Charles River Laboratories International Inc (CRL) 2005 Q2 法說會逐字稿

Welcome to the Charles River Laboratories second-quarter earnings conference call.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS).

As a reminder, this conference is being recorded.

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

Good morning and welcome to Charles River Laboratories second-quarter 2005 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 second-quarter results and review guidance or 2005.

Following those remarks we will respond to questions.

There is a slide presentation associated with today's remarks which is posted on the Investor Relations section of our website at IR.CRiver.com.

A taped replay of this call will be available beginning at noon today and can be accessed by calling 800-475-6701.

The international access number is 320-365-3844.

The PIN number in either case is 787-281.

The webcast will be archived on our website until August 5th.

I'd like to remind you of our Safe Harbor.

Any remarks that we may make about future expansion, 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 statement as a result of various important factors including those discussed in the Company's annual report on Form 10-K filed with the SEC on March 9, 2005 which contains a risk factor section.

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

We believe that the inclusion of these non-GAAP financial measures helps 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 debt measures and reconciliations to those that measures on our website.

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

Good morning.

I'm very pleased to talk with you today about our second-quarter results and outlook for '05.

In the second quarter net sales increased 57.3% to 283 million.

This result includes the effect of the stronger U.S. dollar relative to foreign currencies which reduced net sales by 2% in the quarter compared to our prior guidance.

On a non-GAAP basis operating income for the second quarter rose 48.9% to 66 million with an operating margin of 23.2%.

On a non-GAAP basis EPS increased 13.5% to $0.59 in the second quarter.

We generated free cash flow of 37 million in the second quarter.

We paid 75 million of debt and ended the first half of the year with nearly $173 million in cash and short- and long-term marketable securities.

We're encouraged by the fact that market demand for our research model products and services remains strong as does the demand for outsourced preclinical and clinical services.

Having acquired Inveresk we have positioned ourselves extremely well to participate in the robust markets of drug discovery and development products and services and to play a more strategic role with our clients.

It's been three quarters since we closed the acquisition and we're even more optimistic today about our prospects than we were last October.

We've made significant progress on integrating our preclinical business and improving our clinical business, the results of which you can see in those segment sales, growth and margin improvements.

We've thoroughly educated ourselves about our expanded an extensive portfolio of high-quality value added essential products and services and begun the process of introducing our customers to the significant value we can add to the drug discovery and development efforts.

In our second quarter results we see the beginning of benefits to come and are even more enthusiastic about the strategic opportunities that are open to us as a larger, more integrated provider of products and services that support our customers across the entire spectrum of drug discovery and development pipeline.

In the second quarter RMS represented 46% of total revenues.

Preclinical was 42% and clinical was 12%.

From an operating income standpoint on a non-GAAP basis before unallocated corporate costs RMS represented 57% of operating income, preclinical represented 37% and clinical represented 6%.

The RMS segment grew 8.9% in the second quarter.

When we reported first-quarter results we said that we expected growth would improve in the second quarter and this was the case.

Sales of research models, both rodents and large animals, grew significantly in the quarter.

This growth was partially offset by lower sales of U.S. transgenics services and vaccine products.

Although we don't break out the individual businesses within RMS, I'll provide some color to help you understand them better.

Research model sales were strong in the second quarter, particularly in the United States.

As was the case in the first quarter, immuno deficient mice, the preferred model for oncology and infectious disease research, continued to be the fastest-growing strain on a worldwide basis.

Oncology and infectious disease are two of the fastest-growing therapeutic areas and we see this emphasis in higher sales of these strains.

Certain service provided by our research model business, surgery and the preconditioning of animal models prior to the initiation of the study, including special studies such as heating and aging, also grew nicely in the second quarter.

Some of these services are relatively new and the revenue base is still small, but growth is well in double-digits and we expect these services to provide future opportunities for substantial growth.

Our new transgenics facilities in France and Japan continue to report double-digit growth while sales in the larger U.S. business declined compared to second quarter of last year.

As we've discussed previously, growth in the U.S. has slowed as researchers emphasize the validation of existing models rather than the creation of new ones.

We expect this trend to continue for the balance of '05 and we also expect growth in European sales to slow because one of our large customers has put its transgenics program on hold until next year.

As we mentioned in our first-quarter conference call, we are increasing capacity utilization of our transgenics facility by using some capacity to produce immuno deficient mice.

We expect demand for these high-volume rodent strains to continue to increase and can postpone some capacity expansion by using the existing transgenics base.

This will help us maintain our margins in the RMS segment.

Our vaccine business, which provides FTF (ph) eggs primarily for poultry vaccine production, reported lower sales in the second quarter of '05 than in the same period last year.

Sales in the second quarter of last year benefited from competitor contaminations which have since been resolved and customers want to support these alternative sources of supply.

We've always believed that the breadth and balance of our portfolio is one of our greatest strengths because when one business performs less well others perform better than we expect.

The RMS segment demonstrates this principal quite well, although the larger services business is not growing as quickly as we would like and vaccine product sales are not as strong as last year, the models business and new services are doing very well.

The resultant top-line growth and our containing focus on efficiency and profitability have enabled us to achieve our second-quarter targets and maintain our full-year expectations for the RMS segment.

The preclinical services segment reported sales growth of 98.2% for the second quarter.

The addition of Inveresk was the larger contributor to growth, but our toxicology business grew significantly in the second quarter as pharmaceutical and biotechnology companies continue to increase the use of outsourced development services.

Our customers continue to tell us that an outsource services program is now a key component of their strategic plan to reduce costs, improve efficiency and increase throughput.

Our broad portfolio of value added products and services positions us uniquely well not only to support our customers' preclinical development efforts, but to support their efforts from early discovery through market approval.

The robust growth of toxicology services was offset somewhat by lower sales in our interventional and surgical services or ISS business.

Sales actually declined from the second quarter of '04 when ISS benefited from the medical device company's push to bring drug eluding stents to market.

In order to generate sales growth we have expanded our sales efforts and, in addition to stents, are now focusing on opportunities for other coronary and orthopedic devices.

As a result we have signed many new studies which we expect will improve our sales in the third and fourth quarters of '05.

However, we still believe that this small portion of our business will be slow for the balance of the year.

Increasing demand for toxicology has resulted in all of our preclinical facilities operating near optimal capacity.

We are now booking studies well into the first quarter of '06 including preselling the new expansion in Edinburgh, Scotland which will not come online until the first quarter of next year.

As I've already discussed, in order to accommodate growing demand we will be expanding our preclinical capacity in Massachusetts in '06 and Nevada in 2007.

I'm very pleased to announce that this week we purchased an existing 400,000 square foot facility in the Worcester, Massachusetts area.

We plan to immediately refit approximately 40% of the space with an expected occupancy date in mid '06.

The additional capacity in this new facility will provide the capability to commit a certain percentage of the space to dedicated service agreements as well as the ability to expand to meet our customers' needs over the next few years.

I'd like to give you a brief update on our preclinical integration.

And I'll start by saying that we're delighted with the progress we've made.

Our senior management team is working extremely well together and has implemented a number of initiatives which we plan to enhance our customer relationships, improve our operating efficiency and establish cross-selling initiatives.

I told you about some of these efforts in earlier discussions such as standardized bid receipt and proposal processes, NAFTA (ph) service agreements and study protocols and reports.

In addition to those efforts, we've created 20 integration teams to harmonize and coordinate services and are establishing centers of excellence to enhance service to customers and improve profitability.

We're evaluating global initiatives which will leverage the power of our portfolio from research models to preclinical to clinical services.

And we are continuing with our best practices analysis and Six Sigma like programs to gain cost savings and improve operating efficiencies.

The results are clearly evident in the second-quarter non-GAAP operating margin which rose to 23.4% from 20% in the first quarter of '05.

All of our initiatives are well underway and we are on track to complete many of them as well as achievement of our 10 millionths synergy target by the end of this year.

We are right where we expected to be at this point in time and we are moving forward aggressively with our integration plans.

We are very pleased with our preclinical performance in the second quarter.

We are extremely well-positioned to capitalize on the strong market demand for our services and are working to identify new opportunities to serve our customers on a broader strategic platform.

At the same time we continue with our efforts to integrate and harmonize our business and expect that those efforts will lead to sales growth and higher profitability.

The clinical services segment reported net sales of 33.5 million, this compared to Inveresk's reported '04 second-quarter net sales of 32.1 million and our first-quarter '05 net sales of 31.7 million.

As we discussed on our first-quarter conference call, since closing the Inveresk acquisition we have intensified our efforts to improve our business capture rate by focusing on four key therapeutic areas -- oncology, ophthalmology, cardiovascular and infectious diseases.

As a result of this strategy we won a number of verbal awards in the first quarter and I'm pleased to report that our win rate has continued in the second quarter with particular success in oncology and ophthalmology.

We believe that the verbal awards won in the first and second quarters will continue to drive revenue growth in the third and fourth quarters of 2005.

Our European clinical business, which we call EAP, performed very well in the second quarter.

The effect of the European clinical trials directive is waning with more U.S. customers returning to our world-class Phase I clinic in Edinburgh.

Phase I net sales were level with the same period last year and we expect continued improvement in the third and fourth quarters of '05.

Phases II-IV business was also strong benefiting from ongoing trials and new contracts won in the second half of last year and the first quarter of '05.

In the U.S. we continue to feel the effects of softer new business signings in the third and fourth quarters of '04.

Given the length of time between verbal awards and the initiation of clinical trials, new contracts awarded in the second half of last year would be required to drive net sales growth in the first half of '05.

We are confident that the strong level of verbal awards in the first half of this year will improve our net sales growth in the third and fourth quarters.

Our strategy to improve profitability is also yielding results with the clinical non-GAAP operating margin improving sequentially to 14.8% from 12.1% in the first quarter of '05.

We are generating margin improvements through a combination of high internet sales, operating efficiencies and cost control.

The result is a more efficient operation which we expect to continue to improve throughout '05.

As you know from the press release, we are reaffirming our sales and our GAAP and non-GAAP earnings guidance for '05.

We still expect that net sales growth will be in the range of 48% to 52% even though foreign currency translation is causing a 2% negative affect compared to our earlier guidance.

The GAAP earnings per diluted share range remains at $1.70 to $1.80 and non-GAAP earnings per share, which exclude amortization of intangible assets and compensation charges related to the merger, are still expected to be between $2.30 and $2.40.

Sales guidance is based on the addition of Inveresk, continued strength of the demand for our drug development products and services and new sales initiatives.

The EPS guidance is based on a combination of higher sales, operating efficiencies and cost efficiencies.

For the third quarter of '05 we expect sales growth in the range of 58% to 61%, earnings per diluted share in the range of $0.44 to $0.46, and non-GAAP earnings per share between $0.58 and $0.60.

Although we expect sequential net sales growth in the third quarter, the usual seasonality of the RMS business and the larger proportion of services sales in the sales mix are expected to restrain margin growth; therefore the third-quarter range for non-GAAP earnings per share is unchanged from the second-quarter range.

In closing I want to say again that we're very pleased with our second-quarter results and the outlook for '05.

We continue to see strong demand for our products and the increasing use of our services in various stages of the discovery and development pipeline.

We believe that as pharmaceutical and biotechnology companies look to streamline their operations they will increasingly turn to us.

By using our services we believe our customers will be able to redeploy their internal resources in more productive ways, increasing the number of compounds in the pipeline and speeding their time to market.

We have positioned ourselves extremely well to support and enhance our customers' efforts to develop new drugs, devices and therapies to improve human and animal health at a time when our customers are outsourcing more services than ever.

Beyond strategic partnership, our call is do forward integrate into our customers' space so that the distinction between us and them becomes invisible.

We intend to leverage our core competencies in laboratory animal medicine and husbandry as well as general and specialty toxicology while our clients focus greater attention on basic drug discovery of both large and small molecules.

We will provide all of the necessary services from breeding to colony maintenance to compound testing and believe we can do it more efficiently and more cost effectively than our customers.

Increasingly we believe that clients will either outsource their animal work to us and thereby utilize our staff and facilities in lieu of their own and/or have our staff go in and manage their laboratory animal operations in order to reduce costs as well as the potential for contamination.

We believe that there will be a time when we will sell research models and never have them leave our facilities.

For a company like ours with expertise in research model production and support services and preclinical testing and in clinical trials the opportunities are larger than ever before.

We are increasing our focus on development of an integrated suite of products and service offerings, both through internal development and strategic acquisition which we believe will position us to support our customers even more effectively.

From a financial standpoint we have the means to support our growth -- strong cash flow generation is funding our capital expansion projects.

In addition to expansions and acquisitions, our ability to generate cash also enables us to repay debt or to repurchase our common stock.

The choice to do one or the other is essentially an economic decision, but in either case improves our profitability.

All of our efforts, whether in sales growth, operating efficiency or uses of cash, are geared towards building a larger company which can best support our customers and employees while increasing shareholder value.

I'd like to thank our 8,000 employees for their exceptional work and commitment and our shareholders for their continuing support.

And now I'll turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

I'm going to give you some financial highlights from the second quarter 2005 starting with the effects of foreign currency translation.

Jim has already covered the sales, so I'll just reiterate that sales in the second quarter would have been 2% higher if the currency rates had remained unchanged from those in effect when we gave guidance at the end of the first quarter.

Principle changes were in the euro, yen and pound.

The backlog, which was 421 million at the end of the second quarter, was also affected by foreign currency translation.

The backlog declined by 6.5 million from the first quarter of 2005 due to a 10.3 million loss from foreign exchange translation.

Our net new bookings were 155.2 million for the quarter compared to 139.8 million in the first quarter, an increase of 11%.

As we expected, our cancellation rate was down considerably in the second quarter at 15.6 million from 23.9 million in the first quarter.

The net book to bill ratio was 1.0 in the second quarter compared to 0.96 in the first quarter.

When comparing Charles River to traditional CRO's, you need to take into account the fact that clinical businesses generally have larger backlogs because of the longer time frames from signing to project completion.

Our clinical business accounts for less than 15% of total company revenue and less than 25% of the combined preclinical and clinical revenue.

In addition, certain service offerings within our preclinical business, such as biosafety testing and analytical chemistry which have a fast turnaround for book to bill, don't lend themselves to backlog.

And as was mentioned before, we only record business in backlog when we have written confirmation.

The gross margin in the second quarter was 39.4%, down from 41.4% in the same quarter last year due primarily due to the greater proportion of service businesses in the sales mix.

Preclinical and clinical were 53.9% of total sales in the first quarter of 2005 compared to 33.4% in the same period of 2004.

Compared to the first quarter of 2005 the gross margin increased 1.2% due to improved capacity utilization.

SG&A in the second quarter was 47.6 million or 16.8% of sales compared to 29.2 million or 16.2% in the second quarter in 2004.

The slight increase in SG&A as a percentage of sales was primarily due to the 2.8 million compensation charge associated with the assumption of Inveresk stock compensation plan.

This is being recorded in the unallocated corporate overhead.

Excluding the impact of the compensation charge, SG&A for the second quarter was 15.8% of net sales.

We also had an increase in other unallocated corporate overhead expenses which we expect will be lower in Q3 and Q4.

We are amortizing the cost of Inveresk's stock option plan over three years.

We have already amortizing 8.1 million in the last three quarters.

The quarterly charge will decline rapidly going forward.

We will amortize 1.3 million in the third quarter and 0.7 million in the fourth quarter this year leaving the balance of 1.2 million to be amortized over the six quarters beginning in 2006.

Another factor in the increase in SG&A was our employee stock grants earlier this year.

In view of the pending implementation of FAS 123R, we evaluated the cost of stock options and their value to employees and determined that a greater percentage on our grants should be in restricted shares.

The 2005 grants resulted in the expense of approximately 1.9 million or approximately $0.02 per share for the second quarter.

The total cost of the grants was 24.7 million which we are amortizing over three years.

In 2005 we will amortize 6.5 million or approximately $0.06 per share, a cost which was not contemplated when we gave our original EPS guidance in December, but which will be covered by better than expected performance.

This was also recorded in unallocated corporate overhead.

On July 28, 2005 our Board of Directors authorized the repurchase of up to $50 million in common shares.

Funds for the repurchase will come from cash on hand, cash generated from operations and proceeds from employee exercise of options.

As of July 20, 2005 there were 71.8 million shares of common stock outstanding.

Any shares repurchased will reduce the impact of restricted share and option grants on fully diluted shares outstanding.

Shares may be purchased from time to time on the open market depending on market conditions and trends.

We expect any share purchases would recur over the next 18 to 24 months.

The operating margin in the second quarter was 17.6% compared to 24.5% in the same period last year and 16.6% in the first quarter of 2005.

On a non-GAAP basis, which excludes Inveresk-related amortization of 13.1 million and compensation charges of 2.8 million, the operating margin was 23.2% compared to 24.5% in the same period in 2004 and 22.5% in the first quarter of 2005.

The slight decline year-over-year was due primarily due to greater proportion of service businesses in the sales mix.

The sequential increase in the non-GAAP operating margin was due to higher sales and increased operating efficiency.

The sequential improvement was in spite of the fact that foreign currency translation negatively affected the margin rate.

In the second quarter to mitigate the effects of foreign exchange we implemented a hedging program on the Canadian dollar and are currently evaluating the benefits of a more comprehensive hedging program.

The RMS operating margin in the second quarter was 32.9%, down from 34.2% in the same period in the prior year and from 33.1% in the first quarter of 2005 due to lower sales volumes in U.S. transgenics services and vaccine products and higher fuel prices.

The operating margin for preclinical service was 14.9% compared to 19% in the second quarter of 2004 and 11% in the first quarter of 2005.

The decrease year-over-year was due to amortization associated with the Inveresk acquisition.

When excluding the Inveresk-related amortization the second-quarter operating margin was 23.4%, up significantly from 19% in the second quarter of 2004 and from 20% in the first quarter of 2005.

The margin improvement was due to higher global toxicology margins partially offset by margin erosion in interventional and surgical services.

In the clinical services segment the operating margin for the second quarter 2005 was 5.8% compared to 2.6% in the first quarter of 2005.

When excluding Inveresk-related amortization the second-quarter 2005 operating margin was 14.8% compared to 12.1% in the first quarter of 2005.

The operating margin increase in the first quarter was due to higher sales and improved operating efficiencies.

Net interest expense was 4.8 million in the second quarter compared to 1.3 million in the second quarter of 2004 and down from 6.3 million in the first quarter of 2005.

Year-over-year interest expense increased due to debt associated with the Inveresk acquisition.

To close the acquisition we borrowed 400 million under a term loan facility and drew down 100 million of a 150 million revolving credit facility.

At the end of the first quarter our debt balance was 666.6 million.

As you know, we called our 185 million of convertible debt all of which was converted into common stock during the second quarter.

We recorded the reduction in debt and an increase in equity to reflect the conversion.

For the year to date we have repaid a total of approximately 95 million of debt, 75 million of which was in the second quarter.

So at the end of June our total debt was only 406.5 million.

On a last 12 months basis ending June 25, our debt to EBITDA ratio was 1.5.

The tax rate for the second quarter and year to date was 27.85%; the non-GAAP tax rate was 29.25%.

Net income was 31.9 million in the second quarter of 2005 or $0.44 per diluted share compared to net income of 26.3 million or $0.52 per diluted share in the second quarter of 2004.

On a non-GAAP basis net income was 42.5 million compared to 26.3 million in the second quarter of 2004, a 61.7% increase over last year.

On a non-GAAP basis earnings per diluted share were $0.59 for the second quarter compared to $0.52 per diluted share in the same period of 2004.

Some comments on working capital, working capital was 163.1 million, a decrease of 34.2 million from the first quarter of 2005 due primarily to lower cash balances as a result of the repayment of debt.

At the end of the second quarter we had cash and cash equivalents of 166.5 million plus 6.1 million in short and long-term marketable securities for a total of 172.6 million.

Given the global nature of the business, a portion of our cash is overseas; we are currently examining our option for repatriation, but have not yet made a determination if we will repatriate cash under the American Jobs Creation Act of 2004.

Accounts Receivable were 210.3 million at the end of the second quarter, up 8.5 million from the end of 2004.

Our DSO was 36, up from 32 days in the first quarter and at the end of 2004 due primarily to timing.

We do not believe there are any credit-related issues and our bad debts have historically been very low.

Capital expenditures were 11.9 million in the second quarter; for 2005 we now expect capital expenditures to be approximately 125 million including major expansion projects at our preclinical operations in Montreal, Edinburgh, Nevada and Massachusetts.

Total capital spend may change based on the timing of these projects.

Depreciation was 11 million in the second quarter; our estimate of depreciation for 2005 is between 45 and 50 million.

Total amortization expense for the second quarter was 14.3 million and is expected to be 58.2 million for the year.

Operating cash flow was 48.6 million in the second quarter of 2005 and 82.8 million for the first six months.

Free cash flow was 36.8 million in the second quarter and 58.5 million for the first six months of 2005.

For 2005 we expect cash from operations to be in a range of 230 to 240 million and after CapEx of approximately 125 million, free cash flow in a range of 105 to 115 million.

That concludes our remarks.

We'll now take your questions.

(OPERATOR INSTRUCTIONS).

Eric Schmidt, SG Cowen.

Jim, given the weakness that you've seen of late in that transgenics services business, I'm wondering if you could just frame the size of that business for us.

Is it 10% of RMS, 20%, 30%, 40%?

And what was the year-over-year decline -- single digits, double-digits?

Any comments would be appreciated.

We're not going to break down details of the transgenics business quantitatively except to just reemphasize the fact that it is a relatively small part of that business.

That we have been experiencing and enjoying growth overseas and we have had the decline in the U.S.

And as we've talked about in the last couple of calls, it's been a continuing phenomenon in view of the fact that clients are spending more time understanding their animal models rather than just continuing to make them.

I guess we're most pleased with the fact that we're able to utilize really fine facilities in strategic geographic locations to produce immunocompromised mice which is our largest selling animal strain and one that's increasingly more important for both oncology and infectious disease work.

And so the efficiency that we're getting from utilizing that space well certainly offsets and compensates for the decline in the transgenics business.

So it's difficult to give any more specificity than that, Eric.

Tom, can you tell us what the absolute FX impact was on the top line say year-over-year?

Year-over-year it was up about 1%.

So with the headwind in FX it's essentially declined from what we had seen in previous quarters versus last year.

And then maybe either you or Jim could talk about this financial decision that you'd be facing with your cash flow as to whether you're inclined to buy back stock or repay the debt and how you'd go about making that decision?

We can both discuss that.

I think the principle reason for doing this is to try to offset some of the additional shares that we're issuing for stock options and restricted shares.

So we're anticipating doing that depending on the quality of the financial analysis.

I'll let Tom comment on that.

I think we'll do either/or, Eric, opportunistically.

So obviously looking at the share price and/or looking at debt which, of course, we have flexibility to pay down at anytime, particularly the revolver.

As I mentioned in my remarks, we are getting a certain amount in inflows into the Company from employee portions of stock option exercises and I think certainly we would want to put that back into the share purchase.

Last year as an example we received about 25 million from the employees and their share of the strike price to exercise options.

So I think we'll probably do a little bit of both and I think we'll do it opportunistically at the time depending on where the share price is and other factors.

Thanks a lot.

Dave Windley, Jefferies & Co.

Tom, could you -- I didn't keep up with you on some of the items in the unallocated corporate overhead that would affect I guess non-GAAP presentation that increased sequentially from 1Q to 2Q.

Could you help me understand that?

There's a few things that I mentioned and -- all of course of which are in GAAP and not all are in non-GAAP.

The Inveresk stock compensation charge is in GAAP but we take that out for non-GAAP purposes.

However, when you look at unallocated it's in the unallocated and sequentially that would not be that different.

It would actually be down a little bit.

The restricted shares that we talked about would also be in unallocated and, since we did that in the latter part of Q1, that number would have increased in Q2.

So sequentially that number would be up and, as I said in my remarks, since Q2 was a full quarter it would be a little bit more static going forward until it's amortized completely.

And the last thing I mentioned was just a period-related issue where we had a spike and certain items in particular which, as I noted, I wouldn't expect those to reoccur in Q3 or Q4.

Okay.

Jim, I guess the question for you if I might frame it in terms of earnings growth and that is to say prior to the Inveresk acquisition you were seeing accelerating earnings growth and beating expectations and that's kind of been an historical pattern for Charles River since you came public again.

And since the Inveresk acquisition, especially these last couple of quarters you've characterized your feelings about the quarter as very plays with a middle of the range result.

And I wondered if you could characterize that or talk about your feelings about that?

Is that an acknowledgment of the challenges of putting two big companies like this together and/or some of the headwinds that you're facing?

Or do you, in fact, think that in the not too distant horizon that Charles River can return to an accelerating EPS forecast and some upside surprises to the earnings number?

Good morning.

We, as I said in my remarks, are really pleased with the integration efforts so far.

And so we are progressing as we anticipated that we would and putting the companies together nicely in a way that certainly on a non-GAAP basis we're seeing sequential improvement in operating margins, increasing sales growth and really good capacity utilization.

So we're going to continue to see strengthening of the preclinical business going forward.

We've also had a similar phenomenon in the clinical business with improving sales and earnings there as well and I think that our strategy of focusing down on a few therapeutic areas is bearing fruit and will continue to do so.

So we're pleased with the directional growth there, the margin expansion and the way the two companies have really become one and we're just really digging into our best practices initiative and Six Sigma initiative to drive efficiencies even further.

I also think that additional larger capacities like the new Massachusetts facility that we just acquired will certainly enhance efficiency and also our ability to capture additional business both dedicated and otherwise.

In the preclinical business it's about anticipating demand and staying ahead of it and having sufficient capacity to do what the clients want.

The research model and services business I think is performing extremely well and we have a down tick this quarter because of the transgenics business and the vaccine business which is a small business that we don't talk about much.

It had an unusually strong last year because of competitor contaminations which they have come out of.

I think if you put the portfolio together demand continues to be strong.

I can't predict whether we're going to beat our guidance; that's always a lovely thing, Dave, but we're pleased to be hitting our guidance, we're pleased to be doing well with the integration, and we're servicing our clients in a much more positive and comprehensive fashion than we have historically.

So yes, we're optimistic that directionally our EPS and margins will continue to improve.

Hopefully they'll continue to improve faster than our sales as they have historically.

And our sales growth is pretty much -- is exactly, actually, as we had projected it would be and we're confident we can continue to deliver those numbers.

On -- just one last question.

On the areas they you've highlighted, transgenics vaccine and then the ISS, do you feel like you -- are your sales efforts beginning to gain some visibility as to when that will pickup maybe out into '06?

In those areas I should say.

We're beginning to gain some visibility.

As we've said, they're going to -- all three of them are going to be a drag for '05.

The interventional and surgical business definitely was buoyed up by sort of a bolus (ph) of business in the drug-eluding stent market for sure.

We're going to see additional devices that require our services.

As we've said, that transgenics has been slowing down.

We're certainly hopeful that the slowness in that growth will recede and Avian is really an unusual year-over-year comparison.

That's always been a very strong business for us.

It was particularly strong last year because of our customer -- because of competitive problems.

So I would think directionally that those businesses could show some improvement next year.

Thanks for taking the questions.

Ken Kulju, CSFB.

Just wanted a little more clarification on the '05 guidance.

Yours sales growth guidance for '05, you're basically sustaining that despite the adverse currency hit.

I was wondering if you could just talk to that point.

Secondarily, on your operating margins, particularly in the preclinical and the clinical service area, those seem to be tracking quite well.

Could you provide a little more detail on how you expect those margins will improve in the second half of the year -- whether we have any seasonality effects or influences of currency?

Thanks very much.

This is Tom, I'll respond to the first part of your question.

You broke up a little bit on the second part so after I respond I'll ask you to pick up a little but on the second half.

We are seeing some headwind, negatively of course, from the foreign exchange and Jim talked a little bit about the drag of transgenics service and what not.

So where we are seeing some strength in our businesses versus before is in the preclinical and to some extent in the clinical area.

So I think we're seeing a little bit more strength there, a little bit of headwind in the FX and of course we're moving a little bit sideways in the transgenics services, as Jim mentioned.

If you'll repeat the second part of your question again, Ken, we'll obviously answer that.

Sire.

Just with respect to the second half, as you look at your operating margins you're tracking quite well on the preclinical and the clinical service area.

I was wondering if you could talk to how you expect your operating margins to perform more or less in the second half of the year as you look at the base that you've re-established 2Q, how you expect it will basically transition through the year on the operating margin side?

As Jim mentioned, and I think I did to a lesser extent, in the third quarter with respect to sales mix we do anticipate seeing some sequential growth continue in both preclinical and clinical.

However, as we've seen in the past, from a seasonality standpoint we do expect to see the RMS decline sequentially in the third quarter from the second.

And as I think you know and most of our other investors know, that will put some pressure on the margin.

Having said that, I think the margin will hold up pretty well overall, maybe down slightly because of that mix and probably move sideways from there into the fourth quarter.

So I think it will continue to be strong, but I think the mix, particularly in the third quarter, will put a little bit of pressure on the margin.

Thank you very much.

Eric Coldwell, Robert W. Baird.

First, I was hoping you could quantify which divisions were most directly impacted by the foreign currency.

I would assume preclinical probably took the biggest hit with Edinburgh and Montreal.

And then secondly, we appreciate that backlog is broken out only on what's signed, but I was hoping you could give us some sense on the quantification of the verbal awards especially towards the clinical side of the business?

Thanks very much.

This is Tom.

Our foreign operations -- RMS we have a big foothold in Japan, that was obviously impacted by the yen.

Lots of RMS activity throughout Europe which was also impacted but by the euro.

And our preclinical businesses in Scotland were impacted by the movement of the pound.

So those are the primary areas of impact.

We are going hedging activities in Canada; that's a little bit of a dynamic, but we did not see a significant move between the Canadian dollar and the U.S. dollar during that period.

Although the exchange hedging we were doing would have mitigated some of that.

So hopefully that answered your question.

The latter part of the question was on verbal awards, Jim.

Can you repeat the question again?

Yes, I said we appreciate the fact that you break out only what is signed in terms of your backlog, but if you could give us a sense of the verbal awards that you've alluded to over the last two quarters, kind of the magnitude of those and how close you are to maybe bringing those into signed authorizations?

Well, there just significant in increasing -- it's always difficult to tell (technical difficulty) between getting the verbal awards when they'll sign.

We are optimistic that the size of them will really help drive the business for the back half of the year.

So it's an extremely positive sign for us and I think an indication that the focus strategy is working well.

Would you be willing to quantify what the book to bill would have been had you included those verbals?

No, we really are pleased and proud of the fact and actually think it's a very responsible and rational way of reporting the backlog by not including verbals because until they've converted they're not signed business.

And so, either we're going to include them or we're not, and so we decided not to include them until they become a certainty.

Okay, thanks very much.

Derik de Bruin, UBS.

Just a couple of questions.

So since you're now looking at using cash to buyback shares or paydown debt, does this at all change your appetite for doing acquisitions?

No, it doesn't.

We're I think in a very strong financial position and, as we've said for a while, we continue to look at possible strategic acquisitions in a variety of areas both geographically and with regard to enhancing our current products and services and we'll do those deals if and as they're beneficial and if and as they strengthen the portfolio.

I think our situation here with the authorized share repurchase, as Tom said, we can do that or paydown debt.

They're mutually exclusive situations and one really has no bearing on the other.

So don't take that as a sign that we've somehow fundamentally changed our acquisition policy because we haven't.

Are you concerned that with so much capacity coming online in the sector throughout 2006 that you're going to see some (technical difficulty) to your ability to get pricing power?

We're really not.

The capacity that we're adding, and I think our competitors are adding, is a response to and a reflection of the demand quotient which I think is intensifying and I think it's much more strategic in nature and less sort of haphazard.

I also think what we're all seeing -- I can only speak for Charles River -- much more focus by clients on the potential of getting dedicated space.

I think we are already having some discussions with regard to the space that we just bought this week, in fact.

So I think that we will be able to price appropriately to be paid for the quality of our services and the investment that we are making in people and space.

I do think there is a fundamental change in the way our clients are looking at this work, and I think we are going to see the outsourcing trend accelerate.

Not only will that provide pricing opportunity, but it will provide the opportunity to continue to expand our space.

So I know there are always reference to historical cycles in this business.

I continue to think that they are not valid in projecting what is going to happen in the future.

The market has changed fundamentally, both in terms of the consolidation of our client base and the pressures that they are under to get drugs to market faster.

Okay.

Comparing the RMS division sequentially, certainly excluding the FX impact, saw a pretty good acceleration in the business.

But could you remind us that while certainly the transgenic services has been an issue for a couple of quarters, were some of the things that were impacting the first quarter, have those been dealt with in the second quarter or are they still getting some carryover (indiscernible)?

I'm not sure exactly what you're referring to.

One of the things that we did mention in the first quarter was that sales of large research models was slow, and that tends to be a -- always is a timing factor.

We don't know exactly when clients will take delivery of larger animals, so that was a drag on the first quarter.

It benefited us in the second quarter because we got the benefit of the timing as a result of shipments.

Immunocompromised mice has been consistently strong for several quarters now on a worldwide basis.

So we certainly said that in the first quarter.

Transgenics has been a continuum for us.

I think this is the third quarter we reported a decline in the U.S. with an uptick in our foreign operations.

The Avian products, a small part of our business, is something that is certainly dragging down the second quarter.

So the core business of sort of making (ph) and selling animals continues to be strong and actually it benefited in the second quarter from the large model.

Just one final point.

Could you give us an organic growth number for your clinical business?

No, we wouldn't break that out.

I think the only thing I would say that pro forma growth for the Company in the second quarter was about 10%, which is consistent with where it was in the first quarter.

Okay, thank you very much.

Paul Knight, Thomas Weisel.

Is that bank line a floating line, Tom?

The bank line of credit?

Yes.

Yes, it is.

It is LIBOR plus.

Thirty-day?

We can lock into the LIBOR 30 days or 60, that kind of thing, but it is floating.

Jim, pharma spending seems to have been strong in a lot of the companies in this industry in the June quarter.

Can you say that it -- and also Europe seems to be strong.

Did you see kind of a tone pickup in the second half and in Europe particularly what did you see?

I don't think we've seen a fundamental change quarter-to-quarter.

Pharma has always been our largest client base.

It was quite strong in both quarters as had the big European business.

I'd say it was more consistent rather a discernible (ph) pickup in the second quarter.

Okay.

And then, Tom, a last question on that.

You mentioned there's what? -- 2.8 million of amortization was in the unallocated corporate line?

2.8 million of restricted share grant amortization, correct.

And that is recurring you said in the future?

Yes, it is, the restricted shares.

The options that we issued earlier this year will be amortized over three years consistent with the vesting period.

And that unallocated corporate line you're saying should stay about where it's at or go down a bit?

No, what I said was that we did have an increase in a couple of period-related expenses and for those items it would probably go down a little bit.

So the restricted share grant would be linear from where we are in the second quarter.

Like millions or a couple million or can you quantify it yet?

Not quite by that much.

I think it'll move down a little bit moderately from where was in Q2.

Okay, thanks.

Frank Pinkerton, Banc of America Securities.

Several of the large cap Pharma companies on their conference calls this quarter have talked about restructuring their research and development process to streamline and make it more efficient.

Can you speak to ways that Charles River is in contact with these companies and what's the strategic plan to try to help them through that process both in the models and in your services businesses?

We're in contact with our customers at a variety of levels if not daily, certainly weekly throughout the world.

And as I said in the very end of my prepared remarks, we're quite confident that we're going to see a fundamental shift in the way we do business with our clients to respond to exactly what they're facing.

What's been coming for a while is the necessity for them, whether it's Pharma or biotech, to put increasing resources into (indiscernible) discovery.

And a lot of the development work, particularly the animal-related development work which we do more of than anyone, there's an opportunity for them to rationalize their internal resources to decrease it and certainly not to add to it.

And so, I think that we are beginning the process, as I said in my remarks, of forward integrating into our space and taking over a lot of the services for them either in their shops or a contract staffing business or in our facilities by having them outsource the maintenance of their animals and certain of the early screening tests with us.

So again, our capabilities as a lab -- medicine company both on the product side and to house their animals and on the service side to do late stage discovery, early development and of course later stage development I think is a significant opportunity for us and in a lot of ways really a necessity for them.

And I think that there's an acknowledgment that we can do the work at least as well if not better than they.

And I think there's also an acknowledgement that our cost structures are lower and it provides them and economic benefit to outsource.

So we are finally continuing to see our core animal business driven faster and by both contract staffing and the preconditioned model activities that I talked about.

And also I think it will continue to drive the tox business.

Great, thanks.

And another question I guess surrounding capacity that you're bringing on into several facilities with the preclinical and the tox business.

Can you frame that for us over the next two to three years given some type of a metric, what additional increases to capacity do you think you can bring on?

The easiest way to say it is that we're bringing on capacity both in Europe and in North America.

We're bringing it on quite aggressively.

We're bringing it on I think slightly ahead of what we know the current demand is.

And the building that we just acquired gives us enormous flexibility.

I think flexibility is going to be increasingly important and we're going to work harder to mix between dedicated service -- dedicated contract for tox services and business that is not as long-term.

I don't want to give in terms of numbers or rungs or percentage because it's just something we haven't done -- maybe something that we could contemplate doing in the future.

But I think the challenge really is to continue to understand the input that we're getting and anticipate the needs and to buildout ahead of it and we're quite confident that we're doing that.

So as I said, what I do say is coming on in Europe in '06, we'll have this new building 40% occupied in the middle of '06, and we'll have new space coming on in the western part of the United States in '07 and, of course, we had new space come online first quarter of this year in Montreal.

Great.

And I guess, Tom, can you help me with the higher CapEx guidance?

Is that difference all for the new building or are there some other investments in there?

Thanks.

Just quickly and then we want to move on to the next caller.

The increase in our CapEx estimate is directly attributable to the recent acquisition that we just did in Massachusetts.

So there's some other things at play obviously, but that's clearly the key driver and that's the change -- the fundamental change in the number that we provided.

John Sullivan, Leerink Swann.

Can you speak briefly directly to the Inveresk integration and the clinical services area?

Has there been significant personnel volatility since the end of the first quarter?

No, there's been no volatility at all.

We've strengthened that team, the team that we sort of put together at the end of last year is intact.

We have added to that group and we'll continue to do so in a couple of key areas now.

And we've really gotten to know the depth of that organization, the second- and third-tier managers who are quite strong -- have given some of them more significant roles and are finding that we're building a strong culture and I think people are enjoying being part of Charles River after a couple of those companies were bought and sold previous to our making the acquisition.

Okay, thanks very much.

The recently acquired Worcester facility, was it already in use elsewhere in the industry or privately as a preclinical service facility?

It was a business in (indiscernible).

So picture it as a very a large shell with all the necessary HVAC capabilities and pretty much enormous flexibility to finish it as we would like to in some cases with satisfying specific needs of customers.

But generally it will be a space that we'll be able to grow into as the market pushes us forward.

Okay, thanks very much.

And last question -- regarding products within RMS, was the business skewed a little bit more toward the end of the quarter this quarter?

Just looking at the currency affect, I'm just wondering if more business came in later in the quarter when the dollar was its strongest.

No, not necessarily, John.

We do break our financial cycles on a 4, 4, 5 basis.

So June would have been a larger month.

But the RMS business is generally fairly evenly spread; it's not a discrete product that you can bulk up at the end of the quarter.

So I think it's just a function more of the dramatic rate movements that occurred to the mid to latter part of the quarter.

Thanks very much.

Chris McFadden, Goldman Sachs.

A couple of items.

Tom, you've talked a couple of times about the impact of FX relative to the sales line.

Could you just take us down the P&L and to the extent you can quantify what the impact was to operating earnings, that would be helpful.

Secondarily, you've put out obviously a target relative do merger synergy realization, $10 million I believe was the target.

Can you tell us how you feel like you are against that expectation for the year here at six months?

And just remind us how you expect the benefits to impact the P&L, whether you think they would show up more in the segment results or in the unallocated corporate overhead?

And then a quick follow up, thank you.

On your first question, for the most part with the exception of Canada -- and I mentioned that we didn't see a material movement in the rates there -- our sales that are generated overseas are translated back to dollars.

But most of those countries such as Scotland and where we are in Europe and Japan -- almost all of our costs are also denominated in local currency.

So what we end up seeing is lower results in dollars on the top line and lower results in dollars at the bottom line, maybe with some equivocation in the margin rate, but generally it falls through in that particular manner.

So we see some lower sales and we see some lower operating income and margin impact is sometimes impacted also.

With respect to the synergies, we have achieved the 10 million, it's flowing through our P&L.

The majority of the items that we talk about that pertain to the 10 million in the first year were driven from corporate expense reductions -- corporate primarily Inveresk.

We had two development departments, two presidents, two CFOs, two corporate accounting staffs, things like that.

So those we took out immediately.

We looked at some major overlap of programs such as insurance programs, both property and casualty and D&O and we made changes immediately realizing some savings.

And we looked at marketing and sales and made some changes also -- fairly rapidly but not as quickly as the other areas.

So those savings are all locked and playing through the P&L for the year.

As we move away from this year, some of our savings are more in best practices, efficiencies, selling, cross selling and those we baked into the second 10 million which we talked about for 2006.

So to be clear, having achieved the $10 million synergy objective for this year is inclusive of the $10 million roughly quarterly unallocated number that we saw here in Q2?

I think the answer to that is, yes.

The way you're phrasing your question I'm not 100% sure.

But of course we're looking at savings that are not necessarily coming out -- for an example, out of legacy Charles River.

So many of the savings that I talk about came from the Inveresk side of the business.

So when you look at Legacy Charles River you'd have to do some sort of a pro forma analysis of their unallocated with ours versus for instance our Legacy Charles River number.

So hopefully that helps.

I'm not sure if that's exactly the question that you asked.

I guess said differently, is it possible that any of the realized synergies in the first six months of this year impacted the margin results in the segment reports either in clinical or in the preclinical segment?

No, I don't think so.

I think a different thing that we did see as an example, which we talked about earlier in the year is that Legacy Inveresk had reported some items such as depreciation and a facility cost in SG&A where we historically apportion those expenses to the appropriate part of the business.

So if it's production activities we report it in cost of sales.

So we did make some transition of cost -- more into the margin and less in SG&A so you would have seen that kind of reclass which we discussed really in the fourth quarter and the first quarter so we haven't seen residual questions on that.

But that wouldn't have benefited you on a Q2 versus Q1 in terms of the margin improvement.

No, and of course it wouldn't have any impact on operating income either.

Very good.

And then finally, your bookings, at least on a sequential basis which is one metric, are obviously not as strong as probably you would have liked.

You've talked about verbal versus written awards and obviously there is some cancellation activity in there.

What is, from a planning perspective, what is the rate of net bookings or net backlog that you'd like to see the Company begin to generate and I guess how should we think about the trajectory of that number in the second half of the year?

I do think, Chris, that we would like to see the bookings be a little bit higher.

We're comfortable with the visibility that we have today, however.

And one of the things that Jim talked about was in the preclinical area we're booking well into the first quarter of 2006, so one of the things that we're struggling with a little bit today is how much longer we can build backlog in the preclinical area given that we're already booking out until the first quarter and longer in some cases of 2006.

So one of the ways that we're trying to attack that is, as Jim talked about earlier, through some dedicated arrangements which we are in some of those conversations.

But until we do some things like that, I think it's fundamentally difficult for us to build a longer backlog in preclinical because people want the work done more rapidly than that.

We're obviously working hard and we're happy with the results that we're seeing in the clinical area and we've improved sequential sales and we're seeing some good positive trends moving forward.

So we'd like to see the backlog lengthen a little bit there.

Jim talked about some verbal award activities.

It's not our view that we ought to be recording based on verbal activity.

It makes it difficult for us to control that and the way that we would like at the corporate level here.

So we're trying to give you some direction on that, but I think we're going to continue to be steadfast in looking for a written commitment before we bring some of that activity into the backlog that we report.

Tom, is it your understanding or expectation that others in the industry are in fact booking verbal awards in their reported results or in their reported --?

We did a lot of research, Chris, at the time that we first began reporting backlog which was really on our fourth-quarter results.

And because we've gotten some questions on it we have continued to look at what other companies do in their K's and Q'2 and there are some folks out that there that do report verbal.

There are some folks out there that say we report verbal but only when we really have solid assurance, things like that.

And as the CFO and from a corporate perspective, we just like to draw a line in the sand and -- what's a verbal award, who said so, that sort of stuff -- we just don't want to get into those kinds of gray areas.

Very good.

Thank you for the detail.

And that was our last question for the day.

Please continue.

Thank you for joining us today.

We look forward to seeing you soon either on the road in August or at the Weisel, Bear Stearns or UBS conferences in September.

This concludes the conference call.

Thank you.

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