Charles River Laboratories International Inc (CRL) 2009 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Charles River first-quarter 2009 earnings 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'd now like to turn the conference over to your host Ms.

Susan Hardy, Corporate Vice President of Investor Relations.

Please go ahead.

Thank you.

Good morning and welcome to Charles River Laboratories' 2009 first-quarter earnings 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 first-quarter results and review 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 3203653844.

The access code in either case is 994867.

The replay will be available through May 20.

You may also access an archived version of the webcast on our Investor Relations website.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 23, 2009, as well as other filings we may 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 will turn the call over to Jim Foster.

Good morning.

I'd like to begin by reviewing the first-quarter results.

We reported sales of $301.5 million in the first quarter of '09, a decline of 10.7% over the first quarter of '08.

More than half the decline was due to foreign exchange, which decreased net sales by 5.8%.

Including the effect of foreign exchange, the constant dollar decline was 4.9% with the RMS segment reporting flat sales year over year and the PCS segment declining 9.8%.

Operating income for the quarter was $56.6 million and the operating margin was 18.8% compared to $71.8 million and 21.2% recorded in the first quarter of '08.

The decreases were primarily the result of lower sales.

Both business segments have a high level of fixed costs and as a result are very volume-sensitive.

The fact that we were able to limit the margin decline to 240 basis points is attributable to the cost-savings initiatives we implemented in the first quarter, as well as our continued focus on cost control.

Earnings per diluted share were $0.58 in the first quarter compared to $0.72 in the first quarter of last year.

As we discussed during our '09 guidance call in February, we expect the first half of '09 to be more impacted by pharmaceutical restructuring, pipeline reprioritization and the effect of our clients' late-stage focus, as well as weak funding for biotechnology companies.

We still believe that demand will improve in the second half of '09 based on the fact that inquiry levels and bookings have stabilized, although at lower levels than in '08.

In addition, pricing has leveled and while it is a discussion point in most negotiations with clients, it is rarely the primary decision factor.

Clients continue to value our deep scientific expertise, flexibility and creativity as we structure partnerships with them.

Based on our extensive discussions with clients, we expect that some will increase their use of our preclinical services this year as they begin to move molecules through the development pipeline.

We also believe that we will see some evidence of government funding being deployed by academic and government researchers, which may begin to bolster RMS sales by the end of the year.

However, we expect that the announced and escalating merger activity among our pharma and biotech clients will dampen demand in the fourth quarter as those transactions begin to close and the Companies initiate the integration process.

For that reason, while we continue to expect a stronger second half of the year, we believe that the sales increase will be more moderate than we initially anticipated.

Still we believe that the demand from our clients for our broad portfolio of essential products and services supports our '09 sales guidance, which, excluding foreign exchange, is in the range between growth of 2% to a decline of 3% and that disciplined management of expenses, combined with actions we have taken, will enable us to achieve our EPS for '09 within the range of $2.30 to $2.60.

At this point, I will briefly summarize the business segment performance before discussing our plans for this next quarter and the balance of the year.

Sales from our RMS segment declined 4.2% in the fourth quarter to $161.5 million.

When adjusted for the negative effect of foreign exchange, which was 4.2%, the sale of the Mexican vaccine business and the acquisition of MIR, organic growth was essentially flat.

Having performed well through the end of last year, in the first quarter of '09, the production business experienced a greater impact from our clients' more measured spending.

As we had noted previously, sales of outbred rats, the model of choice for toxicology studies, declined in the second half of '08 and that decline continued in the first quarter.

In addition, demand for immunodeficient mice softened.

This was somewhat disappointing given the fact that immunos are the model of choice for oncology research and so many of our clients are focused on this therapeutic area.

Perhaps as a result of this focus and a pharmaceutical company's finalization of '09 budgets in the first quarter, sales of immunos stabilized in April.

Sales to academic and government clients increased in the first quarter due to our ongoing effort to drive growth in this area.

We believe the growth was a function of price increases and share gain rather than new government funds.

Sales from most of the service businesses were relatively flat in the quarter as cautious spending by our clients continued to moderate the growth rate.

The exception was our consulting and staffing services business, which, as a result of the expiration of two large government contracts, reported a significant sales decline.

However, the endotoxin and microbial detection business, or EMD as we now call our in vitro business, continued to post mid-teens growth in constant dollars.

Primarily as a result of lower sales, the RMS operating margin declined 180 basis points to 31.6% compared to 33.4% in the first quarter of '08 despite the large proportion of fixed costs and the increased operating costs resulting from both higher commodity costs and new capacity brought online in '08, we were able to maintain the operating margin above the 30% level through a combination of cost-saving actions and continued cost management.

The Preclinical segment reported sales of $140 million in the first quarter, a decline of 17.2% from the first quarter of '08.

The negative effect of foreign exchange accounted for 7.4% of the decline.

When adjusted for both foreign exchange and the new NewLab acquisition, the net sales decline was 12.2%.

As I have already mentioned, demand for our preclinical services has stabilized.

Unlike the third and fourth quarters of last year when steady slippage and delays accelerated and when inquiry levels and bookings were declining, these indicators of leveled.

Given the availability of capacity, clients continue to wait to commit and in fact, have lengthened the period of time it takes them to make a decision to place a study.

However, they are placing studies and we believe that they will continue to value our state-of-the-art facilities, deep scientific expertise, aggressive experience and flexibility when designing working relationships.

Pricing has also stabilized at lower levels and although it is still a consideration for some clients, we infrequently find it to be the primary deciding factor as to the placement of work.

We believe that we have reached a point where our pricing is aligned with customer expectations and extremely competitive as evidenced by the fact that we are winning strategic business.

We continue to have extensive discussions at the most senior levels with clients and potential clients concerning broader, more strategic relationships, including a myriad of relationships from preferred provider agreements to dedicated capacity to asset transfers.

This is one of the factors which gives us confidence that the market for outsourced preclinical services will flourish again as pharmaceutical companies move through this restructuring period and decline to invest in in vivo-related bricks and mortar and in-house expertise.

It is interesting to note that China is an important topic of conversation in many of these discussions.

As you know, we believe that this market will evolve meaningfully over the next three to five years.

We believe our entry into the market with a 50,000 square foot facility is the right scale for now, although we are looking for a second location.

Having completed our commissioning and validation, we are now the leading international CRO with GLP capabilities in China.

Our clients continue to express their intent to establish large research operations in China and to place GLP toxicology studies with us as we can support them in-country.

Most of the top 10 pharma companies have already visited the facility and have audit schedules for the second quarter.

We expect revenue to build slowly and the operation to exert pressure on the margin, at least through '09.

I would like to update you on our Sherbrooke facility.

Construction and validation of this facility have been completed and the official opening is scheduled for later this month.

The two large pharma clients who intend to collectively utilize the entire facility have completed their audits and are initiating their first GLP studies in mid-May.

The costs associated with bringing these facilities online are meaningful and are impacting the PCS operating margin as is lower capacity utilization, which is the more significant factor of the two.

In the first quarter of '09, the PCS operating margin declined to 15.5% compared to 18.3% in the first quarter of '08.

As we discussed on our February conference call, we plan to use this period of softer demand to streamline our internal operations and to align our business portfolio with the intent to emerge a leaner, more focused company.

As you know, we announced our agreement to acquire the business and assets of Piedmont Research Center, a provider of preclinical discovery services, focused on efficacy studies primarily in oncology for pharmaceutical and biotechnology clients.

I'm very pleased to announce that we closed the transaction on May 1 and welcome Piedmont to the Charles River family.

Its addition, along with MIR, expands our discovery services offering and makes us one of the largest providers of non-GLP efficacy studies.

As I discussed with you on our February call, we continue to enhance our operating efficiency through implementation of a lean Six Sigma initiative.

Currently, most projects are lean, which means that they create value by eliminating non-value-added process steps.

The program is giving us some quick wins and we anticipate larger and broader benefits as we complete ongoing projects and ramp the program across our operations.

In addition to Six Sigma, we are enhancing our operations through the ERP project, which will increase availability and accessibility of information and better support our clients and our own business needs.

The ERP project is currently undergoing integration testing in advance of the anticipated rollout beginning at the end of '09.

We believe that the combination of Six Sigma and ERP will significantly advance our goal to streamline our operation, improve operating efficiency and ultimately to reduce our costs while enhancing customer service.

Our expectations for savings from these projects are modest in the first year, but more significant going forward.

Large biopharma continues to feel the pressure of a pending patent expiration and while most strategic reorganizations and internal discussions are focused on improving pipeline to drive growth, the day-to-day practical actions are manifesting as cost containment.

These challenging market conditions are affecting our business, but we expect them to continue through the end of the year.

However, as our clients drive to improve pipeline throughput while reducing costs, we fully anticipate that virtualization of large pharma will continue.

Our clients are consolidating much more rapidly than expected, which is causing short-term disruption to our market, but in the longer term should actually accelerate demand for our services.

In our view, mergers are a catalyst for outsourcing since it is an extremely efficient means of rationalizing the cost structure.

We continue to have high-level conversations with our clients on the subject of larger, strategic partnerships and expect that, as mergers are finalized and the rate of late-stage discovery and preclinical outsourcing strengthen, a number of these discussions will come to fruition.

While this period of softer market demand continues, we are focusing on aligning our broad portfolio of essential products and services with our clients' needs to enhance our ability to be a key strategic partner.

We expect to continue to make strategic bolt-on acquisitions such as Piedmont as we expand key growth areas in our portfolio.

By doing so, we are becoming an increasingly powerful solution as we provide a single, unified solution for our clients' drug development efforts.

The power of our portfolio is that it supports clients' drug development efforts from late discovery to first in human testing and we are the only preclinical CRO which can offer this range of services.

Combined with internal initiatives to improve operating efficiency and careful cost management, we fully expect to emerge from this period a stronger entity, extremely well-positioned to work side by side with our clients to achieve their drug development goals.

During these complex and challenging economic times, I particularly want to thank our employees for their exceptional working commitment and our shareholders for their continuing support.

Now I will turn the call over to Tom Ackerman.

Thank you, Jim.

This morning, I will speak primarily to non-GAAP results, which exclude acquisition-related amortization, non-cash interest expense related to the new convertible debt accounting rules and changes related to cost-saving actions, asset impairment and other items.

As anticipated, first-quarter sales and earnings declined both year over year and sequentially due primarily to the difficult market conditions, which has led to softer demand for our products and services in both the PCS and RMS segments.

On a year-over-year basis, sales and earnings decreased at double-digit rates.

Below-the-line items did not have a meaningful impact as a higher tax rate and interest expense were offset by a lower share count.

FX contributed to over half of the 10.7% year-over-year sales decline in the first quarter, reducing RMS and PCS sales by 4.2% and 7.4% respectively.

Foreign exchange rates have held relatively stable during the first quarter, but based on slight currency movements, FX is now expected to reduce sales by closer to 6% for the year compared to approximately 5% in our February guidance.

As a reminder, we began to anniversary the strengthening of the US dollar in the second half of the year, particularly in the fourth quarter, so the FX impact is expected to be greater earlier in the year than in the second half.

When looking at sequential performance, sales declined 3% as the normally slow start to the year in the Preclinical business was further exacerbated by our pharmaceutical and biotechnology clients' weaker spending.

RMS sales increased 5.7% compared to a seasonally weak fourth quarter, while PCS sales declined 11.7%, driven largely by the slower market demand.

EPS declined just 2% and was ahead of the 10% decline that we forecast in our February call.

This was primarily the result of disciplined expense management, which enabled us to generate additional cost savings in the first quarter.

In addition, we decided to exclude from non-GAAP results operating losses of $0.02 from our preclinical facility in Arkansas and Phase I clinic in Edinburgh since neither will be an ongoing site for Charles River.

The decision to close Arkansas and stop accepting new business has resulted in very low capacity utilization as the facility winds down to close by year-end.

We remain committed to managing our costs and staffing our facilities appropriately, both based on current demand levels, but also to be able to accommodate our clients' outsourcing needs in the future.

We remain on track to achieve a goal to reduce operating costs by approximately $20 million in 2009, with an annual run rate of $25 million beginning in 2010.

Unallocated corporate costs increased on both a year-over-year and sequential basis to $16.1 million in the first quarter, which equates to 5.3% of sales.

Higher health care and fringe-related costs drove the increases, and costs associated with global IT initiatives were a factor in the year-over-year increase.

We continue to expect corporate costs of 4.5%, plus or minus 25 basis points for the year, as these costs tend to be higher in the first half.

First-quarter net interest expense of $2.3 million was in line with expectations, as lower interest income resulted in both year-over-year and sequential increase.

Interest income on cash balances declined, primarily due to lower interest rates.

We also adopted the accounting change required by FSP APB 14-1 related to convertible debt in the first quarter, which resulted in an additional $2.4 million in non-cash GAAP interest expense for the first quarter of 2009.

We were required to adopt this retrospectively to restate prior periods as well.

All amounts related to FSP 14-1 have been excluded from non-GAAP results.

The non-GAAP tax rate was 30.4% in the first quarter, an increase of 260 basis points versus the first quarter of last year and 370 basis points sequentially.

The higher rate, which falls at the high end of our guidance range for the year, was primarily driven by a reduction in R&D tax credits in Canada.

This is 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 the R&D benefits.

For the year, we now expect the non-GAAP tax rate to be closer to the higher end of our previous range of 29.5% to 30.5%.

Our liquidity position and balance sheet remain strong.

Cash and equivalents, including short and long-term marketable securities, were $225 million as of March 28 versus $263 million at the end of 2008.

The first quarter is normally the weakest quarter of the year for cash flow generation, which historically has caused a slight reduction in our cash balances when compared to year-end levels.

We completed the repatriation of approximately $91 million in accumulated income earned outside the US during the first quarter to enhance our US cash position.

First-quarter accounts receivable remained stable at $211 million and DSO improved slightly to 39 days from 40 days at the end of 2008.

Our bad debt reserve remained unchanged from the fourth quarter.

In the first quarter, we repurchased approximately 1.1 million shares of common stock at an average price of $26 per share, representing a total cost of approximately $28 million.

As of March 28, we had approximately $159 million remaining under our current buyback authorization.

We have continued to repurchase shares in April and the first week of May under our 10b5-1 program, but plan to reduce our repurchases shortly to maintain our targeted liquidity levels following the Piedmont acquisition.

We continue to have $90 million outstanding under our revolver with no change since the fourth quarter.

I would also like to point out one balance sheet change related to FSP 14-1 for convertible debt.

We have approximately $350 million in 2.25% convertible notes outstanding.

Pursuant to FSP 14-1, the net carrying amount included as long-term debt on our balance sheet is only $292 million as of March 28.

The remaining $58 million was classified as the unamortized debt discount, which is included in shareholders' equity.

As I mentioned earlier, the first quarter is historically our weakest quarter for cash flow generation.

Given this and the difficult preclinical market environment, we are pleased to have generated $12.5 million in free cash flow.

This represents an increase of $22 million from the prior year, driven by a $16 million decline in capital expenditures to $25 million and improved working capital.

For the year, we continue to expect a meaningful increase in free cash flow to a range of $130 million to $160 million and capital expenditures in an estimated range of $100 million to $120 million.

I will now review the adjustment to non-GAAP results that we made during the first quarter.

Amortization is expected to total $0.27 in 2009, which is $0.01 higher than our previous estimate, primarily as a result of the Piedmont acquisition.

Severance costs are expected to total approximately $9 million, or $0.08 per share in 2009, including $7.1 million in the first quarter.

This was slightly higher than expected as a result of additional first-quarter actions that we implemented.

In the first quarter, we recorded a charge of $1.6 million, or $0.02 per share, primarily related to an asset impairment associated with the planned divestiture of our Phase I clinic in Edinburgh, as well as other miscellaneous costs.

We expect the sale of the Edinburgh clinic to close by the end of the second quarter.

We expect to incur $0.04 per share of operating losses related to Arkansas and Phase I Edinburgh in 2009, the majority of which will be generated in Arkansas.

Based on preliminary discussions regarding the sale of the real estate in Arkansas, we do not expect to record an asset impairment at this time, but given the tenuous situation in the real estate market, this could change.

We recorded costs of $0.2 million in the first quarter related to the evaluation of acquisitions.

As a result of the adoption of SFAS 141-R, we are no longer able to capitalize deal-related expenses for acquisitions.

We believe it is appropriate to exclude these costs from our non-GAAP presentation.

Because these costs are difficult to predict, we do not forecast them.

In 2009, we will exclude approximately $0.11 per share of non-cash interest expense related to the convertible debt accounting change FSP 14-1.

In total, we estimate that the non-GAAP adjustment will be approximately $0.52, or $0.08 higher than our February guidance of $0.44.

This is primarily driven by the operating losses in Arkansas and Phase I Edinburgh, higher severance costs and amortization related to the Piedmont acquisition.

As Jim discussed, we are reaffirming our sales and EPS guidance for 2009.

There have been numerous moving parts since we originally provided guidance, both favorable such as the Piedmont acquisition and disciplined expense management and unfavorable, including the slight movement of foreign exchange, a tax rate at the high end of the range and a reduction in share repurchases.

However, we believe that the net result of these changes, coupled with our first-quarter results, will allow us to achieve sales and earnings within the ranges that we provided in February.

We believe that the first half will be the low point for the year.

Due to a somewhat robust, less robust sales mix than we expected, we now believe that second-quarter sales will move sideways on a sequential basis.

Although we will benefit from a full quarter of cost-savings actions, we expect second-quarter EPS to be flat or slightly lower due primarily to the less robust sales mix and a sequential increase in the tax rate.

Based on our discussions with clients and the stabilization in the market based on bookings and inquiry levels during the first quarter, we do expect some improvement in sales and earnings during the second half of the year, although slightly more moderate than our view in February.

Despite the significant challenges in our markets and the global economy, we continue to focus on managing our costs and executing on our strategy, which we believe will enhance our competitive position and better enable us to partner with our clients when demand improves.

That concludes our remarks.

We will now take your questions.

(Operator Instructions).

Dave Windley, Jefferies & Co.

Hi, good morning.

Thanks for taking the questions.

Jim, you have talked about stabilization of pricing and order levels, which sounds encouraging.

You have mentioned lower than last year.

I guess last year seemed like it had several levels.

Mid-year might have been very high.

By the end of the fourth quarter, things had declined.

I guess I am looking for a little bit more color around what lower than last year means.

Is that lower than the fourth quarter, lower than the average for '08?

And perhaps maybe put a percentage on the pricing stabilization relative -- what kind of discounts are we talking about to get to that equilibrium level?

Thanks.

The lower than last year comment doesn't refer specifically to pricing; it refers to the overall market demand and the activity that we saw.

So what we are saying is that we are seeing inquiry levels and bookings strengthen and stabilize, but we are not yet back to the demand that we saw certainly in Q1 and Q2 of last year, which were quite robust and were sort of a continuation of what we saw in '07.

As you recall, we started to see a slight moderation in all of those factors in the third quarter and accelerate into the fourth.

We actually saw a decline in inquiry levels and also kind of accelerating slippage.

On the pricing issue, there has been sort of a continual price competitiveness scenario amongst the various players.

It has been somewhat commensurate or very much commensurate with capacity and also obviously related to sort of a pullback in demand, which has sort of all conspired to make price more of an issue.

As we have also said, pricing was not something that we participated in.

Price reductions, at least, is not something we participated in very much last year.

We tried and have always tried to sell across our entire portfolio to get the benefit of the value that we can provide across a larger and different portfolio than all of our competitors both geographically and otherwise.

And have typically prevailed in that regard and have tended to be a premium priced player actually in both of our businesses just given the cost and certification of our infrastructure.

We have, I think appropriately, preferably with volume, but not always, we have appropriately moderated our costs commensurate with our needs either to protect share in clients that we were firmly ensconced or to take share in clients where we sort of had a jump ball bid for work.

I think that the sort of positive punchline is that the market has reached a point now where clients are -- we are meeting the clients' expectations for what they think is rational pricing given the demands on their cost structure and given the availability of capacity.

We don't seem to -- we seem to have less conversation about price.

It is always a factor, as I said in my prepared remarks, but never the primary factor.

And we are quite confident that we are not going to see sort of further price pressure either forced on us by our clients or instigated by sort of smaller players in the field.

So if you take the price sort of stabilization with a leveling off of stabilization inquiry rates and slippage, which I actually think was the most profound problem that we experienced last year because you could never get your hands on what you had booked for the upcoming quarter because it would move just as you got there.

So we had some slippage, but it is normal.

We have trivial amounts of cancellations, which are normal and by the way, have never been a major factor for us.

And so we really think we have reached a point where clients are satisfied and pricing, I would hope that over time, would rebound somewhat and I have to put it in quotes because I do think there is a lot of continuing pressure on our clients and I think the merger activity will probably exacerbate that somewhat.

That's very helpful.

Thank you.

On the streamlining front, with Arkansas and Edinburgh, you are clearly making some facility moves there.

Are there other locations in the system during this period of time that gives you this opportunity to address this type of thing?

Are there other moves that you are considering to further streamline toward your bigger centers of excellence in the Preclinical business?

We really like the -- we really like the portfolio right now.

The streamlining that took place last quarter, particularly with regard to Arkansas, I think was essential and probably, from an efficiency point of view and a fragmentation point of view, something that we probably should have done earlier.

And I think these market conditions really allowed us to aggressively not only trim that site, but other small locations, smaller locations and headcount areas where we were inefficient.

I would say that the portfolio right now, the smallest sites have very specific areas of expertise, extremely good margins even in this market and very good capacity utilization even in this market.

And so they all seem to provide a role for us, whether it is reproductive tox or general toxicology on a high-quality basis, but perhaps without some of the bells and whistles we have elsewhere.

And also there is a location or two, which I think are geographically relevant to us.

Having said that, we constantly are obviously looking at the portfolio and have been looking at it closely over the last six or nine months, but I would say that it is a portfolio that we are comfortable with going forward and provides us competitive strength against both larger competitors, as well as smaller sort of niche geographic players.

Okay, great.

Congrats on the cost control and nice job.

Thank you.

Eric Coldwell, Baird.

Thanks very much.

I was hoping that you could possibly quantify the volume decline on the outbred rats?

I don't think we will quantify it specifically, Eric, except to say that it is meaningful.

It is well below the prior year.

The decline is absolutely in tandem with the slowdown in toxicology as anticipated, but it is not like we don't understand the rationale.

It's not like it has anything to do with share or price.

It fundamentally has to do with this is the primary model for toxicology work and we track that quite closely.

So we are totally confident that, as the preclinical demand accelerates and strengthens and sort of invigorates more in the back half of this year and certainly into 2010, that we will see a corresponding increase in demand in sales of outbred rats, which, as we reminded you all previously, is an extremely profitable productline just because of the sheer volume that we produce and the efficiencies that we have developed over decades.

Thanks, Jim.

I'm trying to get -- I guess what I'm trying to get to is whether the volume decline was more or less than what you saw in terms of outsourcing activity so we could get a sense on whether there was higher demand for internal work at pharma and biotech or whether the decline was -- I think you have basically hit on it, was in line with what you saw in terms of the pace of slowdown of outsourcing.

We see absolutely no indications, Eric, at all that work is going in-house, remaining in-house or that -- we know for a fact that nobody is building any in vivo space to take it in-house.

In fact, some of our clients who had made pronouncements that they had sufficiency of internal space and were therefore not going to outsource because their internal space was allegedly free, that sort of non-fully allocated comment that we hear from time to time.

We are seeing a fair number of our clients who have reversed that position through careful analysis and obviously acknowledged the fact that their internal costs were probably quite higher than ours and not as efficient.

So it is really just running in tandem with the overall outsourcing trend and just an overall sort of reduction in that demand, which, as we have said countless times, we absolutely think is transitory, getting sort of an ultimate fix on when we come out of that is a little bit difficult.

Although I think it is getting increasingly clearer as sort of we sort of step through our each quarter here.

Great.

Next line of questioning is around a couple of the acquisitions.

Possibly our own estimations being off, but it looked like both NewLab and MIR may have generated less revenue than we originally anticipated.

And if I have done the math right, it looks like NewLab is running at about a $16 million run rate, whereas we thought originally, 2008, it was supposed to do $20 million to $23 million.

So I guess the question is was there slower performance in NewLab concurrent with what is going on in the market?

Were we overestimating potentially the revenue run rate of NewLab or was there something else that could have left that business at about $4 million in sales, whereas we would have expected $5 million or more in the quarter?

I am not going to comment specifically on the numbers.

Maybe we can follow up with you later or maybe Tom has a numerical quantification of that.

But demand for NewLab has been extremely strong throughout this kind of period of weakness.

Biotech companies have to test their large molecules, particularly post-manufacture and post getting them into patients.

And this was a facility that has extremely high-quality capability and an interesting group of clients across multiple geographic locales and both large and small biotech and pharma.

So we really haven't been disappointed at all.

I would say that MIR, which is, of course, a much smaller operation, has been a bit slower than we had anticipated.

But it is sort of all part of the discovery outsourcing trend.

We actually don't anticipate that that will continue, but the numbers are small enough that I doubt that you are seeing that make any fundamental difference.

Yes, I would agree with Jim, Eric.

I mean we are pretty much in line, as Jim mentioned.

New Labs is obviously a larger acquisition and I would expect the numbers to ramp up during the year.

Initially, we have been impacted somewhat, of course, given an international operation by the foreign exchange that we have had to experience, but other than that, I would say the results are pretty much in line with what we thought.

And next question relates to foreign currency.

Good details on the revenue impact.

Could you give us an update on the EBIT or EPS impact of the dollars move here?

Well, generally, it would flow through at a margin level given where the Canadian dollar has been moving.

We don't really call out the exact impact in EPS, but it would probably be a little bit less than the flow-through as a percentage of margin if you look at the corporate numbers.

Right.

And then finally with Sherbrooke, the typical experience is when you open a large facility, the quarter that it opens may be actually more dilutive than the ramp-up because you will be fully expensing staff and depreciation of the facility equipment, etc.

Would that be the experience here in the second quarter or is the fact that you have got two clients taking all of the space perhaps an offset on some of the potential dilution there?

Well, it wouldn't be that much of an offset in Q2 because, as Jim said, the studies are really just starting up.

Of course, the studies as they start up will start up in a limited number of studies and then ramp up.

So we really wouldn't start to see an offset until Q3 probably.

Okay.

But then would we expect a nice ramp in Q3 or will it really take a couple of quarters to get up to healthy margin in that unit?

I was going to say it will take a couple of quarters, Eric.

Until the rest of the year.

Okay, thanks very much, guys.

At this time, due to the interest of time, we ask that you ask one question and one follow-up question.

And we will go to the line of Douglas Tsao from Barclays Capital.

Hi, good morning.

Obviously, one of your key competitors has made a decision to not really engage in cost-saving initiatives just given their view that the market will come back.

And obviously from your comments, you obviously would agree broadly with that.

I was just wondering if you could provide some comment on how you are approaching your cost-saving initiatives in terms of sort of preserving earnings today, but without having repercussions down the road.

Are you targeting particular staff levels or positions where you feel that you might have been a little heavy or is this broad-based and affecting sort of all levels within the sites that are being targeted?

Obviously, Arkansas is standing out for closure, but away from the cost savings there.

So without commenting on the competition, which, of course, is perhaps apples and oranges, I don't know what cost structure is, headcount levels were and how they have staffed up their particular businesses and of course, we don't have total alignment versus our competitors.

All we can do is comment on what we have done with our business and why we think it is beneficial forward both in the short and the long term.

So we have been extremely focused on using this period of a slower demand to strengthen our infrastructure, to be more efficient, to work on things like a lean Six Sigma and our ERP and to take a look at areas in the Company, which have historically, even during stronger times, been less efficient, facilities that were less well-built or providing services that were perhaps redundant, though not necessarily beneficial.

And we have taken actions that we are quite confident -- I mean they do two things.

They obviously improve the operating efficiency of the business in the short term and that is important given the vagaries of the economy and the limited lack of visibility.

But we would not and have not and will not obviously take any actions that impair our ability to provide the best possible scientific response and quality work now and when the business comes back more aggressively.

So we have spent -- we hired 1500 people over the last two years.

The preponderance of those were in the Preclinical business.

Lots of those people came from big pharma and biotech companies that had workforce reductions or had been involved in mergers.

So we very much improved the scientific quality of our staff and depth of operation and experience levels and we have, in no way, done that.

So most of our workforce reductions and of course, I would never trivialize any of them.

They are obviously impactful to those individuals and somewhat to the sites, but we have done it in a way that I think that everybody understands that it actually has strengthened the business.

And it wasn't done across the board, sort of top to bottom.

The only place that really happened was in Arkansas obviously where we have taken out an entire facility.

And of course, it is still operational and we will continue to perform those studies until they have concluded.

So we think we have actually only strengthened our infrastructure and in no way have impaired our potential to respond to the market going forward.

Okay, great.

Thank you.

And then just thinking about the Piedmont business, which really sort of expands your drug discovery services platform, it is largely focused on oncology.

Do you plan, and I imagine you do plan on expanding your capabilities into other therapeutic categories, do you believe that Piedmont could accomplish this itself or would you be needing to perhaps make an additional acquisition or perhaps sort of try to grow the business organically perhaps at Piedmont or perhaps at some of your other facilities?

Our goal is to expand our therapeutic area coverage and we do have capabilities in other therapeutic areas now -- cardiovascular and inflammatory and metabolic diseases, but not to the extent of oncology.

Oncology is an area that is much more aggressively outsourced and there is a reason for that.

It is very complicated work to do.

It is not trivial and drug companies actually would prefer not to do that internally.

So we have a very large infrastructure now and have imaging capability on top of that.

It is possible and we are in the process of expanding, both from the MIR internal base, as well as the Piedmont internal base, into other therapeutic areas and we will continue to do it that way as long as we can find sort of world-class scientists that can lead the charge there.

A lot of the gear and the methodology is similar, as well as some of the SOPs.

We are also looking for additional acquisitions in other therapeutic areas.

They do exist.

The companies are relatively small, so the -- and that is fine because while it doesn't give you a large revenue pop, what it does give you is expertise.

So we are -- I think it will be a combination of both, but I do think that oncology is both a primary area of focus for an increasing number of drug companies.

There is a lot of money being focused there and obviously the government is putting more money into NCI as well and the complexity of the work is such that it tends to be more readily outsourced.

Okay, great.

I will hop out for now.

John Kreger, William Blair.

Hi, thanks very much.

It sounded from your comments like you are increasingly comfortable that the market has stabilized, but you are a little bit more cautious about the rate at which it will recover through the balance of the year.

If I got that right, can you just provide us with a bit more clarity about why you think that?

I think you mentioned the timing of the pharma consolidation that has been announced, but anything else coloring your thinking?

As to why we think it is going to moderate?

Yes, exactly.

Well, I mean two things.

One is that the second quarter, as we have indicated, is going to go more sideways than improve and that has to do with how long it took the drug companies to finalize their budget and how long it took -- so the inquiry and booking levels have stabilized.

So it just took longer than we had anticipated.

And I think this sort of overarching question, which I am not sure anybody can answer, I mean we have an opinion on it and I think it is an informed opinion, but the overarching issue is what is the impact of multiple megamergers all at once.

So this is totally unprecedented.

We have three large pharmaceutical megamergers and we have three or four smaller, but not small deals with pharma buying biotech and biotech buying biotech and there may be some more.

So we know that that sort of, generally speaking, there will be some disruption in the short term.

It depends on how complementary the productlines are, so it is difficult to predict.

But I think it would be irresponsible to assume that it is going to be business as usual for the balance of the year, notwithstanding the fact that we have major amounts of consolidation in the industry.

The flipside of that is that the industry was inevitably going to consolidate, probably would have taken three to five years longer and it is suddenly probably going to get done over the next year or two or at the longest three.

And the obvious net effect of aggressive and rapid consolidation would be aggressive and rapid outsourcing.

So that would be very beneficial for our business.

So again, and obviously the fourth thing is what is going to happen to the economy generally.

I think we all have our opinions on that, none of which are particularly good.

But that seems a little bit better.

We know what the mergers are.

We know who the players are.

We can all analyze them.

We know which ones appear to be complementary and which ones aren't.

We know, because they have announced them, when we think they will be done and when the integration process should start.

That will take probably a quarter.

So it gives us pretty good visibility when things are to sort of reinitiate.

But, as we said, we think the second half of the year will be better, but for those reasons, not as good as we originally thought.

Great, thanks.

And then just a quick follow-up.

Pricing, same kind of question.

What are you assuming for the balance of the year in pricing?

Any improvement or just similar?

And could you speculate about longer term how long do you think it will take for pricing to get back to a more normal level perhaps that would have been in place let's say a year ago?

I presume you are talking about Preclinical, but I will answer both.

I think we are getting substantial pricing in our Research Model business, about 3% to 4% on a worldwide basis, which is sticking.

We anticipate that will continue to stick just because of the quality of our products and service and what the competitive scenario is.

Certainly there is little, if any, pricing.

There is actually a few pockets where we have increased price in Preclinical, but obviously basically that hasn't happened.

I don't know what normal pricing is going forward.

I think that's a difficult thing to predict.

I think our clients will probably remain somewhat price-sensitive because of their own internal pipeline and patent issues.

Having said that, there is an obvious correlation between available capacity, pipeline acceleration and price.

And so we do think that there is some opportunity for pricing to improve as capacity becomes [bear] and people have to wait longer periods of time.

They don't have to wait now, so they can place studies at the 11th hour.

So I guess our expectation looking forward is that pricing will improve somewhat, but may never get back to historical levels.

So we intend to make up the gap that that will present from a margin preservation point of view by driving greater efficiency to our facilities.

Thanks very much.

Isaac Ro, Leerink Swann.

Thanks very much.

So just first question, on these drug companies that are perhaps not historically active users of outsourced services, can you say whether or not they may have been maybe more opportunistic in approaching you guys given the lower pricing environment and the availability of capacity?

It really doesn't feel that way.

I mean it feels like we are in the midst of a sea change.

The level and depth of the conversations we are having with clients, we're meeting with the most senior people at our customers weekly, all the big drug companies and the big biotech companies many times at their behest, at their request.

And clients are really talking about longer-term, larger strategic relationships.

So I don't think it's let's do some business with these guys now because capacity is available and we can get better pricing and then we will take it back inside at a later date.

So we have some clients who are aggressively outsourcing, some that are accelerating their process and several who have historically made some cultural and strategic pronouncements that they don't really like outsourcing, it's not the way they want to run their business, are sort of suddenly understanding the benefits of it.

I think that has to do with the fact that they recognize, putting pricing aside and all this, they recognize the fact that we are gaining greater depth of experience than they can internally and that our facilities are much more appropriate for the quality of the work that they want to do.

And it really allows them to pull back, do less internally and focus more of their efforts on discovery.

I don't see any rationale for that changing over time, except for the outsourcing rate to accelerate.

Okay, and then just secondly, on RMS, I think you mentioned some marketshare gains in the academic setting.

Is that a function of several maybe key contract wins or are you seeing that across the board?

And could you maybe quantify, secondarily to that, maybe the benefit you think you might see in academic spending relative to the growth rate we are going to see in the NIH budget?

We are seeing an increase in academics for a couple of very simple reasons.

One is I think a lot of academic institutions have historically preferred to work with us, but the pricepoint of our animals has been too high versus the competition.

The competition has been very aggressive with their pricing over the last few years, so the premium is trivial and sometimes nonexistent.

So our own pricepoint, some of the lack of service that our competitors are offering has provided opportunities for share gains.

We have put more direct salespeople in the academic marketplace.

So there is a correlation between visiting principal investigators and getting the work and absolutely -- we are not seeing it yet.

Absolutely, we believe that the additional NIH budget money will filter down, probably as early as the back end of this year, fourth quarter, to university hospitals and obviously government institutions where that entire group is about 16% of our gross revenue across all businesses.

And we certainly expect and intend to drive that percentage higher going forward.

Thanks very much.

Greg Bolan, Wachovia Capital.

Thanks.

I will just keep it at one here.

So with now two late discovery acquisitions under your belt, can you delve a bit deeper into the strategic rationale for entering the subsegment?

I mean clearly there are very short duration studies that have typically been viewed as core in-house work, but the writing on the wall really suggests a fundamental change and sponsors willingness to outsource these studies.

So I guess my second question is relative to the GLP tox market, how big do you believe this market is?

So we think it is an extremely strategically important move for us and that the drug companies are looking at it the same way they are looking at preclinical tox, but haven't really considered the possibility on a widescale basis of outsourcing because there is no one to outsource it to, unlike the tox guys.

So as we build expertise with some mass and some real scientific credibility and proximity, I think it is causing them to pause and think about that.

It is exactly the same notion.

There is no reason why -- look, the drug companies need to do the basic core discovery, but any of the work -- whether it is GLP or non-GLP, long term or short term, it is animal-related -- can and obviously, in our opinion, ought to be outsourced, particularly to companies like us who are developing this expertise.

So we are focusing on it seriously on an international basis across multiple therapeutic areas.

We reckon that the market is probably $4 billion to $5 billion.

That is the total market, so to compare that to the tox market, the total tox market is probably $12-ish billion plus.

The tox market, you have about $3.5 billion outsourced and in this market, you maybe have $400 million or $500 million that could theoretically be outsourced.

Probably the small animal side, probably $300 million to $400 million right now.

So given how small the business is for us at the moment, if the market sort of just stayed as it is, it's a great market growth opportunity.

As we really start to invest and develop a reputation for this, I think the drug companies will get comfortable.

And as they start to modify their infrastructures, this will be another area that they will look to outsource.

Thanks, Jim.

Tycho Peterson, JPMorgan.

Good morning.

Jim, on your comments before on stimulus, I am just wondering are you anticipating getting dedicated agreements like you had with NCI or how are you trying to position yourself and are you seeing a pickup in kind of grant volume?

I mean do you have a leading indicator here?

I know you said you haven't really seen the demand pick up yet.

We haven't seen that -- we haven't seen it yet.

We have a very big footprint with NCI and NIH and many of the other government agencies.

So since we tend to have the preponderance of the work, we would expect to see more RFPs, which have been very slow over the last year or two and we would obviously expect to win a large number of those, but it is too early to comment on that.

It is not -- we are not looking at it from the point of view of applying directly to the clients.

We are looking at it from the point of view of our not-for-profit client base aggressively applying for funds, not just at the government level, but the university level where we do quite well and the teaching hospitals, which are working closely with them.

So hard to believe that we won't see -- and of course, people are rushing to submit bids right now.

Hard to believe that we won't see some evidence of this in the back half of this year and the opportunity to add some wins as well.

Okay.

As the nature of your discussions with pharma have become a little bit more strategic, can you comment on maybe other emerging opportunities?

I think there has been some discussion about going in and maybe running pharma facilities.

Are there opportunities that you hadn't envisioned a couple of quarters ago as you get more strategic with some of these combined pharma companies?

I want to keep it general because there are some new areas that we are considering really based upon requests from our clients who have said we would really like it if you would provide this type of service or we would really like it if you would look at this acquisition or we would really like it if you could take this off of our hands.

So that is really the way obviously we want to build our portfolio.

A lot of the conversations right now are primarily about scale, about deals across our entire productline.

We have had some conversations that are new, for instance, like going in and managing tox facilities for clients, which is something that we haven't seen historically.

There is more of a confidence level in allowing us to take on these capabilities, but as you look across the discovery and development pipeline, of course, in our case, it is through Phase I, we are open to considering forays into many of the areas that we are not in, but only to the extent that clients really are interested in outsourcing them.

So we are beginning to make some initial inquiries from an acquisition point of view, but also we have one conversation going on right now with a client who is talking to us about offloading something that they do, asked whether we would be interested in providing that service for them on an asset transfer basis.

So I think the sort of watchword or bottom line here is that you need total flexibility in dealing with your clients.

One size absolutely doesn't fit all and we have to listen carefully to individual client needs and respond accordingly.

And maybe just since you have mentioned the asset transfer, I mean are you envisioning a lot more capacity being transferred from pharma to CROs and with that in mind, can you also talk a little bit about how much excess capacity you think there is right now in Preclinical?

Well, I mean I am not going to quantify it, but certainly our capacity is not fully utilized and I can guarantee you it is not either at our competitors.

So we have a moment in time where a fair amount of capacity has been built out and is beginning to be utilized, but it will probably take, in my opinion, through the rest of next year to really robustly fill that up, which is fine.

And by the way, we are happy to have built out the space, have it done in the right geographic proximity at the right scale and sophistication.

I think that will work well for us.

I think certainly a couple of the big mergers that are underway right now we would expect that there would be some asset transfer.

I don't even want to say opportunities because that assumes that we know that they would be beneficial to us.

There will be opportunities for conversations for sure and the only way that we would be interested, since we are not in the real estate business, is if we really could help that particular client or have the ability to use the facility for multiple clients, that it would scale properly from a cost point of view and that the selling entity are guaranteed a certain level of business for us so that it was a sound financial arrangement for us.

So we, for sure, will look at all of them carefully.

I think it is an opportunity to forge potentially close relationships with your clients, but obviously we will only proceed if it makes sound economic sense for us.

Okay.

And then just one last one, can you comment on your outlook for the instrument business for Endosafe and how you think about those trends?

Yes, we are seeing continued strong demand for that franchise, as we have said, in the mid-teens level.

We are continuing good margins.

I would say there is probably some modest sensitivity on the part of our clients because, while it is a small capital item, it is still a capital item, so there are sign-offs required for our handheld unit and in our larger unit, the NCS unit, with a slightly higher pricepoint, there is probably a little bit of a pause.

So we had high teens growth rates last year.

Actually we broke 20%.

I don't want to give a number, but I think the mid-teens number that we saw in the first quarter wasn't surprising, but we should still see very strong growth and profitability from that franchise this year.

Great.

Thank you very much.

Due to the interest of time, we only have time for one more question.

Sandy Draper, Raymond James.

Thank you very much.

Most of the bigger picture questions have been asked and answered, so I appreciate that.

Just maybe a question on the guidance for the second quarter, looking at the flat sequential revenue.

Is there any color you want to give looking at the different segments whether RMS may pick up, PCS may decline a little bit, if things have stabilized, is there a chance PCS could be up, but then offset by a little weakness in RMS?

Just trying to understand if there is any variation between the segments or if overall, you are just seeing flat for both segments?

Thanks.

Sandy, hi.

This is Tom.

We are actually -- both segments at this point should really move in tandem.

We are obviously being somewhat cautious about the outlook.

As Jim said, we have seen lots of things stabilize.

In some respects, inquiries have picked up.

So both of them will kind of move in tandem.

It is always possible that we could be up slightly, but we are not really projecting that.

And we are having a little bit more cautious view of at least the first half at this point based on everything that we have seen.

Great.

Thank you very much.

You are welcome.

That's it unless you are going to take another question.

Do you have any closing comments?

Yes, thank you.

We are out of time for today and I apologize if we didn't get to your questions.

We will follow up with you later today.

Thank you all for joining us this morning and this concludes the conference call.

Thank you.

Ladies and gentlemen, that concludes the conference for today.

Thank you for your participation and for using AT&T executive teleconference.

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