Charles River Laboratories International Inc (CRL) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Charles River's second-quarter 2009 earnings call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session with instructions being 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, Ms. Susan Hardy, Vice President, Investor Relations. Please go ahead.

Thank you. Good morning and welcome to Charles River Laboratories' 2009 second-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 second-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 320-365-3844. The access code in either case is 106309. The replay will be available through August 19. You may also access an archived version of the webcast on our Investor Relations website.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 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 would like to begin by reviewing the second-quarter results. We reported sales of $308.2 million in the second quarter of '09, a decline of 12.5% over the second quarter of '08. Foreign exchange accounted for 5.1% of the decline. Excluding the effect of foreign exchange, constant dollar sales decline was 7.4% with the RMS segment reporting flat sales year-over-year and the PCS segment declining to 15%.

Clearly, our top line continues to be impacted by our clients' restructuring and pipeline reprioritization, lack of funding for biotech companies, and the effect of pharma industry consolidation. In our business planning we are taking steps to drive our future growth and to improve our cost structure, profitability, and balance sheet. That said, the stabilization which we noted in May has continued with pricing inquiries and bookings remaining at similar levels throughout the first half of '09.

Operating income for the quarter was $61.3 million and the operating margin was 19.9% compared to $76.5 million and 21.7% reported in the second quarter of '08, but an increase of 110 basis points from the first quarter of '09 as the benefit of cost savings actions we implemented in the first and second quarters and continued cost control improved our profitability. I will speak more about those actions in a moment.

Earnings per diluted share were $0.66 in the second quarter compared with $0.79 in the second quarter of last year and $0.58 per share in the first quarter of this year. We expect second-quarter EPS to be the strongest in '09 due to normal RMS seasonality in the second half and the fact that the benefits of cost savings actions were greatest in the second quarter.

As we discussed on both our February and May conference calls, we are using this point of softer market demand to streamline our internal operations and to align our business portfolio more closely with the needs of our clients. We are doing so through four distinct paths.

First, by strengthening our relationships with existing and potential clients. Second, by restructuring and realignments of our business operations and sales organizations. Third, through cost control, Six Sigma, and other efficiency initiatives. And fourth, the acquisition of strategic assets and other alliances which enable us to enhance our ability to support our clients' drug development efforts. We are committed to each of these areas and are enthusiastic about the benefits and opportunities they bring.

With regard to our cost-saving initiative, we have already told you about the first-quarter actions which included a headcount reduction of approximately 3% of our workforce, salary and hiring freezes, and tight control of expenses. These actions were followed in the second quarter by a reduction in targeted incentive compensation and other benefits as well as a small number of additional headcount reductions. In total we expect the cost-saving initiatives to result in savings in '09 of approximately $25 million with an annual rate of $30 million beginning in 2010.

We expect to bolster these savings through our Six Sigma program and other efficiency initiatives, but these process reengineering efforts are not simply about cost savings. The purpose of these initiatives is two-fold -- to elevate our client service and responsiveness to best-in-class status and to operate at peak efficiency so that we can best support their drug development efforts providing scientific expertise and experience at a reasonable cost.

At the beginning of the third quarter we made fundamental changes in the way we do business, including the RMS succession plan, reorganization of the PCS business, and realignment of the sales organization. We believe these changes will drive our ability to gain market share and are already hearing positive feedback from clients. It's clear to us that we must continue to change and evolve, to anticipate, respond to, and ultimately exceed our clients' expectations. Everything we do is client-focused and intended to support their internal needs as they streamline their business models.

I would like to review those changes with you now. Real Renaud, Corporate Executive Vice President and President of Global Research Models and Services, has announced his intention to retire by the end of 2010. Real has had a stellar career at Charles River beginning 45 years ago and rising through the ranks to head our global RMS business. Under his leadership we have become the premier provider of research models and scientific support services to the drug development industry, recognized worldwide for our quality, biosecurity, and scientific expertise.

Real has developed a world-class management team including his successor, Dr. Davide Molho, which positions us extremely well to maintain our market leadership. As a first step in the transition of Real's responsibilities Davide is assuming responsibility for North American RMS in addition to his current leadership of the European RMS business. Davide will be relocating to our Wilmington headquarters by the end of the summer where he will work side by side with Real and his senior management team as he transitions his responsibilities.

In addition to the RMS succession we also announced a restructuring of the PCS business and the realignment of the global sales organization. The PCS organizational changes enhance our ability to provide clients with a centralized, integrated global approach to their drug development programs across all businesses. They also enable us to manage our global operations more centrally so that we can make strategic decisions that drive business efficiencies and lower costs.

Through the restructure of the PCS business, which has already been implemented, we have created a dual accountability structure with both global functional teams and site-level management the purpose of which is to standardize all services across the PCS organization. By doing so we will enable the seamless and consistent delivery of services to our clients worldwide.

This is particularly important to our clients who are using multiple sites and want standard protocols and reports no matter where they place studies in the Charles River system. This standardization will become increasingly critical as more clients expand their use of our global footprint.

The realignment of the Sales organization is a key structural element in our ability to enhance service to our client base and drive market share gain. The goal of the realignment is to ensure that clients have access to the full breadth of our portfolio and that they do so through a central point of contact. We are defining an account management strategy for each client and supporting the account managers with functional specialists who can provide necessary scientific expertise.

With knowledge of the entire structure of our portfolio and a deep relationship with the client, the account managers will be in a position to identify clients' needs and fully leverage the Charles River resources necessary to address those needs. In addition to streamlining the sales process for our clients, this is enabling us to migrate from a sales approach which focuses on selling products and services to one focused on providing value-based solutions tailored for individuals and especially for global clients.

We are particularly optimistic about the effect of these changes on the academic and government markets. We are expanding sales coverage of these clients in order to better support the sector which is benefiting from stimulus funding through the American Recovery and Reinvestment Act.

Communication with clients is a critical area of focus for us. At this time when our largest existing and potential clients are reinventing themselves we believe there is a significant opportunity to forge stronger relationships with the key decision makers. For the last three quarters and accelerating recently we have had extensive discussions with senior management of large pharma and biotech companies, including CEOs and CFOs, heads of research and development, and senior strategic outsourcing executives.

We are hearing a consistent message from them that they are increasingly identifying areas of expertise that is non-core and want broader and more innovative strategic relationships with contract research organizations like Charles River who can provide support across a larger portion of the drug development process. Through these discussions we are exploring a myriad of partnership arrangements from preferred provider and dedicated resource agreement to asset transfers. Everything is in play and there is no one-size-fits-all answer.

Our new preclinical facility in Sherbrooke, which we built to support two of our largest global pharma clients, is an example of our flexibility in accommodating client requirements. The facility was built to provide dedicated resources for these two significant clients, both of which initiated their first GLP studies at the site in the second quarter. As we continue our high-level discussions we believe that other agreements will follow as pharmaceutical companies move through this restructuring period and decline to invest in in vivo related bricks and mortar and continue to rationalize in-house expertise.

Our fourth area of focus is the expansion of our portfolio. Throughout our history we have driven our growth through a combination of internal development and strategic bolt-on acquisitions choosing to pursue those areas which would offer broader support to our clients and profitable growth for Charles River. While our clients undergo this period of significant change, we believe it's our task to respond to what they will need tomorrow and build it for them today. Toward that end we are continuing to expand our portfolio through strategic acquisitions and alliances which augment existing capabilities or add new ones.

One example is our growing Discovery and Imaging Services business. Our discussions with senior management of large biopharma companies indicate that many of them are open to outsourcing in vivo discovery services which we believe provides meaningful opportunity for growth. In less than a year through the acquisitions of MIR and Piedmont we have established ourselves as one of the largest providers of in vivo discovery and imaging services for oncology, which is one of the largest therapeutic areas of research.

As pharma companies have rationalized their pipelines they are also increasing their focus on CNS, which is why we have acquired Finland-based Cerebricon, a leader in CNS discovery support augmented by in vivo imaging capabilities. With Cerebricon our therapeutic areas of expertise now include oncology, CNS, cardiovascular, metabolism, and inflammation, which represents five of the largest areas of biopharmaceutical research and development.

We have also agreed to acquire Systems Pathology Company, a pathology software company developing the Computer Assisted Pathology System or CAPS(tm). The CAPS(tm) software is the unique use of analytical smart imaging software technology designed to increase efficiency by facilitating the pathology decision-making process. It does so by fully automating certain labor-intensive processes, in particular the screening of tissue samples to separate normal and non-normal specimens. By doing so the software frees up pathologists to focus more of their time on high-value interpretation of data.

With fully-automated objective software tools the same number of pathologists will be able to evaluate a greater number of tissue, thereby speeding the reporting process. This novel software maximizes the use of expert pathology resources and improves predictive toxicology aligning precisely with our goal to help accelerate drug development.

A limited number of large global pharmaceutical clients are participating in the product development phase, which we believe provides important scientific input to the validation process. We believe CAPS(tm) is a highly-innovative technology which we can use to increase our internal efficiency and reinforce our position as a market leader in toxicologic pathology. We also intend to license CAPS(tm) to our clients who want to use the software internally to improve their efficiency and throughput.

In a third new relationship we have entered into a partnership with MPM Capital, a leading life sciences venture capital firm. This innovative initiative is targeted at advancing underfunded compounds with therapeutic promise to proof of concept as quickly and efficiently as possible.

MPM will focus on identifying and acquiring compounds with significant potential for investment from biopharmaceutical companies and we will have exclusive rights to provide contract research services for discovery, preclinical, and first-in-human testing services to advance those compounds through the milestones necessary for an IND filing.

MPM's innovative initiative provides biopharmaceutical companies with an avenue to develop therapeutic compounds deploying a virtual infrastructure backed by Charles River's extensive discovery and preclinical services capabilities, thereby accelerating the drug development process in a cost-efficient manner. Where appropriate MPM has agreed to champion Charles Rivers' capabilities to its current portfolio of companies for their preclinical work.

When viewed from a strategic perspective we believe these acquisitions and partnership differentiate Charles River from the competition by enabling us to expand our ability to provide innovative services and flexible arrangements tailored to each client's unique needs.

Currently -- certainly current demand for GLP safety assessment is affected by the challenges confronting our clients and exacerbated by the availability of contract preclinical preclinical capacity which enables clients to postpone placement of studies and aggressively negotiate pricing.

Our view of this market suggests that the softness in demand is likely to persist at least through the end of '09 and likely until the second quarter of 2010 after the announced pharma mergers have closed and the integrations are completed when we believe biotech funding will improve and there will be more clarity to the Obama administration's healthcare plan.

It's for this reason that we have adjusted our '09 guidance to reflect sales of 7% to 9% below last year with sales in the second half in line with or slightly higher than the first half. We will continue to tightly control our costs, which is why we believe our earnings per share will be within our previous guidance range. We expect to be between $2.33 (sic -- see slides) and $2.47 for '09 and also expect to generate free cash flow of $130 million to $150 million.

There is no doubt that we are dealing with one of the most challenging business environments we have seen in quite some time. However, we also recognize that this is a time filled with enormous opportunities for our long-term growth. Large biopharma is increasing identifying services which they view as non-core, many of which leverage our core capabilities in veterinary medicine, in science, and regulatory-compliant preclinical services. With the acquisitions and partnership announced today our portfolio of essential products and services has never been stronger or more relevant or better positioned to support our clients' needs.

We have responded to the challenges and opportunities in many ways; certainly for the reorganization of our PCS operation, the realignment of our sales organization, and the acquisitions and partnership. All these efforts make us more responsive to the changing needs of our biopharma clients as they too work through their own restructuring and consolidation.

We expect to continue to make strategic bolt-on acquisitions, such as Cerebricon, to invest in highly innovative technologies like CAPS(tm) and to participate in innovative partnerships, like the one with MPM, which are mutually beneficial. We believe these investments are an effective use of our human and capital resources from which we expect to generate a very good return. And by building our portfolio to support our clients' emerging needs we are enhancing our ability to provide a single unified solution for the drug development efforts at a time when they require our assistance as never before.

The power of our portfolio continues to be its ability to support our 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 products and services. 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, and good 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 charges related to cost savings actions and other items. I will begin by discussing each segment's performance.

Sales for RMS segment declined 4.1% in the second quarter to $165.7 million. On an organic basis excluding FX RMS sales declined 0.6% year-over-year but were flat sequentially. Sales of outbred rats, the model of choice for toxicology studies, have stabilized at lower levels consistent with trends in the preclinical market.

Immuno efficient models were also stable in the second quarter. We continue to see sales to academic and government clients increase in the second quarter and expect this trend to continue as government funding deployed to researchers should benefit RMS sales beginning toward the end of this year.

Excluding consulting and staffing services, sales of our Research Model Services business has declined slightly on an organic basis reflecting cautious client spending on outsourced services. Sales for the CSS business were significantly lower due to the expiration this year of two large government contracts.

The RMS operating margin improved 100 basis points to 31.9% compared to 30.9% in the second quarter of 2008 as cost savings actions offset lower sales volume in the quarter. Lower operating expenses in Japan also contributed to the improvement as we reported an asset write-off in the second quarter of last year.

PCS segment reported sales of $142.5 million in the second quarter, a decline of 20.5% on a reported basis and 17.1% on an organic basis from the second quarter of 2008. On a sequential basis the organic sales decline was just 0.6% as demand remained stable.

PCS operating margin declined to 17.2% compared to 21.2% last year, primarily due to lower capacity utilization. However, the PCS operating margin improved 170 basis points from 15.5% in the first quarter reflecting our continued focus on cost-savings initiatives and expense management. Overall, we reported a sequential improvement in sales and EPS compared to the first quarter.

On our first-quarter call in May we guided for second quarter sales to move sideways sequentially and for EPS to be flat to slightly lower than the $0.58 that we reported in the first quarter. We are pleased to report that our second-quarter results were ahead of these expectations. Sales increased 2.2% sequentially with approximately 1.6% of the improvement related to favorable movements in foreign exchange and 0.8% related to the Piedmont acquisition. This equates to roughly flat organic sales growth versus the first quarter, in line with our expectations and our belief that the market has stabilized.

Second quarter operating margin increased by 110 basis points sequentially due in large part to cost savings actions we implemented in the first quarter and supplemented in the second quarter. Our continuing control of expenses was the primary driver of the 14% increase in EPS to $0.66, well above our prior expectations.

The drivers behind the EPS improvement from $0.58 in the first quarter to $0.66 in Q2 were as follows -- cost-savings actions and other operational benefits contributed approximately $0.04 to the increase, other income related to investment gains associated with our deferred compensation plan added approximately $0.02, and the remaining $0.02 of improvement over the first quarter was driven by the cumulative benefit of fewer shares outstanding, a lower tax rate, the Piedmont acquisition which closed on May 1, and foreign exchange.

I will now discuss these items in more detail. Cost savings were the most significant contributor behind the sequential improvement in EPS. We benefited from a full quarter of the February actions and also implemented additional actions during the second quarter as we continue to make the necessary decisions to appropriately reduce our costs. In the second quarter we selectively reduced headcounts with the underlying goal to maintain staffing levels moderately above the current demand.

It remains difficult to forecast exactly when preclinical demand will begin to rebound, but we must maintain the ability to respond to our clients' needs quickly both now and in the future.

We also reduced the targeted payout levels of our performance-based compensation for this year and rolled back the company-matching contribution on our 401(k) plan. As a result, we now expect to generate additional cost savings of $5 million in 2009 beyond our original goal of $20 million for a total of $25 million this year and an annualized run rate of $30 million beginning in 2010.

We incurred a severance charge of $1.7 million in the second quarter related to the headcount reduction, which was excluded from non-GAAP results. Foreign exchange rates turned favorable in mid-May and generated a 1.6% sequential benefit to sales growth in the second quarter. However, there was only a nominal sequential benefit to EPS over the first quarter as the top-line FX impact typically falls through to operating income at less than the margin rate due to our exposure to the Canadian dollar.

On a year-over-year basis FX continued to negatively impact sales and EPS. We expected to anniversary last year's strengthening of the US dollar during the second half of 2009 and at current rates the FX impact would turn favorable in the fourth quarter.

Unallocated corporate costs remain relatively flat on a sequential basis and the year-over-year increase was primary driven by higher healthcare costs. With unallocated corporate costs running at approximately 5.3% of sales year-to-date through June, we now expect these costs to be approximately 5% of sales for the year, slightly above our previous estimate.

Second-quarter net interest expense of $2.3 million was in line with expectations, flat with the first quarter driven by relatively stable interest rates and debt levels. Other income rose to $1.6 million or $1.8 million more favorable than the first quarter. As I mentioned earlier, this was a result of investment gains associated with our deferred compensation plan. Since gains/losses on these investments are correlated with market returns and are unpredictable, we generally do not forecast an amount for other income.

The non-GAAP tax rate was 29.6% in the second quarter, an improvement of 80 basis points versus the first quarter due to the FX impact on the R&D tax credits in Canada and the geographic mix of earnings. For the year we expect the non-GAAP tax rate to be within the range of 29.5% to 30.5%.

Our liquidity position and balance sheet remains strong and very stable. Cash and equivalents, including short and long-term marketable securities, were $225 million as of June 27 consistent with March, down from $263 million at the end of 2008. Second-quarter accounts receivable remained stable at $210 million while DSO was slightly less favorable at 41 days versus 39 days at the end of March and 40 days at the end of 2008. DSO will still remain well within our targeted range.

In May we suspended our 10b5-1 plan and stopped repurchasing shares in order to maintain our target liquidity levels following the Piedmont acquisition. Prior to suspending the 10b5-1 we repurchased approximately 500,000 shares during the second quarter for $14 million or approximately $28 per share. We currently have $145 million outstanding on our current repurchase authorization and we will continue to evaluate the best use of our cash and free cash flow.

As Jim discussed, we have been deploying capital for strategic bolt-on acquisitions such as the two we announced last night. As always we look to use our cash and access to capital in ways that will drive shareholder value for both short and long term. During the second quarter we drew down $18 million on our revolver for a total of $108 million outstanding at the end of the quarter.

Because interest rates were low, we drew on the revolver to fund a portion of the Piedmont acquisition and maintain our liquidity in the US. We are mindful that our capital allocation discipline and birding use of resources is the cornerstone to maintaining our strong financial position.

In July we received notice that approximately $3.7 million of our auction rate securities would be retained at par value. Following this redemption we will continue to hold auction rate securities valued at approximately $16 million.

Free cash flow increased nicely to $50 million in the second quarter compared to $31 million in the second quarter of last year. This was driven by a $45 million decline in capital expenditures to $20 million in the second quarter. Year-to-date we generated $62 million of free cash flow and we currently expect $130 million to $150 million for the year.

Capital expenditures were $45 million in the first half and we reduced the target range to $100 million to $110 million for the year as many of our larger capital projects have concluded with the exception of the ERP initiative. The ERP project continues to progress well. We have completed cycle two of integration testing with no major issues and have begun cycle three testing. We remain on track to go live with ERP at our US sites at the beginning of next year.

As Jim discussed, we are updating our sales and EPS guidance for 2009. We are lowering our sales guidance to down 7% to 9% on a reported basis including a 3% to 3.5% drag from FX for the year and a 1% to 1.5% benefit from the net effect of acquisitions and divestitures. We now forecast stable to slightly higher preclinical sales for the remainder of the year compared to the more meaningful second-half improvement that we previously expected.

In addition, we are narrowing our non-GAAP EPS guidance to $2.35 to $2.47. Though we are slightly less optimistic about second-half sales, our cost-savings actions and continued capital expense management give us the confidence to narrow our EPS guidance to a range from the low end to the middle of our previous range. This guidance includes the Cerebricon and SPC acquisitions, which are expected to be neutral to $0.02 dilutive for 2009 EPS, respectively.

As we move into the second half of the year, we expect sales to be flat to slightly higher than first-half levels. Third and fourth quarter RMS sales should be flat to slightly lower on a sequential basis as a result of normal seasonality, particularly at year-end. We expect BCS sales to remain relatively stable in the third quarter and to be flat to slightly higher in the fourth quarter.

Key performance indicators have stabilized in the first half of the year, but we have not yet begun to see a sustained improvement. Based on these trends coupled with a slight sequential pickup from FX, we expect third-quarter sales to approximate second-quarter levels.

Third and fourth quarter EPS is expected to be below second-quarter levels, primarily due to the following factors -- two second-quarter items that are not expected to benefit the third or fourth quarters including the $0.02 adjustment related to the reduction in incentive compensation for 2009 and the $0.02 investment gain associated with the deferred compensation plan; slight decline in RMS margins due to seasonality, which has a greater impact on fourth-quarter margins; and $0.02 of dilution from the SPC acquisitions. These headwinds are expected to be partially offset by the incremental benefit from cost savings actions.

We are pleased with the outcome of our efforts to manage the business through the challenges during the first half of the year. We will continue to focus on management of our cost structure as well as further strengthening of our internal organization and operating efficiency.

That concludes our comments. Operator, would you please take the questions now?

(Operator Instructions) Greg Bolan.

Thanks for taking the question. On RMS, Tom, I know you touched on this but from what we have heard it sounds like grant monies from NIH will be awarded starting sometime in late October. Is this a source of strength that you have considered in revised guidance? And if so, would it be possible for you to quantify the potential benefit to RMS constant currency sales growth from these stimulus monies?

Well, I will comment briefly, I guess, on the guidance and Jim can probably give you a little bit more color on what we have heard and seen so far on the stimulus. We don't really expect to see any tangible benefits until the fourth quarter; that is our expectation when they will start to actually release some of these grants. And so as a result of that, Greg, we are not really affecting in our guidance anything significant in the way of increased stimulus activity.

And, of course, as you already know we have been reporting that our activity in academic and governmental sales and research models have actually been pretty strong year-to-date. Jim, do you want to provide any more color on the stimulus itself?

Just that our academic sales have been strong. We are reallocating additional sales efforts to continue to drive that. To the extent to which stimulus monies are available I think we will be able to access it more effectively going forward than historically because of the range of sales people. And as Tom said, we would expect to see some discernible benefit in the fourth quarter; that is consistent with what we said previously.

If I could just step -- since that was quickly if I could just slip just one more in if you will. Tom, as I go through and plug some of the noted assumptions for the back half of '09 it seems to me that earnings guidance appears fairly conservative just based on looking at the first half of '09 experiencing the upside you have put up. Can you talk about variables in the guidance where you could see positive or negative surprise?

Well, I will comment a little bit quantitatively and I guess if Jim wants to add on qualitatively. We started off the year with a fairly wide range given the lack of visibility and volatility in the market. If you look at our guidance for the year, in Q2 we talked about a couple of items in Q2 that we really don't expect to recur. And if you look at the sales range and correlate that to the EPS range, we are in a mode where pretty much moving sideways we believe.

We could uptick a little bit during the rest of the year, which we are actually hopeful for, obviously, as are many people in the industry. And I think depending on where we end up in sales would be really where we would end up in the EPS guidance as well. So I think we continue to be cautious because of the lack of visibility at this point. As we said, we really haven't seen any kind of a real pickup or sustained level of activity at this point in time, so the best we can discern things continue to move sideways.

Greg, I think we believe that our guidance is reflective of how we think the business is going to perform for the balance of the year. We continue to be concerned about the disruption from the mergers, biotech companies having lack of access to capital even though it has freed up a little bit, and the sort of pall that hangs over the industry from the Obama administration.

Having said that, the only thing that could change the numbers going forward is to see a discernible pickup in demand for our toxicology business, which would obviously help both of our segments. We would see an increase in [CD rat] sales pretty much simultaneously with that and we would obviously begin to utilize our capacity better in the preclinical business.

While that is possible, that is not the way we see it and that is not the way we are calling it. We do think the fourth quarter will be somewhat disruptive, integration will be just starting with one of the deals and sort of midway through for one of the other large deals closing. We think it will probably take through the first quarter for that to settle down. And as we have been saying, we anticipate some discernible benefits in the second quarter of 2010.

To the extent that we have called that too conservatively, which we don't think we have, I suppose that provides some upside. But we stand behind our guidance.

That is fair. Thanks so much.

Dave Windley, Jefferies & Co.

On the, I guess what you are calling late discovery services area where we are seeing this interest in outsourcing studies in in vivo work, but in I guess non-GLP settings, I wondered, Jim, if you could help us to understand maybe what the full menu of those things could be or perhaps what you have in place today. And then in discussing that could you talk about your decision to organizationally put these services in RMS as opposed to PCS?

Is that important as you are realizing the businesses any way, but does that matter competitively? And regardless of the answer to that, why did you decide to put these in RMS versus PCS? So kind of two-part question.

Okay. So the Discovery Business, as we are calling it, probably more aptly termed drug efficacy testing, is an important intersection between our clients having a lead compound and their desire to get it into animals and ascertain efficacy quickly. I think as every one knows that it's essentially being done internally by all of the drug companies. They have always felt the need to do it internally because nobody was offering the service externally and it was sort of their way to get a punch line on whether they could go forward with the drug in the regulated trials. So it's something that they have held close to the vest as it were.

We think that once a lead compound has been developed that all of the animal-related work should go externally. We think our capabilities and focus in this area are vastly wider and in more depth than many of our clients. And so we have taken it upon ourselves to make three very strategic acquisitions in less than a year focusing on oncology first and CNS second. We already have some capability, as we said earlier, in cardiovascular work, inflammatory medicine, and metabolism given our diabetic models.

Our goal is that the drug companies will rely on our myriad animal models and capabilities of testing these models to outsource that work to us after we have refined our capabilities. And like our tox work where we are able to, for instance, in our oncology area not only have we refined our capabilities but we can spread that work across multiple clients. So I can just tell you that the conversations that we have had with clients they are quite open to outsourcing.

I can also tell you that if you looked at the client base of the three companies that we have acquired, while there is obviously a lot of biotech, there is an extraordinary amount of large pharma and large first-tier biotech, particularly in the oncology area, who is outsourced a lot. So we think it's a big market and it's modestly outsourced at the current time.

In terms of where we put it, now we don't think it makes any difference in terms of providing the service to the client or even reporting it frankly. We decided to put it there because it's so animal-based; it's non-regulated.

It is at the intersection so we could have gone either way and we discussed that quite deeply. At the moment it's so closely related to our animal models, both the ones that we have and ones we think we may acquire and license in, that we thought the nexus was tighter and more logical with our RMS business.

Okay, great. Thank you.

Douglas Tsao, Barclays Capital.

Good morning. Just a question about the Sherbrooke facility that opened in May. Jim, you had previously said that you expected to have dedicated capacity agreements in place with those two clients. Obviously, it sounds like they have begun running studies there. Are they operating on a study-by-study basis or are there certain contracts in place with specified minimums of work, minimum levels of work?

So these are, I would say, our two largest clients in Montreal; one actually works under a dedicated arrangement now. We are transferring much, if not most, of the work to this new facility. They will take all of the capacity of the new facility so they have begun to work there now. I am not really sure what to call them. We have large contractual arrangements with them. I don't think we are yet at minimums except that with one of them we already had a minimum deal in place; we have essentially just sort of transferred that.

I think in time these agreements will tighten up. It doesn't really matter to us in terms of how the client wants to work as long as they continue to take the capacity, whether it's a long-term dedicated deal with minimums or they just continue to give us large amounts of works under a PO. All I can say is it's evolving and it's actually evolving pretty much exactly at the rate at which we had anticipated when we built this space.

The only reason that revenues were delayed somewhat, as you recall, is we had some construction delays, but these clients have been patiently waiting. Work is filling up as quickly as we can accommodate it.

Okay, great. Then one housekeeping question for Tom. What do you expect to see from the unallocated corporate line for the remainder of the year? The levels we have seen -- last year we certainly saw much higher levels in the first half of the year than the second half of the year. Do you expect to see the same sequential decrease or are there some of the cost savings that you saw benefit in 2Q -- are they going to roll out or roll off in the third and fourth quarters so we should see sort of a continuation of the levels we have seen?

I don't think we should see anything significantly different, Doug. I think we said that our year-to-date with about 5.3% of sales and we said it would be approximately 5% for the years. So that obviously suggests it will be pretty consistent. We did get a couple of pickups in there in the second quarter, both the cost savings but also from non-recurring as it relates, for instance, to our targeted incentive performance payout. So it could be a little bit lower, but I wouldn't necessarily think it would be dramatically lower.

Okay, great. Thank you very much.

Tycho Peterson, JPMorgan.

A question on, I guess, the deals. I am wondering if you can give us a little bit more color for the two acquisitions on customer mix and any integration plans here. Does systems pathology stay as a stand alone or do you combine that with the digital pathology business in Montreal?

Then as a kind of follow-up, with MPM is there any minimum requirement here in terms of what they are willing to give you guys in terms of deal flow?

On the MPM deal, they have committed a certain amount of resources from a specific fund of theirs and they are also going to syndicate the deals with other VC firms. So, yes, we have a general indication as to how much will be dedicated to this deal, which I don't think it's appropriate to disclose at this time, but it will be a significant amount of money.

We have had a fair amount of clients requesting that we find a way to work with them in a manner like this to find funding for these molecules that don't quite make the cut. So this sort of triumvirate of MPM putting up the money and also evaluating the compounds, which they are quite able to do, and Charles River doing the work is something that we are really enthused about.

The Cerebricon deal, all three of the discovery and imaging services businesses will be managed collectively. Obviously, there is a fair amount of overlap in the oncology activity so that will be more tightly managed together. But it will depend on the therapeutic demands of our clients, how we utilize those assets, but we'll share technologies and protocols amongst them. We'll share imaging capabilities amongst them, and we will be expanding into other areas, therapeutic areas, at some of those existing entities given that they already have the basic elements in order to do that. So yes, we will work very closely together, all three of those, to support clients both on this side of the ocean and otherwise.

The Systems Pathology Company is in the development phase, had some modest revenues, but it is in the development phase. That will report into Nancy Gillett specifically, who is a world-class pathologist. We have been a development partner in this field for some time, and our pathologists have been providing technical input as have some large pharmaceutical companies. So it is already a sort of part of our pathology capability sort of matched with extraordinary software capability.

The software -- ongoing software business is a stand-alone entity and location managed by people with deep expertise in that field. So we will leave them to their development efforts while others of us sell the service and the software itself to our pharma clients.

Okay, that is helpful. Then maybe just of taking it a step further and as you think about kind of the strategy here, you have done some smaller M&A deals. The MPM deal looks somewhat unique from a strategic perspective. We have seen some of your competitors actually pull assets from pharma in terms of capacity. Is that something that is of interest to you? And if not, are there other options as you work closely with pharma companies to kind of manage capacity and build the business going forward?

Asset transfer deals are of interest under the right circumstances. We suspect that there will be several coming in the not-too-distant future. We are obviously open to looking at them, as we said earlier.

We are really finding incredible specificity with every client in terms of how they want to work with us. Everyone wants to work with us differently. So if we have a major client that wants to transfer an asset and wants to transfer a significant amount of work to us that will generate reasonable returns, we are certainly interested in that. I suppose that is a way of gaining share and a way of not having to build additional capacity in the future.

It all depends on the economics, the scale of the facility, what the market demands are, and the commitments that the client makes. But we anticipate some of those will be coming soon.

And then just one last one to clarify; in your comments, Jim, did you say you are adding resources for the academic market, trying to beef up that little bit of business with it?

Yes. We are meaningfully adding to our sales contention that is focused solely on the academic market. And we are pretty excited by that because it has been the single area of positive growth for us in fiscal '09 with a relatively modest-sized sales group or actually they are the smaller sales organization. I am talking principally about the US now. So in order to really take advantage of the amount of spending that we are seeing at research hospitals, for instance, and universities, standing out with a larger sales organization should really generate some significant benefits for us.

Great. Thank you very much.

(Operator Instructions) Sandy Draper, Raymond James.

Thank you very much. Just wanted to ask a question on the commentary, Tom, you made about -- if you can maybe review for RMS and PCS what you thought in terms of the revenues. And I am trying to understand how the acquisition revenue fits in in that if things are looking flat sequentially, is that including acquisition revenue suggesting that revenues may decline a little bit more on an organic basis? And just trying to make sure I have got that straight.

On an organic basis it will actually be better in the second half than the first half. And of course the key driver to that or one of the key drivers to that is the fact that last year in the second half is when we really started to see sales decline rapidly late in the third quarter and, of course, through the fourth quarter where it was a little bit a watershed for us. We saw dramatic declines sequentially in both PCS and RMS.

So if you actually look at our guidance range for the second half of the year and migrate yourself from both the high end of our guidance range to the lower end of our guidance range, minus seven to minus nine, the events that change from the first half to the second half is that we do get a continued modest pickup in the Piedmont acquisition, which we did during the second quarter. So from the first half to second half we do see a pickup from Piedmont.

Cerebricon is really the only other. SPC is predominantly expenses in the second half of the year; there is really nominal revenue. Cerebricon is a very small acquisition as we have mentioned. While that would provide some pickup for the second half of the year it would be very, very small. And then, of course, we would have a pickup in foreign exchange.

So depending upon which end of the guidance you migrate to we could be up sequentially in the second half at the higher end of the range or flat or actually down a little bit sequentially given our guidance range. As we said in our comments, we do think that things are moving sideways and potentially up a little bit in the latter half of the year in PCS. And, of course, historically we have seen sales trail off a bit in the fourth quarter for RMS.

So all-in-all my answer sort of down the middle of the road would be we continue to see things moving sideways and that is really kind of how we expect to see it move through the end of the year. Is that helpful?

Yes, that is helpful. So maybe just -- are you willing to put sort of a range for what you think the acquisition revenue will contribute for the second half?

Well, I don't know if we have or not. I think we will get from Cerebricon and Piedmont we are really talking -- we pointed out in the second quarter that Piedmont added 0.8% sequentially, which is around $2.5 million for an early second quarter acquisition. So arithmetically gross that up to two more quarters, Cerebricon for the rest of the year would be very low single digits I would say on the revenue side. So really not a lot there.

I think on foreign exchange we are probably looking at, based on where we see the rates, probably less than $10 million for the second half versus first half. We mentioned that sequentially it was up 1.5% from Q2 to Q1. So, again, I think if you look at the guidance range around those data points there is obviously still room for sequential growth without those items in the second half.

Obviously, the rates could move. I wouldn't expect a big deviation from the pickup from our acquisitions because the numbers are smaller and don't have that big of an impact. At the lower end of our sales guidance range, given obviously the continued uncertainty in the market, it obviously suggests that there could be a slight erosion in the numbers as well. But that is really not what our view is that this point in time.

That is really helpful. I appreciate it.

Randall Stanicky, Goldman Sachs.

Thanks for the question. Tom, maybe -- could you just help us understand where you think in the PCS business peak margins can get back to and how that compares perhaps to maybe your early thoughts on 2010? And just related to that of the $30 million in cost savings that you are expecting for next year maybe help us understand how much of that comes from PCS so that we can get a better understanding of the core profitability. Thanks.

Well, on a non-GAAP basis margins really have actually held up reasonably well. Q1 was a little bit disappointing but even at 15-ish-percent OI it's really a pretty good number. And, of course, we improved that sequentially in the second quarter.

I wouldn't expect it to change a lot for the rest of the year based on what we have talked about for volume. I think the key driver going forward would really be the volume changes. At some point there is only so much that we can do from an expense management standpoint.

So I think as we look to the end of the year or to 2010 I think the key drivers would be volume growth. And a little bit longer term what we can do more broadly with efficiency improvements from some of the initiatives that we have in place like Lean Six Sigma and things like, which is really more about efficiencies out of volume levels versus the kind of cost reductions so far that we have done which are really about volume levels.

So I don't want to put numbers out there that we are optimistic if volume comes back that we can improve the margin on a sustained basis, but I think it's more about utilizing our capacity.

Okay. And then of the $30 million how much of that comes from PCS in 2010 in terms of those cost savings?

I would have to look at the exact details, but the majority of it is obviously from PCS. It's where we have done most of our cost-reduction actions. We have done some in RMS and some at the corporate levels, but the majority of that is PCS, which of course you would probably expect that that is the case.

Right. Okay, great. Thank you.

Doug Schenkel, Cowen & Company.

Good morning. You have said that academic government sales remained strong. Given that the academic government end market accounts for probably over 30% of RMS sales, is it right to assume that the biopharma slowdown is just as pronounced in RMS as it is in PCS? And are there factors that you would point to that are more specific to RMS than PCS that are weighing on demand in this end market?

In your prepared remarks you had talked about the impact of mergers and healthcare reform and the slowdown in biotech funding. I was just wondering if there is something more specific to RMS than PCS that is weighing on demand.

I don't think there is anything more specific. The similar factors are impacting RMS really on a fundamental basis. If you think about the fact that we have got pretty good price increases playing through our RMS numbers and probably some share gains as well, we do have significant unit declines; very, very related, directly related to the pullback in demand in the toxicology business.

It has been consistent; it has leveled off. But until we see a discernible increase in demand in our toxicology work we are just not going to see the outbred rat increase, which is a highly profitable product line for us.

We have also seen a corresponding reduction in immunocompromised mouse sales, which have also flattened out, but very high-value animal models with very high margins also significant unit sales of those are down. That is a commentary on tentative spending by our clients definitely impacted by many of these companies that are involved in the mergers and definitely impacted by a -- generally much more careful about how they are spending their dollars. These are very high-value animal models so we are just not seeing them pulled the trigger as readily as we have historically.

So, again, it's continuing emphasis in getting drugs through the clinic that probably is continuing to impact spending by classic pharma and secondarily by large and medium-sized biopharmaceutical biotech companies. We continue to feel that there is going to be an inevitable turnaround and calling that continues to be extremely difficult. Clarity from quarter to quarter is just simply not there. And it's not there because we are not able to discern it. It's not there because the clients don't know and they are not able to share it with us.

So we are continuing to give the best information that we can. As we have said historically on these calls, it's not conceivable to us that clients won't begin to invest more aggressively in discovery and certainly invest aggressively in the development compounds that have already been discovered and are sort of waiting to go through the development pipeline. I guess the punch line is that the similar factors that have caused a slowdown in demand in tox could have affected a slowdown in purchasing of units in the RMS business.

And just one very quick follow-up. Do you believe that when you start to see a pickup in outbred models within RMS that that could be a positive leading indicator for a subsequent pickup in PCS demand, maybe a quarter or two after?

There isn't that much -- yes, but there isn't that much of a lag. So we won't have to guess at it; it will be the indicator and they will happen simultaneously. We may get a few weeks of purchases in demand on the model side for tox, but we will know based upon a consistent pickup in demand for tox. We track those weekly and very carefully versus our historical trend and also sales to others in the industry.

We will be able to see when toxicology activity resumes at levels that we had anticipated they would be at and at levels that we have enjoyed in early '08 and all of '07.

Great. Thank you.

Isaac Ro, Leerink Swann.

Just looking for a little bit more detail on how you are looking at capital deployment just in light of the shelf registration and the suspended buyback. You mentioned several additional asset transfer deals that you expect to see and I am wondering if that means it's fair to say you might be a participant in those, the sensitive asset transfers. And then just secondly a question on pricing assumptions you have baked into guidance for the toxicology in the second half.

So we will take the second half first. Our pricing assumption is certainly not that pricing opportunities are going to get any better any time soon. We do think that pricing has sort of reached a -- I don't know whether it's rational or not, but it has reached it's bottom. We still see some aggressive activities by some of our competitors that I would say are not particularly rational, but generally we are able to compete effectively when price is necessary.

So I don't think the pricing situation is going to change either way. I don't think it's going to suddenly get more aggressive and I don't think there is going to be more pricing power. We are unlikely to see any pricing power until and unless capacity -- until capacity begins to fill up, then we may see some.

In terms of the asset transfers, as I said earlier and I just want to be clear about that, we anticipate that there will be multiple properties available primarily because of these major mergers. We certainly don't know what those are yet because the clients are legally unable to discuss that, but we can make some assumptions. We are sure that we will be on the short list of large acquirers to potentially buy them.

We are open to doing that if the economics make sense, not that we are sort of blindly interested in that as a way to grow our business or not. We have to take each one case by case. We have had occasions I would say over the past two or three years to look at potential asset transfers and the economics did not work for us and we don't want to go into real estate business so we passed on them.

So we are open to it. I think we are well-financed enough to do those deals if necessary. I think we have the broad gauge management ability to manage large sites as if it was an acquisition, for instance, and are looking forward to the opportunity to evaluate some of those with the hope of getting share and getting a closer relationship with clients. But only if it works well for both of us.

And, Isaac, on the shelf registrations I wouldn't read anything into that, although I don't think we implied anything. In one case it was to replace an expiring shelf registration and the second was to register our options and whatnot. So I wouldn't read anything into that.

Thank you very much.

John Kreger, William Blair.

A follow-up question on this discovery services capability that you are adding to. If we think about the type of workflow that that is, might you be able as that business ramps up to do some of that work in your underutilized toxicology space? Or is it just too different to really use that space that isn't really full at this point?

It depends on the definition. We would put sort of early PK studies into that definition as well as the non-regulated studies for clients (inaudible) bioavailability and getting early answers very quickly. And that is the kind of work that we can do and do do in our toxicology facility. So as that portion of the business ramps up, yes.

With regard to the very specific work that we do at these three therapeutic area-based acquisitions that we have done, it's highly unlikely that we would expand those activities to one of our current tox sites.

Great. Thanks very much.

Jon Wood, Bank of America.

Jim, is the potential for a bigger transaction higher or lower today than it was, say, three to six months ago?

Can you be more specific?

Just bigger than -- we have seen the niche deals you are doing, but --?

A bigger transaction for us, you are talking about?

Correct, yes.

That is a tough question.

Just a comment generally on the M&A pipeline. Is the size and availability, the mix of the pipeline much different right now than it was three or six months ago?

I don't know if it's any different. I suspect that there will be some larger properties available. We are not necessarily looking for those. Again, we are open to looking at deals that dramatically enhance our portfolio and make us more relevant to our clients.

And so we are always asking our clients would the following services be important to you if we were doing them, would you buy X, Y, and Z from one company? Is more of a sole source effort something that you are looking forward to? And the answers are sort of all over the place, but they are sort of gradually moving towards, yes, they want to buy more from single suppliers. And I think the earlier you start with a client the greater the ability to keep them.

So on discovery front, as we are calling it, if we could do the non-regulated studies and we do them well and the compound looks good, it's likely that we will get the regulated work as well.

So I would say that deal flow is pretty good. Most of the things we are seeing are relatively small; that could change. I would say valuations are rational and, again, we are only looking at and have only done deals that we think have strategic relevance.

We are very excited with the three deals that we just did. We have got a very strong operating company in a strategic niche area. We have a technology that is world-class and unique on this pathology services business which sort of transforms our ability to provide those services in a much more effective and efficient manner. On the MPM deal, this sort of working with a venture capital firm to secure these sort of compounds for them and for us to do the work is pretty unique.

We are always looking at new ways to service the client and I think those three deals are representative of that. We certainly don't have our eyes on anything of particularly significant scale at the current time. I think valuations would really get in the way of that, by the way.

Okay, thank you.

Thank you.