Pharmaceutical Product Development 2008 Financial Guidance Call Transcript

Jan. 9.08 | About: Pharmaceutical Product (PPDI)

Pharmaceutical Product Development, Inc. (NASDAQ:PPDI)

2008 Financial Guidance Call

January 9, 2008 9:00 am ET

Executives

Dr. Fredric N. Eshelman - Vice Chairman of the Board, ChiefExecutive Officer

William J. Sharbaugh - Chief Operating Officer

Daniel G. Darazsdi - Chief Financial Officer

Dr. Paul Covington - Chief Medical Officer

Analysts

Robert Gilliam - UBS Securities

Alex Alverez - Goldman Sachs

Jon D. Wood - Banc of America Securities

James Kumpel - Friedman, Billings, Ramsey

David Windley - Jefferies & Co.

Eric W. Coldwell - Robert W. Baird

Doug Tsao - Lehman Brothers

Sandy Draper - Raymond James

John Kreger - William Blair & Co.

Hari Sambasivam - Merrill Lynch

Alan Fishman - Thomas Weisel Partners

Operator

Good morning. My name is Jennifer and I will be yourconference operator today. At this time, I would like to welcome everyone tothe 2008 guidance call for Pharmaceutical Product Development conference call.(Operator Instructions) Dr. Fred Eshelman, you may begin your conference.

Dr. Fredric N.Eshelman

Thank you, Jennifer. Good morning and I will begin by sayingthat except for historical information, all of the statements, expectations,and assumptions discussed in today’s call, including revenue and earningsguidance and compound partnering activities, are forward-looking statementsthat involve a number of risks and uncertainties. Actual results might differmaterially from those in the forward-looking statements. Information about thefactors that could cause actual results to vary is disclosed in the pressrelease announcing our guidance and in the SEC filings for PPD, copies of whichare available free of charge from our investor relations department.

Our net revenue forecast excludes reimbursed out-of-pockets.Although this non-GAAP financial measure is not superior to or a substitute forGAAP net revenue, we exclude reimbursed out-of-pockets from our forecasted netrevenue because they are difficult to accurately forecast and are immaterialbecause they do not affect operating income, net income, or earnings per share.

We also believe this non-GAAP measure is useful to investorsbecause it more accurately reflects the net revenue that PPD will generate fromits services and because it is useful in making period-to-period comparisons.

As you’ll recall, we postponed our guidance call from ourusual timing of early December in order to have a better handle on certainpotential events. We are pleased to report that we do indeed have moreinformation. Having said that, please recognize the assumptions that we aremaking and risk adjust accordingly.

Let’s begin with discovery, which includes compoundpartnering. In early December, JNJ announced that the Dapoxetine applicationhad been made and accepted under the decentralized procedure in Europe, withmore filings to follow in other regions. This is obviously good news.

We believe that the ex-U.S. markets could be substantial.Remember that an additional milestone is due upon EU approval and double-digitroyalties increasing with sales would begin upon launches. PPD would also standto receive sales based milestones.

JNJ have not announced an expected approval date so we havenot included any revenue in the ’08 guidance but would hope for early ’09, ifnot before.

Accentia has been very bullish about blinded SinuNase dataand say that they hope to finalized a commercial partner after unblinding PhaseIII trial in March of ’08. They expect to immediately run another Phase IIItrial, file the NDA in late ’08, and receive a Q1 to Q2 approval in ’09.

If SinuNase is approved and launched, we will receive a 7%royalty on sales. We have not included any revenue in ’08 guidance. Accentia’smarket forecast is for sales of SinuNase to rise to almost $600 million by2011.

We are continuing to work on the statin compound 10558. Theanticipated 2008 spending includes CMC, pre-clinical, and clinical. We expectto have the results from a high dose comparative trial in February of ’08 andwill decide a course of action at that time. We have included these expenses inthe ’08 budget to cover this work.

Now, for the Takeda DPP4 program. The Alogliptin NDA wassubmitted on December 27 of 2007 and we expect the NDA for the compound to befiled by the FDA in Q1 of ’08, triggering a milestone payment to PPD. Webelieve that the timing will allow for a U.S. approval in late ’08, triggeringanother milestone and a very small contribution from sales royalties.

PPD also stands to receive additional development milestonesif and as filings and approvals are made and obtained in other regions of theworld. Besides royalties, there are also sales-based milestones.

Another DPP4 inhibitor, compound number 472, is in Phase IIand if continued will be developed as a monotherapy. We also expect the fixeddose combination of Alogliptin with [pioglytozine] to progress quickly throughdevelopment in 2008.

We had two other potential partnering deals in late stagenegotiations in 2007. One fell apart on economic terms and one on the patentsituation as we saw it. We will continue to evaluate opportunities but havenothing in the 2008 expense budget at this time for new projects.

Remember that this segment also contains the pre-clinicaloncology unit and the bio-marker business. The latter is expected to continueto lose money in 2008 but the pre-clinical oncology unit should be nicelyprofitable.

Roll-up for the full discovery segment 2008 forecast lookslike revenues of $60 million to $65 million and an EPS contribution of $0.18 to$0.20.

Turning to the development services segment, we expectrevenue growth of approximately 17% in 2008, ranging in absolute terms from$1.475 billion to $1.525 billion. We are forecasting segment EPS growth ofaround 15%, resulting in EPS contribution from the segment of $1.64 to $1.72.This assumes that gross and operating margins excluding the stock optionexpense revolve around our targets of 50% and 20% respectively.

Our projected unit growth rates will likely continue toshift revenue ex-U.S., resulting in a 65-35 revenue contribution from NorthAmerica and rest of world respectively. Revenue per FTE is predicted to beessentially flat. CapEx is forecast at $80 million to $90 million, with themajority for facility improvements and expansions and for IT, with theremaining for equipment in the labs and clinic.

The overall rollup for the company looks like this: totalnet revenue should be $1.535 billion to $1.590 billion, representing around a20% revenue growth over 2007. EPS for the full year of 2008 should be $1.82 to$1.92, representing approximately a 36% growth in EPS versus 2007.

By quarter, we believe that the numbers for EPS may be: forQ1, $0.42 to $0.44; Q2, $0.39 to $0.41; Q3, $0.42 to $0.45; and Q4, $0.59 to$0.62.

So we are quite bullish about both segments of our businessand hope to achieve these outstanding results.

Bill Sharbaugh, our COO, will now make a few comments,followed by our CFO, Dan Darazsdi. At the end of Dan’s comments, we will takeyour questions and comments. Bill.

William J. Sharbaugh

Thank you, Fred. While we are anticipating positive resultsfrom our discovery segment in 2008, primarily due to the maturity of our compoundpartnering strategy, the development segment is forecasted to grow at a robust17% while continuing to deliver the best operating margins in the industry.

We expect strong demand for outsource services to continuein 2008 and we expect to see increasing numbers of RFPs that are global inscope and larger in size. Biotech development activity and funding appear to bestrong and with increasing cost pressure on pharmaceutical drug development,our customers continue to evaluate activities to outsource.

We continue as always to evaluate acquisitions that wouldenhance our service offering in terms of geographic scope or technicalcapability. I am referring to smaller, bolt-on or niche acquisitions that wouldfill a gap or lend us a competitive advantage.

Turning specifically to our labs in 2008, we expectcontrolled growth in our GMP lab, bio-analytical labs, and Phase I clinic,while we see our global central lab unit making the largest contribution torevenue growth and operating margin for these businesses.

Stepping back to 2007 briefly, we had a global central labcontract delay which resulted in a revenue shortfall. Despite this delay, weremain bullish about our central lab business and continue to make improvementsin work flow, technology, and data integration that will improve efficiency.

For the Phase II through IV business, we expect to seecontinuing growth acceleration in emerging markets, so our focus will be onbuilding the supporting infrastructure while ensuring high quality. Therefore,we have split Asia-Pacific and Latin America into separate, strategic businessunits with dedicated management teams.

I would like to mention several operational leadershipappointments which reflect the world-class Phase II through IV management team.During the second half of 2007, this was a primary focus for the company.

First, Sebastian Pacios joined PPD on January 2nd asSenior Vice President of Europe, Middle East, Africa Phase II through IV. Dr.Pacios has extensive international clinical research experience. Prior tojoining PPD, he co-founded and rapidly grew a regional CRO, sold it, and thenheld various senior management positions within a top 10 CRO, most recentlyserving as Vice President responsible for clinical research operations andproject management.

In Q407, Paul Colvin joined from Ely Lilly as Senior VicePresident of North America Phase II through IV. He has 15-plus years experiencefrom big pharma with a significant focus in oncology.

In Q307, Simon Britton joined as VP of our Asia-Pacificbusiness and he has 15-plus years of combined experience from GFK and a topfive CRO.

Latin America is led by a PPD veteran, Wendy Buckland, whohas significant experience in this important region, and as I mentionedpreviously, in two high growth markets, India and Mexico, we have hired MDswith significant pharma or CRO experience to run our operations. They are inplace now.

By the end of Q108, I expect to name an executive vicepresident of global Phase II through IV operations and currently, I am doingsignificant work to reorganize and realign our operations to improve ourability to execute.

That concludes my comments and I’ll turn it over to our CFO,Dan Darazsdi.

Daniel G. Darazsdi

Thank you, Bill. All net revenue numbers, gross margins, andoperating margins included in my remarks today exclude reimbursedout-of-pockets and stock option expense.

Before discussing our ’08 guidance, I would like to commentbriefly on our revised ’07 guidance range for EPS. While we have maintained ouroverall EPS within the previously released guidance, we have narrowed the rangefor total company EPS and updated the expected EPS contribution for eachsegment.

The projected ’07 development segment EPS range is lower dueto a project delay in global central labs, an increase in bad debt reserve toaddress several specific issues, and negative impacts from foreign exchange.These declines were partially offset by positive developments in other areas.

Now, turning to our ’08 guidance, first I would like tocomment on each segment’s revenue and EPS guidance and then provide someadditional insight into the assumptions underlying our ’08 development anddiscovery segment forecasts.

Net revenue for our development segment in ’08 is expectedto grow at approximately 17% compared to the midpoint of the ’07 revisedguidance. Income from operations is projected to grow by 17% and remains strongat our targeted 20% margin rate.

Our projected operating margin rate demonstrates continuedfocus on operational excellence to deliver gross margin rates at 50% andcontinued tight management of overhead. For full year ’08 EPS per diluted sharefor the development segment we’re expected to grow by 15%, comparing themidpoint EPS numbers for both periods. EPS growth is negatively impacted by anincrease in stock option expense and share count, which takes the developmentsegment EPS growth to 15%.

The discovery segment has the potential to have abreakthrough year from a financial viewpoint with revenue in the $60 million to$65 million range and earnings per share for this segment in the range of $0.18to $0.20 for ’08. The increase is driven to a large degree by the expected $40million in milestones in connection with the Takeda DPP4 program, with $15million expected in the first quarter and 25 anticipated in the fourth quarter.

Combining the two segments yields top line growth for thetotal company of approximately 20% over our revised net revenue guidance for’07. Full year ’08 earnings per diluted share for the company are expected tobe in the range of $1.82 to $1.92. This includes stock option expense for ’08net of tax of $0.13 to $0.14 per diluted share compared to a range of $0.10 to$0.12 per diluted share for ’07.

Our ’08 forecasted net revenue is based on an estimatedoverall cancellation rate of 25%. Our cancellation rate for the first ninemonths of ’07 is approximately 23% but our historic cancellation rates havevaried from period to period.

The percentage of revenue from backlog for our ’08 forecastis slightly higher than the percentage we used for the initial ’07 forecast.Utilization levels across the company are forecasted to be on par or slightlybetter than the ’07 performance. FTEs are expected to increase at approximatelythe same rate as development revenue growth for ’08.

PPD's foreign operations are expected to generateapproximately 35% of PPD's total net revenue. Historically, the majority ofcontracts that generate revenue for our foreign operations are denominated inU.S. dollars. However, we generally incur expense in the local currency of eachcountry where we perform service. As a result, we have exposure to foreigncurrency movements. We enter into foreign currency hedging activities in aneffort to manage our potential foreign exchange exposure.

Our European Phase II through IV operations represent ourlargest net currency exposure. Due to the growth in our Phase II through IV inLatin America operations, we also have exposure to the Brazilian real. For ’08,our forecast is based on an average exchange rate of $2.02 for the sterling,$1.40 for the Euro, and $0.565 for the Brazilian real. If the U.S. dollarweakens resulting in exchange rates of two-tenths of a sterling and $1.47 forthe Euro and all else remains equal, the impact on our EPS guidance would be areduction of approximately $0.02.

Cash flow from operations for ’08 are anticipated to be inthe range of $275 million to $325 million. We will continue to driveinitiatives aimed at improving DSOs during ’08 in support of our strong cashflow delivery.

For the full year ’08, we are forecasting an effective taxrate of 33% to 34%, compared to an expected tax rate of 34% for ’07. We areforecasting approximately 122 million weighted shares outstanding for ’08.

Finally, I would like to congratulate Craig Eastwood on hisappointment as PPD's new Director of IR. Craig is replacing Steve Smith, whohas left to pursue other interests.

This concludes my remarks. I will now turn the call backover to Dr. Eshelman. Thank you.

Dr. Fredric N.Eshelman

Thanks, Bill and Dan. Jennifer, we’re now ready for Q&A,please.

Question-and-AnswerSession

Operator

(Operator Instructions) Your first question comes fromRobert Gilliam with UBS.

Robert Gilliam - UBSSecurities

I just have a couple of questions. First, I was wondering ifyou could address business wins in 4Q, or potentially RFP activity?

Dr. Fredric N.Eshelman

We’d like to reserve that for the fourth quarter call, whichI think is February the 7th -- Craig, what’s the date? Yes, that’s right, sowe’ll be glad to comment at that time.

Robert Gilliam - UBSSecurities

Okay, just moving on to a couple of other things, I thinkyou mentioned there was a bad debt issue in 4Q07. I was wondering if you could justgive us a little bit more color and elaborate on that.

Daniel G. Darazsdi

We’ve identified a potential risk with one of our clientprojects and we’ve determined that it’s appropriate at this time to take areserve for that risk. I won’t go into the client detail but it was isolated,principally the largest one being a Brazilian or Latin America client butthat’s about all the detail I think is appropriate.

Robert Gilliam - UBSSecurities

Okay, and you think that’s just going to impact 4Q07 and won’timpact --

Daniel G. Darazsdi

Yes, it’s just a one-time reserve that we think isappropriate from an AR viewpoint.

Robert Gilliam - UBSSecurities

Okay. I guess just one final question on the compoundpartnering program; obviously it looks like you are including the $25 millionpotential payment in 4Q08 and I guess given historical approval rates, I guesswhat was the deciding factor in determining to include that in 2008 guidance?It looks like you put that there’s no probability weighting. I was justwondering, is there anything specific about the package you put together thatgives you increased confidence? I was hoping you could just give us a littlecolor on that.

Dr. Fredric N.Eshelman

Well, I think the fact that the submission went in in ’07and therefore theoretically the filing will occur very early in ’08, in Januaryspecifically. That would essentially give us almost a 12-month run-rate for theinitial approval. Given the usual PDUFA dates and so forth, we thought that wasa reasonable assumption. Obviously we have seen the data and I’m not going totry to comment on behalf of Takeda but as far as we are concerned, it was avery good NDA. Anything can happen, as you know, but we certainly did not seeany red flags.

Robert Gilliam - UBSSecurities

Okay, thanks a lot. And then just one final question; I justwant to make sure, because you know, revenue risk is growing at 17%, EPS was at15%. I just want to make sure that’s not coming from any pressure on EBITmargins but instead is more below the line items.

Daniel G. Darazsdi

Yes, as picked up from my comments, when you look at thedevelopment side and you look at the operating margins, the operating marginrates are being maintained on a year-over-year basis. What we are getting comparedto the revenue growth is some dilution based on stock option expense andtraditional share count, so our gross profit rates and margin rates indevelopment are being maintained at our targeted 50-20.

Robert Gilliam - UBSSecurities

Okay. Thanks a lot. I’ll let somebody else hop in.

Operator

Your next question comes from Alex Alverez with GoldmanSachs.

Alex Alverez -Goldman Sachs

Good morning. I just wanted to start off with the centrallab. It seems like you are expecting an improvement in 2008. I was just curiousin terms of what is driving that improved outlook, particularly with the largedelay, which I think was not expected to resume until 2008, and then I thinkthere was another mention about another small delay that is going to impact Q4a little bit.

William J. Sharbaugh

I’ll go ahead and take that, Fred. As was mentioned, thisbig contract that’s been delayed, we expect it to pick up at the start of 2008and that’s certainly going to be positive. In addition, there’s lots of workgoing on inside the labs themselves to make them more efficient. We are alwayslooking for new assays and new tests. We’ve repositioned some of our equipmentand improved work flow.

In terms of data integration where there were sometechnology solutions that are very positive and upgrades to our [LIN] system,some data acquisition activity, so we are doing a lot of internal work in ourlab unit to improve their capability and ultimately the flow of blood throughthem.

Alex Alverez -Goldman Sachs

Would that be then more of an expected improvement inoperating income from the lab as opposed to just all being driven by top line?

William J. Sharbaugh

There’s also been strong sales this year and as you know, inour business when sales are relatively strong a couple of quarters out, thatkicks in from a revenue perspective.

Alex Alverez -Goldman Sachs

Okay, and then I think the third quarter conference call,there was some talk about potentially expanding your post-approval studycapabilities. I was just curious in terms of what the plan is for 2008, whetherthere were any amounts budgeted to hire some new individuals if that might bewhat’s needed, or what the overall plan is around expanding those capabilitiesfor PPD.

William J. Sharbaugh

Well, the first thing I would say about that is we haverelatively strong capability already and have a rather solid book of workthere, so we are a knowledgeable, capable company in that realm.

Secondly, yes, we are in ongoing discussions with sometalent, both internally and externally, that we think will bolster thatparticular business unit. I think you could expect to see some activity in thatarea in the not-too-distant future. And we are making a lot of internalimprovements as well that position us to serve that particular market.

Alex Alverez -Goldman Sachs

And just one last one; Fred, although you mentioned thatthere is nothing in the pipeline right now for new compound partneringagreements, would you still plan to restructure that business if you were enterinto any new agreement in 2008?

Dr. Fredric N.Eshelman

I think if we enter into anything that would be materiallydilutive to the overall company, we would certainly seriously consider puttingthat into some kind of different structure where we would take much lessdilution.

As you know, historically we have picked up compounds thatwere pre-clinical -- i.e., the IND had not even been filed, so that it would bepossible for us to sign such a deal and have some de minimis spend on it priorto putting it into another vehicle but I think the effect, if any, on EPS forthe entire company just wouldn’t be terrifically material, or at least that’sour plan as of today.

Alex Alverez -Goldman Sachs

Okay, great. Thanks for the detail.

Operator

Your next question comes from Jon Wood with Banc of AmericaSecurities.

Jon D. Wood - Banc ofAmerica Securities

Thank you. Has there been a structural change in thecontracting terms on the core development business?

Dr. Fredric N.Eshelman

I’m not quite sure I follow you. What specifically are youdriving at?

Jon D. Wood - Banc ofAmerica Securities

I’m just looking at the DSO. It looks as if the top end ofthe cash flow guidance has some DSO improvement built into it and I’m wonderingthe risk to your ability to improve that metric -- anything going on in theindustry that would suggest a structural change in contracting terms -- paymentterms, basically?

Daniel G. Darazsdi

I think if we look at our DSO performance, comparing ’08 to’07, a couple of key factors I would just highlight. One is as you know, in ’07we did have a couple of clients which we struggled with from a collectionviewpoint and that put some negative pressure on ’07, so from a comparable viewyear over year, that’s one factor.

The other factor is we continue to look to drive DSOimprovement by both very close monitoring of the billed balance -- monitoringthe aged receivables and getting better and earlier escalation to -- that’s onearea.

On the un-billed side, which really gets at the contracting,we’re endeavoring to make sure that we get in place with the initial contractgood milestone payment terms, both trying to get cash early and making surethat we’ve got appropriate milestone payment terms in the contract.

So I don’t think there is an industry change going on there.I think we are endeavoring to put a lot of focus here and hopefully that willhelp improve our cash flow performance.

Jon D. Wood - Banc ofAmerica Securities

Okay, great. Dan, what are your views on the capitalstructure of the company? I mean, is there any sense of urgency from the boardlevel to address the large net cash position on the balance sheet?

Daniel G. Darazsdi

Well, we’ve talked about the disposition of our cash in thepast and the way we are looking at our cash is one, trying to drive strong cashflow performance from an operational viewpoint. To me, that’s foremost ofimportance. And the question that you are really getting at is the dispositionof the cash. As we look to bad cash, break that into a couple of areas -- one,we are looking at how can we support best the organic growth of the businessand making sure that we are strongly supporting the organic growth of thebusiness. Two, we will look at selected or niche M&A activity, which we’vetalked about where we think it’s a positive augmentation to either geographicor to the solution set for the client, but obviously that would be specific andkind of niche related. And then finally, we are evaluating share buy-back at thispoint as one alternative to cash disposition but we’ve also increased thedividend recently.

So I’d say it’s under evaluation, it is getting gooddiscussion and visibility with the management team, and we will inform you asdecisions are being made.

Jon D. Wood - Banc ofAmerica Securities

Okay, great and then -- I don’t know if I missed this butwhat’s the expectation for the shares outstanding for the year for ’08?

Daniel G. Darazsdi

Shares outstanding for ’08, we’ve got weighted averageshares of about $122 million and that’s up, as you know, against the weightedaverage ’07 direction.

Jon D. Wood - Banc ofAmerica Securities

Okay. Thank you.

Operator

Your next question comes from James Kumpel with Friedman,Billings, Ramsey.

James Kumpel - Friedman,Billings, Ramsey

Just in the guidance assumptions, can you just state whetheror not you are including some of those unnamed tuck-in acquisitions in your ’08outlook?

Dr. Fredric N.Eshelman

No, there is no assumption in there for a new acquisition tomy knowledge.

James Kumpel -Friedman, Billings, Ramsey

Okay. Can you maybe distinguish, Fred, for us some of thefactors that would lead you to assume the milestones on Takeda upon FDAapproval in the fourth quarter but not to assume approvals from Europe at somepoint in 2008?

Dr. Fredric N.Eshelman

Well actually, that question goes to the filing strategy forTakeda, so I guess I’d have to refer you to them for that. I just really can’tcomment on that. There are other potential territorial filings, including Japan,but we’ve not been released to discuss that at this moment and therefore, wehaven’t put it in the guidance.

James Kumpel -Friedman, Billings, Ramsey

Okay and then just on the core CRO business, can you commentas to whether or not you’ve essentially experienced the same sort ofimprovement in win rates and sales focus in your performance in the second halfof the year that you initially had been seeing in 3Q?

Dr. Fredric N.Eshelman

Well, that would go to fourth quarter results and we had aprevious question on bookings for Q4, which I am going to have to wait untilour Q4 call in February. But I would say that as we commented, the marketremains very strong as reflected on the business that we have bid on. We haveworked very hard to improve the lackluster results from Q2 of ’07 and I thinkthat our BD folks are making progress and I guess I’ll have to leave it at thatuntil February.

James Kumpel -Friedman, Billings, Ramsey

Okay, and just a last one; Fred, if you could comment onwhat you guys have done as an organization in preparation for some of theexpected increase in post-approval monitoring and Phase IV type studies?

Dr. Fredric N.Eshelman

We’re in the process of doing some restructuring internallyto address those kinds of things. I personally believe that a lot of theactivity is actually going to be reflected in larger Phase III trials and inPhase IIIb trials being launched almost at the time of submission of the NDA,so in other words we wouldn’t really wait until we were farther down theregulatory pathway. That’s just my view.

In terms of pure Phase IV, which by our definition meansthere is no change in dose or indication from the label, I just don’t know howmuch of that is going to happen, with the possible exception of registries andthose types of trials which, why they are extended over a number of yearsactually tend not to be in the -- what we’d call the mega trial range whichsome of the safety trials are.

James Kumpel -Friedman, Billings, Ramsey

I appreciate it. Thank you very much.

Operator

Your next question comes from Dave Windley with Jefferies& Company.

David Windley -Jefferies & Co.

Good morning. Thanks for taking the questions. Fred, Iwonder in your thoughts on what your marketing [inaudible] looks like now --and I’m not asking you to tell me what it looks like but just what you knowabout it and some comments I think you made recently about the surprisingnumber of contracts that are out there now that are in -- that are now ninefigures, in excess of $100 million. What are your expectations in 2008 in termsof movement of the average size of contract in backlog and what influence doesthat have on how quickly you expect those things to convert into revenue? Inother words, should we assume that burn rate will continue to drop because theaverage size of the contract is probably going to continue to get bigger?

Dr. Fredric N.Eshelman

I’m not sure there’s a direct correlation there. As yourecall, at one point our average length of contract for Phase II through IV hadstretched up to 36 months in some quarter. I’ve forgotten which one it was.Then it dropped back to 32. The following quarter it stabilized around 32. I’mnot sure exactly what it will be for Q407 but I am not struck that it is goingto jump back out again.

So until we know otherwise, we are running under theassumption that the 36-month thing was an anomaly and we are going to settleback to somewhere around 30, 32, somewhere in that range.

David Windley - Jefferies& Co.

Okay. Following up on an earlier DSO question, Dan, youanswered and kind of addressed billed and un-billed on the up-fronts. I’mwondering, is your expectation that from a contracting term standpoint, thatthe up-fronts are going to continue to be under pressure? If you commented onthat, I missed it. I apologize.

Daniel G. Darazsdi

I think it’s always a challenge. What I would say is we aregoing to be paying particular attention to the cash flow on aproject-by-project basis for all of our contracts, big and small, and try toget that more visibility and discussion as part of the contracting process. Sothere’s always -- obviously that’s always a challenging area but it’s one wherewe think looking at the difference in contracts over the course of the lastnumber of months, we think there is some opportunity there and we are focusedon it.

David Windley -Jefferies & Co.

Okay. As I am just looking at some stats on pharma growth inyour revenue versus biotech and I think for most of 2007, it’s kind of pushedback towards pharmaceuticals and that’s consistent, Fred, with you’ve beentalking about kind of a resurgence in big pharma outsourcing for a while. Isthat something that -- is that evident in the backlog and is that somethingthat you expect to continue, that big pharma kind of reverses and becomes abigger part of your revenue growth? And does that put pressure on contractingterms?

Dr. Fredric N.Eshelman

We’ll see. I mean, I really don’t expect a precipitouschange in the balance of pharma versus biotech business in our backlog and Iwould comment that although we do feel that the big pharma outsourcing hasup-ticked, there has been quite a change in our view in the biotech sector overthe last two or three years and by that, I mean I was talking to somebody theother day and talking about five very large opportunities that we had seenrecently. And two of those came from smaller biotechs; in other words, theywere not of the Amgen, Genentech, Biogen, [Metomune], [Carron] kind of size andso therefore when you’ve got very well funded by smaller biotechs who areputting out $100 million RFPs, you’ve got a change in the market there whichone could speculate would at least maintain the biotech percentage if not creepit up a little bit.

David Windley -Jefferies & Co.

Okay, and finally, on that bad debt reserve, you mentionedit’s a one-time. Is the exposure on those one or two clients, is it now fullyreserved?

Daniel G. Darazsdi

I would say it’s been identified specifically and adequatelyreserved for.

Dr. Fredric N.Eshelman

It was not what I would call a key client in our link-up.

David Windley -Jefferies & Co.

No, but it is fully reserved?

Daniel G. Darazsdi

When you say fully, we’d say it’s adequately reserved. We’renot expecting -- obviously when we do an analysis of the requirements, wereserve for it so in that context, I would say our expectations are it’s fullyreserved and I would use the term adequately because --

Dr. Fredric N.Eshelman

I think what that means outside the CFO double-speak is wewould not expect it to have a material effect in ’08.

David Windley -Jefferies & Co.

Okay, thanks.

Operator

Your next question comes from Eric Coldwell with Robert W.Baird.

Eric W. Coldwell -Robert W. Baird

Thank you and good morning. I guess my first question getsto the revenue guidance in development. Looking back for posterity for the lastI believe five quarters, PPD's revenue has missed street targets. You’ve cutthe fourth quarter revenue target and yet you’ve delivered pretty strongguidance for 2008 in development and if I heard you correctly, it sounded likeyou are putting in a larger burn rate out of backlog and also baking in some ofthe central lab contracts that you’ve recently won with the anticipation thatthey start on time. Recent experience has not proved to be the case though.Cancellations have been running above norms.

Where do you get the confidence that after ayear-and-a-half, revenue guidance is now more projectable, you can be morecomfortable with an acceleration in 2008?

Dr. Fredric N.Eshelman

Well, I think several factors. As you point out, we have alittle bit more coming out of backlog than we’ve had in the past. We have tolook at the market as reflected on the dollar volume of RFPs that we’ve seenover the last year and our expectations for how those would continue and theexpectation that our hit rate would remain at least as good as it is, if not goup.

We are expecting some improvement in GCL, as you point out,and we’ve maintained all along that although we did have a soft spot in ’07that we thought that was recoverable and a 15% to 20% top line growth rate wasstill within the realm of what we thought we could produce based on the market.So as always, we’re doing our best.

Eric W. Coldwell -Robert W. Baird

I guess as a follow-on, have there been any -- with Danjoining the firm and some change in management, has there been any change inhow you look at the backlog or how you analyze, forecast, project? Have youdone any retrospective analysis on where you fell short over the lastyear-and-a-half and changed your policy in terms of how you do the build-up forguidance?

Dr. Fredric N.Eshelman

I don’t think so. I think our policy has always been fairlyconservative. The fact that we were a little short of revenue was dependent ona whole lot of things, including a sales shortfall that we could not havenecessarily projected before. So I think that our -- the way we go about thisremains conservative. It does not stray over into the sandbag territory but itis our best shot and we’ve been doing this a long time and I think if you lookback historically, we got it right a whole lot more than we got it wrong, so nochange, in other words.

Eric W. Coldwell -Robert W. Baird

Shifting gears, looking at the discovery segments, your 4Q07guidance implies that you are going to be doing something north of $6 millionin the division in the quarter, which would be about a 30% to 35% increaseQ-to-Q following three quarters where growth was negative 16%, 3%, and 4%sequentially. Again, now we’re looking at 30% to 35% type growth in the fourthquarter. What happened in that division? Were there any one-time milestones? Isthere a step-up in PRC’s activity that you think is permanent? How should we bethinking about this discovery sciences group?

And how were you able to reduce your discovery dilution by$0.02 to $0.04 for the quarter, effectively cut it in half to two-thirds indiscovery? I mean, we were looking previously at $0.075 of dilution for thefirst nine months. You were targeting I think $0.11 to $0.13 of dilution forthe year. Now you are targeting $0.09 of dilution for the year, so effectivelya penny-and-a-half in the fourth quarter. It just seems like a major change inthe dilution profile and I guess what I’m driving to, is there somethingphenomenally different in discovery revenue streams or was the statin spend incompound partnering materially lower?

Dr. Fredric N.Eshelman

The statin spending, based on the numbers that you justthrew out, was lower. We changed some of the development plan and program sortof on the fly, if you will, represented by the high dose comparative study,which is underway and we’ll report in February. So that was not quite up to thelevel of what we were planning originally to do in Phase III and that wouldhave included more basic material. It would have included a little bitdifferent clinical program and so forth, and so as we indicated it was lower inQ4.

We will continue to spend in Q1 of ’08 on all the thingsthat we talk about and that’s fully in the guidance and then in Februarythereabouts, hopefully we’ll have the data, upon which we will make a decisionas to exactly what we are going to do with the compound. In other words, eitherwe’ve got the data to out-license it or it’s not favorable enough to goforward.

But either way, at this point in time we would notanticipate a material dilution from that compound post Q1.

Eric W. Coldwell -Robert W. Baird

And just a final question; following the statin, assumingthat either you out-license it or you kill it after the first quarter, which isI guess the assumption here, what is the run-rate internal R&D with noadditional compounds brought in? What would we be looking at on a quarterlyphasing after Q1?

Dr. Fredric N.Eshelman

Somebody will come up with that number here right quick. Canwe go on to the next question and I’ll come back to that for you?

Operator

Your next question comes from Doug Tsao with Lehman Brothers.

Doug Tsao - LehmanBrothers

Good morning. So just to follow on Eric’s questions, itsounds, Fred, just to confirm, that basically in terms of R&D spend on theRanbaxy compound, you will finish the Phase II proof of concept study in thefirst quarter and then basically make a go or no go decision in terms offinding a development partner, but it does not sound like you would continuedown the development path without a partner?

Dr. Fredric N.Eshelman

I think that’s a reasonable assumption, unless we were invery serious discussions with one or more partners. But we couldn’t closesomething as rapidly as we wanted to and we also did not want to delay theprogram. That would be a possible scenario under which we continued to spend inadvance of an out-licensing. But I think again what we are shooting for is tohave the data to either say okay, we’ve got a live one here. Somebody’s goingto take it and so forth pretty quickly or, based on the data we see, we justcan’t see our way clear to spend anymore on this compound.

Doug Tsao - LehmanBrothers

And then in terms of a development partner, would you belooking for a partnership similar to what you have with Takeda, in which thepartner would bear all of the late stage development costs? Or would youconsider an agreement in which you would bear some of the costs?

Dr. Fredric N.Eshelman

I don’t know. We’d have to look at that at the time and inthe context of the overall terms and the overall prognosis for the compound interms of market research. We have had contracts in the past where in theory, wewould have split Phase III costs with people and so forth, but that wasgenerally under the assumption that we’d never get there. Somebody would pickit off before that, so barring something very unusual I think the likelihood ofPPD taking on late stage dilution for a compound is just not likely.

Doug Tsao - LehmanBrothers

Okay, and then you’ve touched on it a little bit in the callso far but obviously the number, the deepening of your management bench and anadditional layer of very high quality people in terms of regional vicepresidents has been significant. I was just hoping you could provide somecomment on what led to that change for the organization, which in the pastseemed to be a much flatter organizational structure.

Dr. Fredric N.Eshelman

Well, we are anticipating a lot of growth and even thoughyou say well, it’s only 17%, which we think is pretty robust, in actual dollarterms and numbers of new hires and numbers of offices and expansion and thisand that and the other, it’s actually quite significant. It requires a lot ofmanagement time. It requires a lot of professional management and so I thinkwe’ve inferred in the past that what we are trying to do is put a team in placehere that can take PPD to the next level and the level of complexity is notnecessarily linear. I think it gets more complex the bigger you get, in otherwords.

We’ve also determined that we are going to be the standardof excellence. We cannot do that without the very best talent in leadershiproles and that’s what we are attempting to do.

Doug Tsao - LehmanBrothers

And can you provide some comment, because it’s beennoticeable, for the most part a lot of the new hires have come from big pharmarather than the CRO world. I was just wondering if you could provide somecomment as to what drove you to go in that direction.

Dr. Fredric N.Eshelman

Well, a couple of things. Obviously we are after very goodmanagement who are accustomed to managing at a big scale. But I thinkimportantly, the situation in big pharma is such that it’s not quite the placethat it used to be for some of these talented individuals to work. In otherwords, it may be brighter on our side of the street than it is theirs. Goingforward, there may be more opportunity here, more excitement, more opportunityto move up and so forth and so on. So I think that the environment is quitedifferent than it was two or three years ago.

Bill, why don’t you comment? You’re directly out of bigpharma.

William J. Sharbaugh

I understand your comments. I would say two things; numberone, PPD compared to our competition is still a lot flatter from a managementperspective and that’s the way we run the business here. We give peopleresponsibility and hold them accountable.

Secondly, I would say there’s actually been a fair balancebetween pharma experience and CRO experience. If you look at North America, wehave a big pharma guy there, Paul Colvin. If you look at Europe, Middle East,Africa, we actually have a guy with a lot of CRO experience there. If you lookat the Asia-Pacific role, Simon Britton, he has a mixture. He had seven, eightyears in a CRO and a similar amount of time in a big pharma company. And if youlook at our Latin American region, we have a PPD insider there with CROexperience.

Now, in other positions throughout the company, we’ve alsobrought a similar mixture of CRO and pharma experience. But as Fred notes, Ithink we are better served by having a diverse management team, so I would saythere’s actually fair balance between the kind of experience we have.

Doug Tsao - LehmanBrothers

Okay, great. Thank you.

Dr. Fredric N.Eshelman

Let me just take the opportunity also to go back to thequestion I think it was asked by Eric on R&D spend post Q1, and while Idon’t want to necessarily address a specific number, the amount of absolutedollars in R&D projected for Q2, Q3, Q4 is de minimis.

Operator

Your next question comes from Sandy Draper with RaymondJames.

Sandy Draper -Raymond James

Thank you. Most of my questions have actually been asked.Just maybe one quick thing; Fred, do you -- and I may have missed it -- did yougive a sort of targeted book-to-bill, or are we still sort of looking at that1.2 to 1.3 as a reasonable range to be thinking about for 2008?

Dr. Fredric N.Eshelman

I don’t think we’ve even calculated it on that basis. Imean, obviously we come up with our internal forecast for new sales based onthe market and based on what we think we can do with close rates and all therest of that, and then obviously we have to pair that up with some assumptionon the burn rate to come up with what we think our projections are.

I think the safe assumption would be that we will have tocontinue to increase authorizations in a similar manner as we have over thelast three, four, five years.

Sandy Draper -Raymond James

Okay, that’s helpful. And then maybe a different way to askEric’s question, if I look back at 2Q, 1Q07 into ’06 and exclude any milestonepayments, is there a reasonable point it looks like you are running it, I mean,on average, say a negative 40% margin discovery sciences, so on the $4 millionto $5 million of discovery sciences revenue, losing say a couple of milliondollars, is that sort of a reasonable base to go forward? Is there anythingthat you are going to be cutting back where, excluding any additional R&Don development or any milestones that would reduce those expenses, or is thatanother way to maybe look at that question? Thanks.

Dr. Fredric N.Eshelman

I think the losses in the discovery compound partneringsegment outside of R&D dilution itself are totally ascribable to thebiomarker unit because the PRC pre-clinical oncology unit as I said is nicelyprofitable. We are projecting continuing losses in biomarker. They arereasonably substantial. We did see an up-tick in sales and a little bit of anup-tick in performance in biomarker in Q4 of ’07 that gave us a little bit moreoptimism. Maybe the time is coming for biomarker to be a creditable commercialundertaker, so we’ll have to see.

But we do have it in at a reasonably sizable loss for ’08.If that would deepen, obviously we’ve got to take steps. If it would improve,then that leads us down another path. But I think that’s primarily the sourceof what you are talking about.

Sandy Draper -Raymond James

Okay, great. Thank you.

Operator

Your next question comes from John Kreger with WilliamBlair.

John Kreger - WilliamBlair & Co.

Thanks very much. A question on the development side of yourbusiness; it seems like ’07 turned out to be perhaps a worse year for largepharma than many expected going into the year, with lots of cost cutting newson the tape. Are you seeing any of that filter down to the interaction you arehaving with clients? Are you seeing it change the behavior in the way they aredealing with their clinical development programs at all?

Dr. Fredric N.Eshelman

You know, the answer is yes and no. On the one hand, yes,everybody is sharpening their pencil and it is hand-to-hand combat on contractsand all the rest of that stuff, but then you turn around and you are looking atall these $100 million plus contracts. So it’s almost schizophrenic kind ofbehavior.

I think all the pharma companies, and rightly so, arelooking at their expenses because they can’t afford the kind of expensestructure that they had in the past but they are also not losing sight of thefact that they are R&D driven. That’s what will make them successful or notand it continues to roll along, albeit with a sharper pencil. That’s about allI can say on that front.

John Kreger - WilliamBlair & Co.

Okay, and then another development question, Fred; if youlook across the portfolio of your businesses, do any of them stand out asparticular weak spots?

Dr. Fredric N.Eshelman

In terms of earnings and/or revenue growth, I guess as notedthe biomarker is weak on the earnings side. Phase II, we’re not putting in atremendous amount of top line growth but we are looking for other improvementsthere and we think that’s a solid business. All of our Phase II through IVunits are projected to grow nicely. The bioanalytical and GMP labs we believewill have nice growth in ’08 and at least maintain their profitability. AndGCL, we expect the turnaround there, so in terms of weakness, I’m not sure Iwould characterize any of it as weakness, with the possible exception ofbiomarker.

John Kreger - WilliamBlair & Co.

Great. And then, if you turn to the discovery business, Ithink Dan, when you talked about -- I think you listed off your use of cash.New partnering deals I don’t believe made that list. Can you just talk aboutwhere that fits in your priorities for cash?

Daniel G. Darazsdi

I would say relative to our cash and that part of thebusiness, we will look at things from an opportunistic viewpoint. I don’t thinkat this point we’ve identified as part of the ’08 guidance significant cashdisposition, but like all things, they are of course evaluating opportunities.

John Kreger - WilliamBlair & Co.

And then a longer term question for discovery, if you arewilling to go there, if we get to a position and it sounds like maybe this willhappen in ’09, where you have got a steady royalty stream, how do you thinkabout new partnering deals then? Do you think about going into a year with abudget, a certain amount of dollars that you’d like to spend to build up theportfolio? Or do you think you’ll continue to be opportunistic? What I’m reallygetting at is what do you think the drop-through rate will be on anyincremental royalties that are generated?

Dr. Fredric N.Eshelman

I think that we will continue to be opportunistic. As far ashaving some set formula for -- we’re going to take 30% of the incomingroyalties and spend that on something else, we don’t have any such formula atthis time and quite frankly, I don’t anticipate that right at this momentbecause as we continue to save, we really would like to harvest what we’ve gotbefore us here -- knock wood -- and anything major that comes in in the future,structure that a little bit differently. That’s certainly our thinking at thismoment in time.

Now, if all of the stars aligned and one or more of thesecompounds just blew the roof off, then maybe we’d revisit that but that’s notour thinking at this moment.

John Kreger - WilliamBlair & Co.

Great. Thanks.

Operator

Your next question comes from Hari Sambasivam with MerrillLynch.

Hari Sambasivam -Merrill Lynch

Thank you. A quick question for Dan Darazsdi; in terms ofthe accounting for the milestones, could you explain why the milestones areaccounted as lump sum as opposed to being amortized? That’s the first one.

And the second question I have is really related tocurrency; when you -- I guess just short of anticipating some currency movesduring the year vis-à-vis the U.S. dollar, where does the company have theability to make the requisite, I would say the expenditure reductions if thecurrency movements go in the wrong way? I’m just wondering, given the ex-U.S. growth,are you mostly trying to sort of deal with this by hedging or do you have someoperational flexibility in your ex-U.S. growth to take out some expenditures?I’m just wondering whether you can maybe give us a bit of color into that.

Daniel G. Darazsdi

Let me try to cover both questions, because they are quitedifferent. First of all on the milestones, the milestones really get after thecash flow dynamics of each project. So when you look at the project and youlook at the milestones as they are being delivered, what that is really anindication of is the actual cash coming in, which is not reflective necessarilyof precisely where the project is from a revenue and margin delivery viewpoint.Because when we go to project revenue recognition, then we are based on apercentage of completion basis, so you are principally looking at cost incurredto date against your total estimate complete, generating your revenue andmargin delivery for the project. So a little bit of decouple there.

So as we try to improve cash flow dynamics, we’ll focus onthe milestones. As we think about how we are performing against any individualproject, then that’s when we’ll look at the cost curve on a percentage ofcompletion basis.

Any other comment on there before I --

Dr. Fredric N.Eshelman

Yeah, just as a further comment from a non-GAAP person, themilestone payments are one-time events and they are to mark an explicitoccurrence that will not recur, so I think as a non-accountant, maybe that’ssome more color on that. And we actually have our Chief Accounting Officer herewho can run you through the GAAP, if you’d like.

Hari Sambasivam -Merrill Lynch

No, I can do that offline. And the second question was onyour ability to take down expenditures. I’m just wondering whether it’s throughhedging primarily or are there operational aspects you can trim off in theevent of a U.S. dollar decline?

Daniel G. Darazsdi

Principally what we work to do is to one, identify what ourcurrency exposure is by country and our two biggest areas of exposure are thesterling, because of our presence in the U.K., and the Euro. We really don’taddress currency to any large degree based on operational changes because ourcost base is basically where it is and it’s growing based on our revenuerequirements there, so what we’ve elected as an approach is to look at hedgingopportunities to help us mitigate the fluctuation in the currencies.

Hari Sambasivam -Merrill Lynch

That’s great. Thank you.

Operator

Your next question comes from Alan Fishman with ThomasWeisel Partners.

Alan Fishman - ThomasWeisel Partners

Thank you very much and good morning. I just had two quickquestions; the first one, I missed the cash flow guidance number for ’08.

Dr. Fredric N.Eshelman

Operating cash flow I believe was 275 to 325 -- is thatright? Yes, that’s correct.

Alan Fishman - ThomasWeisel Partners

Great. Thank you. And then the second one follows up on theR&D question being de minimis. I guess we’ve seen it tick up in 3Q. Wouldthat be the run-rate for first quarter and then we could expect to see R&Dtick back down to the first quarter and then 2006 levels?

Dr. Fredric N.Eshelman

Well, as we said before, we expect all of the -- or the vastmajority of the remainder of the 10558 costs to be accrued in Q1 of ’08 and theR&D charges as we see it now for Q2, Q3, Q4 would be de minimis. I mean,very, very small and so that’s how we see it right now.

Alan Fishman - ThomasWeisel Partners

Okay, so more like prior to what we would have seen beforethe Ranbaxy statin compound?

Dr. Fredric N.Eshelman

I don’t want to get too general with it because as you wellknow, it’s gone up, down, and sideways by a quarter over the years, so all Ican tell you is that at this moment in time, Q1 encompasses the majority ofwhat we expect to spend on the 10558 and since we don’t have anything else onthe plate at this moment, then what we have forecast for the rest of the yearis very small.

Alan Fishman - ThomasWeisel Partners

Okay, great. Thank you very much.

Operator

Your last question comes from Doug Tsao with LehmanBrothers.

Doug Tsao - LehmanBrothers

Thanks for taking the follow-up question. In terms of theTakeda compound, I know that a competitive compound has run into some troublein terms of getting approval, given the lack of safety data being done inrenally impaired patients. I was wondering if you could provide an updatewhether these types of studies have been in the Takeda compound.

Dr. Fredric N.Eshelman

Let’s drop back all the way to the beginning, if we might,and when we first looked at the compound, which was then a Syrrx compound, theTakeda bought Syrrx, the in-vitro and preclinical data that they had at thetime, and they had comparative data for 322, for Januvia, for Galvis, and forone other competitor’s compound. And it looked as though 322, or Alogliptin,was very much more Januvia like in terms of its specificity for DPP4 as versusDPP8 or 9 or any other thing.

So we believed at that time and we continue to believe thatit’s more specific for the receptor [inaudible] -- that’s number one.

Number two, on the renal issue, I’d like to bifurcate thatinto a pharmacokinetic issue in renal insufficiency versus some sort ofmanifestation of renal toxicity. As far as I know, there is nothing in thedatabase with Alogliptin which would make us think that there is inherentlyrenal toxicity and therefore need to have thousands of patients with renal failureto see if we are exacerbating that.

The other issues, as I said, is a pharmacokinetic issuewhere if you’ve got a portion of your compound that is renally excreted, thenit is reasonable to look at people with varying stages of renal failure to seeif you need to make a dosage adjustment because the compound would accumulatetheoretically in those who have a diminished excretion of the compound becausetheir kidneys are failing.

So there are two different issues and certainly the pharmacokineticpiece of this Takeda addressed very well with very specific studies in patientswith all sorts of renal failure going from mild all the way to severe.

So as far as I know, and I have Dr. Covington here, ourChief Medical Officer who can also comment on this, there just does not appearto be an issue. Paul, if you want to add anything, please do.

Dr. Paul Covington

Nothing to add. That’s exactly what Takeda has released andexactly what we feel about the --

Doug Tsao - LehmanBrothers

Okay, so just to confirm, so you are indicating thatspecific pharmacokinetic studies were done in patients with varying stages ofrenal impairment?

Dr. Fredric N.Eshelman

Absolutely.

Doug Tsao - LehmanBrothers

Okay, great. Thank you very much.

Operator

There are no further questions at this time.

Dr. Fredric N.Eshelman

Thank you all very much for the lively questions and debateand we look forward to talking with you in the future. Good day.

Operator

Ladies and gentlemen, this concludes today’s conferencecall. Thank you for your participation. You may now disconnect.

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