Charles River Laboratories International Inc (CRL) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Charles River Laboratories fourth-quarter and full-year 2010 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 would now like to turn the conference over to your host, Vice President of Investor Relations, Ms.

Susan Hardy.

Please go ahead.

Thank you.

Good morning and welcome to Charles River Laboratories fourth-quarter and full-year 2010 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 2010 fourth-quarter and full-year results and review guidance for 2011.

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 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 189150.

The replay will be available through February 23.

You may also access an archived version of the webcast on our investor relations website.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 19, 2010, as well as other filings we make with the Securities and Exchange Commission.

During this call, we will be primarily discussing results from continuing operations and 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 providing a summary of our fourth-quarter results and commentary on our business prospects.

We reported sales of $281.7 million for the fourth quarter of 2010, a decline of 2.9% from the fourth quarter of 2009.

Foreign exchange reduced net sales by 1.2%, so excluding that impact, sales for the quarter declined by less than 2%.

We believe this result is evidence of the trends we described in December that both demand and pricing from our large biopharmaceutical clients have stabilized and that initiatives we have undertaken in the mid tier and particularly academic markets are delivering results.

We are also pleased to note that on a sequential basis consolidated sales improved by 4% with both RMS and PCS segments contributing.

Although it's too early in the year to say definitively that demand from our large biopharmaceutical clients is improving or that the pace we saw in the fourth quarter will be maintained, we view the fourth-quarter results as a positive indicator.

Operating income in the quarter was $48.5 million and the operating margin was 17.2% compared to $49.7 million and 17.1% reported in the fourth quarter of 2009.

Lower sales were mostly offset by cost-saving actions undertaken throughout 2009 and 2010.

Earnings per diluted share were $0.60 in the fourth quarter of 2010 compared to $0.49 in the fourth quarter of 2009.

A lower tax rate and cost base, as well as share repurchases drove the EPS improvement.

Sales for the full year 2010 were $1.13 billion.

The operating margin was 16.3% and EPS was $1.99.

Although these results were below the prior year, we believe that demand for our broad portfolio of essential early-stage development products and services has stabilized and may be on the cusp of a recovery especially considering the fourth-quarter results.

At the same time, we remain cautious in that optimism and have not changed our view that the 2011 first-quarter results will be less robust than the fourth quarter 2010 as our clients work through the normal process of prioritizing projects and determining the extent to which they will utilize CROs like Charles River to accelerate their research and development efforts.

However, based on discussions with senior leaders and decision makers in our large pharmaceutical mid-tier and academic clients and the actions we have taken to improve our operating efficiency, we are confident in our 2011 business prospects.

Therefore, we are reconfirming our 2011 guidance of year-over-year flat sales, earnings per share in a range of $2.20 to $2.40 and free cash flow in a range of $150 million to $170 million.

Despite flat sales, we are driving EPS improvement through a combination of aggressive cost management and a lower share count as we focus on returning value to shareholders.

I would like to give you more detail on the segment results.

In the fourth quarter, sales of our RMS segment fell less than 1% from the prior year and increased approximately 1% when excluding the effect of foreign exchange.

We believe this result indicates a stability of demand which was evident in both models and services and in most geographies.

The operating margin increased 40 basis points year-over-year to 30.5%, demonstrating the benefit of cost actions we implemented in 2010.

Our ability to leverage this benefit was evident in the sequential results were a $9 million increase in sales translated into a 240 basis point increase in the operating margin.

We were very pleased with this result especially in the fourth quarter when sales and margins have historically been lower d due to seasonal softness in demand for research models.

Sales of research models were up slightly on a sequential basis with the largest gains in Europe.

Sales for North America were down moderately, partially offsetting the gain.

Higher sales to services and in vitro were the primary drivers of the $9 million gain.

Sales of Discovery Services increased as our pharmaceutical and biotechnology clients continued to focus on discovery of new therapies and chose to outsource these complex services to us.

We can extrapolate this focus not only from the increased demand for our Discovery Services but also the types of research models our clients are purchasing.

We continue to see demand for inbred mice, which are generally used in the discovery process.

Demand for outbred rats, which are used primarily in toxicology, remained weak in the fourth quarter and has not improved in early 2011.

As I mentioned, toxicology studies generally start up slowly in the first quarter of the year as biopharmaceutical companies complete the process of prioritizing projects.

As it has done repeatedly, the in vitro business again performed exceptionally well both year-over-year and sequentially.

PTS product line continues to propel this business.

We now have thousands of PTS units in the field and cartridge use is expanding rapidly.

We are seeing a steady increase in cartridge sales per reader per day, one of the key performance indicators that we monitor.

The Multi-Cartridge System or MCS experienced robust adoption in the first -- in its first year on the market.

The MCS enables us to penetrate our client's high-volume central testing labs which in turn drives cartridge use.

The in vitro business is one of the highest operating margins in the RMS segment, reporting our goals to maintain the RMS margin at the 30% level.

The PCS segment reported sales of $113.3 million for the fourth quarter, a decline of 6% versus the prior year and 5.4% when excluding the negative effect of foreign exchange.

Demand and pricing remained relatively stable throughout 2010 and the rate of sales decline slowed considerably in the fourth quarter.

While this was expected based on somewhat earlier easier comparables to the fourth quarter of '09, we were very pleased to see a modest sequential increase in sales from the third quarter 2010.

The sequential increase was driven by a larger number of study starts in the fourth quarter and normal study slippage.

The sales increase was offset in part by continued softness in demand for specialty toxicology services.

The operating margin was 12%, a 30 basis points improvement from the fourth quarter of 2009.

The margin declined 20 basis points sequentially as the benefit of cost-saving actions was offset by the sales mix, which continued to included a greater preponderance of short-term studies as well as general toxicology.

Although demand and pricing appear to be stable, there continues to be too much capacity in the global Preclinical Services industry and the excess capacity keeps pressure on pricing.

Our capacity utilization has improved due to the closure of PCS Massachusetts and new business awards but more CRO and pharmaceutical capacity will need to come out of the system before pricing begins to improve.

From a corporate perspective, we intend to continue to aggressively manage our infrastructure and drive efficiencies in order to generate operating margin improvement, the first of the four key initiatives we described when we gave guidance for 2011.

Improved operating margins and moderate capital expenditures primarily for maintenance of our infrastructure will drive our second initiative, improve free cash flow generation.

We intend to utilize cash for disciplined investments in existing businesses with the greatest potential for growth, our third initiative, which we believe will enhance the value of our portfolio to our clients and drive sales growth.

And as we discussed in December and reiterated when we announced the appointment of two new directors to the Board on January 24, we intend to continue to repurchase shares under our current $750 million authorization.

We believe that our intensified focus on these first three initiatives will enable us to execute our fourth key initiative of returning value to shareholders.

In order to drive shareholder value, our two priorities have been a delicate balance of streamlining our operations to improve efficiency and at the same time increasing the value and accessibility of our portfolio to our clients.

We think we have been successful on both fronts, having lowered our cost structure through a combination of headcount reductions, facility closures, and suspensions, elimination of nonstrategic or underperforming assets, and investment in new information technology systems and our Lean Six Sigma program, we are very well-positioned to expand profitability and cash flow.

In fact, although we are forecasting flat sales in 2011, we are anticipating approximately 100 basis points of operating margin expansion on a consolidated basis and considerably more in PCS.

The combination of a higher operating margin and a lower share count due to the repurchase program should drive a significant increase in earnings per share which we estimate would be in the range of approximately 10% to 20%.

Increased operating income will also yield higher free cash flow, which we expect to increase to $150 million to $170 million from $155 million in 2010.

During the same period, we have implemented a number of actions in order to facilitate our clients' use of our global network of preclinical sites.

The establishment of a Matrix management system in the PCS business in '09 has fundamentally aligned functional and operational management, allowing us to continue to standardize and harmonize our processes across the sites.

As a result, our clients now view our preclinical sites as interchangeable.

They can do -- they can and do place programs at a combination of our preclinical sites and are assured of consistent service and support and access to our many experts regardless of location.

Furthermore, improved communication across all of Charles River business units and the realignment of the sales and marketing organization have simplified and enhanced our working relationships with our clients.

The client now has the option to utilize a single point of contact for all interaction with us, which has been particularly helpful for the global biopharmaceutical clients.

As these clients reduce the number of suppliers they use in favor of a smaller number of strategic partners, our ability to leverage our broad portfolio of essential products and services to meet all of their early stage drug development needs is increasingly critical.

We believe our efforts to position the portfolio to meet those needs is meeting with success, as evidenced by the fact that today all of our top 25 large pharmaceutical clients buy across the portfolio through our sales focus on the mid-tier biopharmaceutical companies and the academic and government sectors, we expect to expand on the success we are already seeing with those clients as well.

The challenges of the current operating environment do not diminish our enthusiasm for our portfolio or our strategy to continue to expand our RMS businesses through targeted strategic acquisitions with the appropriate return profile.

As our clients' requirements continue to evolve, it's our goal to provide the products and services they need in order to accelerate the drug development efforts.

With our scientific expertise and global network of facilities, we provide an efficient and effective alternative to maintaining in-house capabilities.

And as they continue their efforts to increase productivity while reducing costs, we believe that ultimately pharmaceutical companies will choose to outsource the majority of preclinical development through partnerships with contract research providers like Charles River.

Over time and regardless of the market challenges, we have maintained our focus on our core competency of in vivo biology.

That discipline has enabled us to build world-class capabilities across our businesses and enhance our ability to fully support our clients as a strategic partner in the drug development process.

Today we believe we are the global leader in the early stage drug development contract research industry.

We believe that our unique portfolio, which spans in vivo discovery through preclinical development and our unparalleled scientific depth, execution and responsiveness are unmatched by competitors.

We intend to maintain and enhance our position through our intensified focus on the four key initiatives which include returning, increasing value to shareholders.

Finally, I would like to comment on the two new directors that we recently welcomed to our Board, Bob Bertolini and Richard Wallman.

Our Board continuously evaluates and looks for appropriate opportunities to enhance its expertise and believed that this was an opportune moment.

The Board has selected two individuals with extensive financial and strategic experience as well as specific strengths that will enhance our ability to execute the strategy that we discussed with you in December.

Bob and Richard collectively bring highly valuable industry knowledge and experience in managing costs, driving operating efficiencies, and strategically allocating capital that will greatly assist us in accomplishing our goals.

Together they will bring financial management and biopharmaceutical industry expertise to our Board, which complements the combined skills and experience of our current directors.

Bo was Executive Vice President and Chief Financial Officer at Schering-Plough until its merger with Merck in 2009.

He built world-class finance and information technology functions and led business development and strategies.

He had responsibility for key financial areas including tax, accounting, and financial asset management among other areas.

Prior to joining Schering-Plough, Bob spent 20 years at PricewaterhouseCoopers where he held positions of increasing responsibility, ultimately leading to global pharmaceutical industry practice.

He obtained extensive experience in audit, financial controls, and corporate governance, while also serving as a senior advisor to management on issues including merger and acquisition transactions.

Richard was Senior Vice President and Chief Financial Officer of Honeywell International from 1999 to 2003.

He served in the same capacity from 1995 to 1999 at its predecessor company, Allied Signal, which merged with Honeywell in 1999.

As Chief Financial Officer, Richard oversaw multiple financial functions including strategy, corporate development, treasury, and tax.

For the prior two decades, Richard had financial leadership roles with IBM and Chrysler.

He played a pivotal role in the reorganization of IBM and supported the effort to reduce costs and implement improved operating controls in capital allocation programs.

Both Bob and Richard will serve on the strategic planning and capital allocation committee, which we are in the process of creating.

The committee will focus on financial strategies, capital allocation, and valuation of the Company's overall cost structure and related best policies.

We believe that Bob and Richard will play a valuable role, as will all of our directors, in achieving or goal of maximizing shareholder value.

I welcome them both to Charles River.

I would also like to thank Nancy Chang and Doug Rogers for the years of expert and thoughtful service to the Company.

They both brought constructive insights and a high degree of integrity and professionalism to our Board and we appreciate their contributions.

In conclusion, I would like to thank our employees for their exceptional work, commitment, and resilience and our shareholders, who have accommodated us with their time and consideration.

Now I will turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

I would like to begin my comments by providing a brief recap of the progress we made in 2010 to improve our operating efficiency.

Despite the challenging environment, I am pleased with the disciplined actions that we implemented to rationalize costs and align our infrastructure with current demand, eliminate underperforming assets, and better position the Company to improve shareholder returns.

Cost savings initiatives we implemented in 2010 are expected to result in cost savings of approximately $75 million in 2011 including the suspension of operations for our PCS Massachusetts facility, the headcount reductions and consolidations of several facilities, and the decision to evaluate strategic alternatives and non-strategic or underperforming assets specifically our Phase I clinic and preclinical facility in China.

We have been on the leading edge in the CRO industry to reduce excess preclinical capacity, to better align our infrastructure with client demand and improve utilization.

Since 2008, we have shuttered approximately 20% of our preclinical capacity including PCS Massachusetts and smaller sites.

These actions are the primary drivers behind the operating margin improvement that we anticipate in 2011.

We have also tightly managed capital expenditures to approximately $43 million in 2010, which contributed to an $18 million increase in free cash flow over 2009.

Another accomplishment in 2010 was the successful implementation of the SAP platform across our PCS in-life operations and North American RMS sites.

The ERP system improves our access to information and we believe it will allow us to further enhance our efficiency now and more substantially when demand rebounds.

We have also focused in on the optimization of our capital structure, which will result in the repurchase of more than 15% of our shares outstanding once the ASR has been completed at the end of this week, utilizing a combination of cash repatriation and low-cost debt.

Stock repurchases are expected to drive meaningful EPS growth in 2011 and we expect to repurchase an additional $150 million of common stock this year.

Collectively, all of these actions demonstrate our intensified focus on four key initiatives, operating margin expansion, improved free cash flow generation, disciplined investment in existing growth businesses, and returning value to shareholders which we believe will enable us to generate improved shareholder returns.

Before I recap our fourth-quarter financial results, let me remind you that I will be speaking primarily to non-GAAP results, which exclude goodwill and other asset impairment charges, acquisition-related amortization, non-cash interest expense related to the convertible debt accounting rules, and charges related to cost-saving sections and other items.

In addition, our fourth-quarter results reflect our Phase I business as a discontinued operation and as a result, prior period comparisons have also been adjusted for this reclassification.

For your modeling purposes on our website, we have provided revised financial schedules for each quarter in 2010 which reclassify Phase I as a discontinued operation.

The schedules can be found on the financial reconciliations page of our investor relations website.

Fourth-quarter results were ahead of our expectations.

Sales improved by $11 million sequentially or 4%, reflecting improvement in both segments but particularly RMS.

The sales improvement led to a nearly 100 basis points sequential increase in the consolidated operating margin to 17.2% as a result of the meaningful leverage from the incremental sales volume on our leaner infrastructure.

Fourth-quarter EPS of $0.60 represented a robust 30% increase over the third quarter.

The operating income improvement generated approximately $0.05 per share of the sequential increase.

A combination of higher other income and a lower tax rate generated approximately $0.06 per share and stock repurchases contributed approximately $0.05 per share.

The benefit from stock repurchases was partially offset by a $0.02 headwind from higher interest expense.

We do not expect a similar benefit from other income and a lower tax rate in the first quarter of 2011.

We are encouraged by the fourth-quarter performance and our business prospects, but as Jim said, our view towards 2011 has not changed.

We are reaffirming our sales and EPS guidance for 2011 because although the fourth quarter of 2010 was stronger than we anticipated, there are several headwinds that are expected to lead to a 10% sequential decline in non-GAAP EPS in the first quarter of 2011.

We do expect sales in EPS to subsequently improve from the first quarter level consistent with the quarterly trends that we discussed on our December guidance call.

But first, I would like to provide additional details on our fourth-quarter results.

Unallocated corporate costs increased by $1.2 million year-over-year and $2.1 million sequentially to $16.5 million in the fourth quarter as a result of true up adjustments to certain accruals at year-end.

For 2010, unallocated corporate expense was approximately 5.9% of sales, which is consistent with the 6% level we expect in 2011.

Net interest expense was $5.9 million, an increase of $3.8 million year-over-year and $1.8 million sequentially, reflecting a full quarter of borrowing under the new term loan, which was finalized in August.

Fourth-quarter net interest expense is slightly below the run rate that we expect in 2011.

We expect a modest increase in LIBOR rates and plan additional borrowing from the anticipated 2011 stock repurchases.

Other income was favorable at $1.4 million in the fourth quarter.

This relates to investment gains associated with our deferred compensation program.

Because this correlates to stock market returns, we do not forecast other income and therefore anticipate a small headwind going into the first quarter of 2011.

In the fourth quarter, the non-GAAP tax rate declined by 410 basis points sequentially to 21.6% principally due to the further benefits from R&D credits in Canada.

We continue to expect the tax rate to increase in 2011 to a range of 26.5% to 27.5% from 26.1% in 2010 primarily as a result of the anticipated reduction in the level of R&D tax credits.

As we mentioned on our December guidance call, we expected to record impairment charges in the fourth quarter related to goodwill and our PCS Massachusetts and China facilities.

These non-cash charges totaled $395 million or $6.28 per share.

Based on management's annual assessment of goodwill, we recorded a goodwill impairment of $305 million or $5.28 per share to revalue the fixed assets, goodwill, and intangible assets on our balance sheet at fair value.

We also recorded approximately $90 million in asset impairment charges principally related to our PCS facilities in Massachusetts and China as well as SPC.

These impairment charges which were recorded in the PCS business segment do not impact cash flow and have been excluded from non-GAAP results.

We continue to carefully evaluate strategies to optimize our capital structure and appropriately allocate free cash flow.

Given our strong fourth-quarter performance, we generated $50.8 million of free cash flow compared to $38.5 million in third quarter and $45.7 million in the fourth quarter of last year.

For the year, free cash flow increased by approximately $18 million to $155.3 million, which was above our prior guidance range.

Free cash flow benefited from the continued lower level of capital spending as well as an improvement in DSOs and better-than-expected operating income in the fourth quarter.

CapEx was $16 million for the quarter and $42.9 million for the year.

CapEx increased moderately in the fourth quarter due to the timing of expenditures for certain projects.

For 2011, we continue to expect free cash flow of $150 million to $170 million and CapEx of approximately $50 million.

DSOs improved to 45 days at the end of the fourth quarter from 52 days at the end of the third quarter.

Our focus on collections and the increase in preclinical study starts, which benefits deferred revenue in the DSO calculation, led to the fourth-quarter improvement.

For 2011, we plan to continue to aggressively manage working capital with the goal of maintaining DSOs closer to the fourth-quarter level.

As a result of our strong free cash flow generation including the DSO improvement and more limited uses for cash in the fourth quarter, our cash and marketable securities position increased to approximately $200 million at the end of the year from approximately $163 million in September.

Stock repurchases remain a capital allocation priority, reflecting our focus on improving shareholder returns both in the near-term and for the long-term as well as our collective belief that our are stock remains undervalued.

We expect the ASR to be completed on February 11, at which time we will receive any additional shares repurchased under the $300 million program.

We received an additional 1.25 million shares from Morgan Stanley on December 21, which bring the total received to date under the ASR to 8 million shares.

Based on the current the VWAP over the calculation period for the ASR, we expect to receive approximately 1 million additional shares on February 11 for a total of approximately 9 million shares.

This is lower than the amount we estimated in December due to the subsequent increase in our stock price.

When combined with the impact on the additional repurchases planned in 2011, we now expect our diluted share count to be approximately 1 million shares higher at the end of the year or approximately 52 million to 53 million shares.

Upon completion of the ASR and including open market transactions, we will have repurchased nearly 11 million shares or more than 15% of our shares outstanding since August 2010.

At that time, we expect to have approximately 55 million shares outstanding and $397 million remaining on our stock repurchase authorization.

As we previously discussed, we expect to repurchase an additional $150 million of common stock in 2011.

We are in the process of conducting our analysis to determine the optimal method for these repurchases, which includes preliminary discussions with our lending syndicate.

As Jim discussed, we are reaffirming our sales and non-GAAP EPS guidance for 2011.

We expect sales to be approximately flat in the 2010 level of $1.13 billion and non-GAAP EPS to be in a range of $2.20 to $2.40.

Phase I has been reflected as a discontinued operation and as a result, excluded from the guidance.

We will also continue to exclude the operating losses for PCS Massachusetts and will begin to exclude losses for PCS China from non-GAAP results in 2011.

As noted in our press release, we have updated our GAAP guidance to reflect a reduction in the expected operating losses of our PCS facilities in Massachusetts and China.

The quarterly gating for 2011 sales and EPS continues to be consistent with the trends that we discussed on our December guidance call.

For the first quarter, we expect sales to decline slightly on a sequential basis, reflecting relatively flat RMS sales and a moderate decline in PCS sales.

We continue to anticipate that PCS sales will decline sequentially from the fourth quarter of 2010 due to fewer study starts early in the year as clients prioritize their projects and finalize their budgets.

These trends are supported by preliminary indications from our January performance.

In addition to the anticipated sales decline, there are several other factors that are expected to lead to an approximate 10% sequential decline in non-GAAP EPS in the first quarter.

Incentive compensation expense is expected to create a $0.06 headwind first quarter as we are reinitiating accruals for our performance-based incentive compensation program in 2011.

We also do not expect similar favorability in the tax rate and other income in the first quarter, which is expected to reduce EPS by an additional $0.05 when compared to the fourth quarter.

These items will be partially offset by a full quarter benefit of the November cost savings actions and a lower share comp in the first quarter following the receipt of 1.25 million shares at the end of December and the pending completion of the ASR program at the end of this week.

However, as I noted earlier, the recent increase in our stock price will result in fewer shares being delivered under the ASR than we originally guided to on our December call.

I would also like to remind you that we have 53 weeks in this fiscal year.

Given our normal 4-4-5 or 13-week quarterly reporting cycle, the extra week is periodically necessary to true up to a December 31 year-end.

The 53rd week, which is the last week of the fourth quarter, creates some margin pressure because we have a full week of cost but given the holidays, a light week for sales.

This effect was already factored into our 2011 guidance.

We point it out to assist you with your quarterly modeling.

To conclude, we are pleased with our strong fourth-quarter performance and are confident about our business prospects in the coming year.

We are poised to benefit in 2011 from the aggressive actions that we have taken to preserve margins and improve shareholder returns in the absence of revenue growth.

We believe that the strength of early stage drug development portfolio, our leaner infrastructure and our optimized capital structure enhance our ability to capitalize on potential value creation opportunities going forward.

Thank you.

That concludes our comments.

Operator, will you please take questions now?

(Operator Instructions) Greg Bolin, Wells Fargo.

This is Tim stepping in for Greg this morning.

Jim, you mentioned strength in Discovery Services and RMS.

Isn't that coming from your big pharma client base or is that more your biotech client base?

Some of both.

I'd say discovery is -- it is a healthy mix perhaps as a preponderance of smaller clients who obviously have to outsource this sort of technical work.

But we have very large biotech, small biotech, and some pharma clients.

I think that pharma clients have historically done this work internally.

I think they are open to and interested in doing more outsourcing, it's just really never been available to them prior to the last couple or three years and we are sort of confident that over time as we build out this portfolio particularly in additional therapeutic areas and perhaps internationally, that we will be able to garner more of the large client work.

Okay, are you seeing any progress from big pharmas actually proceed forward with the stated intention of closing internal preclinical capacity?

Or is there still a tendency to hold on to those facilities and keep work in-house?

Well, you know, the Pfizer announcement indicated some work staying in-house and further closures of space.

I'm not sure whether that's a leading indicator or not, but conversations that we've had would seem to indicate that clients will continue to -- will and are continuing to rationalize infrastructure.

We have looked at a facility since our last call that's on the market.

So they are coming sort of slowly but surely.

It's one of the principal ways for infrastructure to be reduced and we continue to both anticipate it and have that confirmed by our clients.

Okay, then my last one.

Now that we are about halfway through the first quarter and you've talked about clients going through their prioritization process, are you hearing any talk about budget shifting back towards the preclinical spending side?

We have with a few clients.

I had a meeting recently with one that specifically -- this happened to be a client whose R&D expenditures are going up in total for the year, but he made a specific reference to the fact that there would be intensified emphasis on discovery and early investment as distinct from just jamming drugs through the clinic.

So we've had probably three years where there has been an intense emphasis on getting drugs to the clinics and markets.

We understand the rationale and the need for that, by the same token, there's perhaps an equal or perhaps even overwhelming need to see to the future with discovery work today particularly as the patent cliff rapidly approaches.

So I do think that we're likely to hear more clients talk about that.

It may be more subtle than this particular client, who was quite focused on the fact that that was an important change in their operating strategy and R&D allocation.

Great, appreciate the comments.

Thanks.

Dave Windley, Jefferies & Co.

Jim, a little bit different angle on the prior question.

I've heard from some big pharmas that they are, say, advancing in the pipeline this concept of kill fast, do more work on the compound at earlier, cheaper stages to be able to make a decision earlier.

And moving that even into late discovery.

I wondered if you were feeling that or seeing any evidence of that in your discovery services business maybe increased demand there?

And conversely if you have quantified the impact to the reduction in demand for GLP tox as these companies do kill more compounds before GLP tox?

The scale of our Discovery Services business and even our non-GLP business, while growing nicely, it's hard to titrate back to an answer to that except to say that I would say the growth right there, which is positive, is some indication that we are seeing that for sure.

And yes, we know that the greatest emphasis the clients are focusing on now is to try to kill compounds earlier so that they are only working on ones with the highest propensity for success.

And so we feel that by starting earlier we do get a piece of that work and obviously a piece of the work with the drugs that they intend to work on.

So I wouldn't -- it certainly doesn't feel that that has contributed to the slowdown in tox.

It is more of the other things we have already talked about, emphasis on the clinic, some work staying in-house we thought was going to go out, the mix that we are seeing now between specialty tox and general tox and sort of more short-term studies and more churn than we had anticipated.

Obviously it's a smart thing the drug companies are doing and basically that should benefit our business model particularly with compounds that are proving or that they are looking upon optimistically that should see a lot of work for companies like Charles River to try to fast track those to those clinics.

Okay, in terms of pricing, sticking with tox, we've talked about a stable environment for some time.

It's my understanding that one of the primary drivers of your preclinical revenue guidance for 2011 being down is some call it repricing or renewals of longer-term agreements, where that pricing renewal is at lower -- at now lower prevailing spot rates.

And so I wondered if you could just kind of reconcile the two thoughts, stable environment but still having some business repricing down if my understanding on that was correct.

Yes, well, we talked a fair amount last year about the fact that we had multiple large multi-year commitments with primarily big pharma that have cycled off somewhat throughout last year.

And of course they cycle off and the clients find themselves in a world now where the prices are lower, so there was an expectation (inaudible) in the end that our price points come down, which they did, but competitively.

We feel that we've moved through that process, and so we are not going to incur any more of that in 2011.

Sort of built into our guidance is the notion that to the extent that some of those rolled off early in 2010 for instance, there may be a comparative decline, but we shouldn't see that.

And we do feel that pricing except for periodic -- there's still some periodic very low prices by some competitors on certain accounts.

Maybe that is an always always, but by and large, I think that we are all sort of holding pricing, working to fill our capacity utilization and clients I think are satisfied with the price levels, feeling that they are getting good work for the prices they are paying, and they also have had some bad experiences where they pushed certain providers to such low price points that they've gotten poor quality work.

And I think they've recoiled from that and they've retreated from that.

And so it's unlikely we're going to continue to see that kind of pressure.

So you've got sort of a combination of space filling, prices holding, and major contracts having come off and priced lower earlier.

Okay.

Quickly for Tom, was there -- I know you've excluded China, some facilities from the guidance from when you gave it originally.

I don't think Phase I was specifically excluded from the non-GAAP guidance that you gave.

I wondered if there was a contribution either way that we should be aware of in the Phase I guidance before that would not be a part of it now?

An improvement -- well, Phase I was excluded from our guidance.

And because we are restating it, even though it's a benefit going forward, because it's in discontinued, it doesn't necessarily show up quarter-to-quarter or quarter versus last year because we restate last year to exclude it and the third quarter excluded it also.

Okay, thank you.

John Kreger, William Blair.

Thanks very much.

Jim, I think you said early in your remarks that your strategic discussions with clients have given you confidence in the guidance for '11.

Can you just expand a bit on that?

What are the sort of things that they are telling you?

Any notable observations from that?

I'm particularly interested in if you kind of segment your clients in the large versus small and mid versus academic.

Are there any changes in behavior that you are seeing in any of those classes?

Yes, I think it's probably less behavioral change and more granularity in terms of the quality of the information and a bit of structure in terms of how we deal with those clients.

So I think we have exquisite relationships with very large pharma at multiple levels and we are getting very good information and there is a fair amount of potential work available, let's put it that way.

So we are hearing -- we are bidding on large packages and I'm sure we are not the only ones bidding on it, but we are bidding on large packages, so you can see a lot of work that historically has been done only internally, now available for sale.

And I think major seismic moves like the things we are seeing at Pfizer will accelerate that.

So I would say that there's a fair number of very large clients with this big potential.

We have, as we said I think in a couple of calls, we restructured not only our salesforce but the allocation of senior management time, both GMs and scientific management, to spend a similar amount of time to develop similar quality relationships with sort of mid-tier.

So that would be biotechs but not necessarily the household name biotech companies who only outsource and tend to stay with you through the whole process if you can garner that work.

It obviously takes more work and you need more multiple orders from small biotechs to equal even modest work from a big pharma, but there's a lot of money being spent there.

And of course a lot of money is coming directly from big pharma.

So we are spending a lot of time doing that and getting very good feedback from clients that we now know well and others that we've done business with for years but haven't had the same level of sort of relationship.

And we are doing a similar thing with academic medicine and while the principal beneficiary is our research model business and that's about a three-year track record now, we are seeing some tox work coming out of large, very large teaching hospitals and some of the universities.

So I would say there's a continuous process of work being able to come outside, clients making that determination, getting comfortable with outside suppliers through validation and audits and increasing both willingness and need to refine and reduce their cost structures.

Great, thanks.

Just one other question.

You commented earlier on the call that your clients are increasingly viewing your PCS sites as interchangeable.

I think that's a pretty new trend, so just to push a little bit more on that, are you now able to load balance across your various tox facilities?

And how far are you in that process?

Could we take from that that your capacity utilization stats are pretty similar now across your various sites?

It's a very, very important question, so we are the beneficiaries, as you know, of multiple acquisitions and very strong but independent sites.

And through a matrix organization that we have had now for several years, we have more consistency in standardization across sites.

We have better centralization of information flow reports and we have finally, clients who have audited and are comfortable with multiple sites.

So there's definitely an interchangeability of sites.

So we are literally seeing now -- we have some sites that are better utilized than others.

So if they go to book a study at a certain site where capacity is reasonably full and is beginning to be a substantial weight, rather than wait or move to a competitor, which is what we saw historically, we are seeing clients comfortably and willingly go to another site and sometimes more than one other site.

So I would say that we are now at a point where obviously most of our large clients are comfortable with a least two of our sites and many are comfortable with three.

We also have some sites that have very specific capabilities and that could add a greater openness to be comfortable with them as well.

So yes, to use your term, we do have greater ability now to sort of balance where the work goes, to help allocate it, to do what's best for the client both in terms of speed and quality of work.

And so we don't have an imbalance like we have had historically where clients fall in love with a particular site or a particular study director to the detriment of other locations.

Thanks very much.

That's helpful.

Ricky Goldwasser, Morgan Stanley.

Good morning.

I have a couple of questions here.

First, Jim, I think you mentioned before the conversation you had with the pharma executives as R&D spend is going to go up this year.

So do you think that this client is an exception or contact?

What are your thoughts about the total R&D spend except for the outsourcing, which would seem that we were going to see greater outsourcing this year but just a total R&D spend for the clients that you have had conversations with.

I'm not sure they are an exception, Ricky.

Clearly a few are up.

I'd say most are flat and a few are sort of vocally down.

So on balance, probably R&D spending is flat to slightly up, very slightly up.

That's fine.

You have heard us say countless times that that's an important metric but not the principal one that we look at.

The principal one we look at, too, is what's the sort of emphasis of spending on preclinical assuming we can discern that and they tell us that?

And most importantly, what's the volume and rate of work that is outsourced, is that increasing or not?

What's the value of the work that's coming out?

And so it's hard to paint our entire client space with one brush because they are so disparate in the way they function and the way they are financed and in terms of their sort of patent situation.

But I think it's reasonable -- it's actually a reasonably stable situation right now with the drug industry in terms of how they are spending, what they are spending, and how they are spending.

And as I said earlier, I think we should see some sort of gradual emphasis on early development or discovery work rather than this preponderance of spending being in the clinic.

Okay, and then just a question on the margin in the first quarter.

I know you are continuing to guide to lower sales, but should we continue to see margin expansion due to the continuing improvement in cost structure?

Well, we didn't give specific margin for first quarter but we did say what a few of the headwinds were which were below the line and we did say that the cost reductions in Q4 would be a tailwind.

So we will see a better cost structure in Q1 and of course as we talked about, the sequential decline in preclinical sales, notwithstanding the product reductions will create a little bit of a headwind in the margin.

Okay, thank you.

Doug Tsao, Barclays Capital.

Thanks for taking the questions.

Jim, I was just hoping you could provide a little bit more color on the comment that you made in terms of expanding the discovery business.

And I know you indicated that you had planned or were looking to expand internationally.

I was just curious if you could provide a little bit more detail about what you meant there.

Well, it's really more of the same.

Our discovery business is international but we've made acquisitions both domestic and international.

We -- several of our current services businesses are already international.

So we continue to look for strategic acquisitions.

They are both very small and very difficult to find.

So while we continue to do so, I am particularly hopeful that that is going to change the paradigm.

I do think that the best way is to continue to invest in and grow the franchise internally with the addition of both a talented staff and technology and I think some of that will continue to be done on an international basis.

So we have a very good, critical mass of scientific capabilities and a couple of strong therapeutic areas.

The other thing we need to do is we need to flesh out the therapeutic area capability that we have and the last time we did that, we moved into CNS, we did do that internationally -- in other words -- not in the US because that's where the best acquisition was and the best science was.

And so I guess I am sort of indicating that we are willing to go wherever the most appropriate place is, assuming there is a quality acquisition to effectuate it.

And then as a follow-up, obviously you exited the PCS business in terms of China.

You did try to get into the discovery business in China through the WuXi transaction.

Is there any interest in pursuing opportunities in discovery services in China where there seems to be a very robust environment right now?

Although perhaps at a sort of more modest scale.

My response would be less about China and more about the whole area, which is that yes, if a discrete smaller, very tactical high-quality scientific opportunity avails itself in China, and I know that there are a couple of companies that would probably fit that bill, and we thought that the distance was beneficial and not detrimental and communications were -- and there was sufficient scale to interest our clients and it would enhance the portfolio, we would be interested.

We are not going to turn our backs on (inaudible) WuXi deal.

We need to be very thoughtful obviously and very tactical about what and how our next move is in China.

Okay, great.

And then just finally one more question in terms of the PCS business.

I was just wondering if you could provide an update on the Sherbrooke facility.

I know when it was opened it was planned to be occupied by two of your larger clients.

I know at the time you had suggested that perhaps that it basically got filled by dedicated space deals.

Ultimately I think in the last update you gave, you indicated there weren't sort of contracted minimums although you were happy with no level of business that they were providing you.

I was just curious in terms of are those clients still at those same levels and have you been able to fill out the facility with an additional -- additional clients?

Yes, so the Sherbrooke facility was a drag to the P&L last year.

At this time, it is no longer a drag.

The two clients that we essentially built out that facility for, two very large birth care pharma clients, are the principal occupants of that site at significant levels.

And we have also brought a few other clients into that site as well and I'd say from a capacity utilization point of view, it's continuing to improve.

Okay, great.

Thank you very much.

Tycho Peterson, JPMorgan.

Good morning.

Jim, you've laid out some longer-term targets for margins for the PCS business.

You've talked about high teens to 20% within the next three to five years.

Can you just -- given that you are at 12% this quarter, can you just talk about what it takes to get to the maybe 20% level, how much of that is a function of topline coming back versus the cost initiatives you put in place versus other factors we may not be thinking about in terms of additional programs?

Well, I mean, it's actually pretty straightforward.

To some extent it's very much about capacity utilization.

So as capacity fills, the margin will improve and of course, we pretty much indicated -- not pretty much, we have indicated, too, that we're looking for 100 basis point improvement throughout all of Charles River for fiscal '11 with PCS being higher.

So that indicates that we are quite confident given the dramatic changes we've made in the cost structure that at kind of similar price points and gradual improvement in capacity utilization, the margins will increase.

So that, we feel very confident about as we've told you for 2011.

As capacity fills, and there's some pricing power, whether it's sort of across the board or in specific areas, we obviously get some margin accretion there which drops straight through.

And I would figure that that's the situation for 2012.

And then as the mix continues to shift again back to more specialty work, we get an enrichment impact.

We could certainly flow.

We get see some of that this year but we certainly could see that in 2012 as well.

So those three things sort of build on each other depending on how quickly they come and how much they simultaneously benefit the P&L.

We are quite comfortable that we are going to get this back to around 20%.

Okay, that's helpful.

Just following up on Doug's question a minute ago about China, can you just talk to whether there's been any reaction from your clients to your decision to exit China?

And then as we think about kind of this interchangeability between preclinical sites you've talked about, how much of an emphasis going forward will lower cost plays be and how much of a priority is that for clients versus other factors?

So I would say that the response to our decision on China was disappointingly quiet and so the flip side of that would be the justification for our decision.

So the simple reality is that while we've built a very good site with a very good partner and worked arduously and had a lot of work there, a lot of studies done, a lot audits done, and a lot of interest in the sites.

There is really not a lot of real work right now.

There aren't enough compounds to be discovered in China that are ready for GLP work.

There absolutely aren't enough companies interested in sending work compounds from the states or Europe to China to have the preclinical work done probably in large measure because the price points are pretty low in the states and in Europe right now.

So as we've said before, we think China will someday be an important place.

Well, for sure it will be an important place for life sciences.

I think gradually it will be a more important place for preclinical but that could be -- I'd be surprised if you see it be very important in the next five years.

I think our greater interest at the current time would be to have enough demand for our -- for quality research models in China that would go ahead and build a facility there.

So it's going to be a while.

I don't think China is really playing.

China is playing in chemistry and in some CNC and beginning to play a little bit in very early, nonregulated discovery work and non-GLP work, very complex regulated studies.

I think it's going to be a lot longer than we all anticipated.

Okay and then just one last one.

I think you talked about RMS doing pretty well in Europe.

Can you just talk about the underlying trends there and your visibility into Europe in general?

We've had very good performance in Europe I'd say for a couple of years, particularly at sort of our French and German locations.

I think we are just doing a very good job competitively.

We are getting price.

We are holding or modestly taking share.

We have a lot of service activity over there in (inaudible) and some other areas that are performing well.

We've always had a very, very big footprint in Europe and have been able to service the clients in a competitively beneficial way probably with -- particularly with regard to our primary competitor over there, which is where we are probably taking some share.

Okay, thank you.

Derik de Bruin, UBS.

Good morning.

Given that it looks like this Sanofi Genzyme deal is probably going to happen and given that one of your major competitors has a strategic relationship with Sanofi, is that a potential headwind for you?

It's a bit of an imponderable.

Obviously we do a lot of work for both clients, notwithstanding that major deal that you talked about.

None of the major deals were ever exclusive, so we have a very, very good relationship with Sanofi and they have been a big client of ours for years.

So I would guess probably not, Derik, but it so much depends on how independent Genzyme is allowed to be.

There are multiple models which you know all the companies that actually have been left alone from these smaller biotech companies acquired by big pharma.

And in other instances where they are really brought into the fold.

Certainly left alone I would have no concerns and it could even go the other way that strength with Genzyme could provide opportunities with Sanofi.

So we don't really see that as a concern at the moment.

Okay, given that Pfizer is doing some R&D cuts and they're shutting down some of their respiratory and allergy programs, does that put additional pressure on the specialty tox market?

How big a client were they in specialty tox or are they in specialty tox?

I can't answer specifically.

The way we look at the Pfizer announcement, which is a big one, is -- it will have sort of -- it will have an impact, but a modest impact on research models, sales, in some places like Sandwich, obviously, which is a client derived -- we have a UK facility close by.

There is a very apparent immediate commensurate at least uptick in dialogue and interest from them with regard to services, both tox services and other RMS-related services that we are involved in.

So it just feels like Pfizer is going to be more aggressive in their outsourcing.

I would say some of the things that you specifically asked about is not something they've been doing with us in large measure historically, so that shouldn't hurt us either.

Great, I will get back in the queue.

Thanks.

Ross Muken, Deutsche Bank.

Hi, this is [Li Jo] in for Ross.

Thanks for taking the question.

My first one was given that you guys have done a lot of positive actions for the last few months in terms of buybacks and first (inaudible) closures, and that you have elected two new directors and Jim, you specifically mentioned that they would be focusing on the financial strategy and capital allocation.

Could you comment on what your longer-term return on capital is going to be going forward?

Good question.

We are obviously doing everything that we can to improve our returns on capital.

Our weighted average cost of capital presently today is lower than has been historically both in part and parcel because of the market expectations as well as the cost of our debt.

We don't use that as a hurdle rate internally because we do think that they are unusually low at this point in time and will rebound.

So we are doing everything we can to improve that both in an operating standpoint and below the line in treasury in terms of where our capital is and returning shareholder value and things like that.

So we are going to continue to try to improve that.

We always had a hurdle rate and a target of 15%.

That would be high in today's environment, but we are going to do everything we can to get it up to as high as we can.

Sure, and maybe one last one.

You sort of mentioned the capacity for you guys has gone down 20% since '08 and just assuming that if demand were to be flat at current levels, how much industry wide capacity do you think has to be taken down for us to see sort of pricing improvements?

Well, it's part and parcel in conjunction with volume, so I don't expect to see in the near term a lot more reductions in the outsourced space.

We think we are at a good level now.

I know some of our competitors have done adjustments as well.

Internally they are moving away from some of their space.

That obviously helps the overall market if the former clients and/or other companies close some of their in-house capacity.

And of course based on where we are today if volume picks up, that obviously changes the utilization dynamic as well.

So unless volume were to decline, I don't necessarily expect to see much more in the way of reductions.

Maybe we can see something at one of the smaller companies.

I don't know.

But I think it's a little more about what our internal customers would do with their space and what volume would do in terms of demand.

Sure, thank you.

Brigham Hyde, Cowen & Co.

Thanks for taking the question.

Just to stay on utilization for a second, thinking about 2011 guidance, what are you implying for your utilization level in 2011?

And maybe connect that to your pricing commentary and guidance.

Well, we are implying sort of steady, gradual, modest improvements in capacity utilization.

Obviously ending the year lower than our optimal utilization rate or we would be signaling for much higher margins, but certainly better than '10 and way better than '09.

As I said earlier, a willingness on the part of the client to use multiple locations.

So you know, we don't give specific percentages for competitive reasons, but beginning to improve.

I would say that even at the current time we do have a couple of sites with very good capacity utilization, not perfect, better than others, and others improving nicely.

And for us that is critical in terms of margin enhancement, but obviously even more critical directionally in terms of our ability to begin to garner increased prices.

Okay, great.

And then you mentioned in your prepared comments a sales focus on kind of the mid-tier accounts beginning to ramp up and maintaining focus on your top 25.

But just breaking those out, maybe what -- I don't know if you can speak to this, but what percent of sales is that mid-tier now versus the big guys?

And maybe the different growth profiles of those segments.

I haven't broken it out in such a long time.

The other -- my other hesitancy in breaking it out is that so much of the funding from mid-tier comes directly from big pharma that I'm not sure it's a useful distinction to make.

So I think mid-tier has the potential to probably grow faster but it's not a distinctly different class of clients.

Of course they become the sort discovery tools and feeders to the big drug companies.

So -- but we are going to focus on them because they don't have internal capability and you are always dealing with senior decision-makers and they probably have the capability and the desire and actually necessity to make decisions quicker.

So we think we can garner more business there faster.

Okay, and then a final one.

Just thinking about RMS and the outlook with the academic clients given that the NIH budget is still up in the air a bit and a lot of the things might be flattish, I think year-over-year there's potentially stimulus comparisons, etc.

I was just wondering what you are incorporating in your thoughts there?

Well, we've had academic sales up two or three years.

We have it in our operating plan up again this year.

We just have more feet on the ground and a greater sales focus, market focus, and senior management focus on academia.

We are very cognizant of who the largest NIH recipients are and making sure that we are covering those accounts thoroughly.

And to the extent that they are interested, making sure that they understand our entire portfolio and making that available to them as we do to our pharma clients.

So we have actually -- we have been very successful with academia for several years now and sort of been screaming for us to increase the labor component, which we've done.

So we are optimistic that we will continue.

Is it fair to say from that that stable funding with better sales execution is your thought process there?

Yes.

All right, thank you.

There are no further questions.

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