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Covance Inc (NYSE:CVD)

Q3 2007 Earnings Call

October 25, 2007 9:00 am ET

Executives

Paul Surdez - VP of IR

Bill Klitgaard - CFO

Joe Herring - Chairman and CEO

Analysts

David Windley - Jefferies &Company

Brian - Banc of America

Todd Van Fleet - First Analysis

Alex Alvarez - Goldman Sachs

Douglas Tsao - Lehman Brothers

Eric Coldwell - Baird

John Kreger - William Blair

Robert Gilliam - UBS

Sandy Draper - Raymond James

Hari Sambasivam - Merrill Lynch

Jon Wood - Banc of America

Operator

Good day and welcome to the CovanceThird Quarter 2007 Investor Conference Call. This call is being recorded atthis time. For opening remarks, I would like to turn the conference over to theVice-President of Investor Relations, Mr. Paul Surdez. Please go ahead, sir.

Paul Surdez

Thank you, operator. Good morningeveryone and thank you for joining us for Covance’s Third Quarter 2007 Earningsconference call and webcast. Today, Joe Herring, Covance’s Chairman and ChiefExecutive Officer, and Bill Klitgaard, Covance’s Chief Financial Officer willbe presenting our third quarter financial results.

Following our opening comments,we will host a brief Q&A session. In addition to the press release, 19slides corresponding to the commentary you were about to hear are available onour website at www.covance.com. Before we begin the commentary, I would like toremind you that statements made during today’s conference call webcast, whichare not historical facts, might be considered forward-looking statements. Suchstatements may include comments regarding future financial results, and aresubject to a number of risks and uncertainties, of which are beyond Covance’scontrol. Actual results could differ materially from such statements due to avariety of facts, including the ones outlined in our SEC filings.

Now I would turn it over to Billfor review of our financial performance, which begins on page 4 of the slideshow.

Bill Klitgaard

Thank you, Paul. Let me start byreviewing our third quarter results. Net revenues for the third quarter were $396million year-over-year growth, accelerated to $16%. Operating income in thethird quarter was $60.1 million, which is up 22.6% from the third quarter oflast year. Operating margin was a record 15.2%, an increase of 80 basis-pointsover the third quarter of 2006 and a 60 basis-point increase from last quarter.

Net income in the third quarter was $44.6 million, which isup 24.6% from the third quarter of last year, after excluding $2.5 million oftax gain recognized in the third quarter of 2006. And finally, earnings pershare were $0.69 per share in the quarter, up 17%, compared to 2006 on a GAAPbasis, and up 25% after excluding the $0.04 income tax gained in the thirdquarter of last year.

Please turn to page 5 of the slide show. In the thirdquarter of 2007, Early Development delivered 50% of our net revenue, andLate-Stage Development contributed 50%. On a geographic basis, the U.S.contributed 63% of our third quarter net revenue; while the rest of the worldcontributed 37%.

Now, please turn to page 6 to discuss segment results. InEarly Development, net revenue in the quarter was $199.5 million, an increaseof 19.2% over last year. Operating income in the quarter was $51.8 million, anincrease of 28.4% over last year. Operating margin was 26%, which is up 40basis points from 25.6% last quarter, and up 190 basis points from 24.1% in thethird quarter of last year. These excellent results were delivered by strongbroad based performances across the segment.

Turning to Late-Stage Development, net revenues in thequarter were $196.5 million, which is up 12.9% over last year. Operating incomein the quarter was $34.4 million, which is up 13.1% over last year. Operating marginin the quarter was 17.5%, which is unchanged from a year ago, but up 70 basispoints from the 16.8% reported last quarter. Year-on-year improvement inclinical development and increased central lab operating margins were offset bylower OM and market access services.

Now please turn to page 7 to recap some of the backlognumbers. During the quarter, our backlog increased to $137 million, to a record$2.6 billion, driven by strong net orders as well as $40 million resulting frompositive foreign exchange impact. Year-on-year backlog growth was a robust26.5%. Net orders in the third quarter were $493 million which is up 14% fromthe $432 million reported in the third quarter of 2006.

Please turn to page 8 for the review of cash flow data. Inthe third quarter, our DSO was 47 days, which is up one day from the end of Q2,but down eight days from Q3 of last year. Cash at the end of the quarter was$260 million, which is up $52 million from last quarter. Operating cash flow inthe third quarter was $84 million, capital expenditure for the quarter was $43million, and free cash flow was $41 million.

In 2007, we now expect the capital spending to be at least$165 million and free cash flow to be approximately $80 million. We haven’tfurnished the details for the 2008 budget, but we do anticipate higher capitalspending in 2008, as a result of the new preclinical facility we are buildingin Arizona,other toxicology expansions, and several key IT systems projects.

Finally, corporate expenses in the quarter totaled $26 millionor 6.6% of revenue, which falls within the range we communicated to you lastquarter. We continue to expect similar levels of corporate spending for theforeseeable future, reflecting enterprise-wide infrastructure investment thatsupports the higher growth rate of the company.

Now, I would like to turn the call over to Joe for hiscomments, which begin on page 9 of the slide show.

Joe Herring

Thank you Bill, and good morning everyone. On behalf ofCovance’s 8700 employees around the world, I’m very pleased to report our thirdquarter results.

Revenue growth accelerated for thethird consecutive quarter to 16%, and operating margins expanded both on ayear-on-year sequential basis to a record 15.2%. This revenue and marginexpansion combination produced 25% earnings-per-share growth. Demand for ourbroad portfolio of drug development services continues to be very robust. Wedelivered strong net orders of $493 million in the quarter, a 26.5% growth inbacklog to $2.6 billion.

Please turn to slide 10 forreview of our Early Development operations. In the third quarter EarlyDevelopment again experienced very strong revenue growth of 19.2%. Operatingmargin was up 26%, with an outstanding performance, and represented a 190basis-point increase from last year. In the first three quarters of 2007, ourEarly Development teams have produced revenue growth in excess of 20% and a 70basis-point increase in margin year-on-year.

In support of these long-termgrowth opportunities, we continue to invest in new capacity and scalableinfrastructures. In the third quarter alone, we opened three new EarlyDevelopment facilities across three continents. In North America, we opened a state-of-the-artABSL-2 facility in Denver, Pennsylvania, which enhances our vaccineservice offering. Vaccine research is one of the most active areas of newproduct development for our biopharmaceutical customers.

In Singapore, we opened a purpose-builtnutritional chemistry laboratory to serve the Asian region. This facility willbe processing examples for some of the world's largest infant formulaproducers, which are based in Asia. We aretransferring other assets from our Madison Laboratory, which will prepare the Singapore teamto support the product release, stability testing, and labeling data requiredby our clients.

We believe there is a strongmarket opportunity for independent and internationally reorganized safetytesting for companies seeking to export food products into the United States.

In Europe, we opened another expansion of our Münster, Germanypreclinical facility, which is our toxicology [scientific] excellence forhighly specialized primate studies. In addition to the significant expansion ofthe site, we also installed state-of-the-art group housing accommodation forprimates. We believe these investments differentiate Covance Münster as thefirst toxicology facility on the continent, and meet the recent Europeanregulations, which went into effect this past summer.

These three facilities meet unique market needs and fulfillthe capacity requirements we spelled out in our strategic plan. Each of thegrand opening events for these facilities were heavily attended by client andvisibly supported by local government officials. Feedback has been verypositive.

Other investments in our multiyear goal of the toxicologyexpansion plan are also progressing according to schedule. Construction on theremaining shelf space in Madisonis on track and a new space should be available to our clients in beginning ofthe upcoming year. In Chandler, Arizona progress is clearlyvisible with a specialty steel frame taking shape. We continue to achieveproject milestones. That we expect for these projects. And we remain on trackfor opening new facility in 2009.

Finally, in Harrogate UK, we are now beginning construction ofour third large toxicology expansion of this decade, which we also expect tohave come online in 2009. Both our current demand and experience, and ourprojections for the future will need additional capacity, even beyond thesecurrent expansion plans. As we have demonstrated over the years, we have enableto sustain or expand toxicology operating margins even as we build out, and we stillhave a need for testing.

Return on investment for our newtoxicology capacity continues to exceed our expectations and exceeds the Company'saverage return on investment and substantially by our cost of capital.

We continue to have discussionswith clients about using our services more strategically and I expect a fairamount of the new capacity we are building will be utilized under dedicatedspace toxicology contracts. Either way, we continue to see very strong andincreasing demand, which gives us confidence to invest.

Over the past year, we have beenasked our thoughts regarding toxicology services in China. Simply stated, we see China as anopportunity, for an opportunity in the mid to long-term. We come into thisconclusion after numerous exploratory businesses in China, including discussions withSFDA, the Ministry of Health, [tours] about the existing and proposedfacilities, as well as significant discussions and information sharing withmany executive decision-makers in key client organizations.

We see several years passingbefore the Chinese facilities are up to the US GLP standard, and many moreyears before these operations make a meaningful contribution to the globalmarket. Operational and service excellence in our business starts gettinghighly specialized and GLP experienced talent are in place. And it will taketime to get that right in China,Indiaor any emerging market. Frankly only a fresher’sfew companies get it right on a large-scale basis in the U.S. and Western Europe,even after all these years.

Although we do not anticipate making the toxicologyinvestment in Chinain the immediate future, we do expect us to have a presence to service, what webelieve will be a nice opportunity at some point. And we call that in China for China, that is, servicing the localand regional market with world-class toxicology services.

In the near term, the strongest growth opportunities inChina are clearly in Late-Stage Development, and we are making investments andadding staff to participate in that growth opportunity. To help us execute our China strategy, I’m pleased to have Dr. HonggangBi, who joined Covance as Corporate Vice President and General Manager for China,reporting to me and joining the company’s senior most executive managementteam.

Honggang is a well recognized world-class pharmaceuticalscientist, who has held significant management positions at both GSK andPfizer. More recently, he was the CEO of an analytical chemistry company withoperations in the U.S. and China.Hong Gang is responsible for all our businesses in China and we will have oversightfor the entire Asian region.

Please turn to slide 11 to discuss Late-Stage Development.Our Late-Stage Development segment continues to show improvement, as revenuegrowth and operating margins increased for the second consecutive quarter.Central laboratory services continue to recover from the lower kit volumesearlier this year, and both revenue and operating margins increased on asequential basis.

As we forecasted last quarter, the sequential increase wasnot as large as the jump from Q1 to Q2 during the historical summer seasonpattern. But we continue to expect to see sequential improvements goingforward. With the rolling 12 month book-to-bill ratio in excess of 1.5 to 1,and a backlog of larger than $1 billion, we continue to believe that ourCentral laboratory is poised to deliver strong growth.

In fact, our central lab salesteam delivered another record order total in Q3 by wide margins. During thethird quarter, we opened a new purpose-built 13,000 square foot central lab in Shanghai, China,which is designed to support a growing number of global clinical trials thatuse the Chinaarm of a Phase III study. This laboratory uses the same technical platforms,methods and procedures as other labs in our network, to ensure high quality andcombinable laboratory data, regardless of location.

Our Phase II preclinicaldevelopment team delivered another strong year-on-year performance in the thirdquarter. Phase II preclinical trial activity tends to moderate somewhat duringthe third quarter as employees, investigators and patients take summer vacations.So we were also very pleased to see the sequential growth and experience in Q3of this year, as well as continued year-on-year improvement in operatingmargins.

On the talent front in clinicaldevelopment, we continued to attract new employees to our team at a pace toenable achievement of our project commitments to clients. Even moreimportantly, we have been experiencing higher than normal employee retentionrates, well above our typical industry rates. And I credit these investments tonew tools, process improvements, our therapeutic focus in segmentation, and executionof our compelling offer-talent strategy by our leadership team in clinicaldevelopment.

In commercialization services,few biological launches so far this year, which is the key growth driver forour reimbursement hotline services, continues to impact revenue and margins inour market access services.

We remain confident that ourstrong market position, together with the continued record funding of thebiotechnology industry, and increased proportion of biological products in thephase III pipelines, will provide opportunities for market access to resume in itsgrowth trajectory in the future, albeit, not in the very near term.

Our commercialization service segment also includes Periapproval services, which we are investing to capitalizeon the attractive growth opportunity. The post marketing studies we believewill be accelerated by the implementation after PDUFA IV. During the thirdquarter, we made several key hires to augment both the operational andcommercial leadership of our periapproval business.

Please turn to slide 12. Based on many discussions withclients this year, we see continued robust demand for outsource drugdevelopment services continuing into 2008, and beyond. Strong funding continuesto drive drug development investments by our biotechnology clients.

In addition, large pharmaceutical clients are urgentlylooking for ways to convert their maps and development infrastructure fromfixed to a more variable cost structure. [Term] are increasingly looking tomarket leading CROs like Covance, which help develop and eventually executeconversion plans in the years to come.

In addition to these positive macro industry trends, anumber of Covance specific earning drivers give us reason for optimismincluding expanded toxicology capacity; the client ship towards more strategicviews of preclinical services; the strong demand for our clinical pharmacologyand chemistry service offering; the conversion of our billion dollar centrallab backlog to revenue; the improving growth of productivity and profitabilityin clinical development; the continued contribution of Six Sigma benefits asapplied across on entire organization; and finally, the benefits to eye fromour infrastructure investments and talent in Information Technology.

To expand on this last, it'simportant for us to continue building a scalable and automated ITinfrastructure, which will better position us to capitalize on very attractivelong-term growth prospects.

Accordingly, we expect to makeconsiderable IT investments over the next two years. We have developed a systemsarchitecture and integration plan for each key business line. And our supportfunctions, including an enterprise wide implementation of People Soft financeand accounting is a significant upgrade to our central laboratory database,including enhanced automation tools and an expanded data reporting system.

The final implementation phase ofour upgraded pathology and toxicology system and continued automationinvestments in our Phase II free service offering, we expect these investmentswill make our operations more scalable, top drive margin expansion and furtherenhance the Covance’s brand as we deliver drug development data to our clientsin a faster more efficient and seamless manner. Said another way, we plan touse IT systems and talent to make Covance’s capacity increasingly feel like ourclients very own, just faster and more flexible.

Moving to our outlook, our strongfinancial performance during the first nine months, and we just raised our fullyear 2007 diluted earning-per-share target to $2.65. Looking at 2008, we areagain targeting revenue growth in the low to mid-teens range, and dilutedearning per share growth of 20%. Achieving these targets will mark Covance’seight consecutive year, with earnings per share growth of 20% greater.

To close, I would like to saythat I am extremely proud of the extraordinary effort put forward by Convance’semployees in the third quarter. We are focused on delighting clients, whereasto deliver accelerated revenue growth, record profitability, 25% EPS growth anda strong backlog of orders to drive the future success of Covance.

Thank you for your time this morning. And I would like toturn the call over to the operator for the Q&A session.

Question-and-Answer session

Operator

(Operator Instructions). We willhave our first question from David Windley, Jefferies & Company.

David Windley - Jefferies & Company

Hi, congratulations on a good quarter.Thanks for taking my question. Joe, I wonder your closing comments you talkedabout conversations some of the clients and outlook for growth and demand fromthem. I wondered what, why you will mark research might shift on clients viewsfor function outsourcing as the approach shifting their cost structure towardvariable costs and what benefits or challenge that create for Covance?

Joe Herring

Well, David on clientconversation there is a sort of moderation. It seems to be going in thepolarized direction in a couple of years ago were functional outsourcing wasadopted heavily by several clients, other clients will fully service. Both endscan moderate more toward the middle, where even people who are using functionaloutsourcing on a large scale basis.

We are seeing full service needspart to be part of the arm and interior. And people who were full service areseeing opportunities to use functional resources on a case by case basis. So, Ithink both are going to fit in to the next to the mix on a go forward basis.

David Windley - Jefferies & Company

And I mean, Covance can serve ormanage around to deal with either case?

Joe Herring

We believe, we add the most valueto our clients, when we provide the integrated services bundled either leadingto an IND oran NDA. We think we can get faster timelines, we can run more projects inparallel with that of series, and we can have sort of one point person fromCovance that’s empowered to make decisions, and the corollary on the clientside.

However, not all clientsnecessarily see it that way, and we are increasingly changing our serviceoffering to meet a broader range of client needs. Having said that, we stillstruggle to see a pure functional service provider model creating long-termvalue from our clients. We worry that while there maybe some short-term gains,the long-term challenge for our client is getting clinical trials done on timeand accurately and getting to market faster, and having a completelydisaggregated contract trial reporting it to get back together. I think it’sstill an unproven commodity.

David Windley - Jefferies & Company

Okay. Moving to Central lab youmentioned the very high level of orders in the third quarter. Could you give asense and you also mentioned the backlog being over $1 billion. Could you givea sense for what the typical or average duration of contractors in Central lab,and do the third quarter orders move that meet with all?

Joe Herring

We do have average duration of acontract. I think, we’ve said pretty consistently over the last year thatgenerally trials are lengthening both in total fashion and also in some of thereally hard areas being metabolic oncology and cardiovascular. I guess that’sreally, all I have to say.

David Windley - Jefferies & Company

Okay. But as it relates to thethird quarter orders they would look a lot like what you have been seeing overthe last several quarters?

Joe Herring

No. They look very different.They were 20% higher than the all-time record we’ve ever had.

David Windley - Jefferies & Company

Okay, well, other than that?

Joe Herring

But in terms of the therapeuticcategory and geographic spread, I don’t have that information right now, but itwas a very good quarter for the team.

David Windley - Jefferies & Company

Okay. Last question incommercialization specifically market access you commented and have beencommenting about the lack of biologic launches. Can you provide some insightinto the steps that you are taking to mitigate the margin hit from that softnessin the short run until you start to see the biologic affordable up tick?

Joe Herring

Well, I’ve commented before.(inaudible) has been with the company for 16 years always in the segment and hehas a very effective model for how he ramps up staff and ramps down staff asvolume changes. We also completed implementation of a very robust IT systemjust the Siebel System completed full implementation about last year. And weare seeing nice automation benefits would help us preserve margins.

The steps that we took at thebeginning of this year to create consolidated commercialization business thatleverages both our combined -- both our periapproval and our market accessbusiness has also provided opportunity to more effectively leverage theoverhead of those two separate businesses, number one.

And number two is there is a lotof activity and lot of discussions going on related to post marketing studies.And frankly the extraordinary talent that US have in the current economicsoutcomes business risk map type of expertise is really, really helping our periapprovalbusiness in the new heights, we’ve made there.

So its sort of combination ofthings, but again we feel very confident that the number of biological launcheshas definitely got to increase. We don’t see in the first half of '08 maybe noteven in '08 at all. It’s certainly '09 and '10 and because our strong marketposition there. We want to maintain our expertise and our capabilities.

David Windley - Jefferies & Company

Okay, I got that. Thank you.

Joe Herring

Thank you, David.

Operator

We will have our next questionfrom Jon Wood, Banc of America.

Brian - Banc of America

Thanks. This is [Brian] clearedin for Jon. Your operating cash flow guidance suggest sequential decline in Q4.Is there any other reason for that other than conservatism?

Bill Klitgaard

I think the way to the parts,such as the kind of feel back the numbers. We said 165 or at least 165 of CapExand we got 105 year-to-date. So that would implies $60 million of capitalspending in Q4 or higher. We have talked about free cash flow of $80 millionand we backup year-to-date, which we going to come back with is basically kindof the net income for the quarter consistent with the earnings per share 265.

D&A kind of the trending oncurrent levels and the working capital if you look at working capital at thepresent of revenue being pretty much consistent with current levels of workingcapital. So as revenue grows, we get some increase in working capital some useof cash there. They are modeling. You'll see that the numbers come out and sotry to get. We are not indicating any thing how the ordinary I will think forQ4.

Brian - Banc of America

Okay. One more did you sawimprovements appeared to have perhaps level off a bit. Have you had astructural wall on your penny in terms of further improvements or is itreasonable to believe that the metric can continue improving in the comingperiods.

Bill Klitgaard

Yes. Well, 47 days I think thisfavorably compares to some of the other performances you’ve seen elsewhere inthe industry. I think also it down 8 days from last year. That said, there isstill room for improvement. We’ve activities going on throughout all of ourbusiness units to look at this and some places are more successful than others.

But it’s an going pressure forall of our finance leadership company trying to make DSO come down overtime.And also this is a seasonal factor which should be coming into Q4, which shouldbe favorable, I think the DSO potentially. We look forward to that happening.

Brian - Banc of America

Okay, thanks.

Operator

We’ll have our next question fromTodd Van Fleet, First Analysis.

Todd Van Fleet - First Analysis

Good morning guys, nice quarter,I think, we heard you talk a little bit earlier about your ability to achieveyour ROI. Obviously you spend a lot of money this year and CapEx, spent a lotof money next year, I think even more so than this.

In terms of CapEx so guys, I’mhoping you can just help us to understand is relative to may be the past coupleof years and maybe as you look forward or the next two years is the ease withwhich you are able to achieve that ROI hurdle rate, is it becoming easier andI’m hoping you can talk about that in the context of construction costs, therate of increase of construction cost relative to the pricing environment thatyou see on toxicology and Central labs perhaps?

And then somewhat related to thatpoint, if you could tell us what percent of capacity do you need to beoperating both in toxicology and Central lab in order to achieve that hurdlerate?

Bill Klitgaard

Well, although toxic capacity,which is a little, bit negative, very complex answer. We’ve to spend a lot moretime to get into an understanding fully all dependent on the mix of work essentially.But in terms of capital costs, we have seen the same kind of pressure that manyother companies have seen in terms of construction cost going up in the lastyear or so, because of demand for steel in China, other things impacting theconstruction cost.

So we’ve suffer to that a littlebit as well. So in that regard making a high ROI is never easy and hasn’tbecome easier. That said, the profit margins of the company and if you look atour trend here that may increasing and so ROI by nature of being operatingincome divided by investment essentially later, after tax income being dividedby investment.

In some respects that becomeseasier as margins hit higher. But I guess the takeaway I like you to having Iknow there is to think about this. We’ve focused on return on capital intentlyand in terms of everyday, when we look at capital expenditures we make in thecompany, we have been kind of writing the company that way over the last fewyears. It’s paying off now. We are certainly not taking for granted or assumingit’s easy to get there. It’s a hard spot everyday.

That’s a kind of major driverprofitability in companies, high capacity utilization. And we have demonstratedan ability to add capacity and expand ROI even as we make unpleasant capitalinvestments. I can tell you, we turned away COGS of toxicology work in thethird quarter.

And we believe that there is anaccelerating outsourcing trend across the preclinical now in toxicology, bloodchemistry and also in Phase I. And someway we got to step up and provide theinvestment in the capacity for that conversion to occur. And Covance is bothwell and prepared and we have a proven model, I have been able to provide thatcapacity it helps drive strategy outsourcing and improve ROI as we go.

Todd Van Fleet - First Analysis

Great, thanks.

Operator

We'll go next to Alex Alvarez,Goldman Sachs.

Alex Alvarez - Goldman Sachs

Good morning, guys andcongratulations on the quarter. I was hoping, we could start off with the EarlyStage business and as you look at the various factors that benefited margin.Just wanted to get a sense from you in terms which you felt were the mostimportant to be a large increase, we saw in the quarter?

Bill Klitgaard

Big drivers of margin expansion,I think, Early Development it was sort of broad based. I think, I’ve mentionedthat in my comments both tox and chemistry had outstanding performances in thequarter with margin improvement and strong growth. So, I really can't pin it onone particular area sort of across the board.

Actually chemistry grew fasterand has higher margins and even toxicology, serve well for our base. And againanother very good performance in our clinical pharmacology business as well asnutritional chemistry.

Alex Alvarez - Goldman Sachs

And I think that pricing reallyhas not been much of an issue for sometime now. Just trying to get yourthoughts in terms of where pricing sits right now in the minds of customersthat they continue to increase the amount of work that they do with companies likeCovance?

Joe Herring

Well, Alex, we don’t talk aboutpricing going up or down. The reasonable is because our models provide apremium at fair price. And we don’t vary price when capacity gets high takeadvantage of clients nor that we tend to drop it, we are in capacityutilization as well.

We want clients to know what theyexpect, when they come to Covance in terms of a high quality scientific leaderthat they know, a [solid] team that they are familiar with, prices seemsappropriate and just pile in the work. And as they continue to pile in thework, we get more comfortable as to move to a preferred agreement into adedicated capacity agreement. And we do not use price as a way to sort of soupup short-term results.

Alex Alvarez - Goldman Sachs

Okay. And maybe turning to otherLate-Stage segment, can I ask you just discuss some of the investment that youtalked about making the periapproval business to improve your ability to servethe industry. You do see an increase in post approval studies in that? Relatedto that have you started have discussions with clients about their plansregarding Late-Stage trails?

Joe Herring

Well, in terms of investments wehave added significantly to our staff of Epidemiologist as well as othermedical staff. We have been increasing the size of our project managementorganization. The investments are primarily in people. And I’m not sure I mustsay understand, the second part of your question talking with clients aboutclinical trials.

Alex Alvarez - Goldman Sachs

No, just wanted to give a senseobviously there is been a lot of discussions might be about the possibilitythat we could see a lot of post approval, the pick up in the number of postapproval studies. Just was curious, whether you are having those discussionswith clients and what your stands further about their plans to meet some of therequirements?

Joe Herring

Yeah, I think, everyone is stillsort of trying to figure out at the AAA or PDUFA IV and exactly what thatmeans. There is a really two segments. One are going to be both mandated postmarketing surveillance studies and increased enforcement by the FDA in thatarea.

And that's involved was going tobe a growing trend of clients, who want to differentiate their products, byshowing tangible evidence, better safety profiles or longer term efficacy insome of these grab the spaces. We have seen an increase and we will talk aboutit, when some others orders come in.

Alex Alvarez - Goldman Sachs

Thank you.

Joe Herring

Thank you, Alex.

Operator

We’ll go next to Douglas Tsao,Lehman Brothers.

Douglas Tsao - Lehman Brothers

Thank you. Good morning. Joe, Iwas wondering that you’ve talked a lot about possibly expanding the Phase Ibusiness, at this point most of your Phase I capacity is located in UnitedStates. I was wondering have you thought about expanding your Phase Ioperations abroad?

Joe Herring

Absolutely.

Douglas Tsao - Lehman Brothers

And any particular region wouldinterest you?

Joe Herring

I guess for competitive reasons,I don’t want to comment right now because we’re in discussions in a couple ofdifferent areas. But I just say stay tuned. I’m not implying of changingeminent. But as you well know as it sort of a sellers market in Phase I rightnow, and we’ve had I think, pretty good luck in finding fairly valued andvaluable assets in both Radiant and [Global] Clinic and we don’t particularlywant to tip off exactly what we are doing right now.

But Phase I continues to be thehardest and fastest growing area of drug development in the scenario under theleadership of Dr. Mary Westrick that we’ve fairly good model.

Douglas Tsao - Lehman Brothers

Okay. That’s fair enough. Andthen in terms of the margin in the Early Development, it was best margin we’veseen since the third quarter of 2005 and at the time, I believe, Billcharacterized it is sort of perfect storm of positive influence. I waswondering, if you could provide some comment on the margin that we saw thisquarter and whether you think that it’s perhaps a little more durable?

Joe Herring

I think, the extraordinary marginthat we saw, I think, we hit 26.1% it was at a time when research products andparticularly primate business was sort of going over the moon and people arebuying in early and sort of rash buying. So, that was true and extraordinaryevent, what we are seeing today is much more broad based, it’s not a somethingone off kind of an event.

Our strategy sometimes seems veryboring, but it’s operational and service excellence, which retaining clients,they keep attacking in more work, high utilization of our capacity and it isbroad base.

Douglas Tsao - Lehman Brothers

Okay. And then in terms of theCentral lab, have you sensed, you talked about last year when we saw somedeceleration you could have talked a little bit about that study mix shift.Have you seen any changes in the mix shift, has been new business wins in 2007?

Joe Herring

Last year, what we suffered hereand we talked about was some of the therapeutic mix shift.

Douglas Tsao - Lehman Brothers

Yes, with that regard.

Joe Herring

Okay. Where we come back to interms of the current order performance is more of a traditional mix of work, inother words, how much we have in oncology, how much we have in cardiovascularand so forth. That said, there was always clinical indications and theirdifferences even within therapeutic area in terms of clinical trails in variousclinical indications.

So, it's never quite as clean inanswers as this is simple answer, but we are back to more traditional mix. Thatsaid, it’s important to understand that the clinical trials are moving moretowards most geographies because they need to get patients enrolled. And thathas got impacts on both clinical business and also on central lab business.

It takes longer to startup withstudies and so in a sense with the lag time from the win to first get in, it’sabout twice a longer see for example it is in the US. And so even though that thebacklog high and all the factors are looking very positive for central labs, wewant to be cautious about the kind of projections we’re making here, because ofthat general shift in the overall market place. Just want to be cautious aboutthat.

Douglas Tsao - Lehman Brothers

And then Joe you are referringsome upgrades to the toxicology IT system those wondering that you are comingout with the new version of Study Tracker? Is that what you are referring tothat?

Joe Herring

No, I am sorry Doug, I wasreferring to there was a commercial off the shelf system called [IBN] thatwe’ve used for 40 years in our business or 30 years something like that. Andwe’ve been part of the consortium along with some the top pharma clients andhelping them expand and upgrade that system. And we’ve been rolling that outover the last several years it’s a sort of a daunting project.

And we’re replacing handwrittensystems that we’ve in one location, manual systems that we had in the Netherlands,and sort of the most recent version of IBN being upgraded to the new version.And we’re probably half way through with that. We’re very happy with that, thisis not a risk of technical success. It shoots out, it’s to do it right, we aretaking our time. Study tracker upgraded is clearly something that we’re workingon and we haven’t actually launched the project yet. We’re still gatheringcustomer requirements.

Douglas Tsao - Lehman Brothers

Just final quick questionfollow-up on that, do you any of your competitors have access, are they part ofthis consortium under IBN?

Joe Herring

Not the worse steam that I’mtalking about.

Douglas Tsao - Lehman Brothers

Okay. Thank you very much.Congratulations on the quarter.

Joe Herring

Thanks.

Operator

We’ll go next to Eric Coldwell,Baird.

Eric Coldwell - Baird

Thanks and good morning.Following upon some of more recent questions. I was hoping that you could givean update on Radiant specifically yeah, I think, you had three facility movesover the last six to nine months. And I’m, just curious how those are doing andthen and may be a comment on the section over all?

Joe Herring

Well, I guess first of all Eric,we are no longer than a breakout Radiant and comment separately Mary Westrickand her team have created a centralized proposal management and centralizeddemand management organization, such that we don’t receive quote in San Diegoand respond to that [quote]. It goes into centralized function that looks atthe nature of the study, which geography has the best volunteer approval forthat. And its place either in anyone of the ten locations in the US andso it’s a little bit, it’s increasingly difficult for us to break that out.

And so at this point now it isfully integrated. We think that is the full pharmacology business. Having saidthat the clinic form business continues to perform very well and we continue tosee the former Radiant size continue to move to higher levels of capability,higher levels of capacity utilization. It easier and easier for us to recruittalent into the clinic form business and clearly that acquisition is fullyprofitable, fully accretive. And so, at this point I think more job and standand talk about global [pinpoint].

Eric Coldwell - Baird

Whether it would be safe to say,Joe that clinic form in aggregated is back to the margins you saw beforepurchasing a Radiant or is that not yet the case?

Joe Herring

Let’s see if I have that rememberhandy. I don’t have that number and I don’t want to be careless here. We’llhave target back to you, but its uncertain than been ramping to that number,whether it’s exactly there or the other not. I just want to be careful. If youlook at the numbers and it’s fair to say that global clinic form is thatmargins, which are consistent with historical trends.

Eric Coldwell - Baird

That’s great. Second question iskind of two part. Central lab I know that you talked about the year-to yearimprovement. I am unaware, if you commented whether Central lab was upsequentially quarter-over-quarter in terms of volume, Joe, so if you couldquantify that I assume it was. And then as an adjunct to that I’m curious, areyou seeing increased cross sell between the lab and the bioanalyticalcapabilities. And can you give us an update on what’s happening in thebioanalytical facility in terms of volume and pricing?

Bill Klitgaard

Okay. First of all regardingCentral lab volume was up; revenue was up a little bit sequentially. I think,seven of the eight last years. We’ve had a sequential decline from Q2 to Q3 dueto the seasonal patterns that we talked about related to Phase II preclinicaltrial. So, the fact that it was up a little was encouraging and as we did saymargins were up in Central lab. But we sort of may get through the summer andlook forward to continue to see sequential improvement in our Central lab.

Joe Herring

And by the way just to, we doshare a facility with the bioanalytical facility but that business has beenvery strong in its performance. And I’m not sure, I would, try that to CentralLab, I think they just had a very strong performance in the marketplace thistime around.

Eric Coldwell - Baird

Now, when you build BioLink lastfive years ago, six years ago, I forget the exact time part of the top processwas that maybe you could capture an increasing number of those lab samples inthe facility or at least quite fill the two services on combined projects. I’mjust curious, if we can get an update on how that’s tracking?

Joe Herring

Yeah, I would say Eric that was avery good theory that has improving itself out. There is a little bit of thatbut not as much as we’ve had in our investment case. There are other variablesthat have driven the success of our biomedical business. They are having afantastic year, got a good strong year last year, but it's related to otherthings with our clients value more that not having the ship the sample fromcentral lab to another biomedical house.

Eric Coldwell - Baird

Fair enough. Thanks, greatquarter.

Joe Herring

Thanks, Eric.

Operator

We will go next to John Kreger, WilliamBlair.

John Kreger - William Blair

Hi, thanks. The question aboutyour preclinical tox business and dedicated space agreements, is your largecustomers kind of think about their business at increasingly global way? Do youdedicated space agreements start to expand multiple size for those discussionsstill very sized specific. And what I’m getting at is, do you think that therewill ever be an opportunity for load balancing or cost of various facilitiesaround the world?

Joe Herring

Well, the dedicated spaceagreements that we announced at the beginning of this year is with a globalcompanies that have toxicology facilities on multiple continents. And the waythat contract was written, they are using multiple locations.

Having said that, even in thatenvironment, toxicology decisions are still made on a regional basis, it isvery unusual for that study. Let’s say a general tox study for sure and evenquite a few areas especially tox that have an American company place a study inEurope or vice versa.

The one exception in ourportfolio was clearly Münster is the primary specialized excellence for variousocular reproductive tox and they attract work on a global basis. So that is anexception, but by in large with load balancing is less important to ourclients, because they tend to have large chunks of work in both US and Europeand preferred the place to work globally, where they can be there for studystartups, sometimes for interim sacrifice ought to go in and problem shoot ifthere is a safety signal with face to face with our scientific staff.

John Kreger - William Blair

Great, thanks. And then relatedquestion, as you bring on this space, is there a limit in terms of capacityutilization that you’ll allow to go towards dedicated space or you’re alignedto allow that to go up to 100% theoretically?

Joe Herring

I’d love to have it at 100%. Ithink, we’ll have to get there but it’s great for us and it’s great for ourclients.

John Kreger - William Blair

Okay. And then one last questiontalking about the periapproval business are you seeing those decisionsgenerally linked to the pivotal Phase III work or is that really a separatedecision maker within the clients?

Joe Herring

Its client specific and somethought that it was only remodels and some thought of the others so it is notan absolute.

John Kreger - William Blair

Great, thanks very much.

Joe Herring

Okay, John.

Operator

We’ll go next to Robert Gilliam,UBS.

Robert Gilliam - UBS

Good morning. I just had a coupleof questions on 2008 guidance. My first is that whether not guidance includesany acquisitions or share repurchases?

Joe Herring

No.

Robert Gilliam - UBS

No? Okay. And then just as far asanything in guidance or there any business units that used really like most ofthe units are performing at or exceeding expectations? I was just curious, ifyou have any risks or concerns, if there was any particular business that yousee as a risk in 2008.

Joe Herring

Well, we called out the marketaccess business. Again that’s market access is some fraction of our totalcommercialization and hotline businesses some fraction of market access. Soit’s not a huge percentage of our revenue, so it would be a very modest impact.We have talked about cardiac safety services over the last several quarters.

They have had two consecutivequarters of nice volume growth and nice revenue growth in the last twoquarters. Net orders have been much better than it were for the two quartersbelow that. Having said that, it still less than 2% of our revenue. So that’srisk that’s sort of turning around the other way.

But our risk factors are stillabout improving pretty clearly in our financial documents. There all sorts ofregions why we work sort of 24 hours a day around here. With our broadportfolio is not like everyday we wake up and the only thing we’ll think about thetoxicology. We have a big central lab business, a big global clinical businessand commercialization services and research products to make IT investment.

So, all of those you could add upand say there is implementation risks I, mean there is service quality issuesand frankly why that’s a reason why we guide to our revenue targeted low to midteens. We think that in that growth ranges of sweet spot we can drive goodearnings growth a lot of that with margin expansion. But also control sort ofthe scale of what we are doing in the quality, what we are doing. So hopefullythat helps you.

Robert Gilliam - UBS

Yes, yes. So, I guess in youropinion is your guidance conservative would be 20% first half of the year thecomps are pretty easy. I was hoping you can give me a read if you think this iskind of a [big dictionary] or if you feel the numbers that put out this prettyconservative?

Bill Klitgaard

When you get to $1.5 billionbusiness that is literally composed of one project at the time with employeesin 56 countries. Well, growing the top line low to mid teens and being able toget margin leverage of that, while you are making big capital investments andhiring staff. I think, it is a pretty tall order at the size and scale that weare at.

So, there are many companies thatare $5 billion in revenue that can consistently post 20% EPS growth, and wejust finished our guidance with say eight consecutive years. So, I feel prettygood about it.

Robert Gilliam - UBS

Okay. You had a great quarterguys. Thanks a lot.

Joe Herring

Thanks, Rob.

Operator

We will go next to Sandy Draper, RaymondJames.

Sandy Draper - Raymond James

Thanks. Most of my questions havebeen asked. But there is a couple of quick follow-ups. On the Central lab side,you obviously commented really strong backlog. You pull through a little bitbetter sequentially is it backlog strong enough that you’ve good visibility forsequential growth for the next few quarters or is anything seasonal that mayoffset that?

Joe Herring

I think, we’ve talked about, weexpect the growth to continue.

Sandy Draper - Raymond James

Okay, great. And second, justlooking back historically, been a little bit newer the story. Can you justremind me in the first quarter of ’07 you obviously clinical development done avery nice job, you’ve been improving that. It would, it is better look herereally at growing that sequentially that business is coming back or what pointfor this to come more of a normalized year-over-year growth trend?

Joe Herring

Last year certainly we had someissues, we are referring. But clinical and some of the year-over-year comps aremaybe easy compared to some extent of that business. But we expect that to bekind of growth engine for the company going forward and whether that becomes --however they will become a low hurdle. But may I think, before we start tocontinue growth and the opportunity is tremendous. So we expect to see growthin our business.

Sandy Draper - Raymond James

Okay, great. Thanks, a nicequarter.

Joe Herring

Thanks Sandy.

Operator

We’ll go next to Hari Sambasivam,Merrill Lynch.

Hari Sambasivam - Merrill Lynch

Hi, guys. Thank you. Just a quickquestion on the offshore central labs particularly the one in China. Joe what I’m wondering isthat in the US you obviously had some unexpected issues in 2006 with theslowing cap returns and so on and so forth.

And I’m just wondering as yousort of expand central labs in other countries, what level of control do youhave in place that you don’t run into similar issues in our jurisdiction that alittle bit further away from your core market? What type of control, how youbuild in, what you’ve learned from the US experience?

Joe Herring

Well, first of all Hari. I wouldin no way characterize our central lab volumes as a lack of control, zero. Ourcentral lab moderation kit volume has everything to do with winning a largepercentage of trials in these pretherapeutic areas that tend to be long induration and more competition in the space. The net result of that is ourclients are looking to get these clinical trials back on track by openingenrollment in these emerging markets.

Therefore, our central lab isthere because China is aprefect example where we can shift biological fluids and as both we and withour clinical trials, as well as our competitors and our clients enroll morepatients in China.There needs to be central lab support to keep those trials moving along. And soagain, it’s not a lack of control.

Both our Singapore lab and our lab in Shanghai,which was formally tied within Fudan University had grown muchfaster than Central labs in general it’s a profitable business with 300,000investments. I think we've expanded our Singapore Central Lab now a third timeand of course opened up the new facility in Shanghai. So, same management sustainedplatform with same data collection with same management oversight and thatbusiness is very much well controlled.

Bill Klitgaard

Hari, if I could just add onemore thing. One way to look at this is the push of clinical trials in overseasmarket. You looked at the Central labs between 2004 and 2006 about 55% of thekids that went into lab were coming from North American trials. Now, if youlook at the backlog right now and you look forward about 40% of the kid backlogis in the US.

So, that’s the big shift from theUSto overseas. And as I mentioned before there is a longer start time betweenwhen you have the win to when you have the first kid in overseas marketalthough things are impacting us. And it’s not because of our direction, butbecause of where the market is going to find patients.

Hari Sambasivam - Merrill Lynch

That’s great. Thank you verymuch.

Bill Klitgaard

Okay Hari.

Operator

We'll have our final questionfrom Jon Wood, Banc of America.

Jon Wood - Banc of America

Thanks. Just one more any recentstock repurchases stopped during the quarter is it a matter of evaluation orsimply a capital priority issue and as the acquisition pipeline picked up atall?

Bill Klitgaard

Well, we’ve already purchased $60million in stock this year and we’ve, less shares then we did it a year ago. Tobe honest Jon, we were very, very busy this quarter and probably just didn’tget around to it. But it’s certainly not a lack of capital available.

And regarding the acquisitionpipeline even though we don’t appear to be all that acquisitive as a company,we have dedicated resources that are looking for acquisitions all the time. Itjust, we achieved and we want to find something that’s fairly valued that wecan acquire and integrate in a reasonable fashion and create shareholder value.And we continue to look for those opportunities and we keep you posted.

Okay operator, I think that wasthe last question we had in the queue. So, let’s turn back over to Paul.

Paul Surdez

Yeah. Thank you everyone for yourtime today. If you should have any follow-up questions, feel free to give me acall, and we look forward to seeing you on the road in the fourth quarter.

Operator

That does conclude today’sconference call. You may disconnect at this time. We do appreciate yourparticipation.

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