Charles River Laboratories International Inc (CRL) 2008 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Charles River 2008 earnings and 2009 guidance conference call.

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

Later we will conduct a question-and-answer session.

Instructions will be given at that time.

(Operator Instructions)As a reminder this conference is being recorded.

I would now like to turn the conference over to your host, Corporate Vice President of Investor Relations, Susan Hardy.

Please go ahead.

Thank you.

Good morning and welcome to Charles River Laboratories 2008 earnings and 2009 guidance 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 2008 results and provide guidance for 2009.

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 981036.

The replay will be available through February 24.

You may also access an archived version of the webcast on our Investor Relations website.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 provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors including, but not limited, to those discussed in our annual report on Form 10-K which was filed on February 20, 2008, as well as other filings we make with the Securities and Exchange Commission.

During this call when we will be primarily discussing non-GAAP financial measures which exclude among other items the goodwill impairment we recorded in the fourth quarter of 2008.

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 forecast 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 will turn the call over to Jim Foster.

Good morning.

I would like to begin by reviewing the '08 results and will then discuss our '09 guidance with you.

We reported sales of $311.4 million in the fourth quarter of '08, a decline of 2.1% over the fourth quarter of '07, but an increase of 2% when adjusted for foreign exchange.

The increase was driven by the Research Models and Services or RMS business segment which increased 5.3% to $152.8 million in increased 7.4% in constant dollars.

Preclinical Services or PCS increased 8.3% to $158.6 million.

When excluding the effect of foreign exchange, which reduced the PCS growth rate by 600 basis points in the quarter, the decline was 2.3%.

Operating income for the quarter was $59.2 million and the operating margin was 19% compared to 20.7% reported in the fourth quarter of '07.

The operating margin decrease was primarily the result of lower sales growth and higher operating costs associated with our RMS and PCS expansions.

Earnings per diluted share were $0.59 for the fourth quarter compared to $0.65 for the fourth quarter of last year.

Fourth quarter of '08 was a difficult and we, like most others, didn't anticipate the extent to which the global economic crisis and the pharmaceutical market challenges would impact us.

That said, even in this period of macroeconomic slowdown we did post some impressive gains for the year.

RMS delivered organic sales growth of approximately 10.5% resulting in total company net sales growth of 7.4% for '08.

Primarily as a result of higher sales, EPS rose 10.3% to $2.89 despite an increase in the average number of shares outstanding.

We generated $82 million of free cash flow and are financially strong with a sound balance sheet.

This is a significant advantage during a period of economic turmoil.

I am also pleased to say that we completed the final leg of our three-year major capital expansion plan at the end of '08.

As a result of that plan we have two brand-new state-of-the-art facilities located on the east and west coasts of the United States which in addition to our existing facilities in Montreal and Edinburgh, position us extremely well to accommodate the global demand for pre-clinical outsourced services when it intensifies.

Before reviewing our outlook for '09, I would like to briefly summarize the business segment performance.

Sales for our RMS segment rose 5.3% in the fourth quarter to $152.8 million.

When adjusted for the negative effect of foreign exchange, the sale of the Mexican vaccine business, and the acquisition of MIR, organic growth was 7.8%.

The production business held up very well in the quarter.

Although constant dollar sales growth slowed somewhat in Europe, the bellwether US business again reported 10% sales growth.

As was also the case in the third-quarter, strong sales growth for immunodeficient and other mouse strains off-set slower sales for CD rats.

Sales to academic, government and biotech clients drove the growth which supports our belief that drug discovery and early development are ongoing and the resulting compounds and Biologics will ultimately make their way through the development process.

Sales to the service businesses were up in the quarter, driven by our consulting and staffing services business and the acquisition of MIR.

Our Genetically Engineered Models and Services, or GEMS, business was down from the fourth quarter of '07.

This was the result of more measured spending by pharma and biotech clients, particularly in the United States.

Our in vitro business delivered strong growth in the quarter due primarily to sales of the TTS products and the new multi-cartridge reader or MCS.

We exceeded our goals for this business in '08, both in terms of units sold and new customers added.

We have an opportunity to take market share with this exceptional product line and are focusing our attention on that goal.

PTS has been a great competitive differentiator for us because it's exceptionally well-positioned to address the market for lot-release testing.

The FDA and other regulatory agencies are increasingly regulatory guidelines for manufacturing, whether they address specific markets such as nuclear pharmacies or global requirements such as the PAT initiative, the PTS is the ideal product to assist drug manufacturers in meeting the guidelines.

Based on the strength of the PTS product line, the competitive landscape, and our plans for continuous innovation, we continue to believe this very profitable business will deliver strong growth for sometime to come.

The RMS operating margin decline 30 basis points to 27.3% compared to 27.6% in the fourth quarter of '07.

As was the case in the third quarter, the two factors which affected the margin where the increasing influence of services and higher operating costs.

The facility expansions in California and Maryland impacted operating costs as did commodity and energy prices.

Fortunately, energy prices moderated toward the end of the year as did some commodities.

The growth in services and particularly our Consulting and Staffing Services business puts pressure on the RMS margin because although many of the service margins are robust they are not comparable to the product margins.

As we continue to expand our portfolio of high-end services to support the use of models and research, it's likely that this pressure will continue.

However, the in vitro margins are also quite high so as both the services and in vitro businesses grow they effectively offset each other.

This leads us to believe that we will be able to maintain the RMS margin in the 30% range over the longer term.

The RMS business remains a consistent driver of our sales and earnings growth as was demonstrated again in the fourth quarter of '08.

Our research models and services are critical components of our clients' ability to successfully launch new therapies.

We provide the largest number of widely used models and have the most extensive range of scientific services to support our clients' use of models in research.

We are continuing to add to our capabilities both through internal development and through strategic acquisitions such as MIR preclinical services.

We will continue to expand our RMS portfolio strategically adding products and services which enhance our ability to support our clients' drug discovery and development efforts.

The PCS segment reported sales of $158.6 million in the fourth quarter, a decline of 8.3% from the fourth quarter of '07.

When adjusted for the negative effect of foreign exchange and the new lab acquisition, the net sales decline was 4.9%.

This is a high fixed-cost business, so lower capacity utilization quickly translates to a lower margin.

In the fourth quarter of '08 PCS margin declined to 18.2% compared to 20.6% in the fourth quarter of '07.

The decline was primarily due to the PCS market weakness, but also to costs associated with our capacity expansion program particularly in Nevada and China.

As we discussed with you in November when we reported the third quarter, we were experiencing a rapid deceleration of market demand for outsourced services as large pharmaceutical companies reprioritize pipelines and restructured their operations in order to drive down the cost of drug development.

These unprecedented actions of so many of our clients interrupted normal spending patterns, so while our clients continued to spend on outsourced services, they did so in a very deliberate and measured manner.

With capacity readily available, clients continued to postpone placement of studies and pricing was still a negotiating point for many.

We also began to experience weakness in the biotech sector as these companies were increasingly unable to access capital.

These patterns persisted through the end of '08 and into the first quarter of '09 which has led to a slow start to the year.

As is usually the case, some pharmaceutical companies finalize their purchasing decisions for the year in January and are just beginning to commit to studies.

As a result, demand has begun to strengthen in the last few weeks which would suggest a slightly better second quarter.

We expect to have better visibility as we move through the balance of the first quarter, but based on current trends expect the market to be strong during the second half of the year.

Based on our view of the market, we are estimating '09 earnings per share in the range of $2.30 to $2.60, which is based on sales growth in a range of between negative 2% and negative 7%.

This range includes a 5% impact from foreign exchange, so it would represent a range of negative 2% to positive 3% in constant dollars.

Tom will give you more detail about our exposure to various currencies shortly.

Excluding foreign exchange, we expect RMS sales to be flat to an increase of 5% and PCS sales growth to range between negative 3% and plus 2%.

We expect lower sales growth for the RMS business in '09.

Due primarily to weak demand for outbred rats using toxicology and also due to softer demand for services like PCS the first quarter has started slowly.

Price increases on research models implemented at the beginning of the year have provided some offset and consistent with our view of preclinical demand, we expect unit growth for outbred rats to improve later in the year.

Because operating margins are very sensitive to volume, they will be impacted by lower sales growth in '09.

We expected the total company margin to be in the high teens with the RMS margin slightly and the PCS margins meaningfully below '08 levels.

In addition to the volume effect, the PCS margin is also being pressured by our China operations.

We have had to postpone GLP validation by one quarter in China due to local permitting and construction delays, so it will not generate the sales we had initially planned.

By the time of our November conference call we had already assessed our available capacity and decided to limit further expansion.

As you know, we evaluate all of our in-process projects to determine when and how much capacity should be brought online.

To review, our decision was to complete Sherbrooke and to delay Ohio until 2010.

We have not changed that plan although we are experiencing a one quarter construction delay in Sherbrooke.

Between maintenance spending and our limited expansion requirements, we estimate the capital spending in '09 to be in the range of $100 million to $120 million.

This will boost our free cash flow in '09 to a range of $130 million to $160 million compared to approximately $80 million in '08.

We are using this period of market uncertainty to streamline our operations and improve our operating efficiency.

We implemented a few actions in the fourth quarter including a hiring freeze, tight control of discretionary spending, a limited management restructuring, and the closure of a small RMS site in Hungary.

In the first quarter of '09, we have initiated a salary freeze for a substantial percentage of our workforce including all incentive-eligible employees.

We will also implement a headcount reduction which will affect approximately 3% of our total workforce.

These reductions will occur predominantly in the PCS business with the largest number coming from the Arkansas facility, which we intend to close by the end of the year.

We expect this decision will enhance our operating infrastructure because it will enable us to focus on improving utilization of our larger and particularly our newer facilities.

As a result of these actions we expect to reduce our operating costs by approximately $20 million in '09 with an annual run rate of $25 million beginning in 2010.

We have also decided to pursue strategic alternatives for our Phase I operation in Edinburgh.

Currently, we have identified a prospective buyer and are engaged in preliminary discussions to divest the business.

To further enhance our operating efficiencies we are continuing to implement a Lean Six Sigma initiative which we refer to as APEX, or Accelerating Performance Excellence.

The Charles River culture has always encouraged continuous improvement and we are embracing Six Sigma because it provides us with a set of tools to enhance that process.

We have chosen a number of our high-potential employees to be trained as black belts and green belts and are dedicating them to the APEX project.

They will be mentored through the first year by SSA and Company, a leading Six Sigma consulting group.

Our expectations for efficiency gains in the first year of APEX are modest but we believe that the games will increase significantly going forward.

Our guidance for 2009 reflects our expectation that softer market demands, particularly for preclinical services, will persist at least until mid-year.

It takes into consideration the potential consolidation of our pharmaceutical clients, although experience has shown that acquisitions ultimately result in more outsourcing as companies seek to reduce their fixed overhead.

We fully expect this to continue to be the case, although there may well be short-term disruption.

It's worth noting that our assertion that no single client represents more than 5% of our total sales would still be true under all of the current publicly-disclosed acquisition scenarios.

Our pharmaceutical and biotechnology clients are undergoing a period of unprecedented challenge and change as they strive to bring new therapies to market faster and more effectively than in the past.

This has led to the current challenges in our business, but has not altered our belief that this environment is temporary and that our clients will continue to outsource drug development services in order to improve the efficiency of their drug pipeline.

We have a unique portfolio of products and services.

In fact, we are the only provider in the industry positioned to offer a solution that spans the entire spectrum from lead compound selection through IND.

I have had a number of meetings with senior management of our largest clients to discuss opportunities to meaningfully broaden our partnerships with them and am encouraged by these opportunities.

Our value proposition is aimed at exactly what our clients need to achieve their goals -- scientific expertise, flexible staffing and facilities, and lower operating costs.

Charles River remains a strong company focused on its core competencies of laboratory animal medicine and science, and regulatory compliance and clinical services.

We are a market leader in all major business areas, all of which have high barriers to entry.

We are continuously evolving our unique portfolio to enhance our ability to meet clients' needs and have expanded our geographic footprint to support them wherever they are.

As Tom will expand upon, our balance sheet is strong.

We are highly liquid and our capital structure conservative giving us the power to weather this period of softer demand.

We intend to emerge from this period as a leaner, more efficient operation, and combined with our deep scientific expertise enhance our position as an ideal partner for pharmaceutical and biotechnology companies.

During these complex and challenging economic times I particularly want to thank our 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.

First, let me remind you that I will speak primarily to non-GAAP results, which exclude the goodwill impairment, acquisition-related amortization and charges related to asset impairment, cost savings actions, repatriation, and other items.

This morning my remarks primarily focused on two important elements -- our 2009 financial guidance and our balance sheet.

For 2009 we have opted to provide wider ranges for both sales and EPS guidance than in prior years in order to encompass the uncertainty in our market from the reduced visibility into preclinical demand to pending and potential merger activity among our pharmaceutical clients.

Reported sales are expected to decrease between 2% to 7%, which includes a negative foreign exchange impact of 5% based on current exchange rates.

The net effect of acquisitions and divestitures, including the planned divestiture of our Phase I clinic in Edinburgh, adds less than 1% to growth for the year.

The organic sales growth is expected to be in a range of growth of 2% to a decline of 3%.

Based on these sales assumptions we expect 2009 non-GAAP EPS to be in a range of $2.30 to $2.60.

The components of this range include the impact of lower sales and operating income, a negative $0.12 per share impact from foreign exchange, and below-the-line items such as increased net interest expense and a higher tax rate.

These are expected to be partially offset by the cost savings and a lower share count.

I will now outline each of these factors in more detail.

Foreign exchange has a significant impact on our guidance in 2009.

Our guidance is based on current foreign exchange rates and does not include the impact that future movements in these rates would have on our results.

You can get a sense of the magnitude of our sales exposure from the geographic distribution of our 2008 sales.

Approximately 60% of our total sales were generated in US dollars, 16% are invoiced in euros, and 10% are derived in British pounds.

Sales in Canadian dollars represent another 6% and the only other currency where we have notable exposure is the Japanese yen which represents approximately 5% of sales.

For budget purposes we have used current rates as of last week which are as follows -- the euro at 1.30, the British pound at 1.42, the Canadian dollar at 0.825 and the yen at JPY91 per dollar.

The British pound and Canadian dollar exposures are primarily related to our preclinical facilities in Edinburgh and Montreal.

So the foreign exchange impact is expected to have a greater impact on PCS in 2009 representing an FX reduction of nearly 7% compared to a 3% reduction to the RMS sales.

Foreign exchange typically has a more muted impact on operating income and EPS since the FX impact on sales generally drops down at less than the margin rate.

This is because we are naturally hedged at all of our facilities with the exception of PCS Montreal and the Canadian dollar impact tends to have an offsetting effect when all currencies move in tandem.

We expect this to hold true in 2009 and at the rates I just mentioned, foreign exchange will reduce 2009 sales by approximately $70 million and operating income by approximately $11 million or $0.12 per share.

Foreign exchange is expected to have a far greater negative dollar impact on us than in any other period in memory as a result of the extreme currency volatility we have been experiencing.

With this information you can model your own FX assumptions based upon your view of how the dollar will fare against other major global currencies this year.

In light of the challenging market environment in 2009 we believe we are taking the appropriate and necessary actions internally to make our operations leaner and more efficient without sacrificing the ability to fully accommodate our clients outsourcing needs in the future.

As Jim discussed, cost savings actions are expected to reduce our operating costs by $20 million in 2009 at an annual run rate of $25 million beginning in 2010.

To complete these actions we expect to incur charges of approximately $9 million or $0.08 per share, of which approximately 60% will be cash charges.

These charges, which will be excluded from non-GAAP results, will primarily be incurred in the first quarter of 2009.

Unallocated corporate costs totaled $53.7 million or 4% of sales in 2008.

Fourth quarter unallocated corporate expense of $11.4 million was slightly lower than expected.

The anticipated increase in global IT cost was more than offset by a sequential decline in healthcare and fringe-related costs.

Looking ahead to 2009, we expect unallocated corporate costs to be approximately 4.5% of sales with a range of plus or minus 25 basis points.

This represents a modest increase year-over-year due primarily to our investment in global IT initiatives outpacing normal inflationary cost increases.

In recent years our corporate unallocated costs have been waited toward the first half of the year as healthcare and fringe-related expenses have been lower in the second half.

Net interest expense of $5.3 million in 2008 was in line with expectations.

In 2009 non-GAAP net interest expense is estimated in the range of $9 million to $11 million.

This is roughly double the 2008 level primarily driven by lower interest income and cash balances as well as lower capitalized interest on projects.

Interest income is expected to decline due primarily to lower interest rates.

For the first quarter we are adopting the accounting change required by FSP APB 14-1 related to convertible debt and will exclude the incremental GAAP interest expense of $10 million or $0.10 per share from our non-GAAP results in 2009.

We will also be required to reclassify a portion of the $350 million of convertible debt on our balance sheet as shareholders' equity related to the bifurcation of debt and equity that APB 14-1 requires.

This accounting change has no cash or economic impact and we expect to remain in compliance with that debt covenance.

The convertible debt was not dilutive to our share count in the fourth quarter as our average share price was below the $48.94 threshold.

Because the convert was dilutive for the first three quarters of 2008, the average share count for the year was 2 million shares higher than the fourth quarter.

In addition, holders no longer have the right to convert their notes into shares during the fourth quarter as the stock price triggered for these rights was not met at the end of the fourth quarter.

Other expense rose to $5.9 million in 2008 including $3.4 million in the fourth quarter, primarily driven by the loss on investments associated with our deferred compensation plan which we discussed in our third-quarter call.

We generally do not budget for other expense since gains and losses on the investments associated with that deferred compensation plan are correlated with market returns and are unpredictable.

The non-GAAP tax rate was 27.3% in 2008 and 26.7% in the fourth quarter.

In 2009 we expect the tax rate will increase by approximately 200 basis points to 300 basis points to 29.5% to 30.5%.

The increased rate is primarily due to a loss of R&D tax credits in Canada a result of both our efforts to reduce our currency risk by billing more sales in Canadian dollars and increasing requests from PCS Montreal clients to claim R&D benefits.

Several tax items were excluded from our non-GAAP results during the fourth quarter.

The first item was a $1.9 million charge associated with the recently enacted Massachusetts tax law change.

The second item was a $4 million benefit related to our anticipated repatriation of approximately $90 million in accumulated foreign earnings in the first quarter of 2009.

A portion of these foreign earnings will be repatriated via a dividend distribution resulting in a US excess foreign tax credit benefit.

As you know, the majority of our cash is held abroad so bringing this amount of cash back will enhance our liquidity in the US.

As we disclosed in the press release, we recorded a goodwill impairment in the fourth quarter based on management's annual assessment of goodwill.

As a result of this assessment, we were required to revalue the fixed assets, goodwill, and intangible assets on our balance sheet at fair value.

Based on our analysis we have recorded a non-cash charge of $700 million which has been excluded from non-GAAP results.

There is no impact to cash flow or our debt covenants and only a small tax benefit of $2.9 million related to the impairment.

In the fourth quarter we repurchased approximately 800,000 shares of common stock at an average price of $31 per share, representing a total cost of approximately $25 million.

As of December 27 we had approximately $187 million remaining under our current buyback authorization and expect to continue to repurchase shares under in the 10b5-1 program that we have in place.

We expect these purchases to further reduce our share count from the 67 million shares outstanding at the end of the fourth quarter, but the exact share count for 2008 -- 2009 remains dependent on our stock price and corresponding level of repurchases under the 10b5-1.

There were two changes to our capital structure during the fourth quarter.

First, the goodwill impairment translated into a corresponding reduction to retained earnings which lowered shareholders' equity.

As a result, our total capitalization stood at approximately $1.8 billion at the end of the year.

We also drew down an additional $42 million on our revolver in the fourth quarter and at the end of 2008 had an outstanding balance of $90 million.

With total debt of $576 million, or 1.7 times 2008 non-GAAP EBITDA, we believe our conservative capital structure, existing credit facility, and ability to generate cash flow will be more than sufficient to meet our near-term funding requirements.

Cash and equivalents including short and long-term marketable securities grew $263 million at the end of 2008 versus $289 million at the end of 2007.

However, our cash position improved sequentially compared to $233 million at the end of the third quarter.

Fourth quarter accounts receivable declined to $210 million.

DSO remained relatively stable and within our target range at 40 days compared to 41 days at the end of the third quarter, but below 35 days at the end of 2007.

Credit risk has become an increased area of focus in light of the global financial crisis and particularly its effect in our small biotech clients.

We continue to actively manage our receivables, continuously monitor our clients' credit risk profiles, and requires stringent approvals before extending credit to a client.

As a result of these activities, we believe that we have significantly reduce our risk related to client default as evidenced by the fact that we increased our bad debt reserve by less than $1 million in 2008.

We continue to generate approximately 20% of our sales from small biotechs classified with a market cap of less than $1 billion and smaller private companies.

However, we believe this number greatly overestimates our exposure to at-risk clients.

Further analysis indicates that the actual exposure is less than 5% of our sales.

We ended 2008 with free cash flow of $82 million, slightly above our expectations and ahead of $61 million in 2007.

In 2009 we expect a meaningful increase in free cash flow to a range of $130 million to $160 million driven by a significant decline in capital expenditures.

CapEx is expected to decline from $197 million in 2008 to an estimated range of $100 million to $120 million in 2009.

Nearly two-thirds of 2009 CapEx will be related to maintenance projects as we have completed our major expansion projects.

We expect depreciation expense in 2009 of approximately $66 million, an increase of approximately $5 million from 2008 primarily reflecting a full year of depreciation at the new Nevada facility and smaller facilities that opened in 2008.

We expect 2009 amortization expense to decline to $26 million or $0.26 per share based on current exchange rates.

Foreign exchange rates will be the primary driver behind being the $4 million decline from 2008.

As we look at our expected performance over 2009, we expect the first quarter to be the low point for the year; non-GAAP EPS in the first quarter to be approximately 10% below the fourth quarter of 2008.

We expect both the RMS and PCS segments to report lower sales in the first quarter of 2008 partially due to the significant FX headwinds.

Preclinical sales are expected to decline sequentially as well as study delays and constrained client spending continue to impede results.

In the RMS segment we expect sales to show sequential improvement from the seasonally weak fourth quarter, despite a slower start this year.

Our business plan for 2009 factors in a challenging year of global economy and uncertainty for many of our pharmaceutical and biotech clients.

We view 2009 as a year to transition our business to a more cost efficient and leaner organization while continuing to build upon the strength of our balance sheet and cash generation capabilities.

This will undoubtedly leave us in a stronger position to compete when the economy and client demand improves.

Our focus on improving operating efficiency and delivering value to our clients further aligns Charles River as a key partner to accelerate their drug development goals.

That concludes our remarks.

We will now take your questions.

(Operator Instructions) John Kreger, William Blair.

Thanks very much.

Jim, I think you mentioned in your remarks that your outbred rat business was down given its tie to the toxicology business.

Could you just expand upon that a bit?

And give us a sense of your model business, what percentage is generally tied to toxicology work versus other uses?

Probably close to half, John, could be a little bit less than that.

And that isn't consistent necessarily from year-to-year, but I think over the long-term we are seeing about half the animals used for discovery and half used to serve development purposes.

Obviously has an impact; it correlates pretty closely.

You should get some relative early indicator, confirmatory indicator that tox is firming up as we see research model purchases strengthen perhaps a quarter in advance or so.

And we will get a sense of that for the whole industry so it's a very good guideline for us.

Great.

I think you also said that you were seeing some signs recently in the last few weeks of firming up in your business.

Can you just elaborate a bit?

Is that coming in the form of better orders, fewer delays, or perhaps commentary from those client meetings you mentioned?

It's a combination of all.

Inquiry levels have been extremely low the past at least two quarters, maybe three quarters., and they became increasingly so.

And so it started the quarter slow as well in several of our preclinical locations.

We are beginning to see inquiry levels increase substantially or meaningfully at many of our locations.

The second quarter, as we said in the prepared remarks, certainly looks stronger.

That is a very good sign.

What we don't know, of course, is will there continue to be study slippage as we saw very much through much of '08 where not only do we have inquiry levels but we had booked orders.

And they continued to slide sometimes from month to month and sometimes from quarter to quarter.

So inquiries were up substantially as we were able to close that business and hold onto it.

That will serve as the defining metric for us.

And, again, given the fact that there are a large number of preclinical molecules awaiting development, given the fact that that is what the drug industry does for a living, and given the fact that they didn't do as much of that in '08 as perhaps they would have liked to or should have, it's not if they are going to get back to developing them.

It's when.

We believe we are seeing some early strengthening signs that they will do that.

That is definitely buttressed by our conversations with very senior people, so as we also said we have had a large number of those conversations already.

We have several more scheduled for this month and we will continue to do so.

And I am talking about the top two or three person in the drug companies.

So we are talking about long-term strategy, we are talking about the utilization of outsourced services, how much work they will do inside, what types of work they consider core versus the type of work that they are comfortable with finding a strategic outsourcing partner, what they are building or not, how they are going to utilize their internal resources in terms of asset shutdowns or other things.

So I would say a combination of those conversations, the firming up of work, the necessity to get back to work, and sort of leveling of the playing field in terms of capacity buildout and the price point definitely points to a strengthening second quarter, slightly strengthened second quarter and stronger back half of the year.

Thanks very much.

Douglas Tsao, Barclays Capital.

Good morning.

Jim, I was just hoping you could provide some context regarding the pullback that you spoke about having seen in the GEMS business this quarter.

Are we seeing something of similar magnitude to what occurred in the 2005, 2006 period, or is the pullback more modest?

And if you could also sort of elaborate in terms of similarities to what occurred then and the differences to what occurred then?

The prior slowdown, Doug, we saw was much more dramatic.

It was major rationalization of models across a whole range of clients.

It also demonstrated some dissatisfaction with the quality of the models and their predictive or translational value.

So what we are seeing now is something pretty much entirely different.

We are seeing definitely cost sensitivity across all of our clients, and so I think they are going to evaluate what they outsource, what they don't, and the utilization of these models.

But we are seeing a greater acceptance and clients are definitely more pleased with the quality of the models.

The models are much more refined, much more sophisticated, and tend to apparently have better predictive value.

So the commentary which was around genetically altered models was more questionable, I would say, a few years ago.

Now there is a great focus on them.

There is actually somewhat of a resurgence in the creation of the models by our clients who tend to be multi-genetic, so they are much more complex.

And I think we are seeing now just a slight rationalization of the portfolios, and we are seeing strength in different geographic locales, which also gives us the confidence to recognize the fact that these models are deemed to be important discovery tools for our clients.

Okay, great.

Tom, you sort of commented that you saw less than 5% of your customer base as being at risk.

I was just hoping you could provide a little more detail in terms of what you are defining as an at-risk client?

Doug, we took a look at approximately 250 of our clients that we felt fell into that category of smaller companies, biotechs, etc.

And actually in conjunction with our own available data as well as Standard & Poor's, basically looked at those that we thought had capitalizations that were appropriate, cash on hand, and things like that to essentially dwindle down the large number into companies that we felt would probably be more at risk from us in terms of continuing relationship for sales.

So companies that may cut back on sales because they are looking to stretch out cash flow from say 12 months to two years, or possibly companies based on their size that may not exist in business for that much longer.

That is helpful.

I will hop out for now.

Thank you very much for taking the question.

Eric Coldwell, Robert W.

Baird.

First question relates to the Company's plans with clinical pharmacology moving ahead.

Clearly, Edinburgh has been a challenge for sometime, but we understood Northwest Kinetics was actually doing quite well.

Should we read into this that you plan to keep the Northwest Kinetics business and would you have future plans to expand Phase I if you find a site that you are more comfortable with?

Eric, they are very disparate operations.

At one point they were both performing extremely well and the regulatory environment in the UK was challenging and remained challenging for us in the early days.

We also had some currency arbitrage pressures.

I would say looking at not just our location but the competitive locations, I think everybody had the same situation, so just not a viable business strategy for us to continue the Scottish facility going forward.

Northwest Kinetics we have been very pleased with the progression and development of that site.

It was a new facility when we bought it; a reasonably large facility amongst the Phase I players.

We filled it up nicely with very high-value studies and a loyal and repetitive customer base; some in the West Coast but not entirely.

It's a worldwide base as well.

We still believe in the strategic benefit of having Phase I.

We are experiencing some pull through effect from preclinical to Phase I.

In fact, some of that is with some of our larger clients.

Yes, if and as we find Phase I facilities that are of extremely high quality and high science and are in the right geographic locale, and we think that they -- it or they can compliment our current preclinical portfolio, then we would be likely to add something.

We certainly wouldn't be reluctant also to add something offshore along the same lines.

Thanks.

Shifting gears, research models, you had a fairly noticeable price increase in your US catalog for models this year.

I suspect that Europe was less and Japan was flattish in terms of pricing.

Could we get a weighted global average for your expectations of research model pricing contribution in 2009?

It's probably 3% to 4% and as you say, US is always, historically and this year, stronger.

Europe less so and Japan price increases have historically been more on more of a periodic basis, although not necessarily the case this year.

So across the world RMS global business we are probably seeing 3% to 4%.

Great.

Last question relates to in vitro, continues to put up a great growth rate and be a driver for performance in the RMS segment.

We thought we understood from a recent conference or presentation that you made though that the growth rate had slowed to the high teens, down from the low to mid 20s.

Could you just update us on what the growth rate was in the four quarter and what the outlook is for 2009?

It was in the high teens.

We don't consider that any sort of meaningful slowdown.

It's off of -- increasingly off of a higher base.

It's a very strong franchise where we are clearly the market leader.

We continue to take share and continue to convert clients from our historical technology over to the PCS technology, and also the uptake in the disposables or the cartridges is increasing nicely.

We continue to be very optimistic about that product line.

And going forward, both in terms of making meaningful contribution to our sales growth as well as margin contribution.

So we would be looking for a mid-teens to high-teens growth in 2009?

Is that still in the target?

Yes, I think we anticipate similar growth rates to what we saw in the back half of this year.

Great.

Thanks very much.

David Windley, Jefferies & Co.

Thanks for taking the questions.

Jim, are you seeing a noticeable difference in demand levels for specialty toxicology services versus general toxicology?

Either answer it that way or in terms of your ability to maintain utilization levels in the respective pieces.

I mean, we have seen a slowdown pretty much across the board for the last, as I said, few quarters.

I would say that we are seeing strengthening now in terms of inquiry levels and demand, again across the portfolios.

So we have a strong and unique portfolio for which clients seek us out, both because of the geography or the specialty nature or, indeed, if they are looking for general tox.

I don't think that has trend has continued.

I think the new facilities will be very beneficial to us.

Places like Montreal, which has a significantly high compilation of specialty services, we will continue to be in strong demand going forward.

So I think as the market invigorates we will continue to see increased demand across all of what we do.

Okay.

Eric touched on Edinburgh Phase I a little bit.

Was there -- I think the longer term thought process there, even dating back to the prior owner, was the opportunity to pull clients through talks in the Edinburgh area and into Phase I close by.

What factors, I guess, caused that not to pan out?

That was certainly the case early on.

I think it was, in large measure, the nature of the client base that impacted that.

The fact that clients that we had previously were doing business with us and perhaps other people in the states and elsewhere.

Even at a lighter volume we still did see some pull through, but not as much as we had seen in previous years.

So it's really a function of demand, client mix, availability of business from the US that really impacted the basis of the bargain at that location and our ability to be able to use it as strategically as we have been in our Northwest Kinetics sites.

Okay.

Tom, on tax rate I think you mentioned that an R&D -- the lack of an R&D tax credit in Canada is a factor there.

And did I also understand something about your FX impact as it relates to Montreal having an impact on the tax rate?

I didn't quite understand that.

No, the primary impact, Dave, is the not lack but slightly reduced R&D credit in Canada versus last year.

The same to a smaller extent in Edinburgh as well.

In Canada it's because we are seeing more clients profess a desire to be billed in Canada and capture some of those credits themselves.

The other thing that is a little bit at play is just our earnings mix will change a little bit more favorable to the US, which of course we have a higher tax rate in the US.

Okay, thank you.

I will drop out.

Thanks.

Ricky Goldwasser, UBS.

Good morning.

I know you said that the guidance assumes potential consolidation.

Can you just be more specific if you are factoring in what already was announced or also potential additional deals?

And then assuming that Pfizer Wyeth closes in the third quarter would the impact be greater in 2010?

Lastly, what would be the EPS impact if there is no pickup in the second half of the year?

And is that factored to low-end of guidance range and if not, what is the sensitivity on the EPS?

We will split that question up.

Our guidance does indeed anticipate the consolidations, the mergers that have at least been announced and identified.

There may be more, of course, but the ones that are publicly teed out.

We typically -- always in our RMS operating plan assume because it has been the case over the last two years that there will be some merger and we have an operating margin contingency to protect us against that.

Of course, we started the year with that as well this year.

So our guidance does anticipate that there will be the consolidations that we know of.

We have studied our current volume of business for those clients carefully and tried to prognosticate what the impact would be from the consolidation.

It's always a little bit difficult to call it because every single one of them historically has been different.

But we would expect, by and large, some short-term slowdown in purchases across all of our products, research models as well as a preclinical, by one or both of the combined entities, usually one, and a significant pickup in service demand into next year.

So both -- certainly we anticipate both of these deals will be done sometime in '09.

The last half of the question I think was about I think was about sensitivity to the second half of the year, Ricky?

Yes.

I wouldn't want to be too specific on the answer, but let me try to answer it this way.

We set a wider range of EPS in part because of some of the uncertainty that exists out there.

So I think our range itself suggests some level of uncertainty in terms of the recovery, the timing, the liquidity and things like that.

Clearly, if we don't see a recovery as we progress through the year, we will have to continue to reassess the structure of the Company and how we are organized and our particular infrastructure and take appropriate actions.

But at this time, as we said, we are anticipating a stronger second half of the year.

We will have to as the year plays out, obviously, get more visibility and decide if we are taking the appropriate steps within the Company.

Anything else?

So just to clarify, the 230 assumes -- still assumes the pickup in the second half or assumes a partial pickup?

It's like I said, really we have a wide EPS range anticipating the volatility in the market place that it's -- and the visibility that we have that it's not as easy to predict exactly what will happen as we have had historically.

So we have talked about pharmaceutical mergers, which was the first part of your question.

Obviously, that could play into our numbers.

The timing and pace of the recovery could play into our numbers so that is primarily the reason for the wider range.

We could experience some disruptions in our costs.

While I don't expect commodity prices to trend upward dramatically in a near-term, they are always unpredictable.

The range doesn't necessarily cover or encompass every single outcome nor is it intended to be necessarily -- if nothing better happens or nothing worse happens, it's sort of our best range for where we think things will be at this time, giving a little bit more wider berth to that.

Okay, thank you.

Randall Stanicky, Goldman Sachs.

Thanks.

Just a couple of questions.

Tom, in terms of the PCS margin, you gave a lot of detail in the disclosure.

Where do you see that margin hitting from a low perspective?

You talked it about it being down from the 18.2%, I think meaningfully lower.

But where does that go to and then how do we think about when that starts to ramp back up?

We didn't say exactly what we thought it would be in Q1.

So by default I won't be too specific on that other than to say it will come down for Q4 and as Jim said, it will come down meaningfully.

Some of the reasons for that are obviously the headwinds in terms of sales.

We mentioned that sales would be down sequentially; that put some pressure on the number.

While we are taking cost actions -- we are taking those, literally, as we speak.

So this is almost the middle of February so it will have some impact on Q1, but we are not going backwards with our cost reductions.

And we are opening up our Sherbrooke facility little bit later, but still we are opening that up during the first quarter.

We brought on our Shanghai facility during the fourth quarter so we are seeing some increased costs as well because of those.

Q1 should be the low point for the year.

As Jim said, demand seems to be firming up a little bit.

Hopefully, we will start to see a slight sequential pickup as we move through the year and then a large recovery in the back half of the year.

The cost benefits will have a larger impact obviously in Q2 and Q3 and Q4.

I think Q1 will be the low point and then we should pick up from there, Randall.

Okay.

How much of the cost benefit, the $20 million I think you talked, how much of that falls in PCS versus RMS?

We didn't say but certainly based on the head count reductions, which Jim mentioned primarily with PCS, the vast majority of that would be PCS.

Over 75% just as a watermark.

Okay.

Then my last question I want to go back to the utilization theme.

As you think about -- first, what is the utilization?

Then the other part of that is as you think about ramping that utilization back up, how much of that is pulling forward business that you currently have booked?

In other words, moving ahead with projects and avoiding some of the slippage versus the need to go out and bring new business into PCS?

Of course the closure of Arkansas should help our utilization.

We are obviously working with those clients.

There will be a ramp down at the facility itself as we complete studies and things like that.

Our utilization is not at our ideal level right now obviously.

It's not at 50% though, however, either.

It's really somewhat less than what we would like it to be, but not horrific.

One of the things that we didn't express is that while we are taking a number of actions we are still trying to preserve a lot of the key talent that we have and infrastructure that we have so that we don't put ourselves in a position where recovery starts to occur in the second and third quarter and we have actually cut too deep.

So I think we have taken appropriate actions but we are still maintaining quite a resident level of expertise so that we can continue to do that work in a meaningful way as it comes back.

I think it's a combination of those factors, Randall.

Managing our capacity aggressively and that is really one of the keys in terms of driving the margin back up.

I guess the question is how much -- is there a way to place how much importance is it bringing in new business?

In other words, new contracts in PCS versus the slippage issue, which I assume will have better visibility around mid to late March?

We are continuously bringing new business, Randall.

All of the time.

So it is indeed important, not just to ameliorate the slippage, but just to fill capacity and have a larger role of satisfying our clients.

We have a lot of repeat business and a lot of loyal clients, both large pharma and biotech, in multiple locales.

We certainly are hopeful that the slippage is going to continue to dissipate as they really have to get back to developing these compounds.

By the same token, given the geographic locale of our two larger sort of rebuild facilities on the East and West Coasts, there is a huge number of clients out there that are local that we are actively talking to and working with to service.

We just got a new dedicated resource agreement with one of them in our Massachusetts facility for a long-term arrangement, and we think there are more of those.

Certainly, it's a combination of servicing our current clients consistently and bringing on new ones as well.

Great, thanks, guys.

Tycho Peterson, JPMorgan.

Good morning.

Wanted to ask -- you didn't talk a lot about the academic business, but, Jim, we are in an environment here where things are potentially getting better on the academic front.

Can you just comment a little bit as to whether you are seeing any pickup in demand there from your academic collaborators?

It's a little early to see any flow-through from the anticipated increase in the NIH budget.

But we have, I would say for the last three years, focused aggressively in terms of how we structure our sales force to have greater coverage for the academic marketplace, principally in the US of course.

Our sales have been up, were up in '08 in a meaningful fashion.

We would anticipate certainly that that will continue, A) because we are focusing on it, B) because our price premium is less dramatic versus the competition than it was historically.

A lot of the academics didn't buy from us because there was the perception that we were too expensive, which is no longer the case.

There is no question -- I was talking to one of our directors who is a senior policy person on some of these issues in Washington who was saying that we ought to be beginning to see in the back half of this year sort of more meaningful flow-through from the government directly into the academic and university-based marketplaces.

So we ought to see some pickup there.

Also we do a fair number of governments -- a fair amount of government work, as you know.

Obviously, a lot of that is contractually committed over the long term but we would expect to see more RMPs coming out as well.

And given our strong reputation in that genre, I think we will be able to increase sales there.

So I would imagine over time as our academic sales as a percentage of total sales would continue to increase.

Okay, that is helpful.

On RMS, I appreciate the color you provided on price.

Can you give us a sense as to what you are seeing in terms of share?

I felt like coming out of your RMS Day last year that you were still talking about 3% or so from competitive share wins.

Can you jus talk about the competitive dynamic right now?

That sounds a bit high to me.

We certainly have been taking share from our primary competitor over the last, this will be four years now, and I would say maybe a pretend-ish or a year.

Again, that has to do with the compression of our price points and I think the fact that we are providing a higher service level combined with our geographic reach.

So that -- those structural strengths that we have haven't changed at all.

Notwithstanding the overall economic environment, I think we would anticipate that we would continue to be able to continue to take share from that competitor and perhaps others.

Again, our price point versus all of our competitors now is not nearly as dramatic as it used to be.

And indeed, there are some product lines where our prices are the same and a few where they are actually less.

So we are in a very strong competitive position also because of the range of services that we provide.

If you go to the RMS side, our service component is probably one-third of total RMS sales.

And clients who buy research models from us increasingly want us to provide services for them or to them.

In some cases without them even shipping to the client but us maintaining them and providing the services to them.

So whether its GEMS or our laboratory services or our growing discovery services business we think we ought to be able to not only pickup share, but be able to get more of the outsourced business from our clients than our competitors will be able to.

Okay, that is helpful.

Then just a last one on China and I understand the timelines have slipped little bit, but can you give us a sense as to what you are assuming there for this coming year just in terms of that business?

We think we still have a competitive strong competitive position as being really the first large international player who is going to have GLP quality.

Our location is very fortuitous being close proximity to major clients.

Because of the delay we are just sort of finishing the validation of that and while we have a large number of clients who have been interested in utilizing the site, they are not going to make major commitments -- we are doing non-GLP work there now -- but they are not going to make major commitments until the space is fully validated.

So we anticipate we should be getting some commitments from them in the back half of this quarter, maybe the beginning of next quarter.

So it continues to be online in terms of fulfilling customers needs and demands, we are just a quarter behind.

Okay, thank you very much.

(Operator Instructions) Isaac Ro, Leerink Swann.

Thanks for taking the question.

Just wondering if you guys have had conversations with your major pharma customers and potentially seeing cases where you are actually getting maybe materially higher levels of outsourcing levels for fiscal '09 relative to what you would have previously expected but maybe at the same time actually seeing the dollar levels lower than you might have expected?

Just trying to wonder how you are comparing the level of outsourcing versus the dollars that are flowing through to you.

That is an interesting question.

I think not.

I don't think the levels are dramatically higher.

The levels, if anything, would have stalled somewhat and they are beginning to reinvigorate.

Yes, when they do invigorate there is probably some impact across the whole spectrum that is price affected because as long as there is more than sufficient capacity, price will be of a greater issue.

I will tell you that in a lot of our conversations, while price is still important, that science and service are more important.

And so we are really focusing on execution and we are really focusing on providing value as opposed to pricing benefits.

So we are trying to sell our clients a larger range of products and services which cut across both of our businesses.

We are having some success in doing that and while that may end up with more beneficial pricing to the client, it ends up with greater volume to us.

So I think the volumes will increase, as we said, in the back half of the year.

The pricing issues or pressures will continue to persist but we should get more leverage with the increased volume.

Thanks very much.

Greg Bolan, Wachovia Capital.

Thanks for taking the question.

Just one for me here.

Jim, when you think about your Pharma clients' willingness to strategically outsource preclinical work, how much do you think is score to Pharma and how much do you believe is non-core?

I guess I am just trying to get a sense as to how much these sponsors are willing to outsource?

I know this will require a very antidotal answer, but is it everything or is it capped at some level?

We asked that question of every client.

The answers range, as you would imagine, to nothing is score to a great deal of it is core.

But I would say on balance, the clients have a predisposition to keep some of the very short-term studies in house, regain greater knowledge about the molecule and see the very early results.

They have to scale for that and the scientific staff to accommodate that.

When you get into longer-term studies, particularly more of the complex studies and a lot of the specialty work, there is very little interest in doing it.

So we would have to say that much of it is deemed available to be outsourced over time and that very little is essentially core.

I would also say that every quarter and certainly every year that we have the conversations with clients less and less this core.

And I think that is from operational financial necessity on their parts but they really have to make some decisions on what they must do internally.

As they have greater confidence in our ability and others ability to do the work for them, they are letting go of those things.

As we have said historically, we certainly believe that 50% of this work will be outsourced.

Probably 75% will be outsourced or greater and that provides a very large market opportunity for us when the demand begins to invigorate again.

That is helpful.

Thank you.

I am showing no questions in queue.

I will turn the call back over to you for any closing remarks.

Thank you for joining us this morning.

We look forward to speaking with you in the next week and seeing you at various conferences in March.

This concludes the conference call.

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