies.

So we tend to look at them as a collective entity and we look at sort of the growth of our industrial sector.

But we have seen growth in really both large pharma and biotech.

And your second question was about how much toxicology was contributing to our organic growth?

That's correct, yes.

Well, we don't break that out specifically, but obviously the growth in our toxicology business continues to be consistent as we build and fill up these new facilities.

While we have some pricing benefit, we are experiencing significant and consistent organic growth in that productline commensurate with a level -- driven by the level of outsourcing.

(OPERATOR INSTRUCTIONS).

Robert Gilliam, UBS.

Sure, I just want to follow up on I think it was Doug's question from earlier just on the RMS margins, kind of the sequential decline and I kind of understand all the moving parts you laid out there as far as the seasonality that we see, but I guess I was hoping we could drill a little bit deeper and understand why the magnitude of the sequential decline was more pronounced than it has been in the past.

And then also if it is sequential, can you just -- I mean should we expect the RMS margins to kind of rebound to the 43%, 44% level in the first quarter of the year?

Rob, without being specific on the first quarter, we would obviously expect them to rebound like they have traditionally moving over from quarter to quarter.

Last year, we did have a little bit of a positive pick-up in Q1, last year being '07, because we had some quarantine issues in our large animal model facility in the fourth quarter of '06.

So those lead over into the first quarter of '07 and we had probably a little bit better than typical quarter.

But other than that, I would expect them to come up just as we have always said.

I mean the first quarter is typically a good quarter, so I do think that that trend would continue.

Tycho Peterson, JPMorgan.

Good morning.

Following up actually on one of the earlier questions just on the Endosafe, I am just wondering if you can give us a sense as to what the global demand is like.

I mean you have talked about the PAT initiatives here in the U.S., but how you are seeing demand shape up overseas and where you are in the capacity side.

I think you are manufacturing most of the systems in South Carolina, so do you need to add new capacity for the new cartridges?

We are seeing a very good uptake in demand and purchases of this device in Europe.

We sold a lot of these devices for R&D purposes in Europe before we had FDA approval.

We continue to do so and so we have got very strong purchases across a whole range of clients overseas as well.

So there is not a huge difference geographically in the response to the products.

We are doing final assembly manufacturing in our own facility; intend to continue to do that.

We have continuously ramped up GMP production capacity to accommodate the anticipated growth rates and we are comfortable we will be able to continue to do so.

Okay.

And then just on the end-market demand, I'm just wondering if you can comment a little bit about pricing, in particular as we think about some of the capacity additions that have been brought on by the entire industry and then also what the dynamic is like in China these days, who you are bumping into in terms of competition?

Is it mainly local suppliers or are you running into a lot of the global CROs as well?

So that wasn't -- you switched subjects?

Yes.

So pricing on the Preclinical side has been -- continues to always be a factor, but I'd say less significantly than we have seen in prior years.

There is -- I think there is an acknowledgment that we are bankrolling both the space and the headcount significantly and need to be paid for that.

So we have what we believe are appropriate price increases and have had very little pushback at all from our clients.

As I said earlier, we think that the Chinese marketplace for us is going to be a place to support local -- to support international clients who have located in China to use that as another locale for basic discovery.

It's too early to comment on what the pricing scenarios will be there -- over there, except to say that we are quite confident that we can fill up as much of the new facility that we are currently building as we see fit pretty much on day one.

So there really significant client interest in having a high quality GLP facility and of course, we intend to be the first company to open a facility there in the second half of this year.

John Sullivan, Leerink Swann.

Hey, guys, good morning.

Thanks for squeezing me in.

Just a quick question about the biotech industry as a customer group for you.

Funding is probably a little bit harder to come by, especially for some smaller biotechs.

Any change in the profile of business with the biotech industry specifically and how important is the biotech industry to your overall business?

Thank you.

We really haven't seen much of a change.

Biotech continues to increase in a meaningful way.

As I said earlier, we think a lot of the money doesn't just come from the capital markets; it comes directly from big pharma as they use biotech as a discovery engine.

It is certainly a meaningful part of our total sales portfolio and we expect it will continue to be.

I think many people believe that the future success of the biomedical research will come directly from the small biotech companies.

So they will continue to find sources of capital to keep them going.

Sandy Draper, Raymond James.

Thank you.

This is a little bit more of just a high-level question looking back at '07 and looking into '08.

Obviously, throughout the year, you ended up delivering very strong results and beating the numbers.

Just for sort of a perspective, when I look at it between FX, acquisitions, strong organic growth and research and RMS and PCS, how would you sort of qualify where the biggest surprises in 2007 were in terms of beating your results and then looking at it 2008, where do you think the biggest risks are and where would you say the biggest potentials for upside are?

Thanks.

Well, we wouldn't characterize '07 as full of surprises.

I guess the best way to characterize it is that we have a dozen or more P&Ls.

It is unusual that virtually all of our businesses perform well at the same time.

Virtually all of them did and the result of that was that we were able to increase our guidance a couple of times.

We always intended to guide as accurately as possible and so I wouldn't say we were surprised by the results, but we were pleased with them.

We certainly would like to see that trend continue.

It is not necessarily a realistic assumption.

I don't think there are any particular areas of concern that we have.

We think that demand will be quite consistent and concerted for both of our productlines -- RMS and PCS -- given the state of our clients.

We think that outsourcing will continue significantly both on the PCS side and the RMS services side and we are quite confident that we will continue to see purchases of our core Research Model products and our in vitro products be strong as well.

So we believe that our guidance for '08 is an accurate reflection of what we believe the demand will be and sales and profit will be on that activity.

Jon Wood, Banc of America.

Thank you.

Jim, you touched on this qualitatively, but can you give us a sense of your estimate of the growth of the U.S.

Research Model's business in 2008 of the whole market from a volume perspective and then typically what proportion of the targeted price increases in the Model's business are realized in a given year?

Thank you.

So I am not going to answer that specifically, except U.S.

Research Model did about 10% last year.

That's a very strong year for us.

Would like to believe that growth around -- in that area could continue.

It has always been our strongest market with the strongest margin.

We have always been the leader in that marketplace as well.

We provide our price increases at the end of a particular fiscal year and we usually -- if it's going to be pushed back, we see it quite early.

We really haven't.

We try to be responsible and respectful of our clients and their financial situation as we raise our prices.

We have also had some competitive opportunities where we have had competitors raise their prices actually more aggressively than we and reduced the premium that we deserve frankly and so it has actually made our price increases seem even more responsible than I think they are.

So we have seen virtually no pushback.

We believe the demand will continue.

We don't have any -- we didn't have any indications when we were putting our operating plan together that it wouldn't.

Thank you.

And speakers, you may continue with any closing remarks you may have.

Thank you for joining us this morning.

We look forward to speaking with you soon and seeing you at the Cowen and Lehman healthcare conferences in March.

This concludes the conference call.

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