Charles River Laboratories International Inc (CRL) 2006 Q3 法說會逐字稿

Good day, everyone, and welcome to today's Charles River Lab International's third-quarter 2006 earnings conference call.

Today's call is being recorded.

At this time, I would like to turn the call over to the Corporate Vice President, Investor Relations, Ms. Susan Hardy.

Please go ahead, ma'am.

Thank you.

Good morning and welcome to Charles River Laboratories' third-quarter 2006 conference call and webcast.

This morning, Jim Foster, Chairman, President and Chief Executive Officer, and Tom Ackerman, Executive Vice President and Chief Financial Officer, will comment on our third-quarter results and outlook for the balance of the year.

Following the presentation, we will respond to questions.

There's 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 888-203-1112.

The international access number is 719-457-0820.

The pin number in either case is 2313624.

The replay will be available until November 21st.

You may also access an archived version of the webcast on our investor relations website.

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

Any remarks that we make about future expectations, plans and prospects for the Company constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by any forward-looking statements as a result of various important factors including, but not limited, to those discussed in our annual report on Form 10-K, which was filed on March 14, 2006, as well as other filings we make with the Securities and Exchange Commission.

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 GAAP measures and reconciliations to those GAAP measures on our website.

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

Good morning.

In the third quarter, we continued to make progress on our stated goal of focusing on our core competencies.

As you know, we closed the sale of our Phase II-IV business in August and have moved forward on our goal to expand our Phase I business with last week's acquisition of Northwest Kinetics.

We're very pleased with the acquisition because we can now offer high-end clinical pharmacology services in North America, complementing our presence in Scotland.

Northwest Kinetics fits the criteria which we view as most important in an acquisition, market leadership, account and management team, broad medical expertise, and a commitment to customer service.

We welcome the employees of Northwest Kinetics to the Charles River family and look forward to further expanding our clinical pharmacology franchise together.

We were awarded a $112 million 10-year contract by the National Cancer Institute to manage their Research Model Colony.

An outgrowth of the exceptional service we provided, this contract is an extension of an existing consulting and staffing services contract which we have had for 12 years and has doubled its size.

A new feature of this contract is that rather than just managing NCI's facilities, we will also provide dedicated space in our facilities.

To support this requirement, we will build a shared-use facility located near the NCI campus.

One half of the facility will be dedicated to the NCI contract and the other half will be occupied by our RMS business to produce research models and provide preconditioning services for the commercial market.

We found a property in Fredrick, Maryland, and expect to have the new facility operational by the third quarter of '08.

This is our first example of a dedicated space arrangement in the research models business, one which we believe also has applicability for the commercial market.

We continued to buy back our stock in the third quarter, implementing an accelerated stock repurchase plan under which we bought 1.8 million shares.

That brings our total purchases under the existing $300 million authorization to approximately 6.4 million shares at a cost of just over $261 million.

We also delivered a solid performance in the third quarter.

Net sales for the third quarter from continuing operations were $264.7 million, an increase of 9%.

Both RMS and Preclinical sales drove the increase.

RMS net sales were $127.6 million, a gain of 7.3%, and Preclinical net sales were $137.1 million, a gain of 10.6%.

On a year-over-year basis, the consolidated GAAP operating margin was 19.5%, slightly above last year's third-quarter results of 19.4%.

But when adjusting for the adoption of 123(R), this year's third-quarter GAAP operating margin would have been 90 basis points higher.

On a non-GAAP basis, the operating margin was 22.8% compared to 24.3% in the third quarter of last year, but 123(R) accounted for 90 basis points of margin reduction.

On a GAAP basis, third-quarter earnings per share from continuing operations were $0.47 compared to $0.41 for the third quarter of '05.

On a non-GAAP basis, earnings per share from continuing operations were $0.56 compared to $0.52 in the third quarter of '05.

In general, higher sales and fewer shares outstanding drove the improvement, more than offsetting the cost of 123(R), which was $0.02 in the quarter, and a higher tax rate.

On a GAAP basis, lower amortization and stock compensation expense related to the Inveresk acquisition also improved earnings per share.

In our second-quarter conference call, I discussed the fact that research model sales were negatively affected by six large pharma clients who reduced their spending.

Reductions continued in the third quarter, but there has been improvement in several of those accounts.

In addition, sales to other large and medium pharma and biotech clients increased.

As a result, sales were up in North America, Europe and Japan, with growth and the larger North America market reaching high single digits.

We are continuing to see strong growth in the California market, both through expansion of existing accounts and market share gains, and our eagerly anticipated completion of the expansion of our Northern California facilities, which will support that market growth.

The expansion is on track to open in mid '07, and while it will take some time for the capacity utilization to build, as it does, it will free up capacity in our Midwest and Southern U.S. facilities, from which we now ship to California.

In addition, it will also save us delivery costs, since we don't pass on the extra freight costs we incur when we ship to customers from facilities outside of California.

We've also gain traction with our sales efforts targeted at academic institutions.

You may recall that we implemented these initiatives approximately two years ago and have been slowly gaining share.

In the short-term, those share gains have a slightly lower margin due to the fact we've added delivery routes to support the new accounts.

But as the business on those routes increases, we expect the margins to normalize.

The vaccine products business reported stronger sales, benefiting from increased sales of laboratory products.

In vitro again achieved a double-digit sales increase due to a combination of sales of our existing test kits and strong demand in the U.S. and Europe for our new portable testing unit, the PTS.

We are extremely pleased with the response to the PTS.

In addition to sales to existing customers, who are incorporating the PTS in their testing processes, the PTS is opening doors for us with new clients.

Reportability, rapid response time and ease-of-use has strong selling points, and we expect to take market share.

Sales of large research models also improved in the third quarter.

However, contrary to our earlier expectations for higher sales, it now appears that sales in the second half of the year will be slightly lower than the first half.

The reason for the change in our sales outlook is that, in compliance with the request from the Centers for Disease Control, we have extended the quarantine period for a [large shipment] of models, which we imported from Mauritius in August, due to equivocal sales results.

This extended quarantine will take us to the end of December, delaying shipments until the first quarter of '07.

As we expected, Transgenic Services maintained the revenue run rate we have been experiencing over the previous nine month.

So, although sales declined when compared to the third quarter of last year, the rate of decline moderated to single digits.

At the current run rate, we believe that compared to last year, we will report flat sales in the fourth quarter.

At 28.8%, the third-quarter operating margin for RMS was lower than last year's 30.9%.

Seventy basis points of the decline was attributable to 123(R), with the balance due primarily to lower sales of Transgenic Services, higher delivery costs and an increase in the proportion of services in the sales mix.

As we add capacity to support the growing demand for research model services, it does create pressure on the segment's margin.

Continuing softness in Transgenic Services sales also contributed to the margin decline.

But as a result of the actions we implemented in the second quarter, the rate of decline moderated.

In line with our earlier expectations and based on our third-quarter results, we continue to expect sales growth for the second half of '06 to be in the low single digits.

We expect sales growth in the fourth quarter to be lower than the third, due in part to normal seasonality in the RMS business and also to difficult comparisons against the fourth quarter of '05, which benefited from an extra week in the quarter.

Reduced sales large models due to the CDC issue I mentioned previously will all also affect sales growth and will likely reduce the operating margin.

However, we're optimistic about the improvement we've seen in sales this quarter and believe that the longer-term RMS outlook is positive.

Preclinical Services had another robust quarter, with sales 10.6% to $137 million.

We benefited from a continuation of most of the trends we experienced in the second quarter, strong customer demand for our services, stable pricing, and the addition of new capacity.

The growth rate was lower than in the second quarter, but the change was primarily a function of sales mix.

As a result of higher sales, the effective cost savings initiatives we implemented in the second quarter, and lower acquisition-related amortization expense, the GAAP operating margin improved to 16.8%, which included $2 million of costs related to 123(R) compared to 16.1% in the third quarter of '05.

The non-GAAP operating margin decreased to 23% from 24.6% in the prior year, but when adjusted for 123(R) expense, the non-GAAP operating margin would have been 24.5%, which is comparable to the third quarter of '05.

Progress on our Shrewsbury, Massachusetts facility is on track and we're looking forward to opening the doors on schedule in December.

In previous conference calls, I have discussed construction and hiring plans.

This time, I'd like to give you the highlights of our transition plan from our existing to the new facility.

It's a significant undertaking to build out this much space, more than 250,000 square feet in the first phase.

As you already know, our planning was extensive, involving input from the most experienced managers from all of our Preclinical facilities, as well as external consultants.

That planning has enabled us to create what we believe is one of the most efficient state-of-the-art contract research facilities in the industry, and have completed it in only 15 months.

The transition has been planned just as carefully, with attention to enhanced operating efficiency and customer service, and without disruption of current studies.

Many of you have asked about moving our toxicology business to the new building, so I'd like to reiterate that we will be operating in portions of both the Worcester and Shrewsbury facilities simultaneously for at least two to three years.

There are two primary reasons that this is a case.

First, to ensure that there is no interruption of our ability to accommodate our customers' studies, we have continued to book new studies in the Worcester facility while we have been building Shrewsbury.

And pursuant to FDA guidelines, these studies cannot be moved between facilities while they are in process.

Second, located just a ten-minute drive apart, these facilities are extensions of the same business.

We provide the same services using the same people, so customers can continue to work with the trusted study directives and technical support people, regardless of the physical location.

We've commented previously on the fact that we are leveraging our investment and the experience we've gained in building Massachusetts in our new Nevada facility.

Nevada is coming online approximately six months behind Massachusetts, which allows us the opportunity to benefit from our earlier experience.

We are moving ahead quickly on the project and remain on schedule to occupy the first phase of the building in the summer of '07.

As you know, we are reaffirming our sales and earnings guidance for the full year, revenue growth of 6% to 8%, or a range of $1,050,000,000 to $1,075,000,000;

GAAP earnings per share of $1.73 to $1.79; and non-GAAP earnings of $2.12 to $2.18.

We believe our guidance is achievable despite fourth quarter challenges in both Preclinical and RMS.

Although we will have a significant amount of new space available in '07 and beyond, most of our Preclinical facilities are operating near capacity, limiting our ability to take on new work.

The segment's operating margin will also be negatively affected by the ratio of general to and specialty tox in the sales mix and cost of sales associated with opening the new Massachusetts facility.

There will be headwinds in RMS sales' margins due to the issue I discussed concerning large models.

However, we view these issues as transitory and look forward to improving trends in '07 and beyond.

In our view, there is no question that we have greater opportunities today than we have ever had.

We've built a broad portfolio of essential products and services, from discovery through Phase I, which we believe effectively supports our clients' drug discovery and development efforts.

We have developed unmatched core competencies in veterinary medicine and science, and regulatory client Preclinical Services, including Phase I clinical trials.

By taking advantage of our expertise, our clients can focus on what they do best, discovering novel compounds and biologics.

Pharmaceutical companies are focusing on more efficient and cost-effective models of drug development.

As I said this quarter, they are investing less in new facilities and in-house expertise, increasingly choosing to outsource to high-quality contract Preclinical research organizations like Charles River.

Our ongoing discussions with customers concerning their long-term plans, including possible dedicated space agreements, confirm our belief that demand for these services will continue to increase, and that Charles River is extremely well-positioned as the premier provider on which customers can rely.

Our customers, ranging from large pharma to emerging biotech firms to government and academic institutions, choose to partner with Charles River because of the value we provide.

Specifically, our deep scientific expertise and operational leadership, high-quality products and services, state-of-the-art facilities located in close proximity to customers worldwide, our exceptional customer support, and our financial strength and stability.

Combined, these key differentiators are enabling us not only to expand our relationships with our current customers, but also to attract new business during a period of tremendous opportunity.

I'd like to thank our 7500 employees for their exceptional work and commitment and to our shareholders for their continuing support.

Now I'll turn the call over to Tom Ackerman.

Thank you, Jim, and good morning.

I will start by giving you some financial highlights from the third quarter.

First, I would like to remind you that these figures represent results from continuing operations, as our Phase II to IV clinical and ISS businesses have been reclassified as discontinued operations for all periods, effective as of the first quarter of 2006.

I will provide further details regarding discontinued operations shortly.

Let's lead off with sales.

As Jim mentioned earlier, third-quarter 2006 sales increased 9% compared to the third quarter of 2005, with foreign exchange adding just over 1 point to this growth rate.

GAAP rate operating income increased by 9.4% to $51.6 million year-over-year, driven by lower amortization of intangibles and stock compensation related to the Inveresk acquisition.

When eliminating amortization related to Inveresk, non-GAAP operating income rose 2.5% to $60.4 million.

Modest base business improvement in the third quarter of 2006, particularly in Preclinical, was offset by $2.4 million in 123(R) stock option expense.

Both GAAP and non-GAAP EPS improved year-over-year as a result of the same factors driving operating income, while the lower share count was offset by a higher tax rate in the third quarter of 2006. 123(R) costs reduced third quarter 2006 earnings by $0.02 per share.

The adoption of 123(R) had a significant effect on the GAAP and non-GAAP operating margins.

In 2005, all of the amortization was included in unallocated corporate overhead.

This year, upon the adoption of 123 (R) in January 2006, in addition to stock option expense, we began allocating the restricted stock grant amortization to the business units.

This did not change the total cost of amortization of restricted stock for the Company, but did impact our year-over-year business segment comparisons, as there was no allocation to the business units in 2005.

When you adjust third-quarter 2006 to normalize for 123(R), the consolidated non-GAAP operating margin would have been 23.7%, down 60 basis points compared to 24.3% in the third quarter of last year.

The decline was primarily driven by the RMS segment.

We were very pleased with the Preclinical operating margin, which remained 24.5%, excluding 123 (R) costs, comparable to the third quarter of last year.

Continuing with the 123 (R) impact, stock option expense reduced EPS by $0.02 in the third quarter of 2006, as I noted earlier.

Adjusting the third-quarter results to exclude 123 (R), non-GAAP EPS would have been $0.58 compared to $0.52 per share in the third quarter of 2005, an increase of 11.5% versus a 9% increase in sales.

I'll now turn to other income statement and balance sheet factors, starting with net interest expense, which was $3.6 million in the third quarter of 2006 compared to $3.9 million in the same period of 2005.

This change was driven by higher interest income on our cash balances, partially offset by interest expense related to the convertible offering.

We currently expect full-year net interest expense to be approximately $12 million to $13 million, slightly less than previous guidance due to higher interest income on cash balances.

The GAAP and non-GAAP tax rates increased in the third quarter of 2006 to 32.2% and 32.1% respectively compared to 28.9% and 29.3% last year.

The increase in the third-quarter tax provision is primarily attributable to the recording of a tax reserve related to the issuance on September 25, 2006 of intepretive tax guidance by the German tax authorities, a tax expense related to the recording of several out-of-period adjustments during the quarter, and a reduction of tax expense related to the completion of a statutory tax audit.

Excluding the net effect of the discrete items, our third-quarter tax rate would have been comparable to the second quarter of 2006 on a non-GAAP basis.

We now estimate our full-year GAAP and non-GAAP tax rate to be in the range of 28% to 28.5%, and 29% to 29.5%, respectively, as a result of these third-quarter items compared to our earlier estimate of 28.5% to 29.5% for both GAAP and non-GAAP.

The $48.7 million loss from discontinued operations in the third quarter is primarily due to a $45.3 million income tax expense related to the tax gain on the sale of our clinical business.

The $184.4 million loss year-to-date also includes a charge of $129.2 million of clinical Phase II-IV goodwill impairment that was recorded in the first quarter.

Although we did not report a book gain on the sale of the clinical business, we were required to record a tax gain, since the tax basis of the business was substantially less than the $215 million in proceeds we received.

As a result, we incurred $45.3 million in corporate tax expense.

At the end of the third quarter we had cash and cash equivalents of $253.5 million, plus $108.7 million in short- and long-term marketable securities, for a total of $362.2 million, compared to $134.8 million at the end of 2005.

This increase was driven by the cash proceeds received from the issuance of the convertible offering and the sale of our Phase II-IV clinical business.

Accounts Receivable were $185.3 million at the end of the third quarter, up from the fourth quarter of 2005 due to the higher sales.

Our DSO increased to 37 days in the third quarter of 2006 when compared to 31 days for the fourth quarter of 2005, primarily as a result of a reduction in deferred revenue due to the mix and timing of studies in our Preclinical business and the increase in trade receivables.

We do not believe we have any credit risk as a result and are working to bring DSOs back down to historical levels.

On a year-to-date basis, free cash flow was $3 million compared to $75.2 million for the first nine months of last year.

The key drivers of the decline were tax payments made in the first quarter of 2006 for profits repatriated in 2005, a reduction in deferred revenue, and an increase in prepaids.

In addition, capital expenditures year-to-date were $99.8 million versus $69.2 million in the first nine months of last year, reflecting increased investment in our Preclinical and RMS facility expansions.

Depreciation for the first nine months of 2006 was $32.9 million, slightly above $30.4 million for the same period of 2005.

And total amortization expense was $27.9 million compared to $34.6 million in the first nine months of last year.

Our full-year 2006 guidance for free cash flow remains in a range of $25 million to $50 million, and we now estimate CapEx at approximately $175 million.

We believe CapEx will be at the low end of our previous range due to the timing of certain expenditures, but not due to project delays.

Depreciation is expected to be $45 million and amortization will be $37 million.

We are reiterating our 2006 guidance of non-GAAP EPS from $2.12 to 2.18, or $1.73 to $1.79 on a GAAP basis, and revenue growth in the 6% to 8% range.

I would also like to point out a few other details.

We did make some minor revisions to our guidance for the tax rate and other items which I discussed earlier in the call.

You may recall that our 2005 fiscal year had a 53rd week, which is necessary to periodically true up to a December 31 year end, given our 4/4/5, or 13-week, quarterly reporting cycle.

That 53rd week was included in the fourth quarter of 2005, effectively giving us an extra selling week and creating difficult comparisons for the fourth quarter of 2006.

As a result, the additional week is expected to reduce the revenue growth by 3 to 5 percentage points compared to the fourth quarter 2005.

With regards to 2007 guidance, we will be issuing a press release on the evening of December 13th, and will host a conference call and webcast at 8:30 AM Eastern time on December 14th.

Conference call details will be provided in the next few weeks.

That concludes our remarks.

We will now take your questions.

(OPERATOR INSTRUCTIONS) Christopher McFadden with Goldman Sachs.

(indiscernible) for Chris.

Could you please comment on what the decline in demand for research models from some of your large Pharma clients could imply for your other service lines within RMS?

Alex, I'm sorry -- could you repeat the question, please?

Sure.

I just wondering what the decline in demand for some of your research models from your large Pharma clients could imply for your other service lines within RMS.

Well, we didn't have a decline in research models.

We've had -- in the second quarter we talked about several of our large pharma companies reducing costs.

And we did experience sort of a slowdown in demand in the second quarter.

As we indicated, while there has been some continuation of decline with some of them, several of the large clients have come back and increased their orders.

And as a result of that, we had really favorable sales, particularly versus the prior quarter, in Europe and Japan and particularly in North America.

So we were pleased with the result.

We also had increase sales from a whole host of other pharmaceutical and biotech clients.

Again, the service part of our RMS business is very much driven by the continued pharmaceutical outsourcing trend, pretty much the same trend that drives our Preclinical business.

So actually, we would look favorably upon that as we look forward as well.

Okay, thank you for the detail.

Frank Pinkerton with Banc of America Securities.

Great, thanks for taking the question.

Can you give any details either on the 2006 performance or what expectations are for Northwest Kinetics going forward?

Sure.

We can tell you that we are very pleased with our acquisition, and it's an essential element in really having a successful strategy and being able to pull through from Preclinical to Phase I, as we are experiencing in Scotland.

The demand for Phase I has been quite substantial, as we've seen as we went through the process of trying to acquire this business.

And we would anticipate that the performance of this company would be reflective of that increasing demand as we go forward.

Again, we hope to be able to use this facility very much in concert with our extension of our Preclinical operation in Nevada, I would say, primarily, but I think we will also see clients from across the country as well.

As a follow-up, you spoke about an additional facility with your NCI contract, and then said that that was kind of a joint shared facility.

Is that a facility that Charles River will be building and owning?

Is it going to be jointly burdened on the cost side, and what is the time to think of the capital expenditures starting for that facility?

Thanks.

It is an usual and, I think, creative structure, but it is one where we will be putting out most of the capital, which -- it's not huge amounts of capital, but most of the capital, which will play through our CapEx plans, both in '07 and somewhat in '08.

The facility will be done at the third quarter of '08.

It's a facility that at the end of the contract period we will own.

Thank you.

David Windley with Jefferies & Company.

Wanted to get clarification, Tom.

You, I think, explained part of the year-over-year decline in corporate overhead, if I followed your comments correctly.

I was wondering what caused the sequential decline of nearly $5 million in corporate overhead.

Was that the same reason -- the allocation of the restricted stock grants?

Not really, David.

Let me recap kind of since the beginning of the year and put it in the best context for you.

I would say the first quarter of the year was probably a normalized spend rate for us in corporate overhead.

In the second quarter, if you remember we talked, about some additional expenses that occurred in the second quarter that we really didn't expect to see reoccur.

In the third quarter, we didn't have that happen from the second quarter, and we also had some benefit from expense reductions as part of our restructuring in the second quarter, so to speak.

And we also had an accrual reserve reversal for the early adoption of accounting bulletin 108.

So as I think about the fourth quarter, I would really expect that to be more in line with probably the average of the first three quarters, which again, the first quarter being the most normal of those three quarters, I would say.

Okay.

And then I believe that there were -- in the shedding of the Phase II-IV to Kendle, I was under the impression that there were some corporate cost allocations to that business that wouldn't have gone with that business.

Were those costs that you were able to just slough off after that business went away?

Or I just wondered where those costs went.

Right.

We were able to reduce some of those costs, but those that we were not able to reduce, some of them would remain in corporate overhead and some of them would probably remain in the Preclinical business.

So a little bit of those three areas actually.

Okay, great.

And my other question is around Preclinical.

And Jim, you commented a little bit on some reasons that margins might be under pressure in the near-term.

Could you talk about your pre-selling activity for the space to open in the next month or so?

And as you bring that business on and open that space, any additional color that you could provide around the impact to margins, including what you expect that mix to look like, given that mix was an impactful item in the third quarter.

Thanks.

Okay.

We will take all three parts one at a time.

We did have a little pressure on the margins compared to the second quarter, but you will recall we articulated that quite grew clearly that we expected that that would happen.

We had really an extraordinary second quarter where everything fell really perfectly in terms of the mix and capacity utilization.

So we are pleased with the margin in the third quarter, notwithstanding the fact that it's not quite as perfect, but still pretty well balanced between specialty and general tox.

As I also said in my remarks, we are looking at the Worcester and Shrewsbury facilities as sort of holistic entities, sort of entity really, in terms of how we book in studies, both in-life studies and related lab services.

And so we are continuing to bring business into the Worcester facility as we build out Shrewsbury.

Some of that will stay there for some period of time until it's finished.

But clients will have the opportunity to get to develop a close relationship with study directives and the people doing that work, which should help intensify and move the work from the old facility to the new one in a smooth fashion.

Also, the associated laboratory work we can put at both facilities.

So, preselling effort that goes well.

We have booked some work, particularly on the lab side, which we will be able to start in the new facility when it opens for business in the first quarter.

I guess we would -- for a host of reasons, we would expect that the new facility will put some pressure on the margins, just because of the associated cost of starting it up.

The mix, I think, will be less of an issue in Massachusetts because it tends to be more general tox and associated lab services, rather than some of the sophisticated, high-end tox capabilities that we provide in places like Montreal.

So I think as it fills up, it will have less of an impact from a mix point of view.

Okay.

And I think one of the benefits that you've talked about long-term about moving to these two new buildings, two new areas of capacity, was the greater efficiency of the way they are laid out and the way you will be able to drive workflow through those facilities.

I'm wondering what your thought is about maybe the relative inefficiency of having to operate out of two locations, albeit close together.

Yes, well, it does present some pressure on the margins.

Having said that, depending on how successful we are in filling up the capacity, I don't think that will be a major issue.

Obviously, once we are able to move out of the older facility, we do expect that we're going to get the same efficiency benefit that we have at our other large facilities, which should be beneficial at that point in time.

It's a little bit difficult to say when that move will be.

But as long as the capacity fills, I don't think we're going to see too much downward pressure -- I'm talking sort of the back end of '07 and into '08.

Okay, thanks for the detail.

I appreciate that.

Doug Tsao, Lehman Brothers.

Thanks a lot.

Just as sort of a follow-up to Dave's question, you expect to see some margin pressure in Preclinical in the first half of next year?

Sort of easing as we move into the second half?

Well, we hope it eases.

I mean, we have a very large facility coming online in Massachusetts, and will have another one coming online -- a portion of the Reno facility coming online in the second half.

So we're going to have some pressure on the Preclinical business throughout the whole year.

As we said multiple times during this year, our goal would be to try to hold margin across the whole Preclinical sector.

We haven't finished her '07 plan yet, so I can't tell you for sure whether that is something we will be able to do, but that is our aspiration.

We've got some efficiency gains and really outstanding capacity utilization at other facilities, which would offset that nicely.

So, yes, we would anticipate some pressure in margins, at least for the first half of the year coming out of Shrewsbury.

Okay.

And then turning to the study mix, you sort of commented that 2Q was really where everything sort of fell into place.

So we should interpret this quarter's study mix as a more normalized mix for the business?

It's hard to say what normalized would be.

I know we're pleased with the margin this quarter and we're pleased with the mix.

And we do have a balance, and while we'd like to have a disproportionately high specialty tox mix, the reality is the clients want both.

So yes, I would say that I suppose to some extent this is more normalized.

By the same token, depending on how the demand falls, we certainly could crank that margin up in any particular quarter if the demand was there.

So 2Q is probably as good as it gets.

It wasn't really a fluke; it's just not something that can be anticipated every quarter.

And then on the RMS side, you commented on the extension of the quarantine for some of the large animal sales.

Was that something that affected this quarter, or is that something that will begin to affect 4Q?

It didn't really affect third quarter.

It will affect the fourth quarter only because by the time that testing is done, we're going to be very, very late December, where nobody is going to want to take animals because of the holidays.

So it will put some pressure on the fourth quarter, which ought to be alleviated in the first quarter of '07.

Okay.

And sort of could you provide -- obviously, you had some success in the traditional RMS business, selling to biotech clients as well as academic institutions.

I was wondering if you can provide some more color on what led to this.

Was this a new focus of the sales organization or what were the competitive dynamics there?

It's several things.

On the academic side, it is definitely intensified focus of sales organization and more salespeople.

To some extent, that is the same case in the California market.

The California market is a place where we have a relatively large facility which we're expanding to respond to the growth in that marketplace, both academic, biotech and a little bit of pharma, at a time where the competitive response is less robust from a capacity point of view.

Also, we've had some pricing compression between us and multiple competitors, which I think has benefited our share gains.

Okay.

Did you see to some extent what you saw in RMS this quarter a reflection of just sort of the global R&D trends which has seen biotech companies become a bigger proportion of the overall spend?

No, it's not a bigger proportion of our overall spend.

Our overall spend is still probably 50 pharma and 30 biotech.

I would say that biotech does grow faster than pharma on a percentage basis, but obviously the total numbers are smaller.

Okay, great.

Thanks a lot.

Tycho Peterson with JPMorgan.

Thanks for taking the call.

A number of questions have been answered, but following up on the questions about Shrewsbury, Jim, you had mentioned earlier the concept of dedicated space.

Is that something that becomes a factor with Shrewsbury here in the near term?

And if so, how do you anticipate that playing out?

Yes.

We've had and continue to have several conversations with both large pharma and biotech with respect to both Shrewsbury and Reno.

Again, nothing's definitive yet so we don't have anything to report.

We think it's rational to have some portion of those facilities to be dedicated space.

If that's the way it plays out, it gives you a certain level of stability.

And there are clients who are obviously not building their own space, but would like to have larger amounts of space.

But it's difficult to predict the conclusions of these conversations, because as we've said previously, as pharma in particular gets under more pressure from a cost point of view, they tend to be reluctant to sign up for these long-term engagements.

So there are a few companies that are doing particularly well, I think that may be more prone to doing this.

So we're beginning to have increasing numbers of tours of the facility.

I think a lot of people have admired it conceptually and from the outside to some period of time [they are in there].

And I think directionally, we would be hopeful that we could allocate some of that space to dedicated contracts in both locations.

Okay, thank you.

And then I'm wondering if you could comment a little bit on pricing trends, intra quarter, and whether there is anything notable, both in the model side, but more generally speaking, in Preclinical?

I'd say the Preclinical trend has remained relatively constant.

We're able to get some price, given how dear capacity is.

So that is really not a surprise, and pretty much we've had that situation all year.

Pricing in the RMS business has not been easy.

We have raised and gotten the price increase.

As I said earlier, we've actually had some price compression by some of our competitors be more aggressive with their pricing practices.

I think in the long-term, that is going to be beneficial for us, because we believe that we provide a premium quality product and premium quality services.

And if the premium price is not as substantial as it was historically, that should be beneficial to us.

So I think pricing has been available to us in both of our businesses, a little more pushback on the research model side, though.

Okay.

On PTS, as we kind of look forward in terms of that business ramping up, are there new growth areas for next year that we should be thinking about?

IN how would you characterize, I guess, demands so far, now that it's been out for a little while?

Demand for the PTS has been quite robust, as anticipated.

As we indicated, for the third quarter we have double-digit growth rates.

People are taking great interest in this unit because it's easier to use for portability.

We did sell several hundred units for research purposes prior to getting FDA approval, so we have a fair number of clients who are familiar with the device and have been waiting for FDA approval before they actually tried to use it on a widescale basis in multiple places within their production facilities.

While we are already looking at alternative and extended uses of the device for things like clinical diagnosis, I think our primary focus and the primary sales activity that we will have, I would say, for the foreseeable future, certainly through '07, will be primarily in the endotoxin area, which we have been historically with our current test kit.

And we hope to both get new clients and convert existing clients to this new technology.

Okay.

And then finally, on the U.S.

Phase I, how do we view that opportunity going forward?

Do you have what you need there or are there additional acquisitions you look to kind to bring onboard -- in terms of added capacity, Phase I in the U.S.?

Yes.

From a strategic point of view, it would be preferable for us to have some Phase I capability in reasonably close proximity to our major Preclinical locations.

So I would say that we'd like to find something sort of close to the -- on the East Coast of the United States or close to it.

And that could work in tandem with Shrewsbury, Montreal.

We have something in Scotland already.

And of course, Northwest Connecticut will work in tandem with our Reno operation.

So the close relationship between the Preclinical sellthrough and the associated lab work that's done on Phase I samples is one that we think is beneficial.

There's not a lot of players, both medium and large players, in the Preclinical arena that have Phase I capabilities.

So we think it would be a discernible competitive advantage.

So we will continue to look, we will continue to be as careful as we were in the Northwest Kinetics acquisitions, because we are looking for a high science, we are looking for good margins, we're looking for exceptional reputation and some reasonable scale.

So we liked Northwest Kinetics because it had 150 beds going in, with the ability to take that up to 250, and that gives us a really good critical mass.

So there are a number of possibilities.

It's not clear to us yet whether any of those meets our criteria spot on the way Northwest Kinetics does, but we will keep looking.

Okay, thank you very much.

Eric Coldwell with Robert W. Baird & Company.

Thanks very much.

I just want to verify that the CDC-related quarantine issue with the primates is Charles River specific, is that correct?

It is.

Okay.

Tom, you mentioned an accrual reversal in your corporate unallocated line.

I was hoping you could be a little more specific on what that amount was.

Yes, we early adopted accounting bulletin 108, and that was essentially two items.

One of them was the accrual reversal that I mentioned.

And of course I also mentioned the other item, which was one of three tax items that I mentioned.

I don't have the two details in front of me, but the net amount of that was -- of the early adoption was probably about $0.01 pickup.

And then of course when you include that with the other tax items, the net impact of all of that was really zero on the EPS.

Okay, thanks.

You made some, I think, favorable comments on Transgenics having another quarter of relatively stable sales and looking to be stable year-over-year in the fourth quarter.

Could you give us a sense on ex U.S. business?

I realize it's a smaller piece of Transgenics, but what is happening in Europe and in Tokyo?

Europe has been slightly positive for most of the year, and it's difficult to anticipate what that would look like going forward.

As you said, it's a much smaller business and it's dependent on really a handful of very large customers.

But we don't have any indications of a major shift there.

Japan has been slightly down -- again, that is even a smaller business yet, even dependent on fewer customers in a much smaller market.

And I suppose that we wouldn't anticipate a greater change there either.

So if you roll it out, we have seen consistency now for a full year in the aggregate business with it just holding at this level.

We will lap of the fourth quarter of '05 and have flat sales growth.

And we don't have any indication from clients that that's going to change in the aggregate on an international basis in a major way in the foreseeable future.

Thanks for the color.

On Transgenics, if I can follow up.

The flat sales growth, what happens to operating profitability in that scenario?

And I guess what I'm really asking is I realize you have moved some immunodeficient mice into the excess capacity.

But if you look specifically at your Transgenic footage, what is happening with profitability there going forward?

We did take a fair amount of cost out of that operation historically.

And the goal is to get that to a stable point where we're able to hold margins going forward if the volume were to stay at this level, which we anticipate that it would.

And while we've never culled that out, I guess I would remind you that while the profitability was never at the same level as our research models, it was quite profitable for a service line of business.

Okay.

Shifting gears to Shrewsbury, you mentioned in the slides in the formal remarks that you are going to continue to operate the two facilities as expected.

Being more specific, when you say two facilities, I assume you are still meaning the, I think, three or four buildings that exist in Worcester.

Is that the case or is it really just going to be one building in Worcester now?

Well, we have three buildings sort of in tandem next to one another.

And over time, we will vacate some of that space, and obviously we will try to do that in an orderly fashion so we're able to vacate a building at a time.

It's hard to say exactly when we will get to -- we own one of the three buildings, so it's likely we will stay in that one longer than the other two.

And our goal is to have the combined entity as efficient as possible, and that would require us to vacate the old facility when the studies are over and we're able to do that.

Right.

And then just one last question now.

I understand that you can move some of the associated lab work into the new Shrewsbury facility quicker perhaps than in-line animal studies.

Do you actually have an animal tox study scheduled to ramp up in the fourth quarter of '06, or is it going to be primarily lab work, chemistry going on there in calendar '06?

In the new facility?

Yes, in the new facility.

The new facility really will just be -- the facility will be open and validated in Q4, and the business activity will start there in the first quarter.

Okay, thanks very much.

Derik De Bruin with UBS.

Good morning.

Most of my questions have been answered, but just wanted to touch on a couple of points.

Just a little bit confused on comparing the non-GAAP numbers year-over-year between the [56] and the 52.

The 52, is that excluding a stock option number in the 52 for last year?

Yes, I believe that is correct, Derik.

Okay.

That is about $0.03?

I think it was about $0.02.

About $0.02, okay.

I guess the other question I had was there is some -- you did exclude about $200,000 in stock-based related comps from the quarter.

I guess this was related to the Inveresk acquisition.

Why was that excluded?

Well, the portions -- that was a non-GAAP adjustment, I think would be your question.

So really all we were doing was pointing out that one of the differences between GAAP and non-GAAP was the amortization and equity expense associated with the Inveresk acquisition.

Of course, that piece that we noted is the remaining piece of course doesn't include the Phase II-IV, for example.

Okay.

So that is just basically we feel kind of obligated to say what the GAAP/non-GAAP difference is, rather than just point out what the GAAP and non-GAAP EPS is.

Okay.

And I guess you had briefly touched upon talking about some pricing in the RMS business.

You had said last quarter that your main competitor was raising prices in this space.

If you could just talk about are you still seeing that and the other pricing trends in the RMS?

Yes, we've seen both of our primary competitors, one in particular, be aggressive with their price increases.

One of our competitors follows us in terms of the time of year that they increase their prices.

So, yes, we have seen that continue.

As I said earlier, that causes compression in a positive way with our price points, which really, I think, has been beneficial to us, principally in the academic sector and in some other markets where we have stronger -- better proximity from a location point of view and larger facility capabilities.

So while pricing is something that we will, I think, always strive for and always be able to get, we've been consciously trying to be rational in our price points and considerate and thoughtful of the needs of our clients.

Okay.

I guess as the new facilities come online, last quarter you managed to get a little bit of new capacity online.

It doesn't sound like you got any more this quarter.

Are you expecting to have any business book through as you get the Shrewsbury initially opened in the fourth quarter?

A little difficult to hear you.

But --

The question I said that you had said that last quarter you had a little bit of additional capacity come online.

It sounds like that you're at optimal capacity now.

Do you expect to have any business booked from the new Shrewsbury facility in the fourth quarter?

No.

The new business for the Shrewsbury facility would be instigated in the first quarter of '07.

Okay, thank you.

Paul Knight with Thomas Weisel Partners.

Jim, can you talk about what were the drivers behind the 7% RMS growth?

Sure.

We had strong sales in North America, growth in production and sales.

I'd say that's one of the biggest items.

That's a very large business for us and really emblematic of research demand.

And also nice growth in Europe and Japan.

I'm just saying in the basic production business.

You are saying unit volume?

Yes, I am saying unit volume.

And then the last question is, what is your unit outlook for next year?

Are you optimistic about that unit environment for '07?

We haven't either finished or commented on '07 yet, Paul.

So I'm going to hold off commenting on that, except to say that what we did see on the second quarter is we saw sales depressed by really a handful of clients whose unit purchases and were way below the prior year.

We did feel that that would ease and soften, because it is essential for them to ultimately increase the unit purchases in order to increase the discovery efforts, and we're beginning to see that.

So directionally, we would anticipate that that would continue to ease in most of the clients.

But again, we're putting the final touches on our '07 plan and we will be having a conference call in about a month to specifically talk about '07.

Okay, thanks.

John Sullivan with Leerink Swann Investment.

Good morning.

Tom, I was just going to ask you to go over the revenue guidance for the business units in the fourth quarter again.

In RMS, are you saying fourth-quarter sales lower than third-quarter sales?

No, I think what Jim had said was that we would expect it to be somewhat comparable year-over-year with the fourth quarter of last year.

In RMS?

Right.

And I don't think he said anything more than that on Preclinical.

So for Preclinical, fourth quarter comparable to fourth quarter of last year -- is that what you are saying?

No, we really didn't provide that breakout, John.

Really what we said is for the total year, 6% to 8%.

And I think that is where Jim's comments were directed.

And I mentioned separately the impact of the 53rd week, which we had in the fourth quarter last year.

I understand.

So is there firmwide revenue guidance for the fourth quarter?

No, we did not break that out.

Okay, thank you very much.

That does conclude our question-and-answer session.

I'd like to turn the call back over to Ms. Susan Hardy for any additional or closing remarks.

Thank you for joining us this morning on our third-quarter conference call.

We'll look forward to seeing you in the future and that concludes the call.

Thank you very much.

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