CORPORATE PARTICIPANTS
Susan
Hardy
Charles
River Laboratories - Corporate VP of IR
Jim
Foster
Charles
River Laboratories - Chairman, President & CEO
Ge
Li
WuXi
PharmaTech - Chairman & CEO
Tom
Ackerman
Charles
River Laboratories - EVP & CFO
CONFERENCE CALL PARTICIPANTS
Dave
Windley
Jefferies
& Co. - Analyst
Greg
Bolan
Wells
Fargo - Analyst
Doug
Tsao
Barclays
Capital - Analyst
Andy
Schenker
Morgan
Stanley - Analyst
Katherine
Lu
Oppenheimer
& Co. - Analyst
Eric
Coldwell
Robert
W. Baird - Analyst
John
Kreger
William
Blair - Analyst
Robert
Jones
Goldman
Sachs - Analyst
Derik
de Bruin
UBS
- Analyst
Eric
Lo
Bank
of America Merrill Lynch - Analyst
Doug
Schenkel
Cowen
& Co. - Analyst
Todd
Van Fleet
First
Capital - Analyst
Hongbo
Lu
Piper
Jaffray - Analyst
Sandy
Draper
Raymond
James - Analyst
Tycho
Peterson
JPMorgan
- Analyst
Steve
Unger
Lazard
Capital Markets - Analyst
Ding
Ding
SIG
- Analyst
Operator
Ladies
and gentlemen, thank you for standing by. Welcome to the conference on the
proposed combination of Charles River Laboratories and WuXi PharmaTech. For the
conference all the participants are in a listen-only mode. However, there will
be an opportunity for your questions and instructions will be given at that
time. (Operator Instructions) As a reminder, today's call is being recorded.
With that being said, for opening remarks I will turn it over to the Corporate
Vice President of Investor Relations at Charles River, Ms. Susan
Hardy.
Susan Hardy -
Charles River Laboratories - Corporate VP of IR
Thank you
and good morning, everyone. On the call today from Charles River are Jim Foster,
Chairman, President, and Chief Executive Officer, and Tom Ackerman, Executive
Vice President and Chief Financial Officer. Joining us from WuXi PharmaTech are
Chairman and Chief Executive Officer Dr. Ge Li, and Chief Operating Officer and
Acting Chief Financial Officer Edward Hu.
Our call
today will begin with comments from Jim Foster about the rationale and strategic
opportunity that this transaction represents, followed by Dr. Li's viewpoint of
the strategic importance of this combination. Tom Ackerman will then follow with
a discussion of the anticipated financial impact of this transaction and a brief
summary of Charles River's first-quarter results, after which will open the line
to questions.
Before we
begin, I would like to note that slides 3 and 4 contain our Safe Harbor
statement as well as additional information concerning Charles River's
acquisition of WuXi. Any remarks that we may make about future expectations,
plans, and prospects for the Company constitute forward-looking statements for
purposes of the safe harbor provisions under the Private Securities Litigation
Reform Act of 1995. Actual results may differ materially from those indicated by
any forward-looking statements as a result of various important factors
including, but not limited to, those discussed in our annual report on Form
10-K, which was filed in February 19, 2010, as well as other filings we make
with the Securities and Exchange Commission.
During
this call, we will be discussing both the transaction as well as Charles River's
first-quarter financial performance, including non-GAAP financial measures. We
believe that these non-GAAP financial measures help investors to gain a
meaningful understanding of our core operating results and future prospects,
consistent with the manner in which management measures and forecasts the
Company's performance. The non-GAAP financial measures are not meant to be
considered superior to or a substitute for results of operations prepared in
accordance with GAAP. In accordance with Regulation G, you can find the
comparable GAAP measures and reconciliations to those GAAP measures on the
Investor Relations section of our website through the financial reconciliations
link.
In
addition, in connection with the proposed transaction, Charles River will be
filing a preliminary and definitive proxy statement and other materials with the
SEC. We urge security holders to read these materials before making any voting
or investment decisions because they will contain important
information.
With
that, I am pleased to introduce the Chairman, President, and Chief Executive
Officer of Charles River, Jim Foster.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Thank
you, Susan. Good morning and thank you for joining us on such short notice. I am
extremely pleased to announce that Charles River has today signed a definitive
agreement to acquire WuXi PharmaTech for approximately $1.6 billion in cash and
stock.
As
summarized in slide 5, this combination will create the first and premier
early-stage contract research organization offering a full range of products and
services from model -- molecule creation to first in human testing on a global
basis. The combination of Charles River's expertise in in vivo biology and
WuXi's expertise in chemistry creates a partner capable of supporting clients'
early-stage drug development efforts as no other CRO can. And of providing the
expertise whether a client chooses to work in North America, Europe, China, or
any combination of the three locales.
As a
result, combining the two companies will dramatically improve both companies'
ability to meet clients' needs. We also believe Charles River and WuXi are an
exceptional cultural fit with both companies deeply committed to their clients
and employees. Recognizing all of these advantages, we believe we will drive
shareholder value by leveraging the combination to drive profitable revenue
growth.
On slide
6, you see a quick snapshot of both companies which shows the strength of this
acquisition from several different perspectives. Founded in 1947, Charles River,
which trades on the New York Stock Exchange under the ticker CRL, reported $1.2
billion in sales in 2009 and employs approximately 8,000 people. Founded in
2000, WuXi, which trades on the New York Stock Exchange under the ticker WX,
reported $270 million in sales in 2009 and employs approximately 4,200
people.
In terms
of core capabilities, the transaction combines the global leaders in in vivo
biology and chemistry to enhance our offerings. No other CRO offers this range
of expertise from molecule creation to first in human testing. Partnering with
the leading CRO in China gives us an immediate significant presence in what is
considered by our clients to be the next frontier for drug
development.
From a
scale perspective on a combined basis our 2009 sales would increase from $1.2
billion to almost $1.5 billion and our employee base would expand significantly
to approximately 12,200.
Slide 7
outlines what will be the new corporate profile of the combined entity. Our
headquarters will remain in Wilmington, Massachusetts, with the addition of
three Board members from WuXi, and we are very pleased that Dr. Li will be one
of them. Our Board of Directors will number 13. Dr. Li will also serve as a
Corporate Executive Vice President of Charles River and President of our Global
Discovery and China Services business, joining Real Renaud and Dr. Nancy
Gillett, who will continue to head the RMS and PCS businesses, respectively. I
will remain in my present position, as will Tom Ackerman.
There
will be three divisions reporting directly to me -- Research Models and
Services, Preclinical Services, and our new segment, Discovery Services. On
slight eight we outline the strategic rationale for this transaction. To
summarize, we believe this combination delivers compelling benefits from a
strategic, financial, and client perspective. It gives us an immediate,
significant presence in China, an increasingly vital region of focus for the
drug development industry.
Please
turn to slide 9. This transaction is about creating a fully integrated, global,
early-stage CRO. By combining WuXi, a high-quality, well-managed discovery
chemistry company with a significant presence in China, with Charles River, a
premier CRO and the leading research models provider with a major presence in
North America, Europe, and Japan, we are building a significantly more valuable
enterprise with a unique and comprehensive portfolio of discovery and
development services.
Charles
River and WuXi have highly complementary portfolios with limited overlap. We are
a leader in in vivo biology and they are a leader in chemistry. As such, we will
offer our clients a portfolio that spans molecule creation to first-in-human
testing. Our global presence will also be unmatched. Our footprint will enable
us to support clients wherever they choose to work -- in North America, Europe,
Japan, or China. As a result of the combination, we will enhance our value as a
strategic partner to the biopharmaceutical companies by offering more
capabilities around the world to support their drug development
initiatives.
The next
three slides show how the complementary services of the two companies will
combine to provide a full portfolio of expert early-stage CRO services to our
clients across the chemistry, in vivo biology, and manufacturing support phases
of drug development. WuXi's core competencies in chemistry provide the necessary
support for early discovery, including compound synthesis, assay development and
screening, and hit-and-lead identification and optimization.
In
addition, WuXi supports process scale-up and research manufacturing in the
preclinical process, commercial manufacturing during the clinical process, and
bioanalytical services and testing throughout. Charles River's core competencies
support the entire in vivo late discovery and preclinical process through our
expertise in research models; recent expansion of our discovery and imaging
services; extensive preclinical capabilities including pharmacology, safety
assessment, manufacturing support for Biologics, Phase I clinical trials;
bioanalytical services and testing throughout.
Together
our integrated portfolio will enable us to support our clients through the
entire early-stage drug development process, engaging them earlier in the
discovery process and staying with them throughout their IND filing. In
addition, the acquisition will enable us to become a significant provider of
manufacturing services to support small molecule therapeutics. Slide 13 looks at
our portfolio from the perspective of revenue by reporting segment. We have a
more balanced and diversified portfolio comprised of three business
segments.
Based on
combined 2009 sales, research models and services would have represented 44% of
our revenues, Preclinical Services 41%, and Discovery Services, the
fastest-growing of the three, 15%.
Turning
to slide 14, we drill down on our capabilities and our market positions within
the three segments. In Discovery Services or DS we will combine WuXi's
market-leading discovery chemistry platform, which includes structural biology
and modeling, medicinal chemistry, discovery biology, and pharmacology and
manufacturing, with Charles River's Discovery and Imaging Services or DIS. The
only change to the RMS segment is that it will no longer include
DIS.
We remain
the market leader in research model production, providing the largest number of
widely used research models and a broad spectrum of services to support their
use in research. The PCS segment will now include WuXi's preclinical toxicology,
as well as their biopharmaceutical testing. As a result of the addition of
WuXi's biopharmaceutical service platform, formerly AppTec, Charles River will
now be the market leader in that space.
Now
turning to slide 15, let me talk further about how this transaction is going to
drive profitable revenue growth. The DS segment will be a strong revenue driver,
benefiting from the fact that pharmaceutical companies are increasingly choosing
to outsource their discovery processes. In addition to chemistry, there is a
significant opportunity to grow WuXi's downstream services, including service
biology, DMPK and ADMET, formulation, process research, bioanalytical chemistry,
and manufacturing. In addition, we will be able to offer WuXi's services
upstream to Charles River's existing client base.
The DS
services are high-margin, which will help drive higher operating margins for
Charles River. As many of you know, WuXi is developing its GLP safety assessment
capability in China and has built an extensive facility to support the expected
volume of work. As a result of our expertise, we expect to be able to accelerate
the development of GLP capabilities in China. We are committed to ensuring that
WuXi's preclinical operations meet the very high standards for which all Charles
River's operations worldwide are known and believe that as a result we will
benefit as some of our clients place an increasing volume of safety assessment
work in Charles River.
There is
also an emerging opportunity in China for manufacturing active pharmaceutical
ingredients or APIs for clinical trials and commercial scale-up through WuXi's
new manufacturing services facility. This is a significant new service offering
from Charles River that supports the growing trend by our clients to outsource
manufacturing to China. We believe the scope of our expanded portfolio will
offer new opportunities to drive growth through different avenues, including the
ability to sell upstream and downstream to our existing clients and attract new
clients and gain market, and to encourage both existing and prospective clients
to outsource more services rather than invest in infrastructure to maintain
in-house capabilities.
Slide 16
details WuXi's impressive sales growth trajectory since 2004, from $21 million
in 2004 sales grew to $270 million in 2009 and are estimated to increase to a
range of $310 million to $320 million in 2010. The China-based laboratory
services business had driven growth consistently and with the opportunities for
growth that I just described, we believe laboratory services will continue to be
a significant contributor to the combined company's top line. For those of you
who are unfamiliar with WuXi, let me give you an outline of its facilities and
the services provided at each site.
Slide 17
illustrates the Chinese facilities. There are multiple buildings in Shanghai,
which in total represent one million square feet of Discovery Services capacity.
There are two GMP manufacturing facilities totaling approximately 300,000 square
feet in the Jinshan District of Shanghai and 250,000 square-foot discovery
chemistry facility in Tianjin and a 314,000 square-foot GLP facility in Suzhou,
which has begun to provide preclinical safety assessment services. These
facilities represent state-of-the-art contract research and development and
manufacturing capacity, which provide a growth platform for services in
China.
Slide 18
shows the US facilities, which include 75,000 square feet in Philadelphia for
biopharmaceutical services, 82,000 square feet in St. Paul for medical device
testing and manufacturing, and 51,000 square feet medical device facility in
Atlanta. Combined with our biopharmaceutical services capability, principally in
the US and Germany, we believe we will be the market-leading provider of
manufacturing support for biologics. As biologics become a larger portion of
therapeutics, we believe these services will be in even greater demand from our
clients.
On slide
19, we outline the benefits of this transaction from our clients' perspective.
First, we will have a larger footprint with more capabilities enabling clients
to partner with one strategic, large, global, well-financed provider for their
needs from chemistry to man. We think this presents an attractive opportunity to
clients who are looking to gain more value from a smaller number of substantial
service providers. We will also have the ability to support clients in North
America, Europe, or China based upon their specific needs.
We
believe that our expanded capabilities will enable the seamless transfer of
therapeutics across our early-stage continuum, assisting our clients in making
earlier go/no go decisions, and thus helping to reduce the time and cost to
bring a drug to market. We think this will resonate with our clients as they
recognize the enhanced opportunities they can derive from working with us. Slide
20 shows that for the combined companies, this transaction represents a
tremendous opportunity to expand our relationship with clients.
We will
focus on enhancing our partnership with clients where both Charles River and
WuXi have strong relationships and on leveraging those relationships where one
or the other of us is preeminent. Because of the compelling benefits of the
combined portfolio, we also expect to be able to build relationships with those
clients with whom neither of us currently has significant share. As a result of
this combination, we will have a competitive advantage as we pull through from
both companies' clients both upstream and downstream. And we believe that client
retention will increase due to the breadth of our portfolio and our continuing
commitment to deliver high-quality science and exceptional service.
As
indicated on slide 21, following the combination we will have a diverse customer
base with approximately 87% of our revenue base represented by commercial
clients and 13% by academic and government clients. In the commercial category,
we include large pharma and biotech, small- and mid-tier pharma and biotech,
CROs, and agricultural and chemical manufacturers. Our top 10 clients will
represent approximately 35% of sales with the largest client representing
approximately 6% of sales and only three clients above 5%.
Turning
to slide 22, let me talk about the strategic importance of China. Simply put,
China is the new frontier for drug development. Global pharmaceutical companies
are looking to take advantage of the opportunity to reduce costs while
leveraging China's highly skilled scientists. We see emerging opportunities for
every area of our business -- chemistry, safety assessment, and manufacturing
services, and eventually research models as clients advanced development
activities in China.
With this
transaction we are requiring the largest early-stage provider in China,
immediately establishing us as a significant presence and enabling us to
participate in the growth of the next research and development powerhouse which
many believe will ultimately be second only to North America.
We expect
some proportion of our safety assessment work will migrate to China, although
the current limited capacity will restrict the amount of work that can be done
there for some time. More than 8 million square feet of preclinical capacity in
North America and Europe and only about 0.5 million square feet in China today,
it will be some time before China represents a significant portion of drug
development safety assessment work.
On slide
23, we show the geographic diversity of our 2009 revenue on a combined basis --
58% of our revenues are generated in North America, 22% in Europe, 15% in China,
and 5% in other parts of Asia. The 15% of revenue generated in China is nearly
entirely from US and European clients. Over time we expect these proportions to
change, with China representing a more significant percentage of total
sales.
Turning
to slide 24, we are very pleased with the scientific leadership that will join
our company. I have already mentioned that Dr. Li will head the Discovery and
China Services business and will be a member of our Board of Directors. Ed Hu
will join Charles River as a Senior Vice President and General Manager of Global
Discovery and China Services . Dr. Shuhui Chen, who will also be a Senior Vice
President, will be the General Manager of Chemistry Services, and Dr. Suhan Tang
will be a Vice President and General Manager of Manufacturing Services. These
four men are scientific leaders and highly-experienced managers who were
educated in the United States, had distinguished careers in US-based
pharmaceutical companies, and returned to China to build the largest and most
respected provider of discovery and chemistry services.
In
addition to management talent, we expect our growing business to benefit from
the large, educated workforce in China. We are greatly impressed by the
dedication of the WuXi employees we have met and expect them to play a
significant role in the expansion of our combined business. It's noteworthy to
point out that WuXi is one of the largest global employers of chemists in the
pharmaceutical industry. currently 2,000, and a total of 2,900 scientists with
advanced degrees, which we believe is a distinct competitive
advantage.
Please
turn to slide 25. Despite the different national cultures, during the due
diligence process we were very impressed that our two companies have so much in
common from a corporate culture perspective. We share a dedication to exceeding
customers' expectations and a mission to accelerate our clients' drug
development efforts. We both put a high priority on scientific expertise. We are
employee-centric. We are focused on market leadership and continuing to build
shareholder value. Please turn to slide 26.
Now I
would like to give Dr. Li an opportunity to share his perspective.
Ge Li -
WuXi PharmaTech - Chairman & CEO
Thank
you, Jim. I am pleased to speak with you today about this exciting transaction
which transforms our companies and creates the first fully-integrated, global,
early-stage CRO. With the combination of our expertise in chemistry with Charles
River's expertise in in vivo biology, we will
provide
our clients with support for a broader portion of the early-stage drug
development process than is available from any other CROs. This will enable our
clients to gain more value from a single provider, simplifying their outsourcing
process.
It will
also offer us opportunity to generate pull-through for both companies, upstream
for Charles River and downstream for WuXi. We believe this presents a
significant source of a new potential revenue growth for the combined entity. By
bringing together the two companies we will also have a much larger global
footprint. This will enable large pharma clients to choose where to place work,
making us strategically more relevant to their drug development
efforts.
Perhaps
most exciting to us, Charles River's global pharma clients will now have access
to our services in China. This is another strong avenue for growth which will
explore through Charles River's 200-person sales force. We believe that the
exposure offered through this large and experienced sales force will enable us
to capitalize on upstream opportunities.
To become
an integral part of a large organization accelerates our vision of providing
services in China to the rest of the world. We look forward to the opportunities
that are open to us as the first and premier fully-integrated, global,
early-stage CRO and to executing our combined vision to support our clients'
drug development efforts worldwide.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Thank
you, Dr. Li. On slide 27, we summarized the reasons we are enthusiastic about
the acquisition of WuXi. The transaction combines the leaders in chemistry and
in vivo biology, creating the first fully-integrated early-stage CRO. We will
have a larger footprint with more capabilities in this space than any other
provider, enabling clients to strategically partner with one company from
chemistry to man.
Already a
market leader in North America, Europe, and Japan, the Company will also be
extremely well positioned to support global pharma's who view China as the new
frontier for drug development. We believe the transaction dramatically improves
both companies' ability to meet clients' needs and that we will leverage the
combined portfolio by selling upstream and downstream to each other's clients.
We gain an expanded management team and scientific expertise which will support
us as we continue to grow our business. WuXi provides the opportunity to drive
revenue growth and expand Charles River's margin, and we believe we will in turn
drive shareholder value.
Now let
me turn the call over to Tom Ackerman, who will provide a financial review of
the transaction and summarize our first-quarter's results.
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Thank
you, Jim. Turning to slide 29, let's review some of the transaction highlights.
As you know, the purchase price is $1.6 billion, which includes WuXi's debt and
cash. Each WuXi shareholder will receive -- and I would like to remind everyone
that WuXi trades as ADSs representing eight of their ordinary shares for each
ADS.
Each WuXi
shareholder will receive a combination of $11.25 in cash plus $10 of Charles
River common stock, which is subject to a collar. The collar for the stock
portion of the consideration will be determined based on our stock price over a
20-day period shortly preceding the closing. What this means is the high end of
our collar is approximately $43.17 while the low end is at $37.15. Based on
WuXi's closing stock price in April 23 of $16.57, this represents a 28% premium
and based on a 30-day average closing price a 38% premium. The transaction is
expected to be taxable to WuXi shareholders under US tax law.
We expect
the closing to occur by the fourth quarter of 2010 subject to approval by the
shareholders of each company and the satisfaction of customary closing
conditions and regulatory approvals. Upon closing, WuXi shareholders will own
approximately 22% of the combined company on a fully diluted basis. On slide 30
you can see that on a non-GAAP EPS basis the transaction is expected to be
neutral to slightly accretive in 2011 and increasingly accretive in future
years.
We expect
to generate cost synergies of $20 million on an annualized basis beginning in
2011 from public company costs, G&A, and refinement of certain operating
units. We believe there is a significant opportunity to generate revenue
synergies. We have not incorporated those into our accretion analysis, but we
will be focused on driving revenue synergies as we go through the integration
planning process. The combined company is expected to be a strong cash
generator.
Turning
to slide 31, we demonstrate the strong financial profile of the combined
companies. Profile is based on 2009 results and does not include the benefit of
the expected $20 million of cost synergies nor any effect of potential revenue
synergies. In addition, WuXi's results include stock-
based
compensation, which is different from WuXi's historical reporting, so that the
two companies' operating margins are shown on a comparable basis.
You can
see that the combined revenues will be approximately $1.47 billion with an
operating profit of 19%. Had we included estimated synergies, the profitability
would have been greater.
On slide
32 is a combined profile based on the two companies' current guidance for 2010.
The combined sales range would be between $1.51 billion and $1.56 billion and
operating income between $263 million and $285 million. As was the case in the
previous slide, we have adjusted WuXi's estimated operating income to include
stock-based compensation which is different from their guidance. We have not
adjusted the combined revenue or operating income estimates to reflect
anticipated revenue or cost synergies. During the acquisition, Charles River
will not be providing stand-alone EPS guidance.
To
finance the transaction as shown on slide 33, Charles River will take on $1
billion of new debt. Cash on hand and proceeds from additional debt will be used
to pay the cash consideration to refinance a portion of Charles River's and
WuXi's existing debt and to pay an estimated $60 million of transaction fees and
other expenses. Our pro forma operating leverage will be 3.3 times. We are
pleased that committed financing will be provided by JPMorgan Chase and Bank of
America Merrill Lynch.
Now let
me give you a brief summary of Charles River's first-quarter results. I will
speak primarily to non-GAAP results, which exclude acquisition-related
amortization, non-cash interest expense related to the new convertible debt
accounting rules, and charges related to cost saving actions and other
items.
On slide
35 you can see our top-line performance in the first quarter which reflects
consistent performance of the research model business and the stabilization of
preclinical demand. We reported sales of $297.3 million for the first quarter of
2010, a decrease of 1.4% over the first quarter of 2009 with a slight sequential
increase when compared to the fourth quarter. Foreign-exchange benefited net
sales by 3.4% year-over-year.
Excluding
the effect of foreign exchange, constant dollar sales decline was 4.8% with the
RMS segment reporting a 3.7% growth year-over-year and the PCS segment declining
14.5%. Turning to slide 36, the non-GAAP operating margin for the first quarter
declined 400 basis points year-over-year to 14.8%. Sequentially the operating
margin declined 170 basis points, driven primarily by higher expenses related to
the resumption of our incentive compensation program for 2010, as well as by ERP
costs partially offset by the benefit of cost-saving actions.
Non-GAAP
earnings per diluted share were $0.45 in the first quarter, compared to $0.58 in
the first quarter of last year. At $0.45, EPS was consistent with the outlook
that we provided on our guidance call in February when we indicated EPS would be
down approximately 10% from $0.49 in the fourth quarter. On slide 37 you can see
that sales for our RMS segment increased 6.6% in the first quarter to $172.2
million.
When
adjusted for the 2009 acquisitions of Piedmont and Cerebricon, which contributed
approximately 3.5%, and the 2.9% benefit from foreign exchange, organic growth
was essentially flat. The RMS operating margin declined 120 basis points to
30.4% compared to 31.6% in the first quarter of 2009. The decline reflects
increased operating costs largely stemming from compensation and overhead
allocations such as information technology.
Shown on
slide 38, PCS sales were flat sequentially from the fourth quarter, demonstrated
the plateauing of preclinical demand. Pre-clinical sales continue to be impacted
by stable but lower than historical prices as well as a greater proportion of
short-term studies in the sales mix. These factors also led to the 620 basis
point year-over-year decline in the PCS operating margin to 9.3% in the first
quarter of 2010. The 120 basis point decline in the sequential operating margin
was driven largely by increased compensation costs.
Turning
to slide 39, I will provide some color on the second quarter. As we have already
mentioned, we continue to view the second quarter of 2010 as the beginning of
improved demand for our Preclinical Services. We base that belief on more robust
inquiry activity in the first quarter of this year and the percentage of revenue
already booked for the second quarter.
While the
increased inquiries have not yet translated into a sustained improvement in
bookings or backlog as a result from the normal lag in the selling cycle, we
believe it demonstrates that clients are starting to reinvigorate their late
discovery and early development pipelines. For the second quarter, we expect
sales to increase 2% to 3% from the first quarter as PCS sales begin to improve.
On a sequential basis, we expect non-GAAP EPS will increase 8% to 10% as the
preclinical sales improvement drops to the bottom line at a higher incremental
margin rate given the leverage on our fixed cost base.
Susan Hardy -
Charles River Laboratories - Corporate VP of IR
That
concludes our remarks. Operator, we are now ready to respond to questions
..
Operator
(Operator
Instructions) Dave Windley, Jefferies & Co.
Dave Windley -
Jefferies & Co. - Analyst
Good
morning, thanks for taking my question. Congratulations on getting this deal
announced. I wonder, Jim, if you have had any clients that have expressed a
desire to contract for integrated services that Charles River assuming
combination with WuXi would boast? In other words, are clients pulling you in
this direction or do you feel like you are leading in that direction and will
kind of have to pioneer the cell for integrated services once you get
there?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Thanks,
Dave. It's really a competition of both. I would say that every client we meet
with, particularly large pharma and large biotech, talks about their desire and
need and intention to buy more services from a smaller number of providers. So
they want to do it on a global basis; they want to do it with companies that are
well financed; and they want to do that with companies that are geographically
dispersed and have more services rather than fewer.
So it
will be a combination of the fact that some companies will contract throughout
the whole process. Some companies will contract for a substantial portion of the
process. Some companies will pick and choose along the drug development
continuum, and some months or some years they'll buy certain services and
products from us and sometimes others. But the relationships that we are
building and that we understand WuXi has built with very senior people in the
drug development industry, we both reached the point where our clients depend on
us greatly and respect our science greatly and will want to do this whole range
of work with us.
We hope
to find ourselves increasingly on the same side of the table with our clients as
they are planning their drug development activities for the upcoming year, let's
say, and determining what work to apportion out and what work to keep
internally. Obviously with a greater footprint we will be able to garner
significantly more of that work as a single corporate entity.
Dave Windley -
Jefferies & Co. - Analyst
Okay,
thank you. On the synergy comments, in particular the facility portion of that,
I think maybe Tom alluded to that, I wondered if you could provide a little bit
more color about where you are expecting to see some facility tweaking to
achieve some synergy.
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Well,
there are some overlapping areas of work, Dave, as you probably know. and we
think there are good opportunities to improve efficiency there. In light of
confidentialities with employees and things like that, I would prefer at this
point not to go into too much detail but we do believe there are some good
opportunities for efficiencies there.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
So, Dave,
we will have a global integration team comprised of both Charles River and WuXi
senior executives and specific executives in certain areas that will be working
through all of the integration activities, both operationally and G&A wise
over the next several months until close.
Obviously
we will talk about that answer specifically to your questions at close. But as
Tom said, both for employee reasons and competitive reasons that is not
something we are prepared to talk about how.
Dave Windley -
Jefferies & Co. - Analyst
Okay. If
I can just ask one on the quarter and then I will bow out, the commentary about
1Q has proven -- I will back up a step. 1Q is basically what you guided to on
the last conference call. Your 2Q broad brush strokes comments suggests
something like $0.50 in earnings for the 2Q, which represents a somewhat I guess
shallower ramp in the early part of the year than we had anticipated or
conversely a bigger back-end loads than we had anticipated.
Are you
seeing demand manifest as you had anticipated in preclinical or should we
interpret those kind of guidance comments as demand is still a little sluggish
and coming around in preclinical?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
I would
say that demand -- I would say that the first quarter turned out very much like
we had anticipated and we believe that our comments about the second quarter are
quite consistent with what we always said and originally said. We have increased
inquiry levels. As we said in our prepared remarks, the sales cycle for that to
convert into backlog takes a bit longer. Pricing has absolutely stabilized and
in some instances improving, and we are quite pleased with how much of the
second quarter is booked at this time.
So we
still have some of the pricing from the prior year in there and the mix is
probably still a little bit more towards short-term, but we do expect an
increase in both top and bottom line in preclinical. And we believe it's the
beginning of a consistent, concerted improvement in that sector of our business.
So we really feel that the numbers we just gave you are quite consistent with
our earlier remarks.
Dave Windley -
Jefferies & Co. - Analyst
Okay.
Thank you and good luck.
Operator
Greg
Boland, Wells Fargo.
Greg Bolan -
Wells Fargo - Analyst
Thanks
for taking the questions. Just to start off with a quick technical question,
does WuXi have a go-shop provision and is there a breakup
fee?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
There are
certain provisions to that extent, Greg.
Greg Bolan -
Wells Fargo - Analyst
But none
that you guys can disclose this morning, I am assuming?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Yes, that
would be correct. To the extent -- let me answer it a different way. Both
parties are very committed to each other and there was a lot of discussion about
deals (inaudible) it be happening within the two parties. So I think while there
is always some customary provisions such as you asked about, we worked very hard
to keep the two parties together through most circumstances. But there are some
breakup fees in the agreement, as you would expect.
Greg Bolan -
Wells Fargo - Analyst
All
right. Thanks, Tom. And Jim, this is kind of a broad-based question, but you are
just now starting to touch an inflection point for preclinical activity, which
is great. So I am just wondering why the leap to digest or consume such a large
acquisition at this point in time?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Because
that is what we are hearing from the clients. We exist to increasingly service
our clients, which is a dynamic and changing marketplace through consolidation
and the pressures that are on them with the patent cliff and federal
legislation, etc., etc. And as I said earlier, it is increasingly clear, has
become increasingly clear to us, that our big clients want to and intend to deal
with a smaller number of providers.
We have
thought periodically, and it's hard to quantify, I would say sort of have
quarterly conversations internally about moving upstream to chemistry. Obviously
the ability to capture clients earlier and work with them at the very essence of
discovering the compound is a very important pull-through at helping our
downstream work. So the greatest expertise that WuXi brings, we don't look at
that as a monumental digestion exercise.
We look
at that as putting the complementary strengths of the two companies together,
continuing to support our current clients, and just moving forward rapidly. The
portfolios are quite complementary with only a limited amount of overlap. We
feel quite confident, given the combined management strength of the combined
entity, that we can do both, both rebuild meaningfully and aggressively and
profitably our preclinical business and also sort of absorb this new and large
business in a wholly-integrated fashion.
Greg Bolan -
Wells Fargo - Analyst
That is
helpful, Jim. And then just a last question. It looks like you are still
sticking to your view that demand for preclinical Services is picking up here in
2Q. But if we take a step back and I just look at the margin in PCS coming in at
around 9% and I think we all understand obviously the overcapacity situation in
tox and what you guys are burning off at this point in time in terms of the
lower price work at the end of last year. But I have to ask is the North
American toxicology market still attractive to you over the long
run?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
It's
extremely attractive. Also remember that the margins in the first quarter are
also impacted by year-over-year comparisons of incentive compensation payments
(technical difficulty) in the prior period and significant IT costs. Along with
the capacity and the pricing. Now we have just told you that we believe the
second quarter will be better top line and the margins will be better as well so
we begin to fill capacity and absorb those incremental expenses.
And, yes,
the variability that we saw in the first quarter was very small, variability
meaning to plan and to our guidance. To juxtapose that to the prior year it's
really a dramatic change and so there is a lot more clarity and certainty in the
demand quotient. We really feel clients have gone back to work. So many of them
had to finalize the budgets in the first quarter and so many of them were really
kind of being tentative. We can feel it now getting back to work.
We are
seeing significant inquiry levels really at all of our preclinical sites. Some
of the preclinical sites already had very good capacity utilization. Obviously
others will have to follow and catch up. So, yes, we are hearing and feeling and
experiencing very positive demand from the clients. It doesn't appear to be
quite as good as it is because of the historical price points, which we have
certainly hit the bottom of and we will begin to improve over time.
Greg Bolan -
Wells Fargo - Analyst
Thanks so
much and congrats on the deal.
Operator
(Operator
Instructions) Ladies and gentlemen, in the interest of time and fairness to
others, could you please limit yourself to one question? Doug Tsao, Barclays
Capital.
Doug Tsao -
Barclays Capital - Analyst
Thanks
for taking the question. Just, Jim, in terms of the business at WuXi, obviously
they have the manufacturing business which I presume you are a little less
interested in. I was just wondering if you could provide your thoughts there in
terms of the strategic fit with the sort of discovery and preclinical services
portfolio for the combined company.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Yes, are
you talking specifically about the manufacturing piece?
Doug Tsao -
Barclays Capital - Analyst
Yes.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
So
clearly the principal driver was the chemistry business. WuXi is preeminent in
that field, has built a very big, very profitable business doing that, and has
significant client relationships in that area. Manufacturing is frankly
something we have looked at many times in the US and Europe and actually had a
small manufacturing business years ago that came with our Primedica acquisition.
The economics really didn't work very well for us in the
States.
So what
we found to our delight is we found through the due diligence this manufacturing
process in China from a capital drop point of view and labor component point of
view is that the price points and the cost structure is much more rational. It's
a very robust business there already in manufacturing API for preclinical and
clinical indications and some possibility of doing this on a commercial
scale.
So yes,
given the locale, given the demand quotient, given the close relationship that
this has both with our preclinical activities and our clinical activities, it's
a really good additional -- it's really good addition to our portfolio. So while
it wasn't the primary driver, it's a piece that we are quite pleased to have in
the portfolio. It rounds it out significantly and continues make it very
unique.
Doug Tsao -
Barclays Capital - Analyst
And then
just sort of I have to ask as a follow-up, obviously when you bought Inveresk
you took on the clinical development business. At the time you said you wanted
to pursue it and you thought it was an attractive opportunity. Then a couple
years later the business was sold. Is this a situation where you are making a
long-term commitment to the manufacturing piece or is this more of a sort of
initial trial?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
It's a
fair question. I think that the manufacturing business is very, very different
than clinical, so in the clinical business we surely weren't looking for that.
We got ourselves an underscaled business, it very difficult to compete, and it
was a very commodity-oriented activity. Whereas the manufacturing -- WuXi has a
very high quality niche on small molecule manufacturing, which obviously is a
wonderful addition to creating the molecules themselves and then manufacturing
it. So strategically it's quite stronger and tighter than it was in
clinical.
Also, the
combined company doesn't have to have the largest manufacturing capability in
the world to have it be important. It just has to be very high-quality and to be
able to service our customers. So we don't look at this as something that we are
trying. We don't look at this as something to kind of came with the deal. We
look at it as something that has great strategic significance in a unique locale
with a unique cost structure that we can really make sing for us.
Doug Tsao -
Barclays Capital - Analyst
Okay,
great. Thank you very much for taking my questions.
Operator
Ricky
Goldwasser, Morgan Stanley.
Andy Schenker -
Morgan Stanley - Analyst
Yes, this
is Andy in for Ricky. Just real quickly, given your expected neutral to slightly
accretive guidance in 2011, can you discuss kind of what you are assuming for
WuXi in 2011? And then also just how are you thinking about competition in China
longer term, especially around pricing?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
With
respect to 2011, unfortunately to your question, neither company has provided
guidance on that particular time other than to say that with respect to non-GAAP
EPS we do expect the transaction to be neutral to slightly accretive. But in
terms of the top line, neither company has provided that yet.
Andy Schenker -
Morgan Stanley - Analyst
Okay. And
then just on the second part, how are you guys looking at competition in China
longer term, especially on the pricing side? How is that affecting
you?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Are you
talking about local competition?
Andy Schenker -
Morgan Stanley - Analyst
Yes,
local.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
We
certainly think that we are going to have, and already have, an early lead,
much, much more significant to fully integrated facilities, and we certainly
feel that we will be able to compete effectively in that marketplace on quality
and be paid appropriately. In terms of the relationship to sort of US and
European pricing, that will change over time. US prices are actually quite low
right now, in some cases comparable to China. I suspect over time European
prices will end up slightly higher because given the relative cost
structures.
So we
feel very confident we will be able to compete effectively, both from a scale
point of view, a pricing point of view, and a margin point of view in all three
geographic locales.
Andy Schenker -
Morgan Stanley - Analyst
Okay,
thank you.
Operator
Katherine
Lu, Oppenheimer & Co.
Katherine Lu -
Oppenheimer & Co. - Analyst
Thank you
for taking my question. Congratulations. I am just wondering what kind of
regulatory hurdles do you need to clear in both China and the US and the timing
of the clearance?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Regulatory
hurdles for the deal itself, is that what you are saying?
Katherine Lu -
Oppenheimer & Co. - Analyst
Yes.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Not in
China that we are aware of and the usual filings in the US. We are highly,
highly confident that there are no issues from a regulatory point of view in
this transaction moving forward.
Katherine Lu -
Oppenheimer & Co. - Analyst
Could you
just quickly remind us what is your China revenue in 2009?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
I don't
think we ever disclosed that. Charles River's China revenue in 2009 was quite
small and it was a business that certainly wasn't contributing to our operating
margins. Why don't we leave it at that?
Katherine Lu -
Oppenheimer & Co. - Analyst
Great,
thank you.
Operator
Eric
Coldwell, Robert W. Baird.
Eric Coldwell -
Robert W. Baird - Analyst
Thank
you. Question relates to Q1 in particular. I was hoping you could quantify the
incremental year-over-year nominal increase in IT and compensation costs so we
could have a better sense of the impact on earnings relative to, say, pricing or
market demand.
Tom Ackerman -
Charles River Laboratories - EVP & CFO
The
biggest area, Eric, for IT would have been in ERP, where we disclosed that for
2010 the full-year number would be in a range, if I remember correctly, of about
$15 million to $20 million. So if you break that down quarterly it's up
significantly versus last year. I don't believe we disclosed the compensation
specifically, but what we said is a couple of things. One, we had of course
frozen a number of wages across the Company in 2009 which we would reinvigorate
obviously for a variety of reasons in 2010 at the employee
level.
And in
addition to that many of our businesses did not pay out performance bonuses in
2009. Some businesses did at a much reduced rates from planned. And while we
haven't completely reinstituted the full plan for performance bonuses in 2010,
we did implement performance bonuses again at a slightly reduced level. Given
our performance to date were actually accruing consistent with that. So that,
while not a cash expense in the first quarter, does hit the P&L versus last
year.
Eric Coldwell -
Robert W. Baird - Analyst
Okay. If
I could just have a quick follow-up, you mentioned when you create the three new
-- the third reporting segment, Discovery, for Charles River you will pull the
existing discovery business into the new segment. I am hoping you can quantify
the existing discovery business for us in terms of either 2009 revenue or the
first quarter of 2010.
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Yes, the
best -- on an annualized basis it would be less than -- Charles River's
discovery business would be less than $50 million annualized.
Eric Coldwell -
Robert W. Baird - Analyst
Less than
$50 million annualized this year?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Correct.
Eric Coldwell -
Robert W. Baird - Analyst
Okay,
thanks so much.
Operator
John
Kreger, William Blair.
John Kreger -
William Blair - Analyst
Great,
thanks very much. A question actually for Dr. Li. Could you just give us an
update about how the Discovery Services business in China has held up in the
face of the slowdown in pharma spending over the past year? Do you feel like the
demand for that business and the pricing for that business has stabilized at
this point or are still under pressure?
Ge Li -
WuXi PharmaTech - Chairman & CEO
Well, no
offense, John, we continue to see a strong demand from our customers. Actually
our -- to answer one of the early questions, we do see our clients' demand for
more fully-integrated service.
John Kreger -
William Blair - Analyst
Great,
thanks. And then a quick follow-up for Tom. Tom, do you have a rough sense about
what the anticipated cost of debt will be, the interest rate?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
We do. I
am not prepared to disclose that at this particular time but what I would say is
that we do have commitment, as you know, from JPMorgan Chase and Bank of America
Merrill Lynch. The debt markets have continued to improve over the last year and
I would say they have improved from where we are today versus just three months
ago. So we are very optimistic at this point in time that we can construct a
debt package with flexibility to do certain things on our half and the terms
itself would be favorable.
John Kreger -
William Blair - Analyst
Great,
thank you.
Operator
Robert
Jones, Goldman Sachs.
Robert Jones -
Goldman Sachs - Analyst
Thanks
for the question. You guys talked about the growth prospects in China, which I
think is widely accepted, but can you share a little bit more perspective on how
you think about the timing of the market growth in China and maybe how you
foresee the competitive landscape changing over time?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
I will
let my colleague, Dr. Li, answer that.
Ge Li -
WuXi PharmaTech - Chairman & CEO
Actually,
again as I said earlier, our customers are looking for integrated service, are
looking for more services from a single supplier. And I think this deal makes so
much strategic sense because we should allow the combined company to truly offer
from a compound synthesis to a first-in-man. So this is a -- this will
completely change the landscape. We are going to be so much better and so much
dominant.
Robert Jones -
Goldman Sachs - Analyst
That is
helpful. So then just specifically, I guess Dr. Li, if you could, on the current
WuXi operating margins that are around 20%, do you see that as sustainable as
this market evolves over time?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Well,
actually again, because we [have applied] more and more service capabilities and
our clients are looking for us -- working with us for solutions that are full
service and not just only a single compound (inaudible). And by offering
complete the solution and service to our partners we will anticipate that our
operating margin will improve.
Robert Jones -
Goldman Sachs - Analyst
Appreciate
it, thanks.
Operator
Derik de
Bruin, UBS.
Derik de Bruin -
UBS - Analyst
Good
morning, I kind of wanted to follow up on one of Doug's questions. This goes to
the medical device testing. So you bought back in 2004 River Valley Farms and
you did some medical device testing; you got out of that. I guess WuXi does have
some medical device business there. I am just wondering has that market evolved
or changed since you have got out of that.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
I would
say somewhat. This is a very small part of this deal. I would say the market has
evolved somewhat . The location, particularly the St. Paul facility being right
in sort of medical device country, I think is very, very helpful in terms of
garnering fair amounts of business directly from those clients. The nature of
some of the work is unique and sort of pulled together in one or two
locations.
So we are
dealing with a different scale, with a more sophisticated business, and with a
longer-term operation. So, yes, we think this is a nice add-on to the whole
portfolio, albeit a relatively small piece and certainly not the principal
reason that we are doing this transaction.
Derik de Bruin -
UBS - Analyst
Just I
think it's going to be -- it's hard to argue that China clearly is going to be
the frontier for drug discovery and development going forward. I am just curious
as to why WuXi is interested in selling now given what appears to be just a long
road forward.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
We will
let Dr. Li answer that question.
Ge Li -
WuXi PharmaTech - Chairman & CEO
Well,
actually we were not looking to sell the company and then we found a great
partner. So as you can see, Charles River and WuXi are so complementary in
services. WuXi is strong in discovery chemistry, Charles River is strong in
early development, and the combination will help our clients to move the
compound from compound synthesis to first-in-man.
This
combination fast-forward our dream, anyone, any company can use the fully
integrated service platform to discover (inaudible) drug by a few years. So --
and the plus of this transaction is attractive valuation, so we give our
shareholders about 28% premium for the current stock price and plus a great,
great upside potential for the longer-term.
Derik de Bruin -
UBS - Analyst
Okay,
thank you.
Operator
Eric Lo,
Bank of America Merrill Lynch.
Eric Lo -
Bank of America Merrill Lynch - Analyst
Good
morning, guys. Thanks for taking the questions. In the presentation you guys
mentioned a lot of opportunities for revenue pull-through because of
acquisition. I was wondering how that would -- the WuXi acquisition could change
your longer-term guidance. I think your previous long-term guidance was sort of
for low double-digit sales growth.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Yes, we
certainly feel that over time they will improve our sales growth, I don't know,
perhaps midteens. I think it's a little premature to be giving those numbers,
but WuXi has a much faster revenue growth rate than Charles River does.
Independently we certainly believe that research models will invigorate back up
to maybe, certainly mid to perhaps high single digits. And preclinical on its
own we feel will get to low double.
The
China-based laboratory services should continue to grow much faster, probably
mid to upper teens, and the manufacturing business really depends on a lot of
things but has the opportunity to grow much faster as well. So, yes, it can only
improve the growth trajectory that Charles River has on its own. So I would say
sort of as a conservative number I would be thinking midteens.
Eric Lo -
Bank of America Merrill Lynch - Analyst
Okay. And
you mentioned that you believe safety assessment and work will shift from the US
and Europe to China over time. I was just wondering what you thought that would
have in terms of impact on pricing . And would you expect to see additional
capacity reductions in the US and European markets going
forward?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Yes, so
let's be very clear and careful about what we said in the call. What we said is
that some of the safety assessment work will migrate to China over time. We
already have clients that have told us that they are going to go to China as
soon as there is enough capacity and it's GLP-ready for a whole host of reasons.
Some of it's cost. Some of it is the amount of R&D that they are doing
there.
We have
other clients that may never go and we have other clients that I think will wait
and see. And they are going to China for two reasons. They are going to China
because they are doing their local -- they are doing the R&D locally in
China and they want to do the safety assessment right there, or they really feel
that there is some cost and speed and quality advantage. So there is no question
that China -- as China R&D grows, China safety assessment will grow. We are
starting with a nice infrastructure between our two facilities, which I think
will hold us in good stead for a couple years, maybe three years, whereupon we
will be able to build additional space in China at price points below the US and
Europe.
Having
said that, we can't imagine that the rate of migration will in any way
significantly impact the utilization of the current footprint that we have in US
and Europe. We don't see any way that it will cause reductions in that space.
Remember the space is abundant because everybody built it at once and the market
pulled back. Well, the market is beginning to reinvigorate again. we are quite
comfortable and confident that we will be able to fill up our space in the US
and Europe and China and probably continue to expand in both locales. The price
points I think will be commensurate with the services operated and the cost
structure of these prospective locales.
Eric Lo -
Bank of America Merrill Lynch - Analyst
Sort of
last question for you guys. I was just wondering what your primary use of cash
flow would be going forward. Are you guys done with acquisitions for a while and
would you be focused primarily on paying down debt? What are your thoughts on
sort of share repurchases going forward?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
I would
-- we can't say anything definitively about acquisitions. I would say that this
was certainly going to take time to digest, this very large deal, and make the
complementary business very strong and meet our goals. That doesn't mean that
there aren't opportunities for strategic tuck-in acquisitions along the way that
enhance either of our portfolios and the combined one. I think obviously we will
be paying down debt commensurate with our arrangements. I think it's unlikely in
the foreseeable future that we will be buying back stock.
Operator
Doug
Schenkel, Cowen & Co.
Doug Schenkel -
Cowen & Co. - Analyst
Good
morning. Three questions. Specific to the deal could you talk about how
competitive this process was? Second question is I just want to make sure that
you are not reaffirming EPS guidance. It's possible I just missed that. And then
a third question, you have been getting progressively more confident in a
turnaround in PCS over the last couple quarters. I just wanted to see if you
would comment on whether or not you are seeing a reduction in slippage and
cancellations. Thank you.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
I will
start with the last piece. Cancellations have never been a big problem for us,
so I can't -- so it continues not to be an issue. And I would say slippage is
modest and normal, so we definitely do not have an unusually high level of
slippage that we had at the end of 2008 and a portion of 2009. So there is much
more regularity and certainty and predictability about our business
model.
I think
Dr. Li and I would both say that this was a process that -- it was just the two
of us involved in it because it's a very powerful combination and we share the
personal and corporate and strategic vision . It was just the two companies
finding the appropriate timing and terms to come together. And you had an EPS
question that I will give to Tom.
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Sure. If
you look at slide 32, I don't know if followed the deck, we are maintaining our
sales and non-GAAP EPS guidance. As you can see -- excuse me, sales in non-GAAP
OI guidance, as you can see on the chart. Because of the transaction, the
expected closing, it would be difficult to reaffirm our non-GAAP EPS guidance or
GAAP EPS guidance. But had we not contemplated the transaction, we don't think
that we would have deviated from what we have said in the
past.
Operator
Todd Van
Fleet, First Capital.
Todd Van Fleet -
First Capital - Analyst
Good
morning. Jim, I am hoping you can talk a little bit about the sales channel
integration efforts. I think that one of the advantages that WuXi cited was it
would be able to leverage the sales personnel that Charles River has. So
hopefully maybe you could talk about are you seeing the number of touch points
that the combined entity would have as being reduced from previously or how you
do you see the sales channel evolving for the combined entity over the course of
the next maybe 12 to 24 months? Thanks.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Sure. As
I think you know, we have totally reorganized our sales force over the last six
months or so. We are already seeing the benefits of getting much closer to
really all three segments, large pharma, sort of midrange clients, and the
academic sector. WuXi has been very effective, obviously, in selling and their
senior management is doing most of the selling. I think their senior management
will continue to participate in a significant way, but what we have now is we
have 200 people around the world who are now selling our entire portfolio who
will be able to sell the expanded portfolio.
And I
think the ability to open doors, to reach clients that neither company is
reaching or to reach clients that one company is reaching and the other isn't
will be dramatically enhanced. Yes, we should have a much more focused approach
to the clients where salespeople are opening the doors and senior scientific or
senior management people are closing the doors. There are still a fair number of
our relationships that are very senior that either myself or Dr. Li or other
people are engaged in directly, which I think will be an always, always, but we
have a much larger cadre of people who are doing the preliminary
work.
I think
that is going to bear a lot of fruit in the academic sector in the midrange
sector in particular. Midrange sector we have 3,500 clients just Charles River
alone, so there is a lot of companies to visit and tell the story to. So, again,
while we are very proud of our in vivo biology heritage and I know WuXi is very
proud of its chemistry heritage, we need to move away from clients pegging us
only as a rat and mouse producer and them only as a chemistry company and
looking at the totality of the operations. There is no question our sales force
will have an instrumental role in doing that.
Todd Van Fleet -
First Capital - Analyst
Jim,
would you say that the sales and marketing function then for the combined entity
is something that will need investment or is that an area where you might see
some operational synergies or efficiencies?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Probably
neither. Our marketing efforts are improving all the time in terms of market
share -- market data, and in terms of how to sell in to clients. Of course our
marketing organization in the next few months is going to have to recraft the
message to talk about this larger portfolio. I think that we will wait and see.
I assume that our sales force at the current time is probably large enough to
sell the full story. And if it isn't, we will obviously augment it but that is
not our thought process right now.
Todd Van Fleet -
First Capital - Analyst
Thanks
very much.
Operator
Hongbo
Lu, Piper Jaffray.
Hongbo Lu -
Piper Jaffray - Analyst
Thank
you. And is that Piper Jaffray covering WuXi. Two questions for you, Jim. You
have existing toxicology joint venture in place in Shanghai, namely BioExplorer.
Can you comment on your plan with that part of operations? And also what will
happen to WuXi's existing contracts, especially, for example, the master
toxicology agreement with Johnson & Johnson? Thank you.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
So I am
certainly not going to comment on the last question and Dr. Li may have some
comments, but I would just simply think that Johnson & Johnson would be
delighted with this situation. And I think I will leave it at that. WuXi will
have conversations with them between now and the time of close assuming anybody
wants to make any alterations to that deal.
Our
BioExplorer operation, what we call Charles River China, is a very high-quality
GLP operation. Small facility in Shanghai with now highly-trained employees and
a robust client base where we are doing GLP work. We are going to want to
nurture both locations and strengthen it and make it one integrated activity.
Our integration team will be figuring out the best way to do that, how we
utilize the existing facilities and the existing staff in the most robust way.
Take a look at where we have client overlap and also take a look at places where
we each have different clients. So it will provide an opportunity to service a
larger clientele.
Hongbo Lu -
Piper Jaffray - Analyst
Thank
you.
Ge Li -
WuXi PharmaTech - Chairman & CEO
Hongbo, I
think our clients like Johnson & Johnson will be happy about this
combination because of the strength of Charles River in GLP services will help
WuXi achieving a GLP offering in a short timeframe. So our clients, Johnson
& Johnson and others, will highly endorse this deal.
Hongbo Lu -
Piper Jaffray - Analyst
Thank you
so much, Dr. Li, and congratulations.
Operator
Sandy
Draper, Raymond James.
Sandy Draper -
Raymond James - Analyst
Thanks,
most of my questions have been asked by this point. Just a clarification, I
think, to a couple ones -- this would be for Tom. So, Tom, when we look at the
back-half weighting of the earnings you talked about the stock comp and the ERP.
Is there any seasonality to those where some of those expenses are higher at the
front and they drop down, or is the back half purely an operational recovery
that we wouldn't sort of pull out discrete items that start to fall-off in
expense? Thanks.
Tom Ackerman -
Charles River Laboratories - EVP & CFO
You are
welcome. A couple of things, I referred to incentive compensation as opposed to
stock compensation and that would be more linear. On the other hand, the ERP
would be a little bit more front-end loaded because of the implementation at
January and our follow-in implementation at two of our pre-clinical sites
midyear.
A lot of
those expenses at the time of implementation are expenses as opposed to capital.
But in conjunction with that, we are obviously expecting a continued recovery in
preclinical, so for the back half of the year the strengthening of sales that we
are projecting does drive increased leverage to the P&L.
Sandy Draper -
Raymond James - Analyst
Great,
thanks.
Operator
Tycho
Peterson, JPMorgan.
Tycho Peterson -
JPMorgan - Analyst
Thanks
for taking the question. Just, Jim, in your prepared comments you had talked
about potentially using your expertise to accelerate the tox ramp in China. I am
just wondering if you can clarify that a little bit. I know they have talked
about midyear GLP certification at the new facility. But in that context can you
talk about how quickly you think the GOP tox work can ramp and maybe what
percentage of your work over time may move over there?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Yes, that
comment is intended more to identify the fact that clients' acceptance of work
done in WuXi's Suzhou facility will clearly be accelerated because we now have a
combination of their very large, fabulously designed facility with a core staff,
but with the expertise now coming from us with clients that already utilize and
respect and are comfortable with our expertise.
So it's
less about the kind of short-term will we be ready at the beginning of the
second quarter, will they be ready at the beginning of the second quarter or the
end. Well, first place we are not combined until sort of by the fourth quarter
so we are really not going to have any impact on that anyway. But it's about
overall acceptance and looking at us as one entity. and clients probably
deciding to do their work in China earlier than they would have
otherwise.
Tycho Peterson -
JPMorgan - Analyst
Okay. And
then as we think about longer-term, your own pricing strategy and safety
assessment, for example, or tox and potentially allowing clients to shift work
between sites, can you just talk about the advantages or risks of having a
dual-pricing strategy and then ultimately what percentage of work do you think
will be able to be transferred between sites?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
As we
said, the capacity in China right now is relatively small compared to the rest
of the world and should be for some time. We will grow it commensurate with the
market demand and, look, pricing will be commensurate with the relative cost
structures and, as I said earlier, the mix of work. I think it's unclear how
two-tiered it will be or how dramatically different it will
be.
I mean,
there are some cost benefits in China, so I suspect for some period of time the
prices will be lower. But I also said earlier that prices in the US right now
are extraordinarily low because of the excess capacity. So there it's very much,
like many businesses, capacity-driven and as capacity fills in both locales we
will be able to get more price and better margins. And it's very important that
our clients pay us appropriately for our work, particularly as they shut down
space and rely on us more heavily and particularly as we continue to build new
space.
So the
difference in the pricing we will manage over time and we will continue to sort
of be a changing landscape depending on competition what the clients do and how
well capacity is utilized.
Tycho Peterson -
JPMorgan - Analyst
Great.
And then just one last one for Tom on the tax rate longer term. Can you talk
about how you think about that?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Well,
WuXi does have a lower tax rate, part of it's based on incentives in China. So
we do think that overall the combined entities our tax rate would come down
prospectively, although given the relative size of the two companies it wouldn't
be overly dramatic. But we do expect the combined rate would come
down.
Tycho Peterson -
JPMorgan - Analyst
Great,
thank you very much.
Operator
Steve
Unger, Lazard Capital Markets.
Steve Unger -
Lazard Capital Markets - Analyst
I just
have a quick question about the financing package. Tom, you mentioned that --
did I hear you correctly in saying that you are going to issue a $1 billion of
new debt?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Correct.
Steve Unger -
Lazard Capital Markets - Analyst
Okay, so
the existing cash on the balance sheet is modest in terms of your ability to use
that?
Tom Ackerman -
Charles River Laboratories - EVP & CFO
Well, we
will use a certain amount of cash on hand. We will repay off our current term
facilities so there will be -- while we will issue new debt, we actually will
pay off some debt at the same time. We have $190 million at year-end; WuXi has
about $30 million, $35 million on hand. So we are using a certain amount of
cash, Steve, also.
Steve Unger -
Lazard Capital Markets - Analyst
Then just
on the senior management that's coming over from WuXi, could you talk about is
there -- do they have formal employment agreements in place at this point or is
that still in negotiation?
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
The top
four people at WuXi who are very important from a scientific and managerial
point of view all have long-term contracts with us, all already
signed.
Steve Unger -
Lazard Capital Markets - Analyst
Excellent,
thank you.
Operator
(Operator
Instructions) Ding, Ding, SIG.
Ding Ding -
SIG - Analyst
Thank
you, congratulations on this landmark deal. I just wanted to follow up, how will
the merger impact the pricing of WuXi's current service offering in China,
particularly in chemistry? And also on Charles River's GLP tox service in China
going forward? Secondly, how will the merger impact WuXi's timeline on reaching
GLP status and start to, in the progress, to offer GLP tox service in Suzhou
prior to the expected closing of the merger in fourth quarter? Thank
you.
Jim Foster -
Charles River Laboratories - Chairman, President &
CEO
Dr. Li,
would you like to take that question?
Ge Li -
WuXi PharmaTech - Chairman & CEO
Well,
Ding, Ding, again, as I said earlier, we don't anticipate any pricing impact,
whether it's up or downward. For the GLP readiness, we stick with our timeline.
We should be able to offer GLP service in second half of the year. And again,
this combination of Charles River and WuXi, I agree with you, it's a landmark
deal. And they truly offer our customers a fully integrated service from
compound synthesis to first-in-man.
Ding Ding -
SIG - Analyst
Thank
you.
Operator
I will
turn it back to the presenters for any closing comments.
Susan Hardy -
Charles River Laboratories - Corporate VP of IR
That
concludes the conference call today. I thank you for joining us and we look
forward to talking with many of you as we move forward. Thank
you.
Operator
Ladies
and gentlemen, that does conclude your conference. You may now
disconnect.
ADDITIONAL
INFORMATION AND WHERE TO FIND IT:
This
document may be deemed to be solicitation material in respect of the proposed
combination of Charles River and WuXi. In connection with the proposed
transaction, Charles River will file a preliminary proxy statement and a
definitive proxy statement with the SEC. The information contained in
the preliminary filing will not be complete and may be
changed. Before making any voting or investment decisions, investors
and security holders are urged to read the definitive proxy statement when it
becomes available and any other relevant documents filed with the SEC because
they will contain important information. The definitive proxy
statement will be mailed to the shareholders of Charles River seeking their
approval of the proposed transaction. Charles River’s shareholders
will also be able to obtain a copy of the definitive proxy statement free of
charge by directing a request to: Charles River Laboratories, 251 Ballardvale
Street, Wilmington, MA 01887, Attention: General Counsel. In
addition, the preliminary proxy statement and definitive proxy statement will be
available free of charge at the SEC’s website, www.sec.gov or shareholders may
access copies of the documentation filed with the SEC by Charles River on
Charles River’s website at www.criver.com.
Charles
River and its directors and executive officers and other members of management
and employees may be deemed to be participants in the solicitation of proxies in
respect of the proposed transaction. Information regarding Charles River’s
directors and executive officers is available in Charles River’s proxy statement
for its 2010 annual meeting of shareholders, which was filed with the SEC on
March 30, 2010. Information regarding the persons who may, under the rules of
the SEC, be considered participants in the solicitation of Charles River
shareholders in connection with the proposed transaction will be set forth in
the preliminary proxy statement when it is filed with the SEC.
This
document does not constitute an offer of any securities for sale or a
solicitation of an offer to buy any securities. The Charles River shares to be
issued in the proposed transaction have not been and will not be registered
under the Securities Act of 1933, as amended (the “Securities Act”), and may not
be offered or sold in the United States absent registration or an applicable
exemption from registration requirements. Charles River intends to issue such
Charles River shares pursuant to the exemption from registration set forth in
Section 3(a)(10) of the Securities Act.
FORWARD
LOOKING STATEMENTS:
This
document includes “forward-looking statements” within the meaning of the Private
Securities Litigation Reform Act of 1995. Forward-looking statements may be
identified by the use of words such as “anticipate,” “believe,” “expect,”
“estimate,” “plan,” “outlook,” and “project” and other similar expressions that
predict or indicate future events or trends or that are not statements of
historical matters. These statements are based on current expectations and
beliefs of Charles River Laboratories (“Charles River”) and involve a number of
risks and uncertainties that could cause actual results to differ materially
from those stated or implied by the forward-
looking
statements. Those risks and uncertainties include, but are not limited to: 1)
the possibility that the companies may be unable to obtain stockholder or
regulatory approvals required for the combination; 2) problems may arise in
successfully integrating the businesses of the two companies; 3) the acquisition
may involve unexpected costs; 4) the combined company may be unable to achieve
cost synergies; 5) the businesses may suffer as a result of uncertainty
surrounding the acquisition; and 6) the industry may be subject to future
regulatory or legislative actions and other risks that are described in
Securities and Exchange Commission (“SEC”) reports filed or furnished by Charles
River and WuXi.
In
addition any statements regarding Charles River’s projected 2010 sales and
earnings; the future demand for drug discovery and development products and
services (particularly in light of the challenging economic environment),
including the outsourcing of these services and present spending trends by our
customers; and Charles River’s future performance as delineated in our
forward-looking guidance, and particularly our expectations with respect to
sales and foreign exchange impact constitute forward-looking statements. Such
forward-looking statements are based on Charles River’s current expectations and
beliefs, and involve a number of risks and uncertainties that are difficult to
predict and that could cause actual results to differ materially from those
stated or implied by the forward-looking statements. Those risks and
uncertainties include, but are not limited to: the ability to successfully
integrate businesses we acquire; negative trends in research and development
spending, negative trends in the level of outsourced services, or other cost
reduction actions by our customers; the ability to convert backlog to sales;
special interest groups; contaminations; industry trends; new displacement
technologies; USDA and FDA regulations; changes in law; continued availability
of products and supplies; loss of key personnel; interest rate and foreign
currency exchange rate fluctuations; changes in tax regulation and laws; changes
in generally accepted accounting principles; and any changes in business,
political, or economic conditions due to the threat of future terrorist activity
in the U.S. and other parts of the world, and related U.S. military action
overseas. A further description of these risks, uncertainties, and other matters
can be found in the Risk Factors detailed in Charles River's Annual Report on
Form 10-K as filed on February 19, 2010, as well as other filings we make with
the Securities and Exchange Commission.
Because
forward-looking statements involve risks and uncertainties, actual results and
events may differ materially from results and events currently expected by
Charles River and WuXi. Charles River and WuXi assume no obligation and
expressly disclaim any duty to update information contained in this filing
except as required by law.