Charles River Laboratories International Inc (CRL) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Charles River Laboratories second-quarter 2011 earnings conference call.

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

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

(Operator Instructions).

As a reminder, today's conference is being recorded.

I would now like to turn the conference over to our host, Corporate Vice President of Investor Relations, Ms.

Susan Hardy.

Please go ahead.

Good morning and welcome to Charles River Laboratories second-quarter 2011 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 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 will be available beginning at noon today through August 17.

It can be accessed by calling 800-475-6701.

The international number is 320-365-3844.

The access code in either case is 209354.

You may also listen to an archived version of the webcast on our investor relations website.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, 2011 as well as other filings we make to 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 would like to begin by providing a summary of our second-quarter results and commentary on our business prospects.

We reported sales of $288.3 million in the second quarter of 2011, essentially unchanged from the same period in 2010 with foreign exchange contributing 4.3%.

The RMS business performed well, with sales gaining more than 1% year-over-year on a constant dollar basis.

The decline was due to Preclinical Services.

Demand from our large biopharmaceutical clients remained stable sequentially and the trend towards shorter-term general toxicology studies persisted.

We do not believe there has been any fundamental changes in demand of pricing.

I will speak more about our assessment of the demand in a moment.

We continued to make excellent progress in the second quarter on our key initiative of operating margin improvement due to cost savings initiatives implemented in the fourth quarter of 2010 and our ongoing efficiency program.

Operating income for the quarter was $55.3 million compared to $48.4 million in the second quarter of 2010, a 14.1% increase.

The operating margin gained 240 basis points year-over-year, 19.2%.

The sequential improvement was also impressive.

Operating income rose 7.5% in first quarter of 2011 and the operating margin improved by 120 basis points.

We made significant progress on our initiative of returning value to shareholders.

Earnings per diluted share were $0.70 in the second quarter of 2011 compared to $0.50 in the second quarter of 2010, a 40% increase.

On a sequential basis, earnings per share increased 14.8%; in both cases, improved operating income and share repurchases contributed to the increase.

Since August of 2010 including the two accelerated share repurchase programs and open market transactions, we have repurchased approximately 15.5 million shares or more than 23% of our outstanding shares.

This includes approximately 0.5 million shares purchased on the open market in June.

The result was a lower-than-expected share count, which enabled us to enhance earnings per share.

As a result of the strong results for the first half of 2011 and our expectations for a stable second-half of the year, we are raising our 2011 guidance primarily due to favorable foreign exchange rates which could contribute up to 2% to growth.

We now expect sales to be slightly higher than in 2010 rather than flat, as previously expected.

For earnings per share we are increasing our range to $2.38 to $2.48 from our previous guidance of $2.20 to $2.40.

We are also increasing our guidance for free cash flow to a range of $165 million to $175 million from $150 million to $170 million.

Between our stable sales performance, ongoing efforts to improve operating efficiency, and our stock repurchase plan, we are confident that we can achieve free cash flow and earnings in these ranges.

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

In the second quarter, sales for our RMS segment increased 6.6% to $178.2 million from the second quarter of last year due principally to foreign exchange.

The operating margin increased 350 basis points year-over-year to 32.6% driven by a combination of higher sales and cost actions we implemented in 2010.

On a sequential basis, sales increased by 2.8% and the operating margin improved by 140 basis points.

Year-over-year, every RMS production and service business except Japan contributed to the operating margin improvement despite the fact that a few of the businesses reported sales declines.

The North America research model production business continued to experience soft demand from our large biopharmaceutical client.

As was the case in the first quarter, sales performance in Europe was stronger than in North America, which we continue to believe is a function of the more diverse client base.

Sales in Japan declined less than $1 million sequentially due to the impact of the earthquake, which occurred late in the first quarter this year.

Taken as a whole, the production businesses were down slightly from the prior year on a constant dollar basis due primarily to Japan.

Sales of outbred rats continued to be soft, consistent with demand for toxicology services.

We were very pleased with the performance of the research model services businesses, which includes Genetically Engineered Models Services or GEMS, Research Animal Diagnostic Services or RADS, Discovery Services, and Consulting and Staffing Services, or CSS.

In total, services sales increased 6.6% sequentially.

The primary driver for GEMS, RADS, and Discovery was a large biopharmaceutical client who we believe are increasingly outsourcing non-GLP services in Discovery such as pharmacology and DMPK.

In the past, these services were viewed as core competencies but as biopharmaceutical companies continued to implement the actions to improve their operating efficiency, they are defining a larger list of services which can be outsourced.

Our deep scientific expertise in these areas is well-known by our clients and they are increasingly willing to rely on us to perform these services rather than maintaining the extensive -- and expensive infrastructure in-house.

The in vitro business again delivered very strong results with growth above 10%.

The drivers of the second quarter performance were the same as in the first quarter for Portable Testing System or PTS and the Asian market.

Because the portability and speed of the PTS accelerates the testing process for clients, we continue to identify growth opportunities outside of the core pharmaceutical market such as nuclear pharmacies, dialysis clinics, and small drug and device manufacturers.

We expect these markets to continue to generate growth and also believe that we will increase sales to large biopharmaceutical clients.

We have been successful in placing the PTS and Multi Cartridge System, or MCS, at a number of these clients or require FDA approval of the Multi Cartridge Pack in order to handle the volume requirements of central testing laboratories.

We have filed with the FDA but cannot predict when we will receive approval.

Once approval is obtained, however, we can assist our clients to begin the process of converting to the MCS.

I'd like to give you a brief update on the situation in Japan.

We are extremely proud of the efforts of our Japanese colleagues made to mitigate the disruption to our business following the earthquake.

They have been and continue to work tirelessly to ensure that our facilities are running as efficiently as possible.

They are in contact with our clients on a regular basis to determine their requirements and have supported the clients throughout this period.

As a result, the second-quarter sales and operating margin declines were less than we expected.

The PCS segment reported sales of $110.1 million in the second quarter and decline of 9.3% versus the prior year and 12.3% when excluding the effect of foreign exchange.

The year-over-year sales decline was expected as the first and second quarters of last year did not fully reflect the impact of lower volumes, pricing, or sales mix, which became increasingly unfavorable in the second half of 2010 as demand for specialty toxicology declined.

Although sales were below the previous year, our cost-saving actions and continued efficiency initiatives resulted in a margin improvement.

At 14%, the second-quarter operating margin was 60 basis points higher than the previous year and despite a modest sequential sales decline, was just 10 basis points below the first quarter.

As we discussed on our first-quarter conference call, our large biopharmaceutical clients shape a significant amount of our business representing more than half of PCS sales.

These clients are undergoing their own cycles in their businesses and some are further along with restructuring efforts than others.

We are very pleased that some of our clients who have progressed further through their processes are now increasing the amount of work they place with us.

These increases are being offset by others who are placing less work as they continue their process of rationalizing pipelines and reducing costs or are forced on -- focused on other areas of the drug development pipeline.

We don't expect this variability in demand to change in the short term, which is why we expect that PCS sales in the second half of 2011 will be similar to the first half level.

However, we believe that this is a timing issue rather than a fundamental weakening of demand.

As a result of our enhanced relationships with these clients, we have more insight into how far they have progressed in their efforts to restructure their research and development efforts.

Based upon our discussions, we continue to believe that over the long term they will increase the amount of outsourced preclinical work, including both discovery and safety assessments and choose to do so with Charles River.

Client feedback remains consistently positive.

They respect our scientific expertise, the quality of our work, and our response to service.

We also believe our mid-tier clients will be an increasingly important base for us as a source of revenue growth as a result of the realignment of our sales force in late 2009.

We have allocated more resources to our mid-tier clients, a group which includes small and mid-sized pharmaceutical and biotechnology companies.

We have expanded our outreach to these companies, many of which have increased funding available to them as a result of partnering efforts with large pharma or the capital markets.

Because they generally do not maintain the in-house infrastructure required for drug development, they need partners like Charles River who can afford them scientific expertise on a flexible basis.

Our large pharmaceutical clients are increasingly comfortable with the concept of outsourcing as they strive to create a more flexible and productive drug development model.

All of these companies are at different stages in the process but we believe most of them are further along the curve towards outsourcing than they were a year ago.

As mentioned, in addition to Preclinical Services, they are also evaluating the outsourcing model for pre-IND studies performed during late discovery.

That means there are new opportunities for us and we believe higher Research Model Service and sales in the first half of 2011 for GEMS, RADS, and Discovery Services, are evidence that we are winning our share of this new business.

We believe increasing demand will drive more growth for all of our services including both Research Model and Preclinical Services and are identifying opportunities to expand our portfolio to accommodate our client evolving requirements.

We are evaluating a number of small strategic acquisitions and in licensing opportunities which would enhance the services we can offer our clients.

These deals, most of which would be included in Research Model Services, are focused on Discovery Services, pharmacology, and various technologies.

Some of them represents geographic expansion opportunity.

All of them are measured against our internal hurdle rates, which generally are above our cost of capital.

We are maintaining a very disciplined approach to this process and although we hope to complete one or more deals before the end of the year, we cannot predict the outcome.

My comments today about our large pharmaceutical clients' desire for more strategic partnerships have been more focused on the efficiency these relationships provide.

In our view, however, the single biggest advantage of these strategic partnerships is the power of our combined scientific expertise.

Working together, sharing knowledge and capabilities, and communicating consistently creates a team with a common goal to accelerate the drug development process and discover new territories for patients with unmet medical needs.

The more we work together, the more firmly entrenched we become in our clients' drug development processes and the more they can rely on us to provide the high-quality scientific expertise that in the past was their exclusive capability.

That is our ultimate goal and one towards which every employee at Charles River works every day.

In conclusion, I'd like to thank our employees for their exceptional work, commitment, and resilience, and our shareholders for their support.

Now I will turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

Before I recap our financial performance, let me remind you that I will be speaking primarily to non-GAAP results from continuing operations.

A reconciliation of non-GAAP items can be found in our press release and on our website.

As was the case in the first quarter, our second-quarter performance demonstrates that we are continuing to make progress toward achievement of the four key initiatives to enhance shareholder value.

First, the effective management of our cost structure led to a 240 basis point improvement in operating margin to 19.2% in the second quarter.

We also returned value to shareholders through stock repurchases, which coupled with cost savings generated 40% year-over-year EPS growth to $0.70 per share.

Furthermore, we increased free cash flow by $11 million over the second quarter of last year to nearly $59 million through both improved operating margins and disciplined capital management.

I will now address the drivers behind the outperformance in the second quarter.

Previously we commented that second-quarter sales would be approximately flat on a sequential basis.

We exceeded our estimate by approximately 1% with nearly 3% growth in the RMS segment offsetting a 2% sequential sales decline in the PCS segment.

The $0.09 sequential EPS increase in the second quarter was also ahead of our prior outlook for flat to slightly lower EPS from $0.61 in the first quarter.

As Jim indicated, the primary contributors to the sequential EPS expansion were operating margin improvement and stock repurchases.

The consolidated operating margin improved by 120 basis points sequentially as a result of sales volume leverage and RMS.

Our diluted average share count was nearly 3 million shares lower in the first quarter as a result of our accelerated stock repurchase programs or ASRs and the repurchase of additional shares on the open market.

Our aggressive stock repurchases over the past year have allowed us to return value to shareholders because the lower share count generates greater upside for each incremental dollar that we are able to drive to the bottom line.

With regard to non operating items, unallocated corporate costs were $18.2 million in the second quarter, representing a $1.7 million increase year-over-year and a $0.4 million decline on a sequential basis.

The most significant driver of both the year-over-year and sequential change was health and fringe-related costs, which increased over last year but declined from the first quarter level.

Historically, health and fringe costs have been highest in the first quarter and have declined over the course of the year.

Several other factors contributed to the variability in unallocated corporate costs.

Wages and stock compensation expenses were lower compared to the prior year reflecting the reduction in corporate headcount as a result of the fourth-quarter savings actions.

This was partially offset by higher performance-based bonus accruals related to our strong year-to-date results.

We also incurred consulting fees in the second quarter with services including a program to further enhance process efficiency.

We expect that the cumulative results of these items will yield unallocated corporate costs of approximately 6.5% of sales for the year, an increase over our prior expectations.

We do not anticipate the second half favorability in these costs that we have experienced in prior years, principally due to additional consulting fees that we expect to incur.

Net interest expense increased $0.4 million sequentially to $6.8 million, primarily reflecting a full quarter of the new $150 million term loan added in February to fund the ASR.

For the year, we continue to expect net interest expense in a range of $26 million to $28 million as additional debt related to the February term loan is expected to be offset by the accelerated repayment of debt during the year.

The non-GAAP tax rate declined 120 basis points sequentially and 260 basis points year-over-year to 25.1% in the second quarter of 2011.

The lower tax rate was driven primarily by increased benefits associated with R&D tax credits in Canada.

These benefits are expected to remain favorable for the remainder of the year due to the geographic mix of clients in our Canadian business.

We anticipate that this will result in a non-GAAP tax rate in a range of 25.5% to 26.5% or approximately 100 basis points lower than our prior outlook.

Free cash flow remains an important initiative to enhance shareholder value.

As a result of our strong operating performance, second-quarter free cash flow increased to a robust $58.6 million, up $11 million over last year and $45 million from the first quarter, which is typically our weakest quarter for free cash flow.

Based on year-to-date free cash flow of $73 million and our expectations for the remainder of the year, we are increasing our outlook for free cash flow to $165 million to $175 million for 2011.

We continue to expect CapEx which was $6.7 million in the quarter to total approximately $50 million for the year.

DSOs remained relatively stable at 50 days compared to 49 days for the first quarter and 51 days for the second quarter of last year.

Our capital priorities for the remainder of the year are unchanged.

We continuously evaluate the best uses of cash and anticipate that we will allocate capital to debt repayment and stock repurchases as well as M&A, which Jim discussed.

Stock repurchases remain an integral part of how we return value to shareholders and also a benchmark to which we compare other capital allocation decisions including M&A.

We completed the $150 million ASR on May 16.

Under the program we repurchased a total of 3.8 million shares, most of which were delivered to us when the ASR was initiated in February.

The final 6500 shares were delivered at settlement.

Following the completion of the ASR, we repurchased approximately 0.5 million shares under a 10b5-1 trading program in the second quarter for $20.5 million.

That brings the total expended under our stock repurchase authorization to $545 million since last August, leaving approximately $205 million outstanding at the end of the second quarter for future repurchases.

On our May conference call, I discussed our intention to allocate a greater proportion of cash to debt repayment.

We accomplished this through the $65 million prepayment on our US dollar denominated term loan during the second quarter.

This prepayment and our regularly scheduled installments reduced our total debt by $71 million to $789 million at the end of the second quarter or a leverage ratio of approximately 3 times.

We also repaid EUR40.9 million or approximate $58 million on our euro denominated term loan at the beginning of the third quarter.

We were able to make this payment because at the beginning of the third quarter we restructured our international subsidiaries in a tax-free manner.

This effectively consolidated our two major international holding companies into one, enabling more efficient access to offshore cash for requirements outside of the United States.

We incurred advisory fees of approximately $1 million in the second quarter to facilitate the restructuring which we have excluded from our non-GAAP results.

As Jim discussed, we are raising our sales and EPS guidance for 2011.

We now expect sales to be slightly higher than the $1.13 billion reported last year.

At a range of $2.38 to $2.48, 2011 non-GAAP EPS would represent a 20% to 25% increase over 2010.

The updated guidance reflects our strong first-half performance particularly in the RMS segment as well as favorable foreign exchange rates which drove the increased sales guidance.

FX is now expected to benefit sales by up to 2%.

However, the FX benefit drops through to earnings at less than the margin rate due to the fact that we are naturally hedged in all locales except Canada.

Therefore for the year, we expect the impact on earnings from foreign exchange to be in a range of $0.03 to $0.05 per share.

This includes the second quarter, when FX contributed approximately $0.03 per share to earnings.

The high end of our EPS guidance range assumes favorable trends across our businesses for the second half of the year and normal seasonality in the RNS segment as well as the impact of the 53rd week in the fourth quarter of this year.

The high end of our guidance range also assumes that the second-half outlook for our PCS segment remains stable compared to the first half of the year.

Our EPS guidance does imply lower earnings in the second half of the year.

There are several contributing factors.

The most significant driver is expected to be the RMS business, where normal seasonality and the 53rd week have a significant impact on the RMS operating margin.

We also expect to incur additional consulting fees in the second half of the year related to the process efficiency projects that I mentioned earlier.

And our meaningfully lower share count magnifies the per share impact of any operating income decline.

Pressure on sales and earnings due to normal RMS seasonality in the second half of the year is consistent with historical gating of our quarterly results.

RMS seasonality relates to reduced shipments of small models during vacation and holiday periods in the third and fourth quarters.

Given the fixed cost nature of the production business, a significant portion of this seasonal sales decline drops to operating income.

This year the addition of the 53rd week to true up to a December 31 year end exacerbates the seasonal impact.

Because it is the week between Christmas and New Year's, sales are light but costs are normal, creating added margin pressure.

Based on these factors, we believe second-half RMS sales will be slightly below the first half and the RMS operating margin is expected to average at slightly below 30%.

This represent an approximate 200 basis point decline from the 31.9% operating margin reported in the first half and is expected to be the most significant driver behind the second-half earnings headwinds.

We expect non-GAAP EPS to be similar for each of the last two quarters of the year.

To conclude, we are pleased with another strong quarterly performance which has enabled us to increase our guidance for 2011.

We will continue with our initiatives to improve our operating efficiency, and expand margins, generate increasing cash flow, and enhance shareholder value.

Thank you.

That concludes our comments.

Operator, would you please take questions now?

(Operator Instructions) Dave Windley, Jefferies & Co.

Thanks for taking the questions.

Jim, the services business as you highlighted in RMS, it sounds like they are performing consistently and well.

You called out from a client standpoint large pharma there positively and then contrastingly, those are the same clients that seem to be the soft demand in toxicology.

I was hoping you could perhaps compare and contrast your conversations with those clients in those respective areas.

What is driving their stronger demand for some of the earlier stage stuff versus softer demand in toxicology?

I'm not sure it's a fundamental difference, Dave.

I think the clients by and large are rethinking what is core and we are having that conversation with virtually all of our clients.

Things that they would never outsource historically, they are beginning to.

Now our discovery business is a relatively small business and a relatively new one and it's an area that the large drug companies have never before even considered outsourcing.

I think it is directionally becoming an operational necessity for them and in certain instances, we actually have a broader offering particularly in the in vivo pharmacology area.

So I think we will begin to see that but again you have to just remember the base upon which we are calculating the increase.

These same clients on the safety assessment side, the regulated tox side, we are seeing variability amongst those clients.

I would say that directionally outsourcing is afoot.

It depends on where the companies are structurally.

It depends on what the pipelines look like.

And given that we have a preponderance of our sales coming from the large drug companies, those that have been slow to get on would reduce the infrastructure and therefore have either kept their work in-house or have reduced their pipelines so dramatically that the work isn't flowing out as quickly as possible.

But I would say that the basic notion that the work directionally will be done in much smaller amounts internally is what's driving this whole paradigm shift and I think that we are seeing slightly better uptick in the discovery business only because of the sheer size of that business for us.

Okay, thanks.

And a dovetail off of that, a follow-up to that, wondering in preclinical how your interactions with the mid tier and smaller clients are developing.

Are they changing their patterns at all?

Yes, we restructured our sales force at the end of 2009 to put more emphasis on the sort of mid-tier kind of small pharma, mid-sized biotech clients.

So we have been spending more time with them.

We have seen less significant declines in that business segment.

They are obviously net outsourcers and this is a group that is reasonably well-funded both by the capital markets and by big pharma money.

Some of that money has gone to stabilize their businesses and not outsource, but generally I think as a group, they will continue to outsource in significant amounts.

But from a comparative point of view, I think the sheer size of the pharma companies and the sheer size of the business that they are doing in a preclinical segment and particularly that work that is still in house and none of us have ever seen it externally is -- that's just a dramatically larger opportunity.

So we are obviously mindful about spending time in both segments with a greater emphasis in the mid-tier that we have over the past two years, but I think that directionally the pharma industry continues to be very important to us in terms of driving growth in the preclinical business.

Okay, super.

Thank you.

I will step back in the queue.

Eric Coldwell.

Thanks, good morning.

I am curious if you could quickly touch on your exposure to government and academic accounts and talk about what you are seeing on that front following some of the negative reports out of the life science tools companies that have exposure to those customers.

If you could just give us an update on where you stand and what you are seeing?

Yes, Eric, we are doing well in the government and academic sector.

That is another area where we have reemphasized our sales focus.

We just simply have more people on the ground particularly focusing on where most of the money is coming in from the NIH and other places.

Our academic sales have been up I'd say the last four years.

I'd say they are up a little bit less at the moment than they were a year ago, but they continue to be up versus other segments that we have, number one.

Number two, a fair amount of our business is pursuant to large long-term government contracts.

We've gotten some new contract this year as well.

That's a very good offset to whatever softness others are seeing in the government sector because once those contracts are locked in, obviously we continue to get the revenue.

And the last thing I would say is even in an area of -- even in a space like this where there is some softness for others, research model purchases as a percentage of research studies tend to be relatively trivial and we don't see the sort of softness I think that others see, particularly people providing expensive pieces of equipment for instance.

So we continue to do well in that sector and its remaining reasonably stable versus what others are seeing.

Yes, that's in line with what I would've expected and it looked like more of the pressure was on high-end items.

Could you just -- I'm sorry if I missed this, could you just give us a current update on how government and academic stands up as a percent of total from revenue?

The last time we calculated it, I think it was about 22% worldwide.

It's a bigger portion of for instance European research model sales and always has been just because it's a greater proportion of our client base.

In the US, we have a fairly significant number of government contracts and that's increasing all the time.

So over the past few years, that has increased on a percentage basis in a meaningful way, but again, a great preponderance of what we do is not in the academic sector.

And when you say 22% worldwide, is that for RMS specifically or is that firm total including --?

Well, it's total, but the great majority of it is the Research Model Space.

Okay, quick follow-up for Tom.

You give us the FX impact on the top line, which was similar to what we had expected.

Could you give us the FX impact on the EBIT line either for the firm or, better, for both of the divisions if possible?

Yes, in the second quarter?

Yes, sir.

You meant I suppose the full year.

The impact would be a couple of cents plus or minus, Eric, in the second quarter.

I'm sorry, when you say a couple of cents plus or minus, $0.02 to the EPS, so we could just (multiple speakers) back out to get to EBIT?

Yes.

Okay, great.

Thanks.

John Kreger, William Blair.

Thanks.

Could you just expand a bit on the efficiency initiatives that you mentioned in your comments?

Where are those focused in particular and how far along in the process are you?

Yes, they are -- this is Tom.

They are focused across the board and so both of our business segments as well as corporate and in addition to that, we're actually looking at revenue enhancements as well.

And the revenue enhancements would be in the context of our existing business as opposed to adding the services as an example.

It is essentially two plus phases.

First phase is exploratory in terms of what areas we should be looking at, coming up with ideas and things like that and quantifying and validating those ideas.

And then the second phase would be implementing those particular items that would determine in Phase I make most sense for us.

When I say it could be two plus phases, there could be some items that, given the amount of time or cost to implement, we might do in a Phase III or following.

So we are at this point in time, we are actually moving from Phase I to Phase II, so we've done a lot of groundwork already.

We've come up with a number of opportunities.

We are creating teams and leaders and moving into the implementation phase, which we expect would take anywhere from three to five months.

So in terms of 2011, it's possible we will have some savings later on in the year.

I would actually hope so, but I think that would be less than more and we're not prepared at this point to provide a particular estimate.

Then I think as we move into 2012, we would obviously expect more meaningful benefits, whether its topline and/or costs, moving into 2012.

And so I think we will obviously provide continuing updates on that on our next quarterly call and at that time that we provide guidance for 2012.

That's helpful.

I think it's endemic in your question, but we are obviously using a third party to help us do that, as we mentioned, with regard to the consulting expenses.

Great, thanks, and a follow-up.

Can you give us some sense about where you stand in terms of staff utilization, not facility but staff?

I'm thinking when you do start to see some -- and pick up across your two segments, can you give us a sense about how much additional revenue you could generate before you have to start thinking about increasing staffing levels?

Well, increasing staffing levels is variable to of course increased work, and I think it cuts across different levels of the organization.

So as we increase work in preclinical, at the nearer term, we would be adding more direct labor technician type people and of course as the revenue continues to expand, ultimately we would be adding supervisors, managers, and at some point additional study directors and things like that.

So in the near term what we generally say is with a smaller increase in revenue, let's say up to 3%, we would probably see a flow through of 50% in margin because we would be adding some technician level staff, obviously some variable costs including animal costs and things like that.

And then as we get beyond that, depending on the type of study, the slope of the ramp, we would be adding additional people and additional support services that would diminish the flow-through of the margin impact.

All right, great.

That's very helpful.

Then one last question within RMS, what are you seeing competitively and what sort of price increases are holding in the market?

Our prices are holding up very nicely on a worldwide basis.

We have had very little pushback and very good adoption across the world.

We have had some intermittent aggressive pricing by several of our smaller competitors.

We tend not to respond in kind because we believe that the quality and the value that we put into the process deserves a premium, which while smaller than it used to be is still there.

So most of our clients, particularly our large ones, are very interested in quality and consistency of supply and scientific input and oversight, and the knowledge that their studies won't be interrupted once they start with a particular species or strain.

So our price increases we feel have always been appropriate and rational, given the amount of investment we make in infrastructure, and clients seem to agree with that.

Could you give us a blended average that you are using for this year?

We're probably at 3%, maybe a little higher.

Ricky Goldwasser, Morgan Stanley.

This is Andy Shanker in for Ricky.

Just real quick, last quarter you guys called out some discrete items which helped your PCS margins.

I was wondering if you may be able to quantify kind of what the negative impact from those were in the second quarter sequentially?

Yes, while we call those out, they weren't particularly meaningful.

I would say the benefit of what we saw in Q1 from those items was less than $0.01 essentially overall.

So while we didn't have those recur, that would I think answer your question.

Yes, that does.

Then kind of following up on that, I think last quarter you guys had suggested that operating margins for PCS for the full year would be above first-quarter levels.

I just wanted to make sure you guys are -- that's still the case.

Yes, what we said on the call was that we expected PCS to be similar for the second half of the year as the first half of the year, so we really see trends sort of maintaining where they are in the first and second quarter, which was of course similar in margin to the first quarter and of course the revenue was fairly similar as well.

So we don't see a lot of change at this point in time for the second half versus the first half in PCS.

Okay, so on a revenue and margin basis standpoint?

And then just finally, just what kind of your thoughts on maybe market share.

Do you guys think you will maintain your market share right now in the preclinical segment or do you think there is some chance that due to your mix you might be dropping a little bit?

We are confident that we are maintaining share in the preclinical business.

I think our client base is stable and we continue to do a solid job with our current pharma clients and some new ones.

And as I said earlier, we've had a major emphasis in the mid-tier now for about 2 1/2 years.

So the big clients tend to want to place studies with the largest providers in this field and it's important to them as they make these outsourcing decisions that the quality of the work is done in similar fashion that they could do it internally.

So we have been able to hold on to them and enhance our relationships with them.

Okay, great.

Just following up on that, in the past you guys have noted that your large pharma clients were doing a lot more of their business in-house because they have the spare capacity.

Have they moved forward towards rationalizing that capacity or is future growth dependent on them kind of growing demand?

I think that's really the fundamental -- the fundamental growth issue for us and I think everybody in this field is the amount and rate of work that's currently being done internally by the drug companies.

How much of that will be outsourced and we are definitely seeing some clients get on with that by closing facilities and/or not using them.

We have other clients that we are in conversations with who are at least indicating that that's going to happen.

We have other clients that have indicated it's going to happen but they haven't reduced the headcount sufficiently and for union reasons or whatever keep headcount at certain levels and therefore keep the work in-house.

And some clients even knowing that the costs are higher will utilize internal capacity until they make a decision to eliminate or reduce it.

I think directionally given what we are seeing from the largest companies, both in terms of what they tell us and what they are doing, it's inevitable that others will follow.

And as we have said historically, we think that the sort of 40% that's currently outsourced could get to 70% or 75%.

Given the rationalization of the pipelines, the primary driver of that is going to be reduction in infrastructure.

I think that's -- we have to look to our clients and not really to our competitors for how that -- how and where that's going to happen.

So we do think it's continuing.

We do think it is a timing issue and all we can do is be available and develop strong scientific relationships with these clients.

And then when they make those decisions have the capacity to do the work for them.

Great, thank you very much.

Tycho Peterson, JPMorgan.

Good morning.

Jim, wondering if you can just talk to any color on that study mix short-term versus long-term and any dynamics around study starts, slippage, some of these other metrics?

You know, there continues to be sort of a normal amount of slippage, but this certainly is some and there's some modest amount of cancellations.

I think that is probably and always always and that's a direct result of drugs not making it, not being able to be formulated, and changes in therapeutic area of focus and infrastructure.

We are still seeing a high number of short-term studies versus what we saw a couple of years ago, so this is more churn in the business model.

That is a continuation I think of what we've talked to the last several quarters.

So it's not brand-new, but seems to be a paradigm that we are in now.

So we have a disproportionate amount of short-term studies and general toxicology work.

While that's okay from a capacity utilization point of view, it's not the best from a margin enhancement point of view certainly versus specialty work, which we had much more of.

And this is a manifestation of budgetary constraints, a manifestation of the quality of the drugs that are in the pipeline.

It's a manifestation of how much is still early on for these companies and they are just not going to do the more expensive longer-term studies until the drugs move further through the clinical trial process.

So it's unclear when -- if or when I guess there will be a fundamental shift in short- versus long-term work, although one would expect that in time we would see more long-term studies than we are seeing at the moment.

And then with regards to kind of managing customers through your own restructuring, has that been a pretty seamless process and can you comment on kind of the willingness of customers to be geographic, open to geographic locations?

Yes, it's been a much more efficient process than I think we would have originally thought.

The direct result for instance of closing Shrewsbury was that most of the clients that were there -- by the way we've retained most of them -- but most of the clients who were there went off and qualified multiple sites of ours.

We are also seeing more and more of that by clients that have stayed with us maybe primarily in one site that there is a lot more auditing going on in multiple sites of ours and we are seeing clients be comfortable with utilizing capacity that we have that's available, capacity that they are either comfortable with or geographically is important to them, or they just simply like the mix of work.

And so I would say that most of our big clients now have qualified and are utilizing on multiple sites.

That's obviously very beneficial for us in terms of managing our infrastructure but also gives them the flexibility of not having to wait for long periods of time as the space continues to fill.

So I would say that that is a trend that we are seeing by large and small clients.

Okay, just a point of clarification.

Your comments on Japan, is the idea that this is kind of a transitory issue and things are going to recover in the back half of the year?

I wasn't quite sure what the take away there was.

The take away was that the impact was less significant than we thought it would be in the second quarter and that we think things have stabilized there for the balance of the year in terms of our ability to produce product and the clients' ability to take it.

Okay, then last one, Tom, I think you had mentioned M&A in one of your comments.

Just talk to your appetite for other new geographic additions or new capabilities.

This is Jim.

We are very specifically looking at small strategic deals and I would put them -- I would call them technology deals, so we are either acquiring an operating company that has some scientific capability that we don't have that our clients want or we are literally acquiring a technology that we think we need to strengthen our current portfolio or add to something that we are currently doing that we want to do more of.

These deals are principally research model related.

They are pharmacology, discovery, as I said, specific technology-related.

I would say that they are all virtually upstream.

A couple of things are geographically based, they could be geographically based and technology based by the way.

And we are going -- we are being and will be very rigorous in terms of the financial stream that we put these things through.

But enhancing and expanding the portfolio is critical to our clients and we get a lot of our ideas for what services we ought to be adding simply through requests by our clients.

We also get some specific ideas for acquisitions with regard to companies that our clients have worked with who think that they might be more comfortable if they were part of a larger company like Charles River.

Great, thank you.

(Operator Instructions).

Douglas Tsao, Barclays Capital.

Good morning.

So, Jim, I was just hoping you could provide a little color on what the trends have been relative to the backlog in the PCS business over the last six to nine months?

I would say that there is some variability in the backlog to go the last six to nine months sort of stable to slightly down.

And I suppose that that sort of jives with the overall demand that we are having, the nature of the demand and the mix between large clients and small ones.

It's sort of the predictability of demand continues to be complex as is the visibility.

And our visibility is only as good as what our clients are able to tell us.

We are still encountering a reasonable amount of churn from them in terms of continuing to rationalize their infrastructure.

So I'd say stable to slightly down.

Okay, and then in terms of your comments regarding acquisitions and largely focused on drug discovery, should we interpret that as commentary from your clients indicating that that is the area in which they are more likely to outsource in the near term?

Or you are having -- perhaps a better way to say this -- that you are having the most constructive conversations with clients regarding outsourcing opportunities.

I wouldn't say that they are more focused on discovery than safety assessments, if that's what you are inferring.

I think that it's a continuing dialogue with them about what they are comfortable outsourcing as opposed to keeping inside.

Discovery is new for them and they're not going to be comfortable outsourcing until companies like us have the scientific capability to do the work.

We have made some small acquisitions and many of our service areas of course we've invested in organically and the specific recommendations come from the fact that they're finding very small, very high quality, but very small companies to do this work for them and they are very uncomfortable that they are going to stay in business.

Or that they will have the sort of regulatory rigor and financial staying power that are essential to them.

So it's more about just making sure that we have the capability to do the work for them as they move away from this.

I wouldn't say that they are emphasizing discovery over safety assessment.

I would just say that discovery I think is a new and growing opportunity for companies like ours.

I think we indicated a couple years ago that it's a $4 billion or $5 billion market opportunity and that's just simply with respect to the areas in which we are currently engaged.

I think the whole area of in vivo pharmacology is important.

I think therapeutic area expansion for us will be important in that domain and perhaps geographic expansion as well.

Of course, we can do some of that ourselves but probably it's best to do that through small, high-quality acquisitions where you are acquiring some very good science and some marquee scientists to go with the business.

Okay, great.

Thank you.

Robert Jones, Goldman Sachs.

Thanks for the questions.

Just on PCS, Jim, you referenced the decline in the back half of 2010 from specialty tox.

I was wondering if you could remind us what drove that?

And then more importantly, how has specialty tox been trending thus far this year?

Yes, so the driver to the specialty tox decline, which has probably been going on for even longer than that is a -- it's a budgetary issue, I would say, and we are seeing clients do two things.

We are seeing clients spend a lot of time early on in the drug development process killing drugs as early as possible when they think they have a very small probability of success.

And unlike let's say 2007 and 2008 where they were doing a lot of very expensive studies earlier in the clinical trial process just is simply waiting now.

And that's likely not to change, so they are waiting as long as possible to -- when they think the drug has a really high probability of being approved or at least getting through Phase III.

And I would say that that's the principal driver.

It's important to still be able to offer those services because once they have a compound let's say in Phase III trials, they are willing to spend the money and it's an area that is somewhat less price sensitive because of the essential nature of moving those drugs forward and the fact that they think they have a chance of making it to the market.

So we still like our footprint in specialty work.

It is a competitive -- more of a competitive play, so the clients are waiting longer to do the work, but we have several areas where we continue to distinguish ourselves not just competitively but with our clients as well.

And then just one quick follow-up for Tom.

I just wanted to clarify, the new expectation around the unallocated corporate expenses is now 6.5% of sales.

That was off of 6% previously.

Correct.

Great.

Lastly, guys, is there any update on the Phase I sales process?

We disclosed that we have sold that business in Q1 and the residual is now being reported in discontinued operations.

Great, thanks for the questions.

James Kumpel, BB&T Capital Markets.

Tom, can you just help us understand -- you took the free cash flow number guidance higher, which is great.

And you basically guided that the second-half earnings are going to be down.

Can you give us some of the drivers in the second half of the year that are going to help accelerate free cash flow?

Of course we are doing a little bit better in the first half of the year.

We do typically do better in the second half -- I don't want to call it seasonality but first-quarter tends to be historically our weakest quarter.

A lot of that is due to residual CapEx carryover and things like that.

And of course we have outperformed as I said so far to date and earnings continues to be good and better than expectations.

So I think it is a lot of those factors.

I'm not sure that I would add anything else to that.

Tax rate continues to be favorable, as we said.

I guess my point is that obviously you outperformed on earnings expectations, but you did $73 million in free cash flow in the first half.

At the low end, you will do another $92 million.

At the high end, you'll do $102 million in the second half of the year free cash flow, while your EPS guidance is maybe $1.08 to $1.17 or something along those lines in the second half of the year compared to the $1.31 in the first half.

So is it that your receivables collections are going to be better, your CapEx is going to be lower?

That was kind of what I was getting at.

Well, we're looking for receivables to be slightly better but not significantly.

If you look at the numbers year over year as well, you will see that of course earnings are being increased year over year.

And as I said earlier, from a seasonal expectation, we do typically do better in the second half some of those things that you have pointed out as well as operating margin and things like that.

Okay.

On the 53rd week issue, you highlighted how it impact to RMS.

Can you talk about its impact on PCS?

I would assume it is less pronounced, but is it the same general drivers of slack demand but maintenance costs that you have to keep?

It would be similar.

I would say that it would be a little bit different and one of the things that we don't know as an example is a lot of clients won't start studies in those periods and since a lot more studies are shorter-term in duration, we do expect that we will be impacted and we will see the same similar trend as RMS.

What we don't know at this particular point in time is how many studies will be held up in that particular period.

Obviously longer-term studies for instance that would run through that period won't be impacted because they will have a start date before the end of the year and let's say an end date Q1 or Q2 as an example.

Those will essentially just continue to be worked on during that particular time frame.

So the variability is about the studies that might come to completion before then and then clients that have studies that will start at or around that period which would just say I would prefer to have my study start in January rather than the week of Christmas or the week of New Year's as an example.

So it will definitely be impacted like RMS.

I suspect the impact would be a little bit less than RMS.

But as I said, it's a little bit less predictable based on the shorter-term studies in nature and we are still a good distance away from that, so we don't have all our schedules filled out at this particular point in time in terms of study starts and stops in and around that period of time.

Jim, just lastly, can you just touch on biotech?

Obviously their funding levels have been improving a lot from the baseline of 2008.

And since you touched on mid-tier pharma as a priority and the point of emphasis, where does biotech stack up?

What are you guys doing with that segment?

We use the term mid-tier to describe small pharma but principally biotech, so the mid-tier comments are intended to encapsulate that so we are focusing more on them.

Lots of meetings with management leadership, CEOs, and heads of R&D working to have more comprehensive relationships with them, contractual relationships across our whole portfolio.

I think we continue to make very good progress there but they have always been a particularly lately in the preclinical business, they have always been a big part of what we do principally since those clients have no internal capacity.

So they will continue to be a focus for us.

Great.

Thank you very much.

Ross Muken, Deutsche Bank.

Hi.

This is [Elizabeth Anderson] in for Ross Muken.

I was just wondering if you could give us a little bit more color on your relationship with some of the large customers without -- obviously without giving any specifics and sort of how that's given you more visibility into the PCS business.

Thanks.

The color is that we have been spending the last two or three years developing much more senior relationships with our clients, multiple senior relationships, and we think that's bearing fruit.

We have talked to them about larger purchasing relationships across the whole portfolio.

We are seeing multiple contractual relationships with clients to do that.

We are staying close to them as they make decisions to take infrastructure out and outsource additional amounts of work and give them the assurance that we will be able to manage that outsourcing for them.

And are trying to provide incentives for them to do that sooner and to the extent that they are not ready, just to have them know that we have the capacity and the capability to do it.

So I would say in short that we know our clients much better.

They have a greater understanding of our capability, our resources, our flexibility, our responsiveness, our IT interface, etc., and I think we are top of mind for them as they make decisions about outsourcing particularly their regulated work.

Great, thanks.

At this time there are no further questions in queue.

Please continue.

All right, thank you for joining us this morning.

This concludes the conference call.

And ladies and gentlemen, that does conclude your conference for today.

Thank you for your participation and for using the AT&T Executive Teleconference Service.

You may now disconnect.