Charles River Laboratories International Inc (CRL) 2003 Q4 法說會逐字稿

Good morning and welcome, ladies and gentlemen, to the Charles River Laboratories fourth quarter earnings conference call.

At this time I would like to inform you that this conference is being recorded and that all participants are in a listen-only mode.

At the request of the company we will open the conference up for questions and answers after the presentation.

I will now turn the conference over to Susan Hardy, Director of Investor Relations.

Please go ahead, ma'am.

Thank you.

Good morning, and welcome to Charles River Laboratories' fourth quarter 2003 conference call and webcast.

This morning, Jim Foster, Chairman, President and Chief Executive Officer, and Tom Ackerman, Senior Vice President and Chief Financial Officer will comment on our fourth quarter and full year 2003 results, and discuss guidance for 2004.

Following those remarks we will respond to questions.

There is a slide presentation associated with today's remarks, which are posted in the investor relations section of our website at www.ir.criver.com.

A taped replay of this call will be available beginning at 10:30 this morning, and can be accessed by calling 800-428-6051 and entering pin number 328271.

The webcast will be archived on our website and available for listening until February 18th.

As you know we have revised our financial reporting segment.

The fourth quarter press release, today's comments, and all future communications will be based on the revised segment reporting structure.

In order to assist investors in understanding the financial aspect of the change, we have provided a quarterly restatement for 2003 and 2002 based on the revised segments.

The restatement is posted on our website.

During this call we will be discussing some non-GAAP financial measures.

In accordance with regulation G you can find the comparable GAAP measures and reconciliations to those GAAP measures on our website.

Finally the Safe Harbor.

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 those discussed in the Company's most recent annual report on for 10-K, which contains a 'risk factors' section on file with the SEC.

Now I'll turn the call over to Jim Foster.

Good morning.

I am very pleased to be able to report on our strong finish to 2003, and our optimistic outlook for 2004.

For the fourth quarter and full year of 2003 we delivered growth in sales, earnings per share and cash flow.

Net sales gained 9.2% in the quarter, and 10.7% for the full year.

Fourth quarter EPS increased to $0.42 compared to $0.36 in the fourth quarter of 2002.

For the full year EPS were $1.64, exceeding the high end of our guidance by $0.01.

For the quarter operating cash flow was $44m, and free cash flow was $31m, and we ended the year with record cash and investments on hand of $203m.

We have a strong balance sheet and minimal debt, so our leverage is low.

An improving business environment, especially for biotech companies resulted in a strong finish to the year for Research Models and for our Development Services businesses.

For the fourth quarter Development Services sales exceeded the levels experienced at the end of '02, and operating margins improved significantly.

We believe that the better than expected fourth quarter results are a positive indicator for 2004.

From the long-term perspective, we continue to see our business strongly positioned as the leading provider to the pharmaceutical and biotechnology industries, academic researchers and to the medical device industry, a smaller but rapidly growing business for us.

Our portfolio businesses provides these research organizations with products and services which are essential to their drug and device development efforts.

Before I review the businesses I want to tell you about the changes we made to our segment reporting structure.

As you read in the release, we have realigned our businesses to better reflect our actual operations and management structure.

We believe that in order to maximize growth it was necessary to align related operations, enabling us to manage them more efficiently, and to optimize the synergies between these businesses.

The segment changes align all of the businesses that are based on research model products, in what we now call Research Models and Services, or RMS.

This segment includes the Research Models business, Transgenic Services, Laboratory Services, and Contract Staffing Services, all of which used to be called Discovery Services, as well our Vaccine Support Services business where we produced SPF eggs.

The Development and Safety Testing segment or DST contains the remaining businesses that used to be in our Biomedical Products and Services segment.

Development Services, which includes all of the services required to take a classic chemical compound, biologic or device through the development process, and In Vitro Technologies, comprise this segment.

As a result of the segment changes the RMS segment now represents 66% of 2003 net sales, and DSTs are remaining 34%.

In terms of profitability in '03, before corporate overhead allocation RMS counted for 82% of operating incomes and DST 18%.

Because the services offered in the DST segment are extremely technical and labor intensive, you can expect that the RMS segment will continue to produce a higher operating margin and contribute a larger share of corporate operating income than the DST segment.

The DST segment's profit contribution in '03 was negatively affected by the slower demand for outsourced services experienced for much of the year.

So in view of the improving market outlook, we believe that DST operating margins will improve in '04.

The RMS segment grew 11.7% in the fourth quarter, and 14.5% in '03.

Sales of Research Models increased significantly in the fourth quarter, particularly in North America.

Service Sales also increased as pharma and biotech spending improved.

The segment operating margin increased to 28.4% from 26.3% in the fourth quarter of '02.

As we discussed on our third quarter conference call on October 30, the Research Models business has been slower in the late summer, with greater seasonality than was the case in '02.

The fourth quarter significantly exceeded our forecast due to an improved biotech funding environment and increased big pharma R&D spending levels.

With patents expiring on so many drugs, most pharma companies are emphasizing development spending to get drugs through the clinic into the market, while continuing to invest in basic research.

They are identifying hundreds of thousands of new compounds in an effort to fill the pipeline with as many promising drug candidates as possible.

The advent of high throughput screening and other technologies has improved drug companies' ability to process significantly higher volumes of compounds.

This drive for larger number of acute studies in the discovery phase, where compounds first begin In Vivo testing.

And although drug companies are weeding out unpromising candidates faster, they are still testing a larger number of compounds on research models.

We were encouraged by our increased sales to biotech customers. 2003 was characterized by the downsizing and failure of many biotech companies, but sales to biotech customers strengthened in the fourth quarter.

We expect that given the improving funding environment the surviving companies will intensify their efforts to bring drug candidates to market.

The continuing investment in basis research is evident in the government and academic sectors, where so much early research is done.

We were just awarded a nine-year $3.8m contract by the National Institute on Aging, for development and maintenance of a long-term colony of calorically-restricted rodents.

Spending on Research Models in the not for profit sector increased at the end of the year.

We saw higher sales of in-bred mice which are used to create disease models, and immuno-compromised mice which are used in the AIDS and Cancer research.

We have been targeting our North American Research Models sales efforts towards the academic market, so we are very pleased by the sales increase.

We believe that basic research and the improvement in the biotech market are driving greater demand for services that support Research Models.

Our Transgenic and Laboratory Services business reported double-digit growth in both the fourth quarter and the full year.

For Transgenic Services, this growth reflects the increasing number of disease models being created by generic manipulation, and the corresponding needs of sophisticated housing and high value related services.

We adding capacity in Europe and Japan in 2004, and expect to begin construction on the next substantial facility at our Wilmington Massachusetts headquarters in early '05.

Because Laboratory Services in part supports the Transgenic business, growth in Transgenic also results in an increase in related services to screen animal health and genetic profile.

Contract Staffing sales increased for the year, but as we mentioned in the third quarter, fourth quarter results were affected and 2004 results will be, by the fact that a portion of a large government contract was not renewed.

On a positive note, we were recently awarded a five-year $10.9m contract by the Department of Defense to manage facilities at the Walter Reed army institute.

We are also continuing to focus our sales efforts on commercial and academic contract staffing customers, because we believe that there are a significant opportunities in these sectors.

We have a long standing reputation for providing highly specialized services to customers who want to ensure that their animal facilities are operated in the most efficient and cost effective manner, without compromising animal health.

For customers building new facilities or are looking to upgrade existing ones, we are the logical and beneficial choice in order to ensure that the best trained technical staff is utilized.

We are quite optimistic about the market outlook for 2004, but we are still feeling the effects of the Pfizer/Pharmacia merger, which began to impact us in the second half of last year.

We had a strong first half of '03 with these customers, so we expect the first half of '04 will be slower in comparison.

We have accounted for that in our 2004 plan, as well as for the adverse impacts from additional pharma mergers.

In the DST segments sales growth was 4.9% for the fourth quarter, and 3.9% for the year.

The segment growth rate was affected by the closure of our contract manufacturing facility in the fourth quarter of '03, which reduced the segment growth rate by approximately 3%.

Even so, the DST segment operating margin increased in the fourth quarter to 19.3% from 16% in the fourth quarter of '02, and from 16.6% in the third quarter of '03.

We attribute the margin gain to higher sales, the cost savings initiatives that we implemented in the second quarter, and our continuing focus on limiting expense growth.

As a result of improving outsourcing trends in pharma and biotech, Development Services reported solid sales growth in the fourth quarter, and looking at the year, sequentially in each quarter.

The increase in sales and focus on operating expenses resulted in a sequential improvement in operating margin.

We believe there is still some available capacity in certain segments of the market for outsourced development services, and some price sensitivity.

The customer demand has increased significantly from the low point it reached in the first quarter of '03.

We continue to see higher bid volumes and bookings are extending out well into the second quarter of '04.

We added capacity in two of our facilities in '03, and based on projected demand we expect to add both general and special toxicology capacity over the next year, in order to accommodate market growth in '05 and beyond.

Over the past year we have talked about using 2003 as an opportunity to restructure and strengthen our Development Services business infrastructure in order to achieve important scientific business and customer focused goals.

Beginning with the appointment in the fourth quarter of '02 of Dr Nancy Gillett as General Manager of this group, we have implemented a number of changes designed to integrate our sites and maximize our strengths in both general and specialized drug development.

To create an efficient structure that makes it easier for our clients to do business with us, and to capitalize on the growing field of interventional and surgical services.

As you know, we acquired our Development Services businesses through several separate acquisitions over a four-year period, and as a result we had a number of smaller sites which we wanted to integrate into a seamless business unit which would be transparent to the client.

This way we would maintain the technical expertise already in place at each of the units, and a personal service and flexibility which comes from operating smaller sites without compromising customer service.

To date, we have reorganized customer service, standardized the proposal process, the study protocols and report formats, and in the first quarter of '04 we will roll out mycrlstudy.com, a secure web based portal that will enable clients to rapidly review data online and communicate with the study directors.

From study inception to delivery of the final FDA ready report, clients will be able to discuss study protocol, ongoing study design, and in-progress reports with the study directors.

We believe this proprietary system represents a tremendous advance over competitive systems, enabling clients to work faster and more efficiently to complete studies which are critical to their drug development efforts.

On January 8 we announced the acquisition of River Valley Farms, a privately held medical device contract research business located near Minneapolis, one of the major medical device and cardiovascular research houses in the world.

For the last three years Charles River has provided Contract Surgical Research Services through our Worcester Massachusetts division.

That business, in which we test medical devices prior to clinical testing, grew significantly in '03.

The introduction of combination devices, such as drug eluting stents was the principal driver of growth.

We have combined River Valley Farms with our existing business to form a unit we call Interventional and Surgical Services.

Already a major provider of these outsourced services, the River Valley Farms acquisition has placed us squarely in the number one market share position.

Due to the advances in combination devices, and our market leadership in this area, we expect this unit to grow faster than the overall market for outsourced services.

Sales of the In Vitro Detection products increased in the fourth quarter due to strength in the North American market, and to the first sales of the PTS, our portable test system for endotoxin detection.

We officially launched the product to the research market in the third quarter, and we were very pleased by customer response.

We are still in the process of compiling validation data for the FDA, and expect to file for a license later this year.

In the interim the PTS can be used in the research and development market, and the in-process market where an FDA licensed product is not required.

Because of its rapid results and ease of use, many of our existing customers are using the PTS for in-process testing.

We are also selling to biotech companies who were outsourcing in-process testing because they don't have the necessary in-house expertise.

In addition, we are exploring opportunities in non-traditional markets for water and surface monitoring, such as the food and beverage, hospitals and pharmaceutical industries.

As you know from the press release we have revised our '04 guidance upwards.

For the year we now expect sales growth in the range of 7% to 11%, compared to our earlier guidance of 5% to 9%.

And pro forma earnings per share of between $1.78 and $1.84.

The upward guidance is due primarily to the acquisition of River Valley Farms, the benefit of foreign exchange which has moved in our favor since we originally gave guidance for '04, and the European financial reorganization.

It is also due to our optimism of our markets and the opportunities we see this year.

In the beginning of '03 we talked about a barbell effect in the drug pipeline, where there was emphasis on late stage discovery and Phase III testing.

This resulted in a slower demand for toxicology services and we saw the effects for most of the year.

When we discussed the barbell we stated that at some point the drug compounds and late discovery would begin to flow through the development pipeline, increasing demand for outsourced toxicology services.

We believe that progression began in mid 2003 as evidenced by our sequentially improving Development Services sales, and will continue in 2004.

Our fourth quarter results suggest that demand for Research Models will remain stable overall, and that specific models, such as in-bred and immuno-compromised mice and disease models will continue to increase.

These are the Research Models that showed the strongest growth in 2003, and we expect that growth to continue in 2004.

Because researchers believe that these models are better predictors of human disease, we also expect that researchers will continue to develop more of them, which should result in growth in our Transgenic and Laboratory Services businesses.

The current strength of the biotech market should also intensify demand for research models and related services.

And because biotech companies often outsource as an alternative to maintaining in-house expertise, we anticipate an increased demand for Development Services.

This guidance is exclusive of any acquisitions we might make in 2004.

Acquisitions continue to represent a core component of our growth strategy.

We continue to identify opportunities in the pre-clinical space, with a goal of maintaining a balance between products and services.

At this time we are focused on product opportunities, but no matter what opportunities we pursue we maintain our focus on doing strategic acquisitions that enhance our ability to service our customers while improving our bottom line.

One of the actions we've taken in order to help drive our growth strategy was the establishment of a six member Scientific Advisory Board last November.

The purpose of the SAB is to provide advice, counsel and input to further enhance the Company's portfolio with high end products and services.

The board members are experts in a number of relevant scientific areas, including pharmacology, toxicology, genomic, bioinformatics, proteomics and medicine.

The SAB will play a vital role in advising us on our current technologies, new technologies for licensing, and with regard to potential acquisitions.

Their technical expertise and scientific judgment should provide valuable insights to help us service our customers better.

We are very pleased with the 2003 results and the outlook for '04.

Despite difficult market conditions we delivered another year of growth in sales, operating margins, earnings and cash flow, and expect to continue that record in 2004.

We are confident that we can deliver continuing growth in 2004 for two reasons.

First, because we expect overall demand to intensify this year as our customers work to bring new drugs to market.

Second, because our broad portfolio of products and services, essential to the drug and device development process, enables us to be responsive to the essential needs of our clients.

From a long term perspective we believe we can continue to grow because our business is well positioned as a leading provider of essential products and services to the pharmaceutical and biotechnology industries.

Our goal is to maintain that position by delivering an increasing array of high quality products and services to existing and emerging markets.

In closing I want to thank our nearly 5,000 employees for their exceptional work and commitment, and our shareholders for their steadfast support.

Now I will turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

I am going to give you a brief overview of the fourth quarter and 2003 and some color on guidance for 2004.

Net sales of $156m in the fourth quarter increased 9.2% from the fourth quarter of 2002, and were up 3.2% or $4.8m from the third quarter of 2003.

RMS increased 11.7% versus the fourth quarter of 2002, due principally to increased sales of Research Models, while DST increased 4.9% versus the fourth quarter of 2002, and 6.7% from the third quarter of 2003.

Sales included a net favorable currency impact of approximately 4.5% versus last year, a result of a strong Euro and Yen.

For the full year net sales were $613.7m, up 10.7% including a net favorable currency impact of approximately 4% versus 2002.

Net sales attributed to Springborn and Biolabs, both of which were acquired in 2002 contributed approximately 3% to the net sales gain.

Gross margin in the fourth quarter were 38.2%, up from 37.2% last year, and from 37.4% in the third quarter of 2003.

The RMS gross margin was 39.6% for the quarter, compared to 37.9% in 2002.

Margins increased in the fourth quarter due primarily to an increase in sales, and a level core structure.

The DST gross margin was flat with 2002 at 35.7%, and improved from 33.2% in the third quarter of 2003, principally due to higher DST sales and the cost saving program initiated in the second quarter of 2003.

The full year gross margin was 38.1% compared to 37.7% in 2002.

SG&A in the fourth quarter was essentially flat at 14.7% compared to 2002.

For the full year SG&A was 14.6% of sales compared to 15% in 2002, due to our focus on operating expense management.

Amortization expense was $1.2m in the quarter, unchanged from the fourth quarter of 2002.

For the full year amortization expense was $4.9m compared to $3,4m in 2002.

The increase was due to the acquisition of Biolabs and Springborn in June and October of 2002.

The operating margin in the fourth quarter was 22.7% of sales compared to 21.7% in the fourth quarter of 2002, and unchanged from the third quarter of 2003.

The RMS operating margin increased to 28.4% from 26.3% in 2002, principally due to higher sales of Research Models, Transgenic Services, Lab Services and Vaccine Support Services.

The operating margin for DST improved to 19.3% from 16% in the 2002, due principally the higher Development Services and In Vitro sales and improved operating efficiency in our Development Services business.

The full year 2003 operating margin was 22.6% of net sales, compared to 22% in 2002.

Net interest expense was $1.7m in the fourth quarter, and $6.7m in 2003, compared to $1.6m and $9.1m respectively in 2002.

The decrease was due to repayment of our 13.5% senior notes and term loan facilities in the first half of 2002.

The income tax rate in the fourth quarter of 2003 was 38.5%, unchanged from the fourth quarter of 2002.

The full year tax rate in 2003 was 38.5%, unchanged from 2002, but excluding a $0.5m benefit associated with the release of a valuation allowance in 2002.

Net income was $20.6m in the fourth quarter, or $0.42 per diluted share, compared to net income of $17.5m or $0.36 per diluted share in the fourth quarter of 2002.

Net income in 2003 was $80.2m, or $1.64 per diluted share, compared to $50.1m or $1.06 per diluted share in 2002.

The 2003 results included a asset impairment charge of $3.7m for closure of our contract production facility, a litigation settlement in our favor of $2.9m, and a $0.9m charge for the cost savings program.

The net charge for these three items was $1.6m or approximately $0.02 per diluted share.

The full year 2002 results included charges for early retirement of debt and cancellation of a revolving credit facility totaling $29.9m or $0.36 per diluted share.

Adjusting for all these items, 2003's non-GAAP earnings per diluted share were $1.66, a 16.9% increase over 2002's non-GAAP earnings of $1.42 per diluted share.

In calculating EPS in the fourth quarter, as we do every quarter, we are adjusting net income by $1m tax effected to [indiscernible] the interest expense on the convertible debt, and using a diluted share count to 51.3m, which includes the shares as if the convert had occurred.

Some brief comments on our working capital.

Working capital was $256.5m at the end of the fourth quarter, an increase of $21m from the third quarter, and an increase of $91.8m from the end of 2002, principally due to increased cash.

Cash on hand at the end of the fourth quarter was $182.3m in cash and cash equivalents, plus $20.5m in marketable securities, or a total of $202.8m compared to $179.7m at the end of the third quarter, and $127.5 at the end of '02.

Cash provided by operating activities was $43.5m for the fourth quarter, and $128m for the year.

Free cash flow was $30.6m in the quarter, and $95.3m for the year.

Accounts receivable were $111.5m at the end of the fourth quarter, slightly less than the third quarter, and $17.3m higher than the end of the fourth quarter of 2002.

DSO was 67 days at the end of the fourth quarter 2003 compared to 65 days at the end of the third quarter, and 64 days at the end of 2002.

The increase in DSO is due partly to timing of collections, and also to foreign exchange.

We believe that the increase in DSO was temporary.

We continue to focus on collection and expect DSO will improve in the first quarter of 2004.

Inventory levels rose slightly 452.4m at the end of the fourth quarter, and were up $8.5m from the end of last year due primarily to higher research models inventories and foreign exchange.

Long term debt was $185.9m at the end of the quarter, $185m of which was our convertible bonds.

That was a decline from $196.3m at the end of the third quarter due principally to the payment of the note to the former owners of Springborn Laboratories.

Capital expenditures were $12.9m for the fourth quarter and $32.7m year-to-date, in line with company expectations.

D&A was $8.3m in the fourth quarter and $29.6m for the full year.

Some comments on 2004 guidance.

We note in the press release that we began a reorganization of our European operations in the first quarter of 2004.

Our existing structure in Europe was put in place at the time of the [IPO] and was more appropriate for a debt laden company.

Under the new structure we will establish a Dutch Holding Company which will own our European entities and will allow cash to accumulate offshore.

By centralizing cash management we expect to improve operating efficiency, increase yields and enhance our investment opportunities.

Retaining cash offshore will also facilitate acquisitions.

The reorganization will not involve reductions of personnel or facility closures.

The reorganization is expected to result in a one-time non-cash charge to earnings for the write off of a deferred tax asset in the first quarter of 2004 of approximately $0.15 per diluted share, but is expected to improve 2004 earnings diluted share by an estimated $0.02 to $0.03 when excluding the charge.

The earnings benefit is expected to increase in 2005 and to continue thereafter.

Our 2004 guidance is as follows.

The company now anticipates that net sales will increase between 7% and 11%, higher than the previous guidance of 5% to 9%.

This is due to the acquisition on River Valley Farms on January 8, the benefit of favorable foreign exchange rates, and an improving business environment.

We anticipate maintaining stable operating margins or increasing them slightly versus 2003.

While we anticipate margins in DST to improve in 2004, we expect a slight decrease in RMS margins due to supply issues and capacity expansion costs.

We will also see an increase in SG&A due to costs associated with Sarbanes Oxley, and anticipate increases in spending for milestone R&D.

We are estimating a tax rate in 2004 to be approximately 37.5%.

As a result of the strong sales growth, stable operating margins, and the benefit of the European reorganization, we now expect 2004 earnings per diluted share to be in the range of $1.78 to $1.84, excluding the one time charge for reorganization of the European operations.

For 2004 we expect capex of approximately $40m, and free cash flow in excess of $100m.

For the first quarter of 2004 the company expects that net sales will increase between 7% and 11%, and that earnings per diluted share will be in the range of $0.43 to $0.45 excluding the one time charge.

That concludes our remarks; we will take your questions now.

Thank you.

Thank you. (Caller Instructions).

Our first question comes from Eric Schmidt of SG Cowan.

Please state your question.

Good morning everyone, congrats on a good quarter.

Tom, a couple of questions on the guidance for '04.

First, on the tax rate, I assume that's coming down also because of the European reorg?

And could you comment on whether there might be further tax benefits beyond '04?

Well that is contributing to part of the rate reduction as you implied or inferred, Eric.

And in '05 and beyond the bad debt itself will be more stable in dollars, while it will increase in '05.

So as the company gets larger the percentage impact will actually diminish, but the dollar amount will increase.

I know that's a little complicated but it's more of a specific dollar benefit that it is a specific percentage rate benefit if you would.

Okay.

And then I was hoping that you might be able to give a little bit more detail on the revenue guidance for next year, either broken down by division or through some of the metric you've used in the past, acquisitions, pricing, units, FX etc.

Sure.

Just a few comments on that.

I would expect that the RMS would be some way in line with the overall guidance that we gave, in other words the 7% to 11%.

But DST sales would probably grow faster than that.

So as we've now realigned our segments, as Jim pointed out, the RMS segment is a much bigger piece of the pie.

So the activities both on margin and sales growth are more driven from that piece.

So again I think that the Research Models and Services would be within the 7% to 11%, and the DST would probably be a little bit higher than that.

In terms of looking at FX and/or acquisitions probably the accumulation of those two items in '04 versus '03 would account for about 2% I would say.

So we're not really seeing a significant benefit yet in '04, and nor did we say River Valley was significant.

So really if you look at the 7% to 11% and conclude that a couple of percents approximately are from the acquisitions and FX, the remainder is clearly from the company as we know it historically.

Great.

Thanks a lot.

(Caller Instructions).

Our next question comes from Ken Kulju of CSFB.

Please state your question.

Good morning.

Just a couple of points of clarification, Tom.

You had indicated that the operating margins in the Research Model and Services segment were going to be down in '04 slightly.

I was wondering if you could just walk us through those reasons?

I think I heard you say something about capacity constraints.

And also I was just looking for some clarification in terms of where some historical businesses now reside.

Particularly, where is Pathology Associates now reported, and also Springborn Labs, if you could just walk us through those?

Thanks.

Ken, I will take the first part of the question and I will let Jim respond to the second half of it.

Within Research Models and Services, which now includes of course some of the services that Jim will elaborate, we are, due to the growth of model activity in the last few year as we've mentioned to some degree, we've actually been adding capacity which we haven't done for a long time historically.

We do expect to add some capacity in Japan this year, some retrofit of Research Model space as we develop disease models overseas and actually start breeding some of the models from our arrangement with Jackson Laboratories both in Europe and in Japan.

And of course we are also expanding internationally in Transgenic Services, which Jim made reference to as well.

In addition to that we are doing some things in our US market for Research Models also.

So we're actually doing a little bit more capacity expansion at one point in time than we have historically.

And as I said earlier, we really haven't been doing that much capacity expansion globally for just Research Models.

So that's actually [printing] the growth in margin a little bit as we said.

So hopefully that answers your question, if not you can follow up, but I will turn it over to Jim.

The realignment of the segments in the area that we now call Development and Safety Testing, that's just the former development businesses, all the acquisitions that we made to actually build that business from essentially 1999 until the present.

The two that you specifically enquired about, Pathology Associates and Springborn are in the DST segment, as are all the other Tox businesses.

So that's primarily what we used to call Development, and also the In Vitro Technology business is in that new segment.

Okay, great.

Thank you.

Our next question comes from Paul Knight of Thomas Weisel Partners.

Please state your question.

Hi, Jim, could you go over the animal demand profile that you talked about earlier in the call in your prepared remarks?

What models are most in demand?

Sure.

What I said was that we believe the demand for kind of our basic models is stable year-over-year.

We should continue to see significant increases as we've seen in '03 and in '02, of what we've commonly referred to as disease models.

So that includes our immuno-compromised animal models and the disease models which we specifically referred to in the areas of diabetes and hypertension in particular.

So we are going to continue to see the disease models increase disproportionately fast to our standard animal models because of their enhanced predictive abilities.

Do you see the market moving from D into R?

Well we've seen the market actually move towards more late stage development, which is obviously helping out toxicology business.

But also it's a push to get the compounds through the clinic and out into the market.

So we're not seeing a wholesale shift back and forth.

I think there's still a sign investment in basic discovery by a lot of the drug companies.

Many of them will be increasing their investment in that area, but I would say right now overall there's a slight emphasis in the development area than the discovery area.

Do you think pharma is getting a lot of hits out of their screening programs?

Well yes, I mean they're getting a lot hits in terms of compounds that look like they are more likely to make it through the clinic, and I think they are doing a much more efficient job, a) in screening more and b) having things go through the development pipeline that have a greater probability of getting there.

I think the timeframe unfortunately has been somewhat elongated because of the complexity of the diseases that they're chasing.

So that hasn't helped the overall timeframe, but hopefully the throughput should yield more drugs at the end of the day.

We also hope that these disease models, in particular the transgenic ones, the genetically altered ones will help them do a better job right after the early screening in determining whether these drugs are likely to be beneficial in man.

And that should also enhance the ultimate hit rate.

And lastly, were your biotechnology customers increasing their rate of spending as the quarter was wrapping up?

Yes.

We've seen, commensurate with the increase access to capital market and continues infusion of cash from the pharmaceutical industry, we certainly have seen more robust spending by the biotech clients through the fourth quarter, and we anticipate that that will continue.

Our next question comes from Meirav Chovav of UBS.

Please state your question.

Hi, good morning it's Derek DeBruin.

Great quarter.

A couple of question.

Could you just give us what your outlook is for the Proteomics Services businesses in '04?

Sure.

Proteomics Services business had a slow start last year in terms of what our expectations were.

Having said that we are very pleased with the technology and we are very pleased with the amount of trial samples that we have been sent by a whole range of clients from very large pharma to middle and small biotech clients.

So we are optimistic that that business will continue to have an accelerated run rate, that some of the smaller test samples will turn into larger programs, particularly with big pharmaceutical companies who at first [blush] had been quite positive about the technology.

So it will continue to be a slow ramp, just given the state of the marketplace and the complexities that their clients are dealing with.

But we are optimistic that '04 will be where we see some increased demand for that service.

So are you expecting to be accretive then in '04?

No, we are expecting it to be more important than it was in '02, and moving towards accretion sometime in the future.

Great.

Could you give us a little bit more color on River Valley in terms of revenues?

And I guess what now is the percentage of total revenues is the Intervention and Surgical Services?

And also, I'm not really familiar with that landscape; could you just talk about some of the other competitors and what's going on in that marketplace?

Sure, I think the best color is just to tell you that River Valley, in combination with Charles River's current business in that is less than 5% of our revenues.

So it's an increasingly significant piece and it's got nice growth rates.

So just to take a moment just to make sure you're clear about what we are doing.

We are doing safety testing for medical devices before they go into the clinic, and that's for large medical device testing companies, many of whom don't do that themselves or would prefer not to.

So our veterinary expertise, particularly surgical expertise is quite important to them.

The competitive landscape is primarily academic, and while I think the academic competitors do good work, their regulatory oversize is lacking, and obviously their response times are not business-like.

And the balance of the competition is primarily for in-house work.

And so as we make these increasingly large facilities available with this professional staff, we are quite optimistic that we will continue to take share.

We are already in a market leadership position in what's a reasonably fragmented service sector, and we intend to maintain that position.

Okay, great.

And looking at your toxicology services, just talk about the customer mix there.

Are you seeing lots of single customers coming in or a few large ones?

I know Covance reported that they had had a couple of very large customers come and I was just wondering what the overall trend is that you're seeing at the moment?

it's quite a large customer base.

Again it's large pharma and mid sized pharma and small biotechs.

We are getting business with new clients all the time.

We are increasing our footprint with current clients.

We have a fair amount of new business.

Our specialty areas, particularly areas like reproductive toxicology are quite strong and we maintain a leadership position in it as I said earlier.

We have a dramatically strengthened infrastructure and dramatically enhanced technology interface with our clients, which we think will give us a strong competitive position.

Thank you.

Thank you.

Our next question comes from Chris Shibutani of JP Morgan.

Please state your question.

Thanks very much.

I don't know Tom if you answered the question earlier about your top line guidance for 2004 and how you've typically broken that out between pricing and FX etc?

Could you provide that?

Well I gave you a little color on FX and the impact of River Valley, which I said would be probably in the neighborhood of a couple of percent.

I think our pricing milestones we've actually talked about somewhat, but just to put that in a little perspective for you.

On the Research Models and Services globally the price impact would probably be in the range to 3% to 5%, and it does vary geographically as we've said.

Typically in Japan we have not done much in the way of price increases for the last couple or three years.

Europe is a little bit lower than the US, and North America continues to be our key market for driving pricing.

On the DST side of the market, we have seen an improving climate in pricing for sure, but I think looking out to '04, while we don't expect the intense or fierce kind of pressure that we saw in '03, I wouldn't expect a rapid expansion in pricing unless the market actually expands rapidly from where it is today.

So hopefully that helps, Chris.

Sure, it does.

Expansion of the capacity into Europe and Japan, could you provide a little bit more commentary about how we should expect that to roll out and what you are seeing in that market that's triggering that decision?

Well I think the…

That's primarily in the Transgenic Services sector.

And so we're responding to a consistent concerted demand pretty much around the world.

We also have been putting Jackson Laboratories animal models in our facilities, both in Tokyo and in fact in our Belgian facility.

So some of it's basic Research Model related, but a lot of it is just increasing demand for transgenic services, which we see around the world.

And in some cases with the same customer in multiple geographic locales who want to use us pretty much as their hotel services.

So we will continue to increase that space internationally to support the demand and to some cases stay slightly ahead of it so we can preempt or help preempt out clients from going ahead and building space themselves, which they certainly would prefer not to so as long as that capacity is available.

And then lastly, in North America you talk about targeting academic not for profit sector there.

Verify if you could a little bit, there's general perception that Lifetime Schools and even the NIH budget has a proxy.

Obviously your business has other opportunities such as the Department of Defense contract you described there.

Can you give us a sense for the size of that revenue opportunity in the context of your total business?

And what the academic market, and how that should be viewed in terms of your business specifically?

We have very large opportunities… let's just talk about the North American market for a moment, which is still probably the most robust market we have.

We have significant opportunity in as much as we have always been primarily selling to the pharmaceutical industry.

And what's precluded us from getting more share in the academic community is our price point, which has always been at a premium.

Well we've seen over the least couple of years, 1) because our focus in that area, and 2) because of the flow of funding from big pharma directly into the academic institutions to do basic research, is less price sensitivity.

So we've seen actually sort of a movement to buy quality from these folks at a time when we have the animal models and where I think in a large financial base commercial clients are calling the shots.

We think that the not for profit market is of similar size to the pharmaceutical market in terms of dollars spent.

So since we have a much bigger footprint than the pharmaceutical markets, we have a nice footprint in the academic market, but the growth opportunity is really quite significant for us, so we intend to stay focused in that area.

Great.

Thank you very much.

Our next question comes from David Windley of Jeffries & Co. Please state you r question.

Thanks for taking my questions.

Jim, looking back over the last six months or so, back in the late summer Transgenic Services was one of the areas that showed a little bit of softness when you came out and lowered the guidance a little bit.

And it seems to have picked back up pretty robustly.

Could you talk about what you think caused that?

Was it a blip; and why has it strengthened so quickly?

The adverse impact on the Transgenic business happened in the third quarter, and it was an impact of -- some of it was the result of large pharma mergers, but primarily the result of some problems with several biotech clients, a couple of bankruptcies, and some major workforce reduction and pull backs to either utilize their own space or simply not to do the work at all, not even to create the models and outsource them.

And so that sort of felt like it hit us all at once.

It probably was a little more gradual than that, but it sort of all came together in the third quarter.

So that was obviously disappointing for us.

I think the best thing to leave you with is the notion that the Transgenic Services business, while we're not going to break out specific growth rates for it, because of its sheer size has moderated somewhat over the historical growth rates which were 40% or 50% in prior days, but has sort of settled down to really a substantial growing business with improving market, with demand throughout the world.

So it's highly unlikely that we would have a similar set of circumstances again, with multiple clients which blow up at the same time.

So we anticipate that the demand will continue and these Transgenic animals or disease models will continue to play a greater role in the drug discovery process.

And as a result our services in that field will be more important to our clients going forward.

Right.

It sounds like a very robust opportunity.

And to confirm, that is the area where you are going to be putting some capex in to capacity, and the timing on that was, I think you said early '05?

Is that right?

Well that was two timeframes.

One is that we will continue to build additional capacity this year, and very early '05 we currently anticipate that we will build another large building outside of Boston.

Okay.

And then I have heard from maybe only one, but at least one company that has mentioned some decisions referring to the customer base.

Some decisions have not been made yet.

It's my sense though that the environment this year is certainly a lot better than it was at this stage last year when you talked about pharma companies being slow to finalize budgets and so forth.

Is that accurate and could you elaborate on that?

As you are unfortunately reminding us, the first quarter of last year was uncharacteristically slow in terms of our pharmaceutical clients making decisions on what they would do, particularly on service sector.

And it took them kind of en masse to almost the beginning or the end of March to make those decisions.

We had a very strong fourth quarter as we've reported, and we appear to be getting off to a nice start this year.

We don't see any of those sorts of delays that we saw last year.

It's pretty much business as usual, getting back to an indeed much more decisive and also just a generally more robust spending climate, particularly in biotech, but also in the pharmaceutical industry as well.

So while I can't predict the future, typically the beginning of the year is somewhat of a precursor to what we are going to see in terms of the balance of the year.

Okay, great.

And them maybe one last two-parter for Tom.

Tom, in margin, where would you say is the most significant remaining opportunity for margin expansion?

And then the second part of that, non-related, on the uses of cash front, clearly acquisitions are an opportunity, you already said that.

Remind me what is the timing of your ability to begin to claw back debt?

So to work backwards, Dave, the only debt that we really have is the convert, and we cannot call that, or can call it in the first quarter of '05.

So that takes care of that.

With respect to margin expansion, I guess in the Research Models and Services, RMS, I think the opportunities to expand that would be as disease models probably become more into prevalence if you would and we can really get some volumes up on that given they higher price points, if you would.

We really need to have some volumes there to be able to drive that.

I think while we can probably continue to get in the future some improvements in the research models, I think it will be harder to slug that out in the base model business, if you would.

Okay.

For Services, you know, part of the Research Model business, the margins are pretty good there.

I do think we can probably improve them a little bit, but again some of them have high margins and it's going to be tough to improve a business that's high 20s if you would in percent of operating margin.

So I think the opportunities will probably be a little bit more on the DST side.

But as Jim pointed out, those are sophisticated service businesses where we do have a lot of expensive people doing studies and things like that.

But having said that, as you can see, the margins are a little bit lower there.

So hopefully we can continue to push our science, some of the things that we are rolling out like mycrlstudy.com, you know, will give us an advantage competitively if you would, and the environment from a pricing standpoint.

Okay, great, thanks a lot.

You're welcome, Dave.

Our next question comes from John Sullivan of Stephens Inc.

Please state your question.

Good morning.

A couple of quick questions here.

The first one is this.

I just want to make sure that I understand right the capacity that's being added in various lines over the next year or two.

You talked about in Transgenic Services adding capacity in Europe and Japan this year, and contemplating capacity in the US to break ground next year, is that right?

That's correct.

Okay, and did you talk about Toxicity Testing Services where capacity adds are either underway or contemplated?

Yes.

Well we indicated that we actually added some capacity at a couple of our locations in '03, and that we anticipate additional capacity adds in '04 again in specific locations depending on demand.

Both to ensure capacity for '04, but also to get us ready for '05, as we anticipate the demand will continue to increase.

Okay.

Is there any way you could estimate between that which was added in '03 and that which might reasonably be expected to added in '04 in Toxicity Testing?

What is the additional capacity versus 1/1/03?

It's hard to say.

The answer is capacity is sufficient to meet what we think is the demand and then some.

I know that you are looking for a kind of percentage of the whole and it's hard to [indiscernible] out.

Sure, understood.

Okay, let me just shift gears and just make sure I understand one other issues that you had discussed.

You talked about the Pfizer/Pharmacia merger affecting business in the second half of '03.

I was a little surprised that the second half of '03 was what you highlighted, I would expected, and a lot of other companies that I run around talked about more fourth quarter of '02 and first half of '03.

I just wanted to make sure that I heard that right?

Again, I can't comment on the other companies or what their service [comprised].

Yes, I can just tell you that for us, given what we do and what we did and we now currently do for the successor company, the decisions on closing facilities and how they would use the facilities, and where they would buy their research models, and where they would shift their Transgenic Services work or Tox work, and what the blend would be between internal utilization [indiscernible] in external, really came to us in the last half of the year.

Quite clearly in the third quarter with clear indications as to what it would mean for us very short term, meaning in those six months and for '04.

So whatever transpired in that deal, I think maybe you're talking about what was anticipated before the deal closed.

We actually had no adverse impact at all once the announcement came that their merger would take place.

But only after the deal was done and they began to sort out capacities were we sort of impacted.

So yes, it was the last half of last year.

Very helpful.

Thanks very much for answering my questions.

Our next question comes from Linda Donnelly of Franklin Management Group.

Please state your question.

Thank you.

I wanted to clarify;

I believe you said for '04 the capital expenditures are anticipated at $40m?

And could you give us some guidance on depreciation?

Well this year D&A was just about $30m, so directionally I think the increase would probably be in line with our sales earnings growth if you would on a percentage basis.

Another thing, your net income as a percent of revenue has been increasing very nicely.

That sometimes brings out temptations for competitors to get a little stronger.

Who do you see right now, if anyone, is your true competition?

The good news is that nobody has a mix of products and services that is pretty much exactly what we do.

So we have no direct competitors in every business that we have.

In the Research Model business we continue to have the same competitors who are primarily smaller privately owned companies who do some of the other things we do but not much of it.

And then on the Toxicology side, it continues to Covance and Inveresk I suppose, primarily would be the two best known names.

Alright.

And finally, was there any changes in your under funded pensions in '03?

No there were not.

That's sort of broad question --

Well the numbers I had for the prior year you were under-funded by about $17m, is that still the case?

Well it would continue to be fairly consistent with that.

Our actual position is that we are in a much better funded status in the US, and we are actually a little bit under-funded in Japan.

Alright, Thank you very much for your time.

You're welcome.

Thank you.

Our final question comes from Vivec Connor (ph) of Artis Partners.

Please state your question.

Hi.

Thank you.

I just wanted to ask on the acquisition you made, is that pre-clinical business or is that clinical CRO kind of business, River Valley?

River Valley is pre-clinical, it's doing safety testing of medical devices before they go into the clinic to be tested on people.

Very much consistent with our business as a whole.

And just in terms of you've done a bunch of integration in the Development business now, and how does this fit into that integration process?

It's part of that service, but it's part of that service from a sales force point of view and from a client support point of view, but it's pretty much outside of the integration.

The integration is primarily with regard to our classic toxicology and pathology businesses, of which there were many, and are acting as one.

This sort of stands alongside of it but really is its own entity.

And then I just have one last question.

Can you just help us understand what has been the growth in end market if you compare the biotech versus pharma versus academic, can you characterize that in any more detail?

For our products and services generally?

For the whole company in general?

Do you look at it that way, or you don't - maybe you don't?

Well it's hard.

I mean our growth in academic has been slightly faster because we are focusing on it and we had some opportunities.

I don't think the market has necessarily grown any faster.

I suppose the biotech market continues to be the fastest growing one, but of course biotech and pharma really have begun to kind of merge and the distinction between them blurs.

So I kind of think the growth there is similar.

Great.

Thank you very much and congratulations on a good quarter.

Thanks.

Thank you.

I will now turn the conference back to management.

Thank you.

That concludes our conference for today.

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