Charles River Laboratories International Inc. Q2 2008 Earnings Call Transcript

| About: Charles River (CRL)

Charles River Laboratories International Inc. (NYSE:CRL)

Q2 2008 Earnings Call

August 6, 2008 8:30 am ET


Susan Hardy - VP of IR

Jim Foster - Chairman, President and CEO

Tom Ackerman - EVP and CFO


David Windley - Jefferies & Company

Douglas Tsao - Lehman Brothers

Eric Coldwell - Robert W. Baird

Sandy Draper - Raymond James

Randall Stanicky - Goldman Sachs

Isaac Ro - Leerink Swann

Robbie Fatta - William Blair

Doug Schenkel - Cowen & Company


Ladies and gentlemen thank you for standing by. Welcome to the Charles River Laboratories second quarter 2008 Earnings Call. At this time all participants are in listen-only mode. Later, we will conduct a question-and-answer session; instructions will be given at that time. (Operator Instructions).

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

Susan Hardy

Thank you. Good morning and welcome to Charles River Laboratories' second quarter 2008 conference call and webcast. This morning, Jim Foster, Chairman, President and Chief Executive Officer, and Tom Ackerman, Executive Vice President and Chief Financial Officer will comment on our second quarter results and review guidance for 2008. Following the presentation, we will respond to questions.

There is a slide presentation associated with today's remarks, which is posted on the Investor Relations section of our website at A taped replay 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 access code in either case is 952140. The replay will be available through August 20th. You may also access an archived version of the webcast on our Investor Relations website.

I would like to remind you of our Safe Harbor. Any remarks that we may make about future expectations, plans, and prospects for the company, constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by any forward-looking statements, as a result of various important factors including, but not limited to those discussed in our Annual Report on Form 10-K, which was filed on February 20th, 2008, as well as other filings we make with the Securities and Exchange Commission.

During this call, we will be primarily discussing non-GAAP financial measures. We believe that these non-GAAP financial measures help investors to gain a meaningful understanding of our core operating results and future prospects, consistent with the manner in which management measures and forecasts the company's performance.

The non-GAAP financial measures are not meant to be considered superior to or a substitute for results of operations prepared in accordance with GAAP. In accordance with Regulation G, you can find the comparable GAAP measures and reconciliation to those GAAP measures on the Investor Relations section of our website through the financial reconciliations link.

Now I will turn the call over to Jim Foster.

Jim Foster

Good morning. I am very pleased to report to you today on another strong quarter for Charles River. We reported robust sales of $352.1 million in the second quarter of '08, growth rate of 14.5% from $307.4 million in the second quarter of '07.

The Research Models and Services, or RMS, increased an impressive 20.2% to $172.8 million. Preclinical Services, or PCS, increased 9.6% to $179.3 million, 6% on a sequential basis. Foreign exchange contributed 7.1% and 1.4%, respectively to the segments.

Operating income for the quarter was $76.5 million, and the operating margin was 21.7% compared to $65.7 million and 21.4% reported for the second quarter of '07. Operating income growth of 16.3% was primarily driven by higher sales and improved capacity utilization in the RMS segment and stable corporate costs.

The operating margin gained 30 basis points year over year as a result of very strong RMS performance, which more than offset the decrease in the PCS margin which, as you recall, reflects a significant costs associated with the transition to our new preclinical facility in Nevada.

On a sequential basis, the operating margin increased 50 basis points, due in part to an impressive improvement in the PCS margin. Earnings per share increased 23.4% to $0.79 from $0.64. Again, the driver was strong sales growth and improved operating efficiency in the RMS segment that more than offset the costs associated with the Nevada transition and a higher share count due to dilution from our convertible debt.

Finally, we announced that we are raising our '08 guidance to sales growth in a range of 12% to 14%, and non-GAAP earnings per share in a range of $2.94 to $3.00. Now I will provide more in-depth review of our business segment results.

Sales for our RMS segment rose 20.2% in the second quarter to $172.8 million, with nearly all major businesses reporting double-digit sales growth. When adjusted for foreign exchange, organic growth was an impressive 13.1%.

The segment sales benefited from robust spending by pharma, biotech and academic clients, a stable pricing environment and market share gains. We believe this broad-based growth is evidence of our clients' greater focus on discovery of new therapies, and their reliance on Charles River for our best-in-class research models and the many services we provide to support their use in research.

The operating margin declined to 30.9% compared to 31.7% in the second quarter of last year, and 33.4% in the first quarter of '08. The primary driver of the year-over-year decline was an asset write-down in Japan, which we view as an unusual event and do not expect to recur.

The write-down cost is approximately 90 basis points on the margins. The other factor that impacted the margin was the sales mix. Service sales were very strong and, as you know, services generally carry a lower operating margin than products.

Production of research models was the largest contributor to the second quarter sales growth. Sales of inbred and immunodeficient mice was the primary growth drivers, further supporting our thesis that pharma and biotech companies are increasingly focused on drug discovery.

While sales to large pharma increased, greater growth was generated by biotech and academic clients. We do not find this surprising since pharma is funding a significant amount of research through biotech companies and universities.

All geographic locations reported sales growth. Europe grew at double-digits, and the US business reported high single-digit growth.

Similar to our research models, our Genetically Engineered Models and Services business, or GEMS, also grew nicely in the quarter, particularly in Europe. Genetically Engineered Models, also referred to as GEMS, are used extensively in discovery because GEMS are more accurately mimic human diseases than standard models do.

Researchers believe that GEMS provide better data on efficacy, and hope that their use will lead to development of improved therapies for complex diseases such as cancer, diabetes and AIDS. We have mentioned previously that the basic GEMS have given way to more complex models. Because of their complexity, researchers increasingly need our expertise to improve the success of their GEMS progress.

In the second quarter sales for our Consulting and Staffing Services, or CSS, business were robust in the US and Europe, our primary markets. As you know, this business provides research model facility management services. The margins for this business are lower than the segment average, which partially accounts for the margin decline. The return on invested capital is very attractive, since we generally do not own the facility.

The one exception, our new facility in Maryland, was built to support our CSS contract with the National Cancer Institute. As you know, this is the first dedicated resources arrangement in RMS, and through this long-term agreement, we gained a platform to provide commercial production and services in the very attractive Mid-Atlantic region.

We hosted a successful open house on May 15th with close to 100 customers attending, including senior researchers from the National Cancer Institute. The facility officially opened on July 10th, slightly ahead of the schedule. We believe that this facility will contribute to meaningful growth for us.

Our In Vitro business again delivered growth above 20%, the result of continuing success of the PTS. Growth is increasing not only as a result of a large number of devices in use, but also due to an increase in the average number of cartridges used per device.

We are continuing to expand our market share in nuclear pharmacies as they prepare themselves to comply with the FDA's pending regulations, and are seeing uptake from pharmaceutical manufacturers as they comply with the FDA's PAT initiative. PAT requires timely testing in order to promote improved quality control of the manufacture of medical devices and injectable drugs, a goal for which the PTS is tailor-made.

We are continuing to promote the PTS aggressively in its core markets and also to evaluate niche opportunities where the PTS could provide additional growth. The RMS business remains a consistent driver of our sales and earnings growth. As we demonstrated again in the second quarter of '08, our Research Models and Services are critical components of our clients' ability to successfully launch new therapies.

We provide the largest number of widely-used models and have the most extensive range of scientific services to support our clients' use of models in research. For those reasons, we believe that over the long-term, demand for our essential products and services will continue to be strong.

The PTS segment reported sales of $179.3 million in the second quarter, a growth rate of 9.6% over the second quarter of '07. On a sequential basis, sales gained 6%, reflecting new capacity in Nevada, as well as comparable or higher sales at most of our preclinical facilities, both for toxicology and other services.

While our Massachusetts and Nevada toxicology facilities did exceptionally well, Montreal and Edinburgh did less sales. The primary reason for the lighter growth were less favorable study mix and higher than usual study slippage. We expect these trends to persist through the third quarter of '08, but based on our backlog we expect improvement later in the year.

Although we may see fluctuations in demand from time to time, we continue to expect that pharmaceutical and biotechnology companies will expand their strategic outsourcing as the best alternative to improve the efficiency and effectiveness of their drug development efforts.

We were able to drive the operating margin to 21.2%, an increase of 290 basis points from the first quarter of '08, and just 80 basis points lower than the second quarter of '07. We were very pleased with the sequential improvement which was primarily due to margin gains in Nevada and Clinical Services Northwest as a result of improved capacity utilization.

On a year-over-year basis, Nevada and Montreal were the primary drivers of the 80 basis point margin decline. As expected, Nevada's operating costs were significantly higher as a result of the costs associated with running duplicate facilities during the transition to the new building.

As I just mentioned, Montreal's operating margin was affected by a less favorable study mix, and by unusually high study slippage due to client lead prioritizations and compound availability.

Capacity constraints were also a factor in Montreal. Demand has been robust, which is why we made the decision earlier this year to accelerate the opening of our Sherbrooke expansion to the first quarter of '09.

The Shanghai facility will open in the fourth quarter of '08, approximately one quarter later than our original schedule due to construction delays. We currently expect to offer non-GLP services in the fourth quarter of '08, and GLP services in the first quarter of '09.

China was a factor in the lower year-over-year operating margin, and we expect the delay will have a moderate impact on our sales and earnings expectations for the second half of '08.

The delay was necessary to ensure that we have the highest quality physical infrastructure which will support our business in China, where we intend to be a leading provider of drug development products and services.

Nevada was the largest contributor to the year-over-year sales gain. As you know, the new facility opened on schedule in January, and we continued to ramp up sales in the second quarter.

We experienced strong demand for Nevada's high-end specialty toxicology services, particularly from our West Coast clients. Our clients are very impressed with the state-of-the-art facility and its staff, and the West Coast clients are particularly pleased to have a facility of this caliber located so close to them.

As we have said previously, we were staging the opening of 80% of Nevada, or 370,000 square feet over the first six months of '08. I am very pleased to tell you that we completed the project on schedule, and we are moving ahead with the transition from our legacy facility.

That transition will be substantially complete by the end of '08, though I will remind you that, unlike Massachusetts, we intend to retain a significant portion of the legacy facility for quarantine. Staffing is proceeding on plan, with all of the key positions filled.

Massachusetts also reported significantly higher sales in the second quarter. Management of the facility has maintained its focus on shifting the sales mix to include a larger proportion of toxicology services, and that focus was evident in the quarter's results.

The number of inquiries for GLP studies has increased, and we have been successful in converting those to bookings. As a result, the backlog for longer-term toxicology studies has increased substantially.

We are very pleased with our progress to-date and expect that our ongoing focus on the study mix will support continued sales growth in Massachusetts.

Clinical Services Northwest, our Phase I business in the United States experienced very strong growth in the quarter. You may recall that Northwest was in the process of expanding their facility when we acquired the business at the end of '06.

Northwest's expertise and reputation for outstanding service has enabled it to grow rapidly. Our Phase I facility in Scotland has not performed as well, due at first to regulatory uncertainty in the UK, then, as the environment improved, hindered by the weakness of the US dollar.

We have new management in place at the facility and are taking appropriate actions to improve productivity. However, the operation is impacting sales and earnings growth in '08.

Our Biopharmaceutical Services business, which we call BPS, was also a contributor to the sales growth. BPS provides services to support the development and manufacture of biologics, services which are becoming more important as the proportion of biologics in the drug development pipeline increases.

Recognizing the opportunity to more fully support our clients, we began to strengthen this business nearly 2 years ago. Our first step was a new management team with extensive expertise and market knowledge.

Over the last two years, this team has integrated our BPS operation in the United States, Scotland and Ireland, and expanded the staff. As a result, BPS is now a world leader in cell bank manufacture, from research through full-scale production, and a premier provider of testing to determine the potency of biologics of drug product release testing, and of clinical scale vaccine manufacturing.

Given the opportunities for growth, we believed it was the appropriate time to scale-up the business with the addition of NewLab BioQuality AG, a Dusseldorf Germany based contract service organization which provides safety and quality control services.

We recently signed the agreement to acquire NewLab and expect the acquisition to close by the end of the third quarter of '08. With current operations in continental Europe, NewLab adds consulting services to help manufacturers meet regional GMP guidance on new drugs, and assist in designing ICH-compliant stability testing programs to identify suitable stability test methods for both proteins and plasmids used for gene therapy.

NewLab expands Charles River's current capabilities in process validation services, which mimic new manufacturing processes to verify that potentially hazardous contaminants have been removed.

Both Charles River and NewLab provided extensive analytical, molecular biology, virology and microbiology testing services to ensure identity, quality, stability and safety of biopharmaceuticals, and operate in full compliance with current GMP and GLP regulatory guidance.

The bottom line is that with the addition of NewLab, Charles River intends to be a leader in this rapidly expanding global market.

As a result of the strong second quarter performance and our outlook for the balance of the year, we are very pleased to be raising our guidance for '08. We now expect sales growth in the range of 12% to 14%, including the acquisition of NewLab, and EPS in the range of $2.94 to $3.00.

Based on its outstanding performance in the first half of the year, and our expectation for a similar growth rate in the second half of the year, we anticipate the RMS segment sales will grow at a mid-teens rate in '08 compared with our earlier estimate of high single-digits.

In the PCS segment, we expect the growth rate to improve later in the year, and therefore we now expect PCS sales growth for '08 in the low double-digits compared to our earlier estimate of low to mid-teens growth. We expect as the consolidated operating margin will be moderately below last year, with the RMS margin slightly above and the PCS margin below '07 levels.

As pharmaceutical companies increasingly adopt strategic outsourcing, the virtualization of big pharma and biotech becomes more of a reality. Ongoing expansion of our infrastructure is critical to support the industry trends, as it is hiring qualified staff and broadening our portfolio of essential products and services, whether through internal development or strategic bolt-on acquisitions such as NewLab.

Our unparalleled core competencies of laboratory animal medicine in science and regulatory compliant preclinical services, expertise in drug development, highly qualified staff and ongoing capacity expansions are enabling us to support our clients as few partners can.

We are becoming our clients' infrastructure, working side-by-side with them to accomplish their goals of bringing new therapies to market faster and more efficiently. We expect our unique ability to support our clients from discovery through Phase 1 clinical studies will enable our continuing growth in the years to come.

I would like to thank our nearly 9,000 employees for their exceptional work and commitment, and to our shareholders for their continuing support.

Now I will turn the call over to Tom Ackerman.

Tom Ackerman

Thank you, Jim and good morning. Before I recap our second quarter financial results, let me remind you that I will be speaking primarily to non-GAAP results, which exclude acquisition-related amortization, asset impairment charges and other items.

Sales and operating income grew at strong double-digit rates in the second quarter, led by continued robust sales growth in our RMS business. Solid EPS growth of 23.4% outpaced sales growth of 14.5% as a result of operating margin improvement from lower unallocated corporate expense, as well as the lower tax rate and net interest expense.

As Jim said, the second quarter RMS operating margin of 30.9% declined by 80 basis points year-over-year. The decline was primarily due to an asset write-off in Japan of approximately $1.6 million, which we do not expect to repeat. We installed a new management team in Japan in 2007 and higher expenses were the result of comprehensive review which led to a write-down of certain assets.

These expenses lowered the RMS operating margin by approximately 90 basis points in the second quarter, and excluding these expenses, the RMS margin would have increased slightly. Foreign exchange continues to benefit top line growth, but reduces the PCS operating margin.

FX contributed 4.1% to sales growth, or $12.5 million in the second quarter, which was comparable to the first quarter. The RMS segment benefited by 7.1%, due primarily to the continued strength of the Euro. The PCS segment gained only 1.4% from FX compared to 2.1% in the first quarter, primarily as a result of the impact of a weaker British pound on our facility in Edinburgh.

For the second half of the year, as we anniversary the significant weakening of the US dollar, we expect an FX benefit to consolidated sales growth of just 1% to 2%, based on current exchange rates, compared to 4.1% in the first half of the year. We anticipate that FX will continue to benefit RMS, although at a lesser rate, but would have a flat to slightly negative impact on PCS.

While providing a moderate benefit to consolidated operating income, foreign exchange reduced the PCS segment operating income by $0.6 million in margins by approximately 60 basis points compared to the second quarter of last year. This impact is the result of exposure to the Canadian dollar at our PCS Montreal facility.

The impact has declined from 175 basis points in the first quarter due to the fact that we are reaching the anniversary of the strengthening of the Canadian dollar which began in the second quarter of last year due to both Canadian dollar exchange rates versus the prior year and our efforts to invoice more of our PCS Montreal clients in Canadian dollars, do not expect FX to have a significant effect on the PCS operating margin in the second half of the year.

The second quarter of 2008 marked a seventh consecutive quarter of sequential sales growth led by 6% sequential growth in our PCS segment. The consolidating operating margin improved by 50 basis points sequentially versus the first quarter.

Significant improvement in the PCS operating margin, driven by higher sales in Nevada and Clinical Services Northwest was only partially offset by a sequential decline in the RMS operating margin from a near all time high in the first quarter.

The margin increase and a lower tax rate resulted in a robust 10% sequential increase in EPS in the second quarter. Unallocated corporate overhead of $15 million in the second quarter declined moderately both year-over-year and sequentially, primarily driven by lower employee health, fringe and related expenses.

Global IT cost including expenses related to our ERP implementation did increase year-over-year as expected. For the second half of the year, we expect unallocated corporate overhead to be comparable to first half levels. This equates to roughly 4.5% of sales for the year plus or minus 25 basis points.

The difference between GAAP and non-GAAP on allocated corporate overhead for the second quarter of 2008 is due to the $3.3 million gain from the curtailment of our US defined benefit pension plan which we originally discussed on last quarters call.

Net interest expense continued to decline year-over-year, primarily due to lower interest rates in our floating-rate debt, as well as debt repayment. For the year, we expect net interest expense to be in the range of $4 million to $6 million, this is slightly higher then our current run rate, due primarily to our expectation that interest income will be low in the second half of the year. We plan to fund the new lab acquisition from our existing cash balances.

Our tax rate declined by 280 basis points year-over-year to 26.5% in the second quarter, and 27.1% year-to-date. The reduced rate was the result of corporate tax law changes implemented in certain foreign jurisdictions last year, as well as several discrete items in the quarter.

We now expect a tax rate in range of 27.5% to 28% for 2008, slightly lower than our earlier guidance of 28% to 28.5%. Because of this we anticipate a moderately higher tax rate in the second half of the year than in the first half. This will be particularly the case in the third quarter based on the anticipated timing of several discrete items.

Inspite of our strong global cash position, we borrowed $20 million on our US revolver during the second quarter. We did so to avoid tax implications from repatriating cash held abroad. The added liquidity was needed primarily to find US capital expenditures.

In the second quarter, we repurchased approximately 535,000 shares of common stock at a cost of approximately $33 million. The Board authorized a $200 million increase in our share repurchase program but the increased authorization as of August 1st; we have approximately $231 million remaining under our current buyback program.

I would like to update you on the dilution associated with the converts. In the second quarter, dilution from the convert totaled 1.5 million shares based on an average price of slightly over $61. Because our diluted share count for the year is correlated to this dilution, which can vary from quarter-to-quarter based on share price, we have chosen not to update our 2008 share count guidance.

There have been two developments related to our convertible debt over the last three months. First, we made a convergent trigger on our convertible notes at the end of the second quarter based on our share price which gave hold as the right to convert in the third quarter.

No holders have decided to convert their notes into shares at this time, and we do not expect the same growth as the bonds at nearly a 10% premium to the underlying shares at quarter-end. As a result of figuring the conversion rights, we re-classify a portion of our convertible debt as short-term for the quarter.

In May, the FASB issued a final FSP regarding the change in convertible debt accounting which will be effective for 2009. Although, the FSP has no cash or economic impact on Charles River, it would increase interest expense in our income statement in 2009. We are finalizing our analysis of the impact, and withhold our further comments until this analysis has been completed.

Turning to other balance sheet items; cash and equivalents, including short and long-term marketable securities declined slightly to $282 million at the end of the second quarter from $289 million at the end of last year.

Account receivable was relatively flat from the first quarter at $240 million, but increased from $214 million at the end of 2007. DSO was unchanged from 38 days versus the first quarter, but unfavorable compared to 35 days at the end of the year.

We indicated on our year end conference call that 35 days was at the very low end of our targeted range, and that we expected some fluctuation. At 38 days DSO remains within our targeted range.

As a result of higher net income free cash flow was $21 million for the first half of 2008, a nice increase from $6 million last year. CapEx was also higher at $104 million in the first half versus $87 million last year, principally related to Nevada, Sherbrooke and the RMS facility in Maryland.

We continue to expect CapEx for the year to be between $220 million to $240 million, and free cash flow to be in a range of $50 million to $75 million. For the quarter, depreciation increased $2.3 million year-over-year to $15.4 million, and was $32.2 million year-to-date.

We continued to expect $65 million for the year, higher than in 2007 due to new capacity coming on line. This equates to a step-up depreciation expense in the second half of the year due to PCS Nevada and the RMS facility in Maryland.

Total amortization expense was $7.6 million in the second quarter and our full-year guidance for amortization expense remains at approximately $31 million or $0.03 per share.

We booked several items during the second quarter which have been excluded from our non-GAAP results. We incurred a $3.3 million gain related to the previously announced curtailment of our US defined benefit pension plan which was effective April 30th. We do not expect to incur any further adjustments related to the pension curtailment.

Offsetting this gain, we incurred a charge of $2.8 million. We recorded a $2.2 million charge related to the disposition of our legacy preclinical facility in Western Mass. The charge primarily reflects a revision to the property value based on the local real state market conditions. We are continuing to evaluate our options to dispose off the property.

We also recorded a $0.6 million asset impairment charge related to the intended disposition of our vaccine business in Mexico. In addition to second quarter charges, we expect to record a non-cash charge in the third quarter of $0.04 per share for the revaluation of the deferred tax asset associated with our convertible debt due to a change in Massachusetts tax flow.

Including the revaluation charge, we now expect charges excluded from non-GAAP results to total approximately $0.07 to $0.08 per share in 2008. Based on our strong first half comments and outlook for the remainder of the year, we are pleased to raise our 2008 sales and non-GAAP EPS guidance.

We now expect sales growth to be in a range of 12% to 14% and non-GAAP earnings per share in a range of $2.94 to $3. We have lowered our GAAP EPS guidance to a range of 259 to 265, primarily to reflect the expected impact from the revaluation of deferred tax asset.

Our guidance includes the acquisition of NewLabs which is expected to close by the end of the third quarter, and the intended disposition of the vaccine business in Mexico. Since we anticipate owning NewLab for approximately one quarter in 2008, we expect the transition to provide only a slight revenue growth benefit for the year which is expected to be offset by the loss of revenue from the Mexican Vaccine business.

NewLab is expected to be 20th of EPS in 2008, but slightly accretive to both GAAP and non-GAAP EPS in 2009.

Our 2008 sales guidance implies a moderated growth rate for the second half of the year. As I noted earlier in my comments, this will partially be assumption of a reduced FX benefit in the second half as we anniversary the significant weakening of US dollar. Based on current exchange rates, we expect a 1% to 2% FX benefit in the second half of the year compared to a 4.1% benefit in the first half.

In addition to the PCS top line pressures which Jim discussed, we anticipate that cost in Nevada and China which intensify in the third quarter will restrict sequential PCS margin improvement during the second half of the year.

Because the first phase in Nevada was not completely open until the beginning of July, we will not book a full load of facility costs until the third quarter. The impact of these facility costs will be mitigated overtime as utilization continues to improve.

As a result, we expect the 2008 PCS operating margin to be below last year's 21.5% level. We expect the normal seasonal weakness in the RMS margin in the fourth quarter but overall, expect the 2008 RMS margin to improve slightly compared to last year. For the full year, we anticipate the consolidated operating margin will be moderately lower than in 2007.

Overall we are pleased with our second quarter performance and remain focused on meeting our revised sales and EPS expectations for the year. As our clients continue to face mounting challenges, we strive to adapt our business strategy and portfolio of a central products and services to better support our clients and accelerate drug development.

That concludes our remarks. We will now take your questions.

Question-and-Answer Session


(Operator Instructions). Our first question we go to the line of David Windley with Jefferies & Company.

David Windley - Jefferies & Company

Hi. Good morning. Thanks for taking the questions. Congratulations on another good quarter. Wanted to, Jim, drill in on RMS. You have had a couple of very, very good top-line growth quarters in RMS. You mentioned that all the major business units are growing double-digits. Would it be possible to call out maybe one or two of the ones that are really blowing numbers out? What is driving that growth rate to such a high level?

Jim Foster

Well, actually, the primary drivers, Dave are continued substantial growth in our In Vitro business, sales of PTS, which are growing at a greater than 20% clip. We continue to have this growth rate, and given the penetration into the market and the acceptance of both the device and the cartridges that go with it, we are comfortable that we are going to continue to see growth there.

The core animal business, just the production business has been very strong, both in Europe and the United States all year. As we said, we expect to see a continuation of that, principally driven by the drug companies intend to focus on discovering new compounds.

Thirdly, our services business, albeit it a smaller business than the production business, continues to grow nicely, both on the consulting and staffing services side and on the GEMs side. Again, both of those service businesses are driven by the same factors that drive our preclinical business, which is a desire on the clients' part to utilize our capabilities on a strategic basis instead of continuing to do the work internally.

I am happy to say it is hard to call out one or two, because it really is pretty much across the board. It is nice to see it internationally, and it is also nice to see the blend between the products and services, which is something that we do, and think is sustainable.

David Windley - Jefferies & Company

Right. That is encouraging. So second question then, moving over to PCS. The margin improvement there was impressive. The surprising metric to me was the revenue growth being a little bit on the slow side, and yet the margins did improve there. So it would seem that your utilization in the newer facilities did improve pretty significantly. As you described, the slower activity came away from those facilities.

I think the press release mentioned some capacity constraint, and your prepared remarks sounded a little bit more like, say, softer demand. I was hoping you could help me to understand some of the dynamics that allowed you to improve margin while not necessarily seeing the utilization away from the new facilities that you would have hoped for.

Jim Foster

Well, as we talked about, we are really pleased with the uptake in Nevada and Massachusetts. A lot of moving parts and pieces in both places. In Mass, we have been focusing on shifting the mix towards more higher-value, larger-GLP studies, and we are getting that, and building a backlog and filling capacity nicely.

Nevada, literally, we have been moving into that building, the portion that we are building out was just finished in July. Notwithstanding that, business has been coming in nicely. Nevada tends to be a higher margin offering anyway, so that has contributed to the margin improvement very nicely.

Also, I would remind you that we were also assisted by the very strong growth both in top line and bottom line at Northwest Kinetics, our relatively recent Phase 1 operation.

The capacity constraint issue was principally, just a reminder about Montreal; we entered the year with tight capacity. You may recall that the physical space is literally maxed out; we can not build any further. Yet we have some very loyal, very large pharma clients who really think of Montreal as their own adjunct facility.

We are going ahead and building out the Sherbrooke facility to accommodate those clients faster than anticipated; it will be ready in '09. So we are bucking up against capacity constraints there, hoping that we would have an attractive mix. While we often have an attractive mix, it is something that we cannot necessarily engineer or manage.

So clients for whom we do specialty work will eventually and do eventually require us to do longer-term, more general studies. So we are seeing more of that now. We also had a little bit of study slippage in the quarter as well.

We had some similar metrics in Edinburgh, principally around study slippage. Study slippage is an inherent part of the business. It has to do with continual re-prioritization of compounds and also whether the compound is ready to be administered; that often shifts.

The backlog is obviously critical, because when it shifts, you want to have something else to slide in there. We almost always were able to do that. Sometimes, given the size and study or the species of the study or the specificity of the study, it is difficult to replace it one-for one.

So we had some study slippage there as well, which is a little bit unusual for Edinburgh, but as I said, it is not unusual for the business as a whole. Also, Edinburgh has a wide range of products and services many of which we would call specialty. Again, there, the mix was a little less positive than we would have expected.

So, overall we are very pleased with the results. Very pleased with the growth in most of our operating units, feel that the sliding of studies and the mix issue is inevitably transitory, because the specialty work will return. We are also seeing very good backlog building in the back half of the year, and confident that it will strengthen during that time.

David Windley - Jefferies & Company

Great. Thanks.


Thank you. We have a question from the line of Douglas Tsao with Lehman Brothers. Please go ahead.

Douglas Tsao - Lehman Brothers

Hi. Good morning. Just drilling down a little bit again on the RMS segment where the results were very strong. I have just been wondering, Jim, if you could provide some color around the growth rate that you saw for disease specific models relative to the standard outbred rat, which has historically been a much higher proportion of your overall sales mix?

Jim Foster

The disease model growth rate continues to be faster, particularly in immunodeficient mice which you have heard us talk about for multiple quarters now, widely utilized and respected model for oncological work and infectious disease work. We are continuing to see significant unit growth there this year.

Size of that product offering is still substantially below our classic outbred rat offering. So it is extremely beneficial, but it is not the same order of magnitude or driver.

Now, we also saw good growth in our outbred rat business as well. So, again, we saw very nice growth across the board. Unlike years previously, not so much '07 but years before that, we were very pleased with the growth rate particularly in Europe, where we have, as you recall, extremely high market shares, which means that in addition to getting some price and a positive mix a la the diseased models, we are also continuing to take share probably from our major competitor over there.

There have been some facility closures by our major competitor over there, and we have been able to take advantage of that, both in geographic locales where we have large share and a couple that we have a smaller share.

Douglas Tsao - Lehman Brothers

Then turning to the PCS business; and you noted there is some delay with China coming online. I know originally you had indicated that you were going to offer non-GLP services in; I think it was the third quarter. Then, you know, that began to offer GLP services to accelerate around that time. I was just wondering if sort the initial shift in direction might have impacted the construction of the facility and led to this delay.

Jim Foster

That is a bit of an imponderable. I think a very simple answer is that construction of facilities like this, which is probably unique in terms of its makeup and sophistication, is not usual for Chinese construction companies. We have spent an awful lot of time managing that facility by sending our own people over there to do that. We are very pleased with the way it is shaping up and we are quite confident it will be a first-class Charles River quality facility. Yet we are just enduring basic construction delays having to do with regulatory approvals and the building methodologies over there.

So, I do not think it was a shift in schedule that did it; I think it is their reference point or historical relationship to this building. We will feel much more confident when we build the next facility, which is likely to be larger, having gotten greater experience with the local contractors over there. I think we will be able to structure it and schedule it better.

Having said that, we are really just talking about shifting things one quarter. We have been in contact with our clients who are driving the construction of the operation, because they are desirous of us being able to provide the services. We are happy to be able to provide the non-GLP stuff before the end of the year and the GLP stuff right after the beginning of the year. So, it is really only a slight delay.

Douglas Tsao - Lehman Brothers

Okay. Then, just if I can just get one final, quick follow-up question in terms of China. Should we expect to see an additional ramp-up of operating costs in the third quarter and fourth quarter that might affect PCS operating margins? Or has the spending level reached a level that will remain constant through the rest of the year?

Jim Foster

You will see some additional costs in the back half of the year, with, obviously, less revenue than we had originally forecasted because the facility will not be done. It is not a huge number, but it does have an adverse impact on certainly operating margin and a slight amount on revenues in the second half.

Douglas Tsao - Lehman Brothers

Okay, great. Thank you. I will step out.


Thank you. We have a question from line of Eric Coldwell with Robert W. Baird. Please go ahead.

Eric Coldwell - Robert W. Baird

Thanks. Good morning. Sorry if I missed this, but I did not see any mention of the Endosafe multi-cartridge system in the prepared comments. Can you give us an update on the status of that? Then my follow-up question relates to the Japanese assets. Can you just be a little more specific on what was written down and what the impact of that was, please?

Jim Foster

Yes, the multi-cartridge system, Eric, is selling quite nicely. It is not a huge product offering for us, so it is not something we would necessarily cull out. We just had a review of that business recently, and we are selling those units at or ahead of our budgeted levels, with very positive response and acceptance by the quality control people. So, we are pleased with the way that is going. I will let Tom to answer the second question.

Tom Ackerman

Sure. Eric, the fixed assets we referred to were a handful of facility related assets that had been in place for a number of years, probably over 20 years, that had not been fully depreciated but that were no longer being utilized fully. So, in our review of a number of aspects of the operations and things like that and as we were going through recycles and upgrades, the management team felt it appropriate to write those assets down to zero essentially.

Eric Coldwell - Robert W. Baird

Great, thank you very much.

Tom Ackerman

You are welcome.


Thank you. We have a question from line of Sandy Draper with Raymond James. Please go ahead.

Sandy Draper - Raymond James

Thank you. Two questions. One, just looking at the EPS guidance and first half and second half ramp, I am may be missing something really obvious here, but if you annualize your first half, you get to the upper end of the range. Looking back at the past couple of years, your second half has tended to be as good if not better than the first half. What would you say is key drivers that would push the earnings lower in the second half versus the first half?

Tom Ackerman

Couple of the things that Jim already mentioned, a couple of questions ago, which is additional expenses in China, as an example, as we ramp up that facility.

Sandy Draper - Raymond James

So that could be material? Okay.

Tom Ackerman

Well I am not sure I would characterize it exactly as material. I would characterize it as a contributing factor. Like that, Nevada, while we opened the facility in the first half of the year, the beginning of the year actually, we have actually expanded into the larger portion of the facility really at mid-year. So, we will see an additional ramp in depreciation as well as additional fixed costs associated with that, such as utilities and things like that. As we historically have seen, the RMS margins in the latter part of the year will decline also due to seasonality. So, those would be the three major contributing factors, I would say.

Sandy Draper - Raymond James

Okay, great. Just the follow-up question. I do not know if you have seen it, but it was just announced that one of your competitors announced an asset transfer deal with Eli Lilly. I just wanted to get your thoughts, not necessary specifically on that deal, but just what your interest level is in some of these asset transfer deals where you are actually taking over or buying out the actual assets from pharma and entering in long-term. Is that something you are interested in? What do you think about the economic model there? Just any thoughts there would be helpful. Thanks.

Jim Foster

We are generally open to exploring relationships like that, and have explored several in the past. It obviously depends specifically on the proximity of the asset, the design of the asset and whether it is appropriate for the contract work that we do, as opposed to single use for one specific company. It also has to do with the ongoing relationship that you are able to craft with the seller. It is obviously better to get a running start and get some rational book of business along with that. Then it goes to price.

So, we would be open at a rational price, and a lot of the price points of these facilities are higher than ours, not just from the capital acquisition point of view, but the ongoing running costs are higher. So, if we can get one that is costed out appropriately and helps us support that client and/or others in the right geographic locale, we would love to do that. Obviously, that is faster than building a place from scratch. If you could get business with a client, you have a much closer relationship and a running start. So, we think generally it is a good idea. As I have said, we have looked at several and none of those have met the criterion that I just outlined.

Sandy Draper - Raymond James

Great. Thank you.


Thank you. We have a question from line of Randall Stanicky with Goldman Sachs. Please go ahead.

Randall Stanicky - Goldman Sachs

Great, thanks for taking the question. I just have two. First, can you maybe help us on the RMS margin, Tom, even if we adjust for the Japan impact, the current guidance implies moderation. Consistent with historical trends, but maybe a little bit more than expected in the back half. Is there something that we should think about, given the acceleration in top line, as we think about leverage in the RMS business in general?

Tom Ackerman

I do not really think so. If you look back to 2007, for example, you will see that the RMS margin moved along nicely and almost linear for the first three quarters and then it fell off in the fourth quarter. The model activity itself, which is the largest driver of the profitability in that segment, tends to fall off dramatically in the very end of the fourth quarter, really from Thanksgiving through the New Year's holiday, and it creates quite a little bit of a drag on the RMS margin in the fourth quarter. Even if Services are doing better, as Jim alluded to earlier, the Service margin just does not have quite the contribution that the models do.

The other thing I should comment, which I also mentioned earlier, but following up on, I think, Eric's question, we will also see a slightly higher tax rate in the second half of the year. Even though we expect it to be a little bit below our prior guidance, it will be a little bit higher in the second half versus the first half and that will create a little bit of drag on the EPS as well.

Randall Stanicky - Goldman Sachs

So, just in terms of RMS, that should, at this point at least, mimic last year in terms of that trend for 3Q and 4Q?

Tom Ackerman

Yes, without necessarily saying that the impact would be the same from Q3 to Q4, directionally speaking, you will definitely see a trend.

Randall Stanicky - Goldman Sachs

Okay. Then, just my last question. You announced a pretty sizable increase to your share buyback authorization. How should we think about your plans for share buybacks relative to the current guidance as we think about the remainder of 2008?

Tom Ackerman

Yes, we do buy under a Corporate 10b51 program. It is a grid of volume and price, which we haven't disclosed the specifics of. However, what we have said over the last period is that that would probably give us a year and a half, two years, depending, and I think if you looked at our more recent activity, we should be in a band somewhere in line with that, again, obviously depending on stock price and things like that.

Randall Stanicky - Goldman Sachs

So in terms of that, roughly now $230 million available in the authorization, we should think about that being exhausted over the year to year and a half to two years in a ratable fashion?

Tom Ackerman

Yes, I would say that is probably a good way to state it, essentially.

Randall Stanicky - Goldman Sachs

Okay, great. Thank you.


Thank you. We have a question from the line of Isaac Ro with Leerink Swann. Please go ahead.

Isaac Ro - Leerink Swann

Hi. Thanks for taking the question. Just first off, Tom, could you maybe talk for a minute about how you manage higher shipping cost for the models business, and maybe how higher energy costs could impact margins in the PCS business?

Tom Ackerman

Sure. Well, we do have a surcharge in place. So of course, we try to do the best that we can to manage efficiency. However, of course, some of the rate increases that we have seen in fuel and whatnot obviously run outside of that. So we do have a surcharge in place for our ground transportation globally, and we will continue to adjust that as appropriate.

Isaac Ro - Leerink Swann

Okay. Then maybe just going a little bit deeper into cost of goods, how do you think about labor, raw materials and freight as components within cost of goods?

Tom Ackerman

In terms of what we have seen from higher cost more recently?

Isaac Ro - Leerink Swann

Yes, or cost of goods. What are the components there on a percentage basis for those three items?

Tom Ackerman

Can you be a little more specific? Do you mean what we are seeing year-over-year, or --?

Isaac Ro - Leerink Swann

Sure, year-over-year would be fine.

Tom Ackerman

Sure. In terms of labor in the models business, I mean, it is tending to run more in line with our sales growth. That is similar in PCS as well, except for our expansion activities, where, because of training and things like that, we tend to run a little bit ahead on some of our major expansions.

The other expenses have really run in line. Utilities are obviously a little bit problematic for us at this point in time because of the oil costs that have driven that up. We are obviously looking to be as efficient as we can, and looking at a number of areas where we can try to reduce the actual utilization to have somewhat of an offset to the actual increases.

Feed is an area that has impacted us on some of our businesses where we do not have longer-term pricing arrangements with our vendors in the US. However, we have been insulated from increase in the commodities markets because we do have contracts that protect us at least through 2008. However, as we turn the page on 2009, I do expect we will see some above-average increases in some of our feed commodities because of that.

Isaac Ro - Leerink Swann

Okay, great. Thank you very much. Then just lastly on CapEx, for that $220 million to $240 million, can you remind us how that is broken out between investment and maintenance CapEx?

Tom Ackerman

I believe it is 60/40, growth versus maintenance. Is that right, Susan?

Susan Hardy

I think the maintenance was about 25% to 30%.

Tom Ackerman

Okay, so 75% to 25%, expansion versus maintenance.

Isaac Ro - Leerink Swann

Great. Thanks very much.

Tom Ackerman

Thank you.


Here we have a question fron the line of John Kreger with William Blair. Please go ahead.

Robbie Fatta - William Blair

Good morning. This is actually Robbie Fatta in for John today. Thanks for taking the question. As we think about consolidated margins, can you give us an update on your other initiatives to improve them, such as IT efficiencies and Six Sigma? Then, perhaps more broadly, have your longer-term expectations for margin improvement beyond 2008 changed in any way?

Tom Ackerman

Well, our margin improvement efforts, you touched on a couple of the areas. We recently embarked on a Six Sigma program; we have focused that in PCS. In fact, we have focused it more narrowly on one site, but are beginning to expand that to other sites. So we are very optimistic about the results that we can yield from that.

We haven't made specific margin impact comments yet because we are still in the early stages and would like to be pretty accurate when we make comments like that. However, we are very positive about what we have seen so far and how we think we can improve margin.

With respect to ERP, we also expect to be able to yield a lot of efficiencies, both in PCS and, to some extent in RMS. Again, we have not made specific comments with respect to how much it would improve the margin. However, based on where we are to date, we do think that it will give us benefits over the longer term. It may not necessarily impact us immediately when we turn the switches on because it will take some time to inculcate those new operations and practices into our main stream facilities, but we are optimistic about the benefits of that longer term.

I do not think anything that we have seen nearer term has changed our outlook for where we think we will be with margins longer term. We still do think we can improve the PCS margins over the long haul. We still have an operating margin goal of 25% which of course is a goal that we expect to achieve, but over a multi-year period not in the next couple of years.

So I do not think we have seen anything in the nearer term that would change our view long term. Things like sales growth, capacity utilization, Six Sigma and ERP are all mechanisms to help us get there.

Robbie Fatta - William Blair

Great. Thanks. Then just a quick follow-up on the RMS side. As we look at the organic growth, can you help us figure out how much is attributable to volume growth versus price increases?

Tom Ackerman

For margin growth in 2008?

Robbie Fatta - William Blair

Actually, organic revenue growth, I am sorry.

Tom Ackerman

Organic revenue growth.

Robbie Fatta - William Blair

In the quarter. So it was 13%, how much of that was volume versus price?

Jim Foster

Price is probably 3% to 4%; the rest is volume and mix.

Robbie Fatta - William Blair

Great. Thank you very much.


Thank you. We have time for one last question. We will go to the line of Doug Schenkel with Cowen & Company. Please go ahead.

Doug Schenkel - Cowen & Company

Hi. Good morning and thanks for taking my questions. First question is, on the Q1 call, you said that PCS had rebounded from a light start in January. I believe you suggested that momentum had picked up throughout the quarter, and it actually continued into the second quarter.

I know you have spent a lot of time talking about some of the reasons for what worked and what did not work in PCS this quarter. However, other than capacity constraints, was there anything of note that really changed over the last eight to ten weeks of the quarter? I points to this timeframe just keeping in mind that the Q1 call was held in early May.

Jim Foster

Nothing besides what we have already told you. We had very good demand and very good capacity utilization across almost all of our facilities. Yes, in the back half of the quarter we had study slip. We had studies booked and we were about to start them and they slipped.

We had a mix that was slightly less desirable than we had anticipated. It is almost impossible to call, but historically, the mix has been a little bit richer than that. That will in time shift back to a more positive mix.

Doug Schenkel - Cowen & Company

Okay. To be a little bit more straightforward, I just want to make sure there is no real change in how basically invisibility quarter-to-quarter here relative to how it has tracked the last couple of quarters.

Jim Foster

No, we do not think there is any change.

Doug Schenkel - Cowen & Company

Okay. Maybe just one quick follow-up on that; RMS is clearly doing better than you expected coming into the year. PCS came up a bit light. Recognizing that pharma outsourcing remains a very favorable dynamic for you and that quarter-to-quarter performance can be a bit volatile, any chance you would be willing to share any thoughts on what you think is a realistic one to three year organic sales growth target for RMS and PCS?

Jim Foster

What we have said is that, I think we have talked about it in the aggregate, which is that we are looking at low double-digit growth rates collectively for our business. Up until recently we have been looking at the RMS as a high single digit grower. To some extent, I do not want to say we would be pleased with that, but to some extent, given its historical metrics, we would be pleased with that. There is certainly a possibility we will hit low double-digit growth in that business in the next three to five years.

We would expect PCS over the long term to be in the low double-digit growth levels as well. So, it could be similar; it could be that PCS has slightly higher growth rate. However, in the aggregate our goal has been to grow this business organically at low double digits levels, with buttressed by these strategic bolt-on acquisitions like the one we just announced. We continue to be quite confident in our ability to deliver that level of growth.

Tom Ackerman

Stacey, are we all clear on the line?


Yes, we are.

Jim Foster

We did not know if we were --


Do you have any closing comments, actually?

Susan Hardy

Yes, thank you. Thank you for joining us this morning. This concludes the conference call. Have a nice day.


Thank you, ladies and gentlemen. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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