Charles River Laboratories Q3 2007 Earnings Call Transcript

Nov. 6.07 | About: Charles River (CRL)

Charles River Laboratories, Inc. (NYSE:CRL)

Q3 2007 Earnings Call

November 6, 20078:30 am ET


Jim Foster - Chairman, President and CEO

Tom Ackerman - EVP and CFO

Susan Hardy - VP of IR


David Windley - Jefferies & Company

Douglas Tsao - Lehman Brothers

Eric Coldwell - Robert W. Baird

John Kreger - William Blair

Alex Alvarez - Goldman Sachs

Rob Gilliam - UBS

Hari Sambasivam - Merrill Lynch

Doug Schenkel - Cowen


Good morning, ladies and gentlemen. Thank you for standingby. Welcome to the Charles River LaboratoriesIncorporated, Third Quarter 2007 Earnings Conference Call. At this time, allparticipants are in a listen-only mode. Later, we will conduct aquestion-and-answer session. Instructions will be given at that time. (OperatorInstructions) And as a reminder, this conference is being recorded.

I would now like to turn the conference over to our host,Vice President of Investor Relations, Ms. Susan Hardy. Please go ahead.

Susan Hardy

Thank you. Good morning and welcome to Charles RiverLaboratories' third quarter 2007 conference call and webcast. This morning JimFoster, Chairman, President and Chief Executive Officer, and Tom Ackerman,Executive Vice President and Chief Financial Officer, will comment on our thirdquarter results and review guidance for 2007.

Following the presentation, we will respond to questions.There is a slide presentation associated with today's remarks, which is postedon the investor relations section of our website at A tapedreplay of this call will be available beginning at noon today and can be accessed by calling 800-475-6701;the international access number is 320-365-3844. The PIN number in either caseis 890128. The replay will be available until November 20th. You may alsoaccess an archived version of the webcast on our investor relations website.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 maymake about future expectations, plans, and prospects for the Company constituteforward-looking statements for the purposes of the Safe Harbor provisions under the PrivateSecurities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated byany forward-looking statements, as a result of various important factorsincluding, but not limited to, those discussed in our annual report on Form10-K, which was filed on February 27, 2007, as well as other filings we makewith the Securities and Exchange Commission.

During this call, we will be primarily discussing non-GAAPfinancial measures. We believe that these non-GAAP financial measures helpinvestors to gain a meaningful understanding of our core operating results andfuture prospects, consistent with the manner in which management measures andforecasts the Company's performance.

The non-GAAP financial measures are not meant to beconsidered superior to or a substitute for results of operations prepared inaccordance with GAAP. In accordance with Regulation G, you can find thecomparable GAAP measures and reconciliations to those GAAP measures on theinvestor relations section of our website through the financialreconciliation's link.

Now, I will turn the call over to Jim Foster.

Jim Foster

Good morning. I'm very pleased to speak with you today aboutour outstanding third quarter results. As you know, we believe that thepharmaceutical industry is at an inflection point unparalleled in its history.In an effort to focus their resources on drug discovery, pharma companies areadopting strategic outsourcing as a means to streamline their operations andimprove pipeline throughput.

Having spent the last decade expanding our portfolio ofessential products and services, enhancing our managerial, scientific, andtechnical talent, and extending our global reach, we believe we are extremelywell positioned to support our clients' drug discovery and development effortsand the strengthening demand from big pharma.

Our third quarter results demonstrate the effectiveness ofour organization and validate the investments we made and continue to make, aswe correctly anticipated the paradigm shift that is taking place in the globalpharmaceutical industry.

For the third quarter, net sales increased 18.6% to $314million, the results of strong growth in both the RMS and PCS segments. Theacquisition of Northwest Kinetics contributed 3.2%, and foreign exchange added2.6% to the sales growth rate.

Operating income for the quarter was $70.9 million comparedto $61.2 million reported in the third quarter of '06. Although operatingincome was significantly higher, the operating margin decreased to 22.6%compared to 23.1% in the same period last year.

We expected a decline because of the costs associated withthe transition of our new preclinical facility in Massachusettsand because of higher corporate costs, as we invest in information technologyand scientific and operational staff to support our growing business.

However, we were very pleased with the operating margin,which declined just 50 basis points when compared to last year and improved 120basis points from the second quarter of this year. At $47.3 million net incomefrom continuing operations was 22.1% higher than the $38.8 million reported inthe third quarter of '06.

Earnings per share increased 21.1% to $0.69, even though thenumber of shares outstanding also increased. We repurchased another 382,000shares in the third quarter. But the fully diluted shares outstanding increasedby an amount of approximately 1 million shares due primarily to dilution fromthe convert, option exercises, and a higher share price, which affects theinclusion of stock options to the diluted share count.

Based on our strong third quarter results and ourexpectation that the robust market trends will continue, we are very confident inour outlook for the balance of this year. As a result, we're raising our '07sales guidance to a range of 14% to 16%, which is a combination of lowdouble-digit growth in RMS and a high-teens growth in PCS.

We're also raising our EPS guidance to a range of $2.56 to$2.59, which would represent an increase of between 16% and 18% of our '06results. Now, I will tell you more about our third quarter segment results.

Robust pharma and biotech spending continued in the thirdquarter; and as a result, the RMS segment sales grew 13.8%. Foreign exchangecontributed 2.6%. So, on an organic basis the sales growth was over 11%. Salesof research models in the U.S.and Europe were very strong.

Transgenic services continued to rebound, and the in vitro business benefitedfrom sales of the PTS. Primarily as a result of higher sales and improvedoperating efficiencies, the third quarter operating margin increased 280 basispoints to 31.6% from 28.8% in the third quarter of '06.

As was the case in the first half of the year, sales ofresearch models in the U.S.grew at a double-digit rate; and sales in our European operations matched thatpace. We continue to see our pharma and biotech customers increase theirspending on research models. And sales to U.S.academic institutions and government agencies also increased in the quarter.

Sales were robust across a number of strains, with thestrongest growth in immunodeficient mice and outbred rats. We attribute salesof immunodeficient mice to research, focused on oncology drugs, and sales ofoutbred rats, to safety testing of compounds as they move through thedevelopment pipeline.

Our RMS expansion is targeted at supporting the increaseddemand for our research models. Production in the two new barrier rooms, whichwe opened in California in Junecontinue to ramp and we expect to meet our target of shipping product by theend of this year.

And given the continued strong demand from the Westernregion of the U.S.,our plan to open a third production room in the Californiafacility in the first quarter and begin shipping by the third quarter of '08 isunchanged.

We're also on track with our new facility in Maryland,from which we will support our dedicated resources agreement with the NationalCancer Institute, as well as commercial sales to the mid-Atlantic region.

Sales of worldwide transgenic services increased for thefourth straight quarter. Researchers are continuing to focus on the use oftransgenic models as discovery tools. But unlike early efforts when they manipulatedonly one or two genes, they are focusing on polygenic diseases in whichmultiple genes are implicated.

Most human diseases have complex mechanisms of action, so adisease model with a similar genetic profile is likely to have betterpredictive value of drug efficacy in humans. As they develop more complicatedmodels, researchers have increased the need for the scientific expertise intransgenic breeding and the breadth of services that we offer.

Increased need, combined with a desire for more efficientoperations is driving pharmaceutical and biotechnology companies to outsourcemore of these services. Given our extensive expertise and portfolio ofservices, Charles River is the partner of choice tosupport the use of these models in research.

As you know, our preconditioning services business hasevolved into a broader service offering, which we call discovery services. Thisbusiness, which includes services required to prepare models to go on study, aswell as early pharmacokinetics, pharmacology and in vivo screening, is aimed atproviding our clients with an efficient alternative to dedicated in-houseoperations.

It is early days for our discovery services business, asrelatively few of these services are outsourced, compared to Preclinical Services.But we believe that the same incentives that are driving our clients tooutsource preclinical drug development services are beginning to impact theseservices as well.

We're having an increasing number of discussions with largepharma and biotech customers, and given the opportunities we are seeing, webelieve that over time discovery services will be a growth driver for ourbusiness.

Again, in the third quarter, our in-vitro business deliveredstrong results. We have continued to make great progress with the PTS both inthe U.S. and inEurope. Its portability and ease-of-use are veryappealing from an efficiency standpoint and customers are converting from theconventional test kit to the PTF. The FDA's Process Analytic Technology, or PATinitiative is also driving PTS sales.

PAC promotes real-time in-process test measurement, and thePTS is an FDA-approved endotoxin test tailor made for this initiative. Webelieve that the FDA is beginning to enforce the regulation, because itrecently issued the first notice of regulatory deficiency to abiopharmaceutical company.

As the only FDA approved real-time endotoxin testing method,we expect sales of PTS will benefit from the enforcement of the PAT initiative.The PTS also continues to sell extremely well to nuclear pharmacies. The FDAhas issued proposed regulations, which require a lot-release testing with anFDA-licensed LAL reagent such as the PTS.

Although the FDA has not established a timeframe forissuance of the final regulations or compliance with them, we're already seeingmany of our clients adopt the PTS in anticipation of the regulation. We werevery pleased with the outstanding RMS third-quarter results. Our sales growthreflects the strong demand from many customers for our high-quality productsand the expert services we provide.

Our operating margin reflects the leverage from higher salesand our ongoing efforts to effect continuous process improvement. With the newcapacity provided by our expansion project and our broader service offerings,we believe we will be extremely well positioned to support our customers'requirements for our high-quality, value-added Research Models and Services andto promote our growth.

The Preclinical Services segment reported very strong salesgrowth of 23.1% for the third quarter, including 6% from Northwest Kinetics and2.5% from foreign exchange. Our toxicology facilities delivered very strongperformance due to a number of factors, the most important of which was robustdemand for our services from both pharmaceutical and biotechnology customers.

We continue to experience favorable mix and stable pricingand improved capacity utilization. The PCS operating margin declinedapproximately 180 basis points to 21.8% from 23.6% in the third quarter of '06.As you know, the transition to our new Shrewsbury, Massachusetts facility is expected topressure the margin throughout '07, primarily as a result of the duplicatecosts associated with operating two facilities.

However, with Shrewsburynow operating near capacity and progress being made towards our goal to improvethe service mix, the Massachusettsmargin improved sequentially in the third quarter. The fact that the PCS marginremained essentially flat for the second quarter was the result of the strengthof the Canadian dollar, which has significant negative effects on the operatingmargin of our Montreal facility.

We are quite pleased with the progress we've made in Massachusetts.The final in-life studies, which were being conducted in our Worcesterfacility, were completed in the third quarter, and as of September 1st, all newstudies have been initiated in Shrewsbury.We are continuing to move operations out of our Worcesterfacility and have just a few of the laboratories to go.

We're on schedule to complete the move by the end of theyear and expect further improvement in operating efficiency once we are locatedin one facility. We are making excellent progress on our capital expansionplans. In Nevada, validation isunderway.

We're on schedule to initiate GLP studies in January of '08.We also broke ground in Quebecfor our new facility there and have begun renovations on the facility in China.Our expansion plans are critical at this juncture, when so many of our clientsare looking to expand their relationships with a high-quality,scientific-focused service provider like Charles River.

Partnering with us allows our clients to reduce theirinvestment in infrastructure and the technical expertise required for highlycomplicated specialties, such as reproductive or inhalation toxicology and tofocus on discovery of new compounds.

The addition of these new facilities to our existingpreclinical system will provide us with flexibility, which is unmatched in ourindustry.

We can accommodate our clients at large, full-service orsmaller more-specialized facilities in North America, Europeor China withexpert discovery and development services, and no matter where they choose toplace their studies, with exacting attention to detail and the level of servicewith which they have always associated Charles River.

Given these factors, our expertise, operating efficiency andstrategic location of our facilities, an increasing number of clients arespeaking with us concerning a broad range of working arrangements.

We already have five dedicated arrangements in place,including the three-year $17 million agreement with a top-10 pharma client,which we signed in the second quarter of '07, and a two-year $14 millionagreement with a large biotech client which we signed in the third quarter.

In the past, we've referred to these arrangements asdedicated space agreements but we are finding in our current discussions withboth big pharma and biotech that we are negotiating and signing morebroad-based partnering agreements, which are designed for clients based ontheir individual needs.

We may accommodate clients within our existing facilities,build out shelf space to their particular specification, or establish a newfacility like the one in Sherbrooke, Quebec.We may provide all of the staffing or work side-by-side with client researchersin our facility. Whatever the arrangement, our goal is to maintain flexibilityso that we can support what the clients needs.

Because they have different features, we are now referringto all types of dedicated arrangements as Charles River Dedicated Resources, orCRDR, because that terminology catches the fact that clients rely on a broadarray of resources we provide rather than just physical space.

Whatever the specifics of the arrangement maybe, all CRDRagreements generally involve a financial commitment for multiple years. As wesign more of them, we expect these agreements to represent a meaningfulpercentage of our business. When we give guidance in December, we will provideyou with an estimate of that percentage.

In summary, we are exceptionally pleased with ouroutstanding third quarter PCS performance. Our preclinical tox facilitiesdelivered strong net sales growth, and the leverage from higher sales and ourcontinued focus on operating efficiencies provided a significant offset to thehigher costs associated with the transition to our new facility in Mass.and the foreign exchange effect in Canada.

As pharmaceutical and biotechnology companies continue toutilize strategic outsources to drive better operating efficiency, we believewe offer an unmatched combination of extensive scientific expertise, a serviceportfolio which is broad-gauged in terms of the services offered, andgeographic locations proximate to our clients.

Our capital expansion projects, which are progressing onschedule, will provide the capacity that we require to accommodate ourcustomer's intensifying demand. And given our expertise in regulatory-compliantpreclinical services and our wide-reaching global footprint, including theexpansions in Shrewsbury, Reno, Quebec and China,we believe we are positioned as a premier player in this field with significantopportunities for growth.

Year-to-date, '07 has been a very strong year for us, and webelieve that we will finish the year on a positive note. In part, our successis being driven by our clients' needs for a more efficient and productive drugdevelopment process. But external factors, no matter how positive are only partof the story. A decade ago, we developed a strategy to be the premier providerof potential products and services to the drug development industry and havebeen intently focused on executing that strategy ever since.

To achieve this goal, we have made strategic acquisitions,expanded our product and service offerings, invested in sophisticated newcapacity, and added considerable scientific depth. We have invested internally,building a senior management team that we believe is the best in the industry.

We continue to attract and retain excellent people and havejust announced the promotions of three of our key general managers to theposition of Corporate Senior Vice President. Dr. Brian Bathgate, Head of ourEuropean Preclinical Services; Dr. Jorg Geller, head of Large Model, Avian and Japaneseoperations; and Chris Perkins Head of Canadian and China Preclinical Services.

We are implementing IT initiatives that will enable us todeliver scientific and business information whenever and in whatever form ourclients require. As we grow, we will continue to make these kinds ofinvestments because we believe they are critical to our ability to provideexceptional products and services and to support our clients as they strive todevelop better drugs faster and more efficiently.

And regardless of how large we become, we will maintain anintense focus on our customers, anticipating and responding to their needs, andon our core competencies of laboratory animal medicine, regulatory-compliantpreclinical services, and Phase I clinical services, because we believe that itis those competencies that define Charles River and thevalue we bring to our clients.

In closing, I would like to thank our 8,300 employees fortheir exceptional work and commitment, and our shareholders for their continuingsupport.

Now I will turn the call over to Tom Ackerman.

Tom Ackerman

Thank you, Jim, and good morning. Before I recap our strongthird-quarter financial performance, I would like to remind you that ourdiscussion today focuses on results from continuing operations. Consistent withJim's comments, I will focus my discussion on non-GAAP results, which excludeall acquisition-related amortization and other items.

Double-digit sales growth and improved capacity utilizationin both segments continued to drive operating income, which rose 15.8% to $70.9million. Driven by this operating leverage, third-quarter diluted EPS increasedan impressive 21.1% to $0.69 from $0.57 a year ago, despite an increase in theshare count.

As expected, the operating margin declined slightlyyear-over-year to 22.6% in the third quarter of 2007, reflecting theanticipated decline in PCS margins due to the transition costs in Massachusetts,as well as higher unallocated corporate expense. The 280 basis pointimprovement in the RMS margin partially offset these factors.

On a sequential basis, the operating margin improved 120basis points as operating income growth of 7.8% outpaced sales growth by nearlyfourfold, primarily due to the sequential decline in unallocated corporateoverhead. EPS also increased 7.8% sequentially.

Given the normal seasonality in our RMS business, we do notexpect the sequential comparison to be as favorable in the fourth quarter ofthis year. Foreign exchange had a negligible impact on the bottom line in thethird quarter.

As Jim mentioned, foreign exchange did accelerate the salesgrowth rate by 2.6%; but the operating income effect is muted by the fact thatwe are naturally hedged at most locations, meaning revenues are primarilyderived in the same currency as costs are incurred. However, this is not thecase at our PCS facility in Canada.

In Montreal, themajority of sales are denominated in U.S. dollars, while costs are primarilyincurred in Canadian dollars. The strengthening Canadian dollar negativelyaffected operating margins in the third quarter, negating nearly all of the FXbenefits generated from other geographic regions.

Unallocated corporate overhead increased by almost $4million year-over-year to $11.9 million in the third quarter of 2007, driven bythe expected increases in stock-based compensation expense and IT costs.However, unallocated corporate cost declined sequentially by nearly $4 millionprimarily due to a reduction in healthcare-related expenses.

Assuming more normalized healthcare costs, we expectfourth-quarter unallocated corporate overhead to be slightly higher than thethird quarter. Total equity compensation expense was $7.3 million in the thirdquarter. As expected, equity compensation expense increased nearly $2.4 millionyear-over-year, but only $0.2 million sequentially. We continue to expect thesecosts to approximate nearly $27 million for the year.

Third-quarter net interest expense of $2.3 million decreased$1.3 million year-over-year and $0.3 million sequentially, reflecting debtrepayment. At the end of the third quarter, we prepaid the remaining balance onour Canadian term loan and made payments on other foreign credit lines.

As a result of the Federal Reserve bank rate cuts and thesubsequent reduction in the LIBOR rate, as well as our debt repaymentactivities, we now expect full-year 2007 net interest expense to beapproximately $8 million to $10 million lower than our prior guidance of $10million to $12 million.

The tax rate increased 60 basis points sequentially in thethird quarter from 29.3% in the second quarter to 29.9%, as a result of the taxadjustments based on higher-than-expected year-to-date earnings. This waspartially offset by a discrete benefit related to tax law changes enacted in theU.K. and Germany.We excluded $0.9 million of this discrete benefit from our non-GAAP resultsbecause it was attributable to Inveresk acquisition intangibles amortization.

Last year's third-quarter tax rate of 32% was negativelyimpacted by several discrete tax items. Our tax rate guidance for 2007 remainsat 29% to 29.5%. We had two non-GAAP adjustments in addition to the income taxitem, I just mentioned.

We accrued incremental stock compensation taxes in the thirdquarter, excluding $0.8 million from non-GAAP results as these costs related topre-acquisition periods of Inveresk. The other item is the $0.02 gain on thesale of real estate in Scotland,which we previously discussed. This transaction was completed and thecorresponding gain recorded in the third quarter.

As Jim said, we are on track to exit Worcesterby the end of the year. We have recorded approximately $1.7 million or $0.02per share of impairment charges year-to-date, although nothing in the thirdquarter, primarily related to accelerated depreciation of the Worcesterfacility.

While we continue to estimate total charges of $0.03 to$0.05 for the year, the remaining charges are primarily related to the Worcesterlease impairment and will not be recorded until we cease use of the facility,which is scheduled for December. Once we exit the Worcesterfacility and eliminate the duplicate costs, we expect to reduce facility costsby at least $1 million per quarter beginning in the first quarter of 2008.

Now, I'll turn to some balance sheet and cash flow items. Atthe end of the third quarter, we had cash and cash equivalents of $183.5million, plus 88 million in short and long-term marketable securities, for atotal of $271.5 million compared to $264.3 million as of June 30 and $286.8 millionat the end of 2006.

Accounts receivable were $232 million at the end of thethird quarter, up from $202.7 million in the fourth quarter of 2006, primarilydue to higher sales. Our DSO increased to 43 days in the third quarter versus39 days at the end of last year, due primarily to lower deferred revenue, whichoffsets accounts receivable in the DSO calculation.

However, we continue to focus on collections and have notseen a meaningful deterioration in our receivables aging as a result of thehigher DSOs. Year-to-date, free cash flow was $27 million in 2007, up from $3million last year in spite of spending nearly $38 million more on capitalexpenditures. That equates to a $61 million increase in working operating cashflow.

Our full-year 2007 guidance for free cash flow remains in arange of $25 million to $50 million with CapEx of $200 million to $225 million.Depreciation in the third quarter increased $2.4 million to $13.5 millionprimarily as a result of the new Shrewsburyfacility.

Because we have begun to transition some of our personnel tothe new PCS facility in Reno, wewill begin to book a small of depreciation in the fourth quarter of 2007. Ourfull-year depreciation forecast is approximately $53 million.

Total amortization expense declined $1 million to $8.4million in the third quarter due to a reduction in Inveresk-relatedamortization expense. Our 2007 forecast for amortization expense isapproximately $33 million.

Let me provide a quick update on our share repurchaseactivities. Last quarter, we announced that our Board had increased theauthorization on our share repurchase program to 400 million. In the thirdquarter, we purchased nearly 400,000 shares at a cost of approximately $20million.

As of September 29, we have approximately $108 millionremaining on this buyback authorization. We continue to anticipate just about69 million diluted shares outstanding for the fourth quarter. To reaffirm whatJim said, we have raised our 2007 sales guidance to 14% to 16% and 2007 EPSguidance to $2.22 to $2.25 on a GAAP basis and $2.56 to $2.59 on a non-GAAPbasis.

With one quarter left in the year, we are well on track tomeet our higher sales and earnings forecasts. We continue to expect robustsales growth and operating margins for the remainder of the year, with thefourth quarter pressured by several factors.

Fourth-quarter RMS revenue growth will be affected by normalseasonality and the anniversary of the improvement in the Transgenics business.These factors will be partially offset by favorability in large model sales,due to the comparison to the fourth quarter of 2006 when shipments were delayeddue to an extended quarantine. In the PCS business we will anniversary theacquisition of Northwest Kinetics in October.

We also expect some operating margin headwinds in the fourthquarter. Consistent with historical trends, we expect the RMS operating marginto be impacted by reduced operating leverage from the normal seasonality in thefourth quarter.

In PCS, the Canadian dollar will also continue to be a dragon margins; and as I mentioned earlier, we will incur some startup costs at thenew Nevada facility as we beginto occupy the facility in advance of the January 2008 opening.

We will also incur duplicate costs in Massachusettsuntil we exit the Worcesterfacility, which is expected by year-end. That said, we are extremely pleasedwith our year-to-date performance and continue to believe that we're wellpositioned to achieve our higher sales and earnings goals for the year. We lookforward to providing our 2008 outlook in mid-December.

That concludes our remarks. We'll now take your questions.



(Operator Instructions) And the first question comes fromthe line of David Windley with Jefferies & Company. Please go ahead.

David Windley -Jefferies & Company

Hi, thanks for taking my questions. Congrats on a nicequarter. First of all, I wanted to ask on RMS margin, but for some of theseasonality, Tom, is the improvement in margin generally sustainable? Are thereother underlying trends, be it transgenics, pricing on models, anything in thatregard that are -- perhaps even PTS and leverage there -- that are, say,secular movement in margin on the RMS side?

Tom Ackerman

I would say not, Dave. We obviously had a very good quarter.Margins were very good. I think all things were sort of aligned very well. Wedidn't really have any drags here or there, but in terms of the macro trends, Iwould say there are not any underlying trends that other than seasonality andthings like that bode negative for the margins.

David Windley -Jefferies & Company

That bode negatively for the margins?

Tom Ackerman

Yeah. I would say there were not any of those types ofthings other than seasonality.

David Windley - Jefferies& Company

Okay. So otherwise, third-quarter margins are a reasonableprojection?

Tom Ackerman

Yeah, I would say, the only thing, as I said, all thingswent very well in the third quarter. Even when we are doing well, generallythere is a little bit of a drag here or there. We didn't really experience toomuch of that.

David Windley -Jefferies & Company


Tom Ackerman

I think it's a very good indicator, but it was a goodindicator, in the sense, that things were aligned very well.

David Windley -Jefferies & Company

Right. Okay.

Tom Ackerman

That doesn't always happen.

David Windley -Jefferies & Company

Okay. Moving then on transgenics, obviously the compares tolast year have been easier to this point. And I suspect a decent contributor tothe overall RMS growth in 3Q. Is transgenics growing sequentially by ameaningful amount?

Jim Foster

Yeah. It is, Dave. We are continuing to see improvement inthe demand for transgenic models as more complex models are developed.Continues to be a confirmation of the importance of these models to research.

We obviously saw substantial improvement over the last year,which was a weaker year. But we continue to believe that it will improve goingforward. We don't really see any change in the demand quotient, given the levelof investment that we are seeing our clients make.

David Windley -Jefferies & Company

Okay. Great. So, just obviously trying to narrow in on -- isthe sequential improvement in the business enough to overcome the sequentiallytougher comp to the fourth quarter of last year? Relative magnitudes of thetwo, I guess?

Tom Ackerman

Well, I think just to add a little bit to Jim's comment, wehave been growing sequentially, and, of course, we've had nice growthyear-over-year in transgenic. What we have seen as the year has progressed,though, as the rate, particularly in the U.S.,of increase year-over-year has shrunk gradually.

David Windley -Jefferies & Company

Okay, okay. Super.

Tom Ackerman

It was a trend last year and this year.

David Windley -Jefferies & Company

Okay. And then last question and I'll jump out is, Jim, youdefined for us your CRDRs. Talk about for me the pricing on those and, at leastin your early experience, how those evolve perhaps from a revenue standpointand then also from a margin standpoint?

Jim Foster

Yes, so our goal is to have appropriate returns regardlessof the specific structure. So we have a certain cost of capital, and we want torecoup that and then some. So, what we're trying to do is maintain a maximumflexibility as we interface with clients who all have a totally different goaland want to operate differently.

So whether it should simply what we used to call the olddedicated space arrangements, where they would sort of rent space for aparticular period of years, or literally build out space for clients, or builda new building like we are doing in Sherbrooke for one or two clients who areproviding the motivation, or have our folks go in and manage other people'sfacilities, or work together collectively. And we've even had someconversations, although they haven't come to fruition, with clients who want tosell us their preclinical locations that they have taken out of commission.

So, what we don't want to do is have one-size-fits-all forthese clients. We want to be able to listen carefully and respond to theirneeds and respond to them geographically as well. So it's an evolving way ofdoing business. We are not going to in any way denigrate our margins in orderto respond to the clients' needs. And I think that we should continue to seesort of the demand continue from a revenue contribution going forward.

But the nature of the deals will be perhaps more complex andmore diverse going forward.

David Windley -Jefferies & Company

Okay. Thank you.


And the next question comes from the line of Douglas Tsaowith Lehman Brothers. Please go ahead.

Douglas Tsao - LehmanBrothers

Thanks and good morning. Congratulations on the quarter.Jim, to start off with, or Tom, I was wondering if you could provide somecomment on how you see the transition to the Reno facility; and how that wouldcompare to the transition into Shrewsbury from a cost standpoint, would this bea more or less expensive operation? And how -- what's your thinking going interms of our expectations for that in the fourth quarter as well as 2008?

Jim Foster

Why don't we both try to answer that? You should anticipatethat the Reno transition will besimilar in scale and scope to the Massachusettsone. We will be vacating the facility at the end of '08, as we are vacating theWorcester facility at the end of'07.

We have in-life studies that are ongoing that can't bedisrupted, so we have to finish them in the old Reno facility at some point intime, as we did in Massachusetts; and then start new ones in the new Renofacility.

So we should see similar pressure on the margin through '08.But remember, we should also see -- we expect to see some sequentialimprovement in Massachusetts aswell in '08, also.

Tom Ackerman

Just a couple of other data points to think about. Bothfacilities are about the same size. We will be operating probably a little bitmore of Reno facility on day one, versus how much we built out in Shrewsbury,both facilities will be run by the same management team that is in that area ,both, seven or eight miles from the existing site.

So there are an awful lot of similarities. The work that'sdone at each site is probably a little bit different on a mix standpoint. But Ithink when you tally it all up, in advance of our having completed the 2008plan, it certainly looks and feels an awful lot like the transition at Shrewsbury.

Douglas Tsao - LehmanBrothers

Okay, great. And then, turning to the transgenics business,Jim sort of talked about the technological evolutions there and the increaseduse of polygenics. From your standpoint, do you get better margins from sort ofbreeding and maintaining polygenic colonies versus sort of these single geneknockout/knock-in colonies?

Jim Foster

I wouldn't expect that we would get better margins. Themargins in the transgenic business have been quite good historically and havebeen improving as we continue to fill up the capacity. So like most of ourbusinesses, as we utilize the capacity better, fill up the isolators, themargins will stay the same or perhaps get better.

But the specific nature of the animals, it's unlikely thatthe work product itself will change dramatically.

Douglas Tsao - LehmanBrothers

And how much of a contributor -- you've commented that youare seeing more characterization work, as well as sort of analytical workassociated with the transgenics business. Has that been a significantcontributor to the rebound in that? Or has it largely been just a question ofvolume of colonies?

Jim Foster

There has been some benefit obviously from characterization.But I think the primary improvement that we are seeing is the sheer volume ofnew models that we are setting up almost on a weekly basis; and as I said,filling up the facilities and utilizing our labor wealth.

And again, it is a worldwide phenomenon. We continue to bedelighted to see it happening across the world, which gives us the confidenceto really believe that this is a fundamental refocused investment in basictechnology.

Douglas Tsao - LehmanBrothers

Okay. And then final question. You've spoken a lot aboutsort of entering into discovery sciences more. You have also continued toemphasize your desire to stay focused on the company's expertise inanimal-based medicine.

I was wondering, when you contemplate expanding yourdiscovery services, have you ever thought about getting more into the purechemistry related services? There is a lot of -- there has been a lot of growththere, especially in the Asian market, servicing large pharma companies. And Iwas just wondering if that had entered your radar screen?

Jim Foster

Well, we have indeed thought about it, but it really doesn'tfeel like it takes advantage of our core capabilities. There are lots of peoplein that business already who have been doing it for a long time. While it'scertainly in the development chain for new compounds, it's probably one that wewill continue to leave to others.

So our discovery services business is very much autilization of our core capabilities, premised on our veterinary medicineexpertise.

It's the same drivers that we're seeing in the regulatedpre-clinical studies that are going to drive this. And we think this is asubstantial business opportunity for us, albeit a small one at the currenttime. So we're going to stay focused on the animal-related andveterinary-related aspects of it.

Douglas Tsao - LehmanBrothers

Okay. Great. Thanks a lot. Congratulations on the quarter.

Jim Foster



And the next question comes from the line of Eric Coldwellwith Robert W. Baird. Please go ahead.

Eric Coldwell -Robert W. Baird

Thank you and good morning. The first question is just asimple one on Nevada. It appearsto me at least that, perhaps, your GLP work is starting faster than pastimplications. Is that an accurate assessment?

Jim Foster

Well, we've commented on it before. We have booked studiesand have been booking studies in that for '08. Those are new studies,obviously. So it's pretty much what we anticipated. This is a facility that hasa long and distinguished reputation in large animal toxicology work, similarclient base and the same staff.

So the new facility just makes it, frankly, moreadvantageous for these clients. But we're seeing repeat work with them andexpect to continue to see that but not surprised by it.

Eric Coldwell -Robert W. Baird

Okay. In Shrewsbury,the commentary in the prepared remarks was that it's near capacity on the spacethat's currently being utilized. I guess the question is -- what percent ofthat facility is currently staffed and equipped, and what would be the timingof additional shelf rollouts in Shrewsbury?

Jim Foster

We've finished, we've renovated 60% of about 450,000 feet.There is some administrative space in there. And remember, lots of this isreplacement space. We've renovated that and that, we would say, is nearingcapacity.

Where a lot of that is sort of earlier non-GLP work, we'rebeginning to see a gradual shift in mix, which we're delighted with. I think that'sgoing to be really important to this operation, and that should continue. We'reseeing an increase in the backlog in basic toxicology services at that site aswell. So while we are nearing capacity now, we will see a shift in how thatcapacity is utilized.

We retain another 150,000 feet of space, which is shelfspace. That gives us great flexibility to finish that in a myriad of fashionsand phases at once, depending on what the demand is for our clients. While weare looking at the design, we'll pull the trigger when the demand intensifiesand when we see a more discernible need.

Eric Coldwell -Robert W. Baird

Great. And then, finally, regarding the new facility in Quebec,I guess, there has been some talk about that facility in a press release earlier.But I'm trying to get a sense of what will be unique about that facility interms of maybe your mix of CRDR work there being higher, perhaps, than in otherfacilities or what is the exact plans for that facility in terms of mix andstructure and how you work with clients there versus your other existingfootprint?

Jim Foster

So let's just go back to the driver. The driver for that newspace was the fact that we're out of capacity. We're out of physical space. Weplan to build at our current Montrealsite, which has grown quite large.

We have some very large top-tier pharmaceutical clients, whoprefer utilizing that location, because they have a long relationship with thestudy directors and they're happy with the quality of the work, who, while we mayhave capacity elsewhere, really prefer to stay in Montreal.And that's the fungibility of the space, is definitely a goal of ours. But atthe current time you can't always direct a client to where you want them to.

So there were a couple of clients, in particular, drivingthis space. This is sort of a satellite facility, a kind of the mother-shiplocation that we've had for years. This is clearly a dedicated resourcesarrangement, we have one or two of those clients who will take the first spaceof this site, which we anticipate will be about 300,000 feet.

We'll build out 75,000 feet immediately. And by the timethat's operational, at the beginning of '09, it should be full. So it's more ofthe same sort of work, but as we said on a satellite basis and we also continueto grow it on a dedicated resources basis as well.

Eric Coldwell -Robert W. Baird

That's great. Let me add my congrats on a really strongquarter. Thanks, guys.

Jim Foster

Thank you.

Tom Ackerman

Thanks, Eric.


And the next question is from the line of John Kreger withWilliam Blair. Please go ahead.

John Kreger - WilliamBlair

Thanks very much. You mentioned your results out at Montrealbeing affected by the strengthening Canadian dollar. If you adjust for that,how did Montreal do on kind of aconstant dollar basis in the quarter relative to your expectations?

Tom Ackerman

Montrealcontinues to do exceptional both in terms of revenue and operating margins. Andactually, notwithstanding the margins, the impact from the Canadian dollar, themargins are still extremely strong and, if not for that, it would have justbeen better.

So it does take a little bit off of our overall margin forthe PCS and the corporation. But overall, from a foreign currency standpoint,because of the pickups we have elsewhere, where it's sort of muted on theoperating income level, but we are seeing pickups in sales, as we translate.

John Kreger - WilliamBlair

Great. Thanks. Then, a general question about theprofitability in your pre-clinical services business. As you look across yourvarious toxicology facilities, how would you characterize the performance? Arethey all kind of meeting your expectations or is there a potential to sort ofapply a best-practices approach to drive further margin leverage in thebusiness over the next couple of years?

Jim Foster

We're really pleased with the performance of most of ourfacilities. We've had topline growth everywhere, except for Nevada,which had capacity-constraints we've had sequential improvement in operatingmargins everywhere, except Massachusetts,which obviously had duplicate space.

We have -- our goal is to get to 25% operating margins inthis sector. And we have most of our operations performing at or better thanthat level. So we continue to be pleased with the performance. We still havesome opportunities to maximize and implement best practices across all of oursites.

We're continuing to work hard and drive efficiencies. Wecertainly hope to get increasing efficiencies in Montrealand Massachusetts and Nevada,which are newly built, obviously, and quite flexible in terms of how the spaceis utilized.

John Kreger - WilliamBlair

Great. And then, one last question. Jim, could you justexpand a bit on your dedicated resource comments? As those relationshipsevolve, are they starting to include kind of a dedicated staffing role as well?

Jim Foster

They may. Our goal is to expand our consulting and staffingbusiness, which is predominantly a primarily research model related at the currenttime. We have clients that have space that they want to utilize but don'tnecessarily want to do the work and who may not necessarily have the expertiseto do the work. While it's very early in those types of discussions, we'recertainly having them.

Of course, people are utilizing our facilities, we haveanother arrangement that we're talking about where some of the clients will bepermanently or at least partially located in our facility at the same time. So,again, the goal here is maximum flexibility for the clients, utilizing thefacilities that are proximate to them, whether they are currently built out orcould be built out in the future.

John Kreger - WilliamBlair

Great. Thanks very much.


And your next question comes from the line of Alex Alvarezof Goldman Sachs. Please go ahead.

Alex Alvarez -Goldman Sachs

Good morning and congrats on the quarter, guys. Just wantedto continue with some of the earlier questions on RMS. This year, there havebeen a lot of moving parts that have impacted revenue growth. And I was justhoping if we could get some color from you in terms of what you would kind ofview as a long-term growth rate for the division?

I just want to make sure we don't get carried away withexpectations, because I think the last time that the Street was looking for along-term double-digit growth rate, it did create some challenges for thecompany.

Jim Foster

It's okay, if you get carried away. I think that it'sreasonable to expect, even though we're talking about low double digits forthis year, there is some FX in there. So our realistic aspiration is that webelieve we can grow this business at high-single-digit rate. That's obviously acombination of multiple businesses with different growth rates commensuratewith them.

But we see a very significant demand both in the earlydiscovery side and the later-stage development side of our business, and on theproducts and services side as well. We're thrilled with the way that PTS isgrowing. We're thrilled to see our U.S.rodent sales and European rodent sales are growing at double-digit rates thisyear.

And we are very -- and continue to be delighted with thetransgenic service improvement over the prior year. And we don't really see anyindications that that demand quotient should change. So we're looking at sortof high-single-digit growth, where operating margins are continuing to remainin the low 30s.

Alex Alvarez -Goldman Sachs

All right. Thanks. That was great color. And then in termsof the improved growth in research models right now that you're seeing, wouldyou attribute that primarily to higher spending by customers or is there asense internally that you're making some market share gains as well?

Jim Foster

I think both. We're seeing higher spending in basicdiscovery, as I said, and in development work, because pipelines have to beinvigorated. And that's really the only way to do it. We certainly believe thatwe're taking share from at least one of our primary competitors, particularlyin the United States,particularly in the academic and government sector, and a little bit in thepharmaceutical sector as well.

We continue to get pricing, but we're seeing some nice unitgrowth and increasing mix benefits and believe that those, sort of, metricsshould continue.

Alex Alvarez -Goldman Sachs

And just one last one, in terms of PTS, how many salespeopledo you have out in the marketplace, right now, selling the product? And then,could you just remind us of the sales cycle? How long is it taking potential customersto move from the validation stage of the product to actually making a purchasedecision?

Jim Foster

I don't know the exact number of salespeople on a worldwidebasis. So we'll have to get back to you on that. But it's primarily directsalespeople. It's a highly technical sale that usually requires some sort ofwet lab training. The sales cycle can take a while, sort of, three to ninemonths, kind of, thing.

Even when they're transitioning from our own oldertechnologies, just to understand it, obviously, it's a little tougher when theyare transitioning from a competitor's technology to ours. But once we havecaptured the clients, we feel that we will be able to hold them. And we aredefinitely making those transitions now.

Alex Alvarez - GoldmanSachs

Great. Thank you for the details.


And your next question is from the line of Rob Gilliam withUBS. Please go ahead.

Rob Gilliam - UBS

Hi. Thank you. Most of my questions have been answered atthis point. I guess just one and I don't think that you have addressed itearlier. But just given the robust demand for RMS and as well as the positivemix shift towards transgenics that you spoke about earlier, just curious aboutpricing.

I understand that this is the time of year when you passthrough the new pricing for 2008. And is the 3% still the right number for RMSas a whole or given the positive mix shift could we maybe see that number driftup a little bit higher?

Jim Foster

So we're not going to give details on '08, until our guidancecall, which is in mid-December. So I'm not going to answer that specifically,except to say that we've always been able to improve our prices, appropriatelevels, in our research model business. And I would anticipate that we'll beable to continue to do so next year. And when we do that, we can give you morespecific color on that.

Rob Gilliam - UBS

Okay. Thanks a lot. That's all I have. Appreciate it.


And your next question comes from the line of HariSambasivam. Please go ahead.

Hari Sambasivam -Merrill Lynch

Yes, thank you. A quick question for Tom Ackerman. Justgiven the decline of the U.S. dollar and I'm just wondering in terms of yourcapital expansion plans ex-U.S., how does that -- how do you sort of thinkabout it over the next, say, three to five years with the dollar going where itis?

Secondly, in terms of the U.S. dollar declining as well, howdo you sort of adjust pricing for that? Is it something that you can recoupfrom ex-U.S. clients? Or is it something that you have to eat, like in theCanadian facility?

Tom Ackerman

Yes, the -- well, it's relevant in a couple of ways, Hari.And most specifically in our Canadian operations, where many of our customersare based in the U.S.and the predominant mode of invoicing or method of invoicing is in the U.S.dollar.

So a couple things that we have looked at and continue tolook at is we're having discussions with some of our larger clients aboutpotentially billing those in Canadian dollars, which would obviously alleviatesome of that risk.

We are also doing hedging practices and looking at extendingthose, although given the weakness of the dollar today it would obviously bedifficult to make a long-term hedging decision. But nonetheless we want to atleast put in policies and practices that would allow us to probably go out andhedge longer than we have historically.

We do look at, as we expand, the locations where we areexpanding and the benefits of that. And while the exchange rates are somewhatunfavorable between the Canadian dollar and the U.S. dollar at this particularpoint in time, labor rates historically have been lower in Canadathan they have been in the U.S.So it still continues to be a good source of appropriately priced labor supply.And of course, that's one of the factors we look at as well.

Hari Sambasivam -Merrill Lynch

What about longer-term ex-U.S. expansion with the U.S.dollar going where it is, Tom?

Tom Ackerman

Longer-term, where we would expand, you mean?

Hari Sambasivam -Merrill Lynch

Right. I mean in terms of capital expansion ex-U.S. with theU.S. dollar going down, I'm just wondering that makes it much more expensive tosort do capital expansions elsewhere. So does that sort of figure into yourplans as to how you can recoup this investment if the dollar keeps sort ofdeclining over a period of time?

Tom Ackerman

Well, it does. I mean if you think about Canadaas an example, we are cash flow positive in Canada.So the CapEx that we would spend in Canadawould be mostly driven by operating cash flows within Canadaitself. So it's not like we have to send money from the U.S.up there at an unfavorable rate, or if we needed to we could obviously borrowlocally.

So, I think all those things factor into it, but from wherewe sit today, as an example, the expansion in Sherbrooke,we believe, is still a good transaction to undertake.

Hari Sambasivam -Merrill Lynch

Thank you.


And the final question is from the line of Doug Schenkelwith Cowen. Please go ahead.

Doug Schenkel - Cowen

Hi. Good morning and congrats on a great quarter. Relativeto Street expectations, as I just referred to it was a very good quarter. Ithink Q3, I think it's fair to say that Q3 is usually a bit of a tougherquarter seasonally while Q4, while it's tough seasonally, it usually rebounds abit sequentially.

It doesn't look like that's going to be the case this yeargiven that you have implicitly guided the Street to expect a sequentialslowdown in sales heading into Q4. So just so we can better understand howstrong a quarter Q3 was, can you talk about whether or not you pulled somesales into Q3 that were expected in Q4? And if so, on which side of thebusiness? How should we think about the margin impact both from a Q3 upside andQ4 outlook perspective?

Tom Ackerman

Yes, this is Tom, Doug. There is no -- I would say no -- wewould not pull any sales forward. We wouldn't do that, and it's generally notthat available to us anyway. We can't ship out animals a little early with somesort of a [SPF program].

I think one of the things that I said earlier is that it wasa very good quarter almost everywhere we looked. We always have businesses thatoutperform, we have businesses that are sort of where you expect them, andsometimes of course we have businesses that are under-performing and theportfolio sort of manages that.

This quarter, being Q3, I would not say that we had anydisappointments anywhere. So the stars were sort of aligned all over the place.Corporate expenses were favorable as we talked about, up versus last year butsequentially down versus Q3.

We wouldn't expect to see that same thing in Q4, although wewould still expect to see it on a favorable trend basis. So I think it was avery, very good quarter and I think we are sort of seeing the same similarthings and guiding that way that we would expect in Q4 in terms of seasonality,opening of the new facilities, things like that.

A couple of things that we probably didn't mention in ourprepared remarks is, we did have a bump up in the tax rate in Q3 of last year,which we didn't experience this year. We also expect a higher share count inQ4. Last year we actually had some favorable foreign exchange activities in Q4,and I wouldn't expect that again this year.

Doug Schenkel - Cowen

Yes, okay and now that makes sense. And again it was astrong quarter and I understand it's hard to accelerate sales from one quarterinto another.

Just given how positive you and others have been aboutbiopharma demands on the outsourcing side, it just looks like your PCS salesgrowth is a big conservative, given that if I just punch in the numbers for Q4to get to your full-year guidance, it doesn't look like you're expecting amaterial increase sequentially.

So I don't know. Is that conservatism? Or is there somethinggoing on there from a capacity standpoint? Or is it a transition into newfacilities? Could you provide a little bit more color there?

Tom Ackerman

Yes, well, we certainly wouldn't comment on the type ofquestion and I know you don't mean it that way that is it conservative? I mean,we wouldn't comment on that. RMS is typically down sequentially in the fourthquarter. We don't expect to see anything different this quarter. That's sort ofwhat we talked about in our prepared remarks.

And I do think, we will continue to see some sequentialgrowth in PCS. But I think given the higher profitability of RMS, it sort ofweighs on that more heavily. And then I think if you go into a couple of theother things that we talked about, like the continuing transition inShrewsbury, we now are beginning to occupy Reno, where we will start to havesome duplicate costs that will overlap in the fourth quarter, which is reallythe first time we've seen that.

So while we are not occupying Renoen masse, we do already have people that show up there everyday for work. So weare seeing operating expenses in the fourth quarter. So we kind of have that atboth facilities. So I think it will be a good quarter, but I think it will be adifferent quarter from the third quarter, obviously.

Doug Schenkel - Cowen

Okay. And just one last one, kind of an updated picturequestion. Clearly, you guys have the nice problem of being at full capacity insome of your older and newer facilities. Clearly, there is going to be upsidedriven by mix on the topline as well as at the margin line.

Is there any ability to use, I guess what we're referring tonow as CRDRs as a way to shift projects amongst facilities, so that you couldfree up capacity at some of your facilities where it is tight right now?

Jim Foster

Directionally, that's certainly our goal and particularlyamongst the four big locations that we have, that have a whole range ofproducts and services. We are hoping that over time clients will pretty muchlook at them similarly, so we can sell space that's not fully utilized at aparticular period of time.

And we are quite confident that we will get there. It willtake some time. As I said earlier, clients have long-standing relationshipswith particular locations and particularly the study directors in thoselocations; and there is some reluctance to make changes even within a system assophisticated as ours.

But as we build particularly these two new facilities andare able to validate the depth of expertise we have, we are comfortable thatover time that will change.

Doug Schenkel - Cowen

Great. Thanks for taking my questions.


There are no additional questions at this time. Pleasecontinue.

Susan Hardy

Thank you for joining us today. We look forward to seeingyou at the Credit Suisse Healthcare Conference next week and speaking with youon December 13, when we hold our 2008 guidance call. This concludes today'scall. Thank you.


Ladies and gentlemen, that does conclude our conference fortoday. Thank you for your participation and for using AT&T executiveteleconference. You may now disconnect.

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