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Executives

Michael McKelvey – President and CEO

Keith Schneck – CFO and EVP

Analysts

Raghavan Sarathy – Dougherty & Company

James Terwilliger – Duncan-Williams

David Larson – Leerink Swann

Gene Mannheimer – Auriga

Raymond Myers – Benchmark Company

Mitra Ramgopal – Sidoti

eResearchTechnology, Inc. (ERES) Q2 2010 Earnings Call Transcript August 9, 2010 5:00 PM ET

Operator

Good afternoon and welcome to the ERT 2010 second quarter results conference call. All participants will be in a listen-only mode. (Operator instructions) Please note that today’s event is being recorded. At this time, I would like to turn the conference call over to Dr. Michael McKelvey.

Dr. McKelvey, please go ahead.

Michael McKelvey

Thank you, Jamie, and good afternoon. Thank you for joining us for ERT’s second quarter 2010 earnings results conference call. A press release announcing the second quarter results was released this afternoon and is available at the ert.com and most financial websites. This press release includes the financial results for one month of our recent acquisition of CareFusion’s Research Services division or RS.

This is a transformative acquisition that we’re very excited about. Joining me today is Keith Schneck, Executive Vice President and Chief Financial Officer.

Prior to beginning the call, I would like to read the forward-looking event statement. Certain statements in today’s call may constitute forward-looking statements concerning the company’s operations, performance, financial conditions, and prospects as well as the RS acquisition and its potential impact on ERT. Because such statements involve known and unknown risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements.

In addition, anticipated strategic benefits from the acquisition as well as our ability to successfully integrate the operations of RS in ERT may impact future results. Information about these risks and factors that could cause actual results to vary as disclosed in the press release announcing our results and the RS acquisition and in the Risk Factors section of the 2010 Form 10-Q report and our 2009 Form 10-K report.

Guidance is based on management’s good faith expectations given current market conditions, but any further deterioration of general economic conditions in addition to other factors cited elsewhere, could result in the company not achieving the revenue and diluted net income per share figures provided in our guidance.

Our forward-looking statements speak only as of the date made. We do not undertake and expressly disclaim any obligation to update forward-looking statements to reflect events or circumstances after the dates of these statements, except as required by law. You are cautioned not to place undue reliance on our forward-looking statements.

In addition to GAAP financial measures, we used certain non-GAAP financial measures that exclude charges related to amortization of the acquired intangible assets and the acquisition and other costs related to the recent acquisition of RS and related income tax effects. ERT believes that these non-GAAP measures are useful to investors because of the supplemental information facilitates comparisons of its operations from period-to-period and to the performance of other companies within its industry and also assisting gaining a better understanding of its operating results and future prospects. The discussion of the use of non-GAAP measures is contained in the press release that we issued this afternoon.

I will first give highlights for the second quarter and details on new bookings and our operations. Keith will then discuss the detailed financials for the quarter. I will then discuss some strategic directions for ERT as a result of the acquisition of RS. We will then open up the call to questions.

The second quarter saw a fundamental strategic shift in our business. The acquisition of RS has significantly increased market opportunity and has given us a much broader set of products and services to offer to the clinical trial industry. This has enhanced our platform by enabling us to deliver additional products and services in the future.

Specifically, we now have an industry leading suite of products in respiratory diagnostics for clinical trials that encompass the primary respiratory diseases of COPD, asthma, and cystic fibrosis. We have added significant additional capabilities to our ePRO product and service lines by adding a PDA like device called VIAPad as well as a pen based device called VIAPen. We’ve also added a whole new dimension to the products and services that we can offer our own proprietary diagnostic devices for clinical trials.

These devices give us a great land expanded approach to offer and customize product solutions using multiple modalities for the acquisition of important information in clinical trials. We believe this offers us a key strategic competitive advantage in our industry. These devices also support and enable our future strategy of providing products and services into the healthcare industry.

We’ve received a very favorable reactions and clients, investors, and other stakeholders regarding the potentials for this acquisition on our future business, many clients have expressed support for buying multiple services from one vendor, especially vendors with a strong reputation for quality and services that ERT and RS have in the marketplace.

Other advantages cited by clients are bringing together with a combined medical expertise of two of the leading providers of technology and services used in clinical trials, the increased resources that the company can bring, the increased global footprint of the combined company, and the advantages of working with the company whose sole current focus is on clinical trials.

We define legacy RS and legacy ERT as the organizations as they existed prior to May 28. We are providing some details this quarter on financials for those two organizations separately to provide some historical perspective. Going forward, we plan to face out the distinct reporting of these financials as they will become increasingly difficult to separate.

The second quarter of 2010 showed a significant sequential increase in revenue from the first quarter of 2010 with much of this coming from RS all in the month of June and also a healthy increase from legacy ERT. This increase in legacy ERT revenues is due to the high levels of bookings in the past few quarters that are now starting to turn into revenues.

On a sequential basis, legacy ERT revenues increased 7% in the second quarter and excluding revenues from the EDC operations we sold in June of 2009, increased slightly from the second quarter of 2009. This is the first year-over-year increase in revenues that we have seen since the fourth quarter of 2008.

The increase in legacy ERT revenues was primarily due to a pickup in routine ECG revenues and to a lesser extent, a continued recovery of Thorough QT revenues. While the exact timing of the rebound in Thorough QT revenues remains difficult to predict, we see positive signs in increased bookings and client interest in Thorough QT trials.

The 5.7 million in revenues from RS in the second quarter of 2010 represented a 4.2% increase from the monthly average of RS revenues in the first quarter of 2010, which period was included in the Form 8-K/A that we recently reported. This represents a 36.7% increase from the monthly average of RS revenues in calendar year 2009.

Our gross margin percentage was 54.4% in the second quarter of 2010, up from 53.8% in the first quarter of 2010 and up from 52.3% a year ago, the increase was due to higher volumes and continued productivity improvements. Compared to a year ago, the gross margin percentage increased by 210 basis points. This is a testament to some of the operational changes and efficiencies that we have been enact over the past year in legacy ERT.

GAAP operating income in the second quarter of 2010 was impacted by 4.7 million of acquisition and integration related costs and amortization of acquired intangibles, and other assets related to the recently announced acquisition of RS. This resulted in both sequential and year-over-year declines in GAAP operating margin.

The GAAP operating margin percentage in the second quarter of 2010 was 3.6% compared to 12.6% in the first quarter of 2010 and 20.0% a year ago. On a non-GAAP basis, which excludes the expenses I just mentioned, operating income margin percentage increased sequentially or was slightly lower when compared to a year ago.

The non-GAAP operating percent – margin percent in the second quarter of 2010 was 19.7% which was up from 16.0% in the first quarter of 2010 but down slightly from 20.0% a year ago. GAAP diluted net income per share was down both sequentially and from a year ago. GAAP diluted net income per share in the second quarter of 2010 was $0.02 compared to $0.04 in the first quarter of 2010 and $0.05 a year ago.

However, on a non-GAAP basis, diluted net income per share was up both sequentially and from a year ago. Non-GAAP diluted net income per share in the second quarter of 2010 was $0.08, up from $0.05 in the first quarter of 2010 and up from $0.05 a year ago.

Let me give a little more color on the quarter’s new bookings. The second quarter saw another strong new bookings quarter of $51 million, this included $7.4 million in new bookings in June from legacy RS and $43.6 million in new bookings from legacy ERT. Compared to the prior year’s quarters, new bookings were up 26% when you exclude those new bookings attributable to RS in this year’s quarter and exclude those related to the EDC operations that were sold in 2009 in last year’s quarter.

Our strong bookings in the quarter are a tangible example of what our business development team continues to characterize as a robust selling environment. The increase in large project and program awards that we noted last quarter continued in the second quarter. This is a reflection of the increase in Phase III awards, which accounted for nearly 60% of our new bookings in the second quarter and is also result of the impact of the strategic outsourcing relationships that we have won.

Large pharmaceutical companies continue to represent the largest part of our new bookings by client size at 48%. However, we did see a significant increase in new bookings from small to medium sized clients which represented 42% of total new bookings.

This segment of the market has seen some softness over the past couple of years, but we see indicators have increased in funding for this sector. Another factor in increase in bookings was our continued focus on the value proposition of centralization, which is resonating well with our clients.

The pickup in the small to medium sized segment also bodes well for new Thorough QT bookings. As the vast majority of our Thorough QT studies have historically come from this segment of the market. Based on conversations with several clients, it seems that the small to medium sized segment of the market is seeing enhanced access to credit and investor interest. However, we are well aware that one quarter does not a trend make. We will continue to monitor this in the near-term.

The quarter showed that third consecutive quarterly increase in Thorough QT new bookings reaching the highest levels since 2008. Interest in Thorough QT trials by our clients is starting to pick up again. We continue to build a larger pipeline of potential Thorough QT trials. However, going from pipeline to signing contracts is slower than we had seen historically.

The bookings profile of legacy RS is similar to that of legacy ERT. Except that it is more heavily weighted toward Phase II and Phase III studies. The distribution by client size for legacy RS is roughly similar to that of legacy ERT. In terms of legacy RS, much of its business was from large biopharma companies and almost all of it was focused in Phase II and Phase III.

We see stabilization in pricing with selected areas of increase. This reflects the strong demand for our services and the industry as well as a mix shift toward more small to medium sized clients.

As we stated last quarter, early indications are that new business development activities remain robust into the current quarter. Our business development group has indicated to me that we’re off to a good start to the quarter in July. This cuts across our cardiac safety, respiratory and ePRO product lines.

Our backlog at the end of the second quarter of 2010 was a record $299.4 million, this includes $103.4 million in backlog from legacy RS. Because of a high proportion of the backlog is associated with Phase III studies, the time period for revenue realization from the backlog will increase.

In terms of backlog runoff, we anticipate that 40 to 45% of our backlog will convert into revenue over the next four quarters. The gross book-to-bill ratio in the second quarter of 2010 was 1.8 down from 2.0 in the first quarter of 2010 but up from 1.5 a year ago. The net book-to-bill was 1.5. These book-to-bill ratios are healthy and reflect the transformation from Thorough QT trials which generally have a book-to-bill ratio of close to 1, the longer term Phase II and Phase III trials as well as an improved business development environment.

The cancellation rate for the second quarter of 2010 declined to 9.7% from 21.3% in the first quarter of 2010 and down from 16.1% a year ago. Our revenue for ePRO in the second quarter of 2010 was slightly lower than in the first quarter of 2010. However, we had a record number of new study startups in the quarter which is a positive indicator for the future. While still a very small part of our overall revenue, we are pleased with the positive trends in this area.

In this quarter, we announced the release of a new study from the TUFTS Center for the study of drug development on the adoption of centralized cardiac safety assessments. The new study, supported by another restricted grant from ERG, focuses on the use and adoption of digital and electronic ECGs and reports on industry perceptions regarding the use of a centralized cardiac safety assessment provider and support of clinical studies. While the study reported it only 33% of respondents currently used at centralized ECG approach, which is in line with our own internal analysis, 89% of respondents expect to use the centralized ECGs to increase within the next five years.

The significant increase in the adoption of centralization is due to regulatory pressures and sponsors need to provide high-quality data. We believe that this bodes well for us in the future. The results of the study confirm that respondents yield that the centralized core labs are valuable way of conducting cardiac safety assessments and most executives that were interviewed believe that a higher proportion of cardiac safety studies will be handled by centralized providers in the future.

97% of respondents rated central labs is being more accurate and 90% rated them as being more efficient than a decentralized approach. Despite the reluctance to deviate from using a decentralized approach due to financial concerns, the tough support demonstrates the perceptions are changing. 70% of respondents rated the cost of using an ECG core lab to be less than or equal the cost of using paper. The study further highlights the integrating data and workflows into a core lab can result in improved patient safety, increased productivity, allow faster database locks, enhanced service, greater satisfaction and potential cost savings, all of which are offered by a centralized approach.

We feel that this paper provides compelling insight into the advantages of centralization of ECGs. We believe that many of its findings could well be extended to centralized respiratory diagnostics and ePRO.

I will now turn the call over to Keith for some more details on our financials for the quarter and for guidance for the second quarter of 2010 and the full year 2010.

Keith Schneck

Thank you, Mike. Let me first confirm the numbers. Second quarter revenue was $29.1 million up $7.2 million or 33% sequential increase from $21.9 million in the first quarter of 2010 and up $4.9 million or a 20% from the $24.2 million in the second quarter of 2009. The sequential increase in revenues is due to $5.7 million related to the June 2010 activity of RS and a $1.5 million increase in the legacy ERT revenue. Comparing to a year ago, our revenue is up due to the $5.7 million of RS revenue and an increase of $0.3 million in the legacy ERT business, partially offset by a 1.1 reduction related to the EDC business, which was sold in June 2009 but contributed revenue in that quarter.

Services revenue is up $3.9 million sequentially due to the RS contribution of $2.6 million and an ERT increase of $1.3 million. Site support revenue is up $3.4 million sequentially due to the RS contribution of $3.1 million and a legacy ERT increase of $0.3 million. RS has a higher mix of site support revenue than services revenue due to the significance of the respiratory equipment and related products to a total study value.

Services revenue comparisons to a year ago reflected $2.6 million of RS contributions for June 2010 and legacy ERT services revenues decreasing $0.1 million with ePRO showing $0.4 million increase offset by a $0.5 million decrease in cardiac safety services. Site support revenue increased $3.5 million year-over-year due to RS contributions of $3.1 million and legacy ERT increasing $0.4 million.

Gross margin percentage for the second quarter of 2010 was 54.4% compared to 53.8% in the first quarter of 2010 and 52.3% in the second quarter of 2009. Impacting gross margin in the second quarter of 2010 is $0.8 million of amortization of RS intangibles and other costs which we allocated 50% to services and 50% to site support.

Our gross margin percentage on site support was 52.3% for the second quarter, down sequentially from 60.2% in the first quarter but up from 49.5% a year ago. We continue to benefit from lower depreciation on our cardiac safety ECG equipment as a portion of our older more expensive ECG equipment has become fully depreciated.

In addition, we have more equipment in the field, which is contributing a higher revenue level with a fixed cost basis. Site support margin is down sequentially from 62.2% – 60.2% in the first quarter as we have reported costs associated with our customer support center into the site support costs to better align these costs with a related revenue and the amortization of RS acquired intangibles. These costs totaled $600,000 in the June quarter which previously we reported in costs of service revenue.

Gross margin percentage on services was 55.5% for the second quarter of 2010, up sequentially from 50.7% in the first quarter of 2010 and up from 52.7% a year ago. The increase in margin percentage is driven by the transitioning of customer support costs, out of the services category and into site support category offset by amortization of acquired RS intangibles.

Margins are also up sequentially on the legacy ERT business, due to about a 12% increase in transaction volume. Operating expenses for the second quarter of 2010 were $14.8 million compared to $9 million in the first quarter of 2010 and $7.8 million a year ago. Operating expenses include $3.8 million in the second quarter of 2010 and $0.7 million in the first quarter of 2010, a transaction related costs including legal, accounting, investment banking fees and other related fees associated with the RS transaction.

Operating expenses also included $2 million related to RS operations including $0.5 million of sales and marketing, $1.2 million of G&A and $0.3 million of R&D. Comparing to categories of operating expense, sales and marketing was $3.9 million in the current quarter compared to $3.4 million in the first quarter of 2010 and $0.3 million a year ago with most of the increase due to RS expenses.

G&A was $9.8 million in the second quarter of 2010 compared to $4.7 million in the first quarter of 2010 and $3.5 million a year ago. Excluding the RS transaction costs of $3.8 million and $0.7 million in the second and first quarters of 2010 respectively, G&A increased $2 million sequentially and $2.5 million from a year ago.

In addition to the June RS G&A expense of $1.2 million, we recorded higher bonus and stock-option expense and also recorded an additional $0.6 million to our renew Nevada lease reserve related to the unused facility from the Covance's cardiac safety acquisition in 2007. The remaining lease obligation, which runs from through 2013 is fully reserved at this time.

R&D expense was $1.1 million in the second quarter of 2010 compared to $0.9 million in the first quarter of 2010 and $1 million a year ago.

Moving to income taxes. Our effective tax rate for the second quarter of 2010 was 42.9%. We are projecting a 40% effective rate for the year, which was also the effective rate for the six months ended June 30, 2010. The 2000 tax rate is impacted by several unusual items including, about $4 million of the RS transaction costs, which are not deductible for tax purposes, which increased our effective rate. Offsetting this is the positive impact of the inclusion of the RS operations with income allocated to Germany with a tax rate of about 28.5% which is much lower than the combined US state and local tax rate of our US based legacy ERT operations.

We also had implemented several structural changes within our US and international corporate entities which has a positive impact on our overall effective tax rate. The net effect is that we estimate our non-GAAP effective tax rate to be about 35% for 2010, which excludes the negative impact of the non-deductible transaction costs.

Let me now move to the balance sheet. Balance sheet looks very different due to the acquisition of RS. We entered the quarter with – we ended the quarter with $22.6 million in cash and investments compared to $79.2 million as of March 31, 2010. For the quarter, net cash provided by operating activities was $7.1 million, we paid CareFusion $80.3 million in cash on May 28, 2010 for the RS acquisition, we also have a $2.9 million additional payment due CareFusion in late August in final closing balance sheet adjustments as defined in the purchase agreement all subject to final review of those adjustments.

This brings the total cost of the acquisition to $83.2 million. In addition to use of our existing cash, we borrowed $23 million from our new $40 million line of credit with Citizens Bank. As of June 30, 2010, this borrowing remained outstanding.

Accounts receivable was $31.7 million at June 30, 2010 compared to $15.3 million at March 31, 2010 with RS adding the $15 million of the increase. DSOs were 64 days at June 30, 2010 and in line with our recent quarters. Inventory is $3.2 million at June 30, 2010 and this is a new category coming over from RS as they directly manage the manufacturing of their equipment.

Net PP&E has increased from $25.1 million at March 31, 2010 to $38.3 million at June 30, 2010, but major changes due to the net addition of the RS equipment of $11.2 million, second quarter PP&E additions of $4.9 million, partially offset by second quarter depreciation of $2.9 million.

Goodwill increased $37.3 million from the $34.7 million at March 31, 2010, the $72 million at June 30, 2010 due mostly to the RS acquisition. Total purchase price of $83.2 million was allocated to the following categories. We received $24.9 million of hard assets acquired including accounts receivable, inventory and the net book value of PP&E, which primarily included the rental equipment offset by liabilities assume.

$21.1 million was allocated to the acquired intangible assets based on the valuation we completed with accordance with FAS 141 (R) which consist primarily of technology and acquired backlog. The net difference of $37.2 million is then allocated to goodwill.

Non-GAAP. Starting this quarter and moving forward, we will be providing various non-GAAP financial measures including non-GAAP operating income percentage, non-GAAP net income, non-GAAP effective income tax rate and the non-GAAP diluted net income per share. A reconciliation of these measures is included within the press release and includes the ad back of the RS transaction and integration costs and the RS amortization of acquired intangibles and other assets and their related tax effect using our assumed non-GAAP income tax rate of 35%.

GAAP net income for the second quarter of 2010 was $0.8 million or $0.02 per diluted share. The non-GAAP net income was $4 million or $0.08 per diluted share.

Moving to guidance, we have adjusted our 2010 for revenue and diluted net income per share to factor in the RS acquisition and the present view of our business. We expect net revenues of between $84 and $89 million for the second half of 2010, resulting in net revenues of between $135 million and $140 million for the full year 2010. For the second half of 2010, we expect GAAP diluted net income per share to be between $0.11 to $0.16 per share and non-GAAP diluted net income per share to be between $0.21 and $0.26 per share.

This result in guidance for the full year 2010 for GAAP diluted net income per share of between $0.16 and $0.21 per share and non-GAAP diluted net income per share of between $0.34 and $0.39 per share.

I will now turn the call back to Mike.

Michael McKelvey

Thank you, Keith. Let me now discuss the acquisition of RS that we completed on May 28. We feel that this combination is a transformative one for ERT. It provides us with an expanded product portfolio and allows us to become more of a full service provider to the clinical trial industry as opposed to denticulate a one product company.

We wanted to complete an acquisition of sufficient size to move the needle as opposed to a set of smaller acquisitions that are often as costly and time consuming to consummate. RS offers two services that are complimentary to those previously offered by ERT, cardiac safety and ePRO. RS is also a leading provider of respiratory diagnostic services and a leading manufacturer of diagnostic devices used in clinical trials.

This acquisition delivers on our stagnant strategy to leverage our leadership position in cardiac safety and our expertise as a service and technology provider to more broadly support the centralized collection, standardization, interpretation, and delivery of critical clinical efficiency and safety information for all phases of clinical research.

We believe that the RS acquisition will open up additional markets for us in the clinical trial area in the future. We have discussed the attractiveness of developing products and services for the post marketing clinical trials market in the past. We see several of the products and service offerings of RS providing us with a boost to get into this attractive market.

In addition, we see opportunities in the pharma marketing space. There were also opportunities to leverage the product and services from RS into the health care industry. We’ve always talked about health care as a long run opportunity but we see more opportunity now and perhaps sooner based on this acquisition.

It is important to highlight some of the goals of our integration activities of the two companies over the next few months. We have highlighted four goals that will drive our integration activities. First, ensure that all commitments to our customers continue to be delivered without interruption. Second, leverage both company’s successful approaches and processes to create one new and efficient organization. Third, provide our clients with innovative new services and more capacity. And fourth, provide for continued growth forward and increase opportunities for our employees.

So far, we see the opportunities from this acquisition is greater than we had originally envisioned. The response from our clients and our investors has been very favorable. The opportunities to cross-sell our existing cardiac safety and IVR based ePRO services to both our expanded existing client base as well as new clients appears very attractive.

The optimism about the future prospects based on this integration is certified [ph] in the guidance for the second half of 2010 that Keith outlined a couple of minutes ago.

In the press release announcing the transaction, we gave our expectation that excluding amortization of acquisition related intangibles and transactions cost or non-GAAP diluted net income per share, we anticipate that the acquisition would be neutral to diluted net income per share in 2010 and accretive in 2011.

Our revised guidance indicates that we now believe the RS acquisition will be accretive in 2010 to the tune of approximately $0.06 in the second half of the year on a non-GAAP basis. There are now nearly 300 million in contracted backlog for ERT provide the strong basis for future revenue growth.

Our main focus over the upcoming months will be on successfully integrating the two organizations to provide superior service to clients and to provide a platform for future growth for ERT. This transaction has significantly increased the size of our potential market. As in ECG core lab, legacy ERT had an estimated potential market size of approximately 750 million. We now believe that as a global integrated service and technology provider, the new ERT will compete in a market with potential size of at least 1.3 billion.

The augmented depth, breadth, and scale of a new ERT increase the opportunity to move into adjacent markets that will further increase our potential market opportunity. We also see continued attractive growth opportunities in the cardiac safety market. Over the last few quarters, they’re seeing significant declines in Thorough QT transactions in our core business Phase I through IV routine transactions have continued to increase.

Routine transactions were up 16% from a year ago. Although there has been recent softness in Thorough QT revenue, the guidance from the regulatory agencies that these trials must be conducted remains unchanged. This gives us cause to believe that this segment of the market will continue to pickup.

We break our growth drivers for cardiac safety into two broad segments, those we cannot control and those that we can control. The two that we cannot control are the growth in biopharma R&D spending and the focus on cardiac safety by regulatory agencies. With respect to the growth in biopharma cervical spending, we see increases in spending by large firms and a brighter outlook for spending by small to medium sized firms than in the past year.

Well perhaps not back to the days that the 10 to 12% annual growth in R&D spending, we do see positive growth in the low single digits in this area. With respect to the focus on cardiac safety, we see continued emphasis by the FDA, the EMEA, the Japanese Ministry of Health and other global regulatory bodies and ensuring the rigorous testing regime for new drugs. Cardiac safety is certainly one of the areas that they continue focus in this regard.

The two growth drivers that we can control are increasing centralization and increasing market share. The key around the centralization message is the value proposition, the core ECG labs deliver higher quality data for equal or less cost than and with more convenience. The reduced cost part of the value proposition is the one that we have not highlighted as much as in the past that we have found that this message is starting to resonate with many of our clients and is leading to significantly more opportunities to centralize ECGs in especially late Phase studies.

We believe that we had made progress in the growth driver that we can control, market share. Market share is difficult to measure into all of our competitors our private companies are small divisions of public companies. However, we do feel that the combination of our success in procuring and utilizing large strategic outsourcing agreements are continued reputation for high quality, the continued focus on large complex and global trials that favor their provider that has the biggest global footprint and the addition of the cardiac safety business from RS have allowed us to increase our market share over the past few quarters.

With that, we will now take any questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Dougherty & Company. Please state your name followed by your question or comment.

Raghavan Sarathy – Dougherty & Company

Yeah. Hi, this is Rag; good afternoon. Thanks for taking my questions. I have couple of questions for Mike and the one clarification question for Keith and I’ll jump back in the queue. So Mike, I noticed that the cancellation rate was less than 10% in the quarter. What was the – was the – was a something one-time related thing that drove down the cancellation rate, can you comment on that?

Michael McKelvey

Rag, this is the first time we have included RS in the cancellation rate and they had a very low cancellation rate in the month of June and also the just the way that the project sell, we had fewer cancellations across all types of projects throughout the quarter or so. There wasn’t any one-time thing that that maybe changing.

Raghavan Sarathy – Dougherty & Company

So what is the cancellation that -- I know it was 20% for the ERT business, what is the cancellation rate and is the expectation – what are the expectations going forward?

Michael McKelvey

Well, cancellation rate was 9.7% for the quarter. We would expect it to go back up to more of a normal 15 to 20% range, it may go on the lower end of that range with the addition of RS but we will continue to be as 15 to 20% as a normal range for the cancellation rate.

Raghavan Sarathy – Dougherty & Company

All right. And then can you – can you update us on the automation, are you seeing any demand for automation? Where do we stand on that?

Michael McKelvey

No. The automation picture is the same as we have discussed for the last two to three years. We don’t see demand from our clients, so I continue last quarter business development folks, and that has not changed. We don’t win every project, we have a 50% market share or so but we haven’t really seen much change at all over the last couple of years for that.

Raghavan Sarathy – Dougherty & Company

Right. Then just one follow-up for Keith. So I know you gave a lot of numbers, but this time as I (inaudible) as fast as I can, so Keith you said that was about 3.8 million related to acquisition costs including G&A, you tried – you sort of gave some of sort of breakdown of that between transaction cost and maybe other things, can you repeat that?

Keith Schneck

No that’s the G&A – the cost that were included in G&A, let me just go through. 3.8 million of transaction related costs are included in G&A in the third – in the June quarter.

Raghavan Sarathy – Dougherty & Company

Right. Does it include any sort of restructuring stuff included on 3.8 million?

Keith Schneck

No, that’s primarily all really -- is all transaction driven. So it’s legal accounting investment banking fees and some other accessories.

Raghavan Sarathy – Dougherty & Company

Okay. And then just, if I may add one more question. So I noticed that you didn’t give us a third quarter guidance, so two questions, I mean is – going forward, are you not going to be providing us the forward quarter guidance and then how should we think about third quarter rather terms, I would imagine – I would expect that third quarter would give us of a baseline given you have one quarter of – one full quarter of both companies together.

Keith Schneck

Yeah. When we look at the forecasting just because we’re sort of new and the game with the RS piece being added. We really – we’re comfortable just giving, here is what the six month period looks like as well as there is things that could fall into September, could fall into October it’s really get timing issue and rather than trying to be measured on the accuracy of the September quarter versus the December quarter we’ve thought more comfortable giving overall guidance for the six month period.

Raghavan Sarathy – Dougherty & Company

So going forward, maybe as for the six months you would – you would go back to a normal way of providing quarterly guidance as well as full year guidance?

Michael McKelvey

Yeah. I think we would want to evaluate that. I think from a – from a going forward perspective, we’ve always been challenged with timings of things like (inaudible) coming in or not on a quarter. So I think what we reserve taking into evaluation of that over the next couple of quarters.

Raghavan Sarathy – Dougherty & Company

Okay. Thank you.

Operator

Our next question comes from the line of James Terwilliger from Duncan-Williams. Please go ahead with your question.

James Terwilliger – Duncan-Williams

Hey guys can you hear me?

Michael McKelvey

Yes James, how are you doing?

James Terwilliger – Duncan-Williams

Good. How are you doing? The revenue numbers look good. I’ve got some questions on some of the excluded charges, so just bear with me. The first question I’ve got is, going forward, just why are we excluding the amortization of the acquired intangible assets? Why are we taking the – are we going to be taking that out going forward?

Michael McKelvey

Yeah. That’s pretty consistent with the other companies in our space as well that have done transaction. So the amortization is a cause that determined at the time of the acquisition, it doesn’t change, it doesn’t add any value from a strategic perspective so we’re the more consistent among how other companies are presenting themselves in addition to – we don’t factor those kinds of things in as part of our own internal assessments in operational performance.

James Terwilliger – Duncan-Williams

Historically, we never excluded these, so the only reason we have a change is because the number is jumped up so much with the acquisition is that – is that correct?

Michael McKelvey

Well this is the first time we present any type of non-GAAP reporting. We’ve not done that before.

James Terwilliger – Duncan-Williams

Okay. And for the quarter, we excluded an intangibles of 833,000 is that – do I have the right number?

Michael McKelvey

Yes.

James Terwilliger – Duncan-Williams

And so that was with one month. So for example, Q3, should I be looking at about 2.4 million.

Michael McKelvey

Yeah. 2.4 – Q3 will be much higher because it’ll be a full quarter.

James Terwilliger – Duncan-Williams

And then that’s – is that a fair number to go, go forward with about 2.4 million, 2.5 per quarter?

Michael McKelvey

2.4 is about – is about right for Q3.

James Terwilliger – Duncan-Williams

Okay. Second question, just walk me through again how the GAAP tax rate is 40% – maybe I have it wrong, I apologize, I have the GAAP tax rate is 40% but I have written down that non-GAAP is approximately 35. Walk me through the tax rate adjustments again.

Michael McKelvey

It’s basically the effect of the non-deductible deal costs. So the transaction costs or the 4. – total amount is about 4.5, 4.6 of which about 4 million is non-deductible. So from a metal tamp [ph] standpoint we will not get the deductions, so it is treated as a permanent difference. If we didn’t have that situation, our effective rate would have been 35%.

James Terwilliger – Duncan-Williams

Okay. Is that the new rate we should use going forward, or 40%?

Michael McKelvey

Well, 40% is the GAAP rate for the year. That will be the tax rate for the year. 35% will be the non-GAAP rate.

James Terwilliger – Duncan-Williams

Okay.

Michael McKelvey

And then when you move into 2011, one would assume it’s going to be more closer to the 35% though we haven’t put that number out there.

James Terwilliger – Duncan-Williams

Okay. Again I don’t need to focus on the numbers. I’m just trying to make sure I’m looking at apples-to-apples and I think your revenue number was good and I think revenue number for the second half of the year is very robust, it’s very positive. So I want to give you guys credit, you guys have done a lot of work in a short amount of time. But one last housekeeping question and then I will jump back in queue. The other income line, can you provide me from additional clarity, because that was very, very nice number and so how did we get such a strong other income level?

Michael McKelvey

Well that’s really FX driven. So, it’s foreign currency; it doesn’t depending on what the – which way the numbers are going.

James Terwilliger – Duncan-Williams

And then when you tapped into that line on the long-term debt, can you tell me what the interest is on that?

Michael McKelvey

The interest is generally a LIBOR plus about 1.5%, so it’s under 2% right now.

James Terwilliger – Duncan-Williams

Okay. Great. I’ll jump back in queue guys. Thanks.

Keith Schneck

Well thank you James.

Operator

Our next question comes from David Larson from Leerink Swann.

David Larson – Leerink Swann

Hey, nice quarter. Just what the 830,000 in amortization and something I want to back that those cost out of the model here. Is half of that in – where – which cost of service lines are those following to half in half?

Michael McKelvey

Yeah. We just – 50% of it is in services.

David Larson – Leerink Swann

Yeah.

Michael McKelvey

And 50% in site support.

David Larson – Leerink Swann

Okay, right. And then, do you have the percentages for Phase I percent of total, Phase II percent of total and then Phase III was obviously 60%?

Keith Schneck

In terms of bookings?

David Larson – Leerink Swann

Yes. Or routine studies, people usually provide maybe in your queue or…

Keith Schneck

Right. We’ve – we don’t give those – what we’ve decided to do is just focus on one main number which is in that particular case of Phase III, but the Phase I was roughly in the 10% and the Phase II was roughly in the 15% range.

David Larson – Leerink Swann

Okay. And then, I’m sorry, the Thorough QT study was a percentage of totals, what was that number again?

Michael McKelvey

That’s a number we don’t we – we haven’t given out at the last couple of quarters as well.

David Larson – Leerink Swann

Okay. All right. Probably below 10%. Right that’s all I have thank you.

Michael McKelvey

As part of the reason is that now you’re adding bookings in from RS and so comparable percentages are bit off because RS doesn’t have their Q2 studies.

David Larson – Leerink Swann

Right. Just one other question, with the Thorough QTs, are those required by the FDA or those recommended by the FDA?

Michael McKelvey

Well there is guidance from the FDA that all drugs should look to see whether they need to run a Thorough QT test. They – you can get a waiver from the FDA about whether you need to run a Thorough or not but you need to go through the process, otherwise looking to see whether Thoroughs are required or getting the exception from the FDA or the EMEA or others.

David Larson – Leerink Swann

What percentage would you say actually get the exception in tone, actually have a Thorough QT study done.

Michael McKelvey

You know David I don’t know the answer to that question. I think it’s a high percentage that have to get the Thorough done but I don’t have the exact number that I could give you.

David Larson – Leerink Swann

Okay, great. Thank you.

Operator

Our next question comes from Gene Mannheimer from Auriga.

Gene Mannheimer – Auriga

Thank you and nice quarter and guidance guys.

Michael McKelvey

You’re welcome.

Gene Mannheimer – Auriga

Couple of questions, how do gross margins in the RS business compared to the legacy ERT and your full year guidance is based on gross margin in what range, can you…

Michael McKelvey

Well, we haven’t – we haven’t given that you but at this stage it’s based on just on the June month added margins relatively somewhere to where ERT is, if you exclude the amortization. I don’t – I’m not sure I go to bank with that one, right now, just because that’s just one month, it’s a not a year that makes it, plus the June month generally tends to be a higher revenue contributor than other month. So it’s going to be slightly lower I suspect is because the general nature of the business is right now it has more head count driven, touch points versus technology driven. So at this stage, we haven’t given a margin though I suspect, it’s not going to be a whole lot difference in where we are today.

Gene Mannheimer – Auriga

Okay, great. And with respect to the RS backlog, I think you mentioned it was about 103 million and I believe that’s down relative to where it was when you announce the transaction earlier this year. So is this – is this just a lumpy metric by quarter or would we expect that the backlog is going to be directionally higher at year-end. And then finally, what visibility do you have into that backlog relative to your legacy cardiac safety business? Thanks.

Michael McKelvey

Thank you, Gene. The backlog is lower for two reasons, one, when we originally looked at it, there were some earlier revenue put in that perhaps certainly have been that may have been 2 to 3 million, but the biggest impact was the change in foreign exchange. Foreign exchange went from the euro went from about 1.45 to 1.22 and so that had an impact on the backlog, which is why it’s 103.4.

Gene Mannheimer – Auriga

Okay.

Michael McKelvey

The second is in terms of visibility, you have some good visibility into the backlog of legacy RS. The large majority of their programs are in Phase II and Phase III. Their efficacy, so on their crucial endpoints, in terms of running the trial so you have some good visibility into that backlog as it runs down.

Gene Mannheimer – Auriga

Similar to what you have on cardiac safety or slightly better?

Michael McKelvey

Probably somewhere it’s a cardiac safety and a rough real time, yes.

Gene Mannheimer – Auriga

Okay. And then, last question if I could. Just on the size of the addressable respiratory market, could you remind us what that is and what share you currently have? And is that just a clinical trial services or does that also include device sales? Thanks.

Michael McKelvey

It would just the services side of respiratory diagnostics. Although devices associated with services that wouldn’t include just pure device sales, if you will. Our estimate is between 250 and 300 million and we’re working on trying to get a finer viewpoint as to what our market share is, we’ve used a number of 60% but it’s a number that I always quote – or always caution that we’re still trying to work through some more details on.

Gene Mannheimer – Auriga

Great. Thank you.

Operator

Our next question comes from Raymond Myers from the Benchmark Company.

Raymond Myers – Benchmark Company

Yeah, thank you. I just wanted to clarify something I heard as an answer to Gene’s question, about 2 or 3 billion of backlog was excluded because you shouldn’t have been there. Can you clarify what you meant by that?

Michael McKelvey

No. Is the one we were putting the number together originally because of all the changes in numbers that were just not the right calculation that we wanted to use and so it wasn’t – it was just a – in this calculation of the numbers that we gave back in the 115 numbers.

Keith Schneck

It really was a timing issue with respective, when we ask for information and that’s not having direct access to the books at that point, I think we have some communication in the steps of what we really asking for and the number that we had given or had been given had some additional bookings in it, it was kind of – more of a kind of type of issue.

Raymond Myers – Benchmark Company

But this is in the RS bookings?

Keith Schneck

Right.

Raymond Myers – Benchmark Company

Okay. Got it. And one thing, Michael that you said in your comments was bookings to be signed are taking longer than usual. Can you elaborate on that, I think we’ve heard similar things from Covance.

Michael McKelvey

Yeah. All right. The – that was particularly related to the Thorough QT and if you look at the history of ERT, often times, a Thorough QT study needed to be done very quickly, so the time between a bookings and actual running was fairly small. Now I think the Thorough QT is to become more engrained in the drug development spectrum of a company. So they know they’re going to need to do them and so that the contract for them, but there may be a longer period, 3, 6, 9, 12 months until you actually run the Thorough business. I guess it’s a sign of a maturity of the market as they look toward worth Thorough is needed to go.

Raymond Myers – Benchmark Company

Okay. And did you mean that it’s taking longer to get from signed contracts – from bookings to signed contracts. Where these – are these bookings signed in the first place?

Michael McKelvey

Vast majority of them are signed. Some are – others have got letters of intent, but there is always a piece of paper related to the signature.

Keith Schneck

The strong intention to do them is just a question of when they do them and the trend has been to delay.

Michael McKelvey

Right. And I think that the market is still working through some of the issues that had in 2008, 2009 with the recession in access to capital from small to medium sized firms, but as I mentioned on our prepared remarks, we see that they’re getting better over this environment.

Raymond Myers – Benchmark Company

Right. Great. Thank you.

Michael McKelvey

Thank you, Ray.

Operator

(Operator Instructions) Our next question comes from Mitra Ramgopal from Sidoti.

Mitra Ramgopal – Sidoti

Yes. Hi, good afternoon guys.

Michael McKelvey

Good afternoon.

Mitra Ramgopal – Sidoti

I just wondering, as you look at mix today regarding cardiac and RS, do you see it changing much as you look beyond – as you look into 2011 and kind of where the growth opportunities are?

Michael McKelvey

No. I think the – they both have good growth opportunities. I think there are number of large pharmaceutical companies that have very promising respiratory drugs out there. Cardiac safety is picking up as I mentioned in my prepared remarks, I think the mix would similar to where we are today.

Mitra Ramgopal – Sidoti

Okay. I don’t know when you announced the RS acquisition, your expected cost savings or synergies of 6 to 10 million by 2012, are you – given the new guidance area, is that one of the things that has factored in that you’re seeing on some of those synergies et cetera occurring now or?

Michael McKelvey

No. No, we really haven’t put anything in it at this stage. We said all along that, have of that 4 million or so would be in 2011 and the rest of it in 2012 and our integration plan, continues to be along those lines.

Mitra Ramgopal – Sidoti

Okay. And finally again, if you look in terms of where the revenue today is similar to back in 2008 but a much different operating margin then, what is your sense in terms of like perhaps we get back kind of the margins we saw at your peak?

Michael McKelvey

Well, lots have changed since. It’s really – if you look back on the 2008, it really was a volume driven margin creation. So until our ECG volumes step up to that level, we’re not going to get. We’ll make progress but that was really the high watermark as far as revenues and our – when you look at the OpEx as a percentage of revenues, we were down around 26% or so and so we need to drive revenues higher and keep OpEx obviously lower and that will ultimately drive the bottom line numbers. On the gross profit line, we’re getting closer we’re in the mid-50s. So on a non-GAAP basis and we’re getting closer.

Mitra Ramgopal – Sidoti

Okay. Thanks again.

Michael McKelvey

Thank you, Mitra.

Operator

And our next question comes from Raghavan Sarathy from Dougherty & Company.

Raghavan Sarathy – Dougherty & Company

Hi, thank you. Couple of more questions for Keith, actually for Mike. You said you’re expecting revenue conversion of 40 to 45%, did I hear that right Mike?

Michael McKelvey

Yes, you did. Yes.

Raghavan Sarathy – Dougherty & Company

So, is that – is that low enough because it takes longer for RS bookings to convert or it just reflecting what’s happening in a broader environment.

Michael McKelvey

No. It’s pretty way it’s consistent with what we’ve given in the last two calls. So I think that that has changed at all where we used the 40 to 45% from backlog.

Raghavan Sarathy – Dougherty & Company

Okay. And then in terms of – in terms of taking the guidance up, it seems like you’re not getting any cost in the adjacent at this point but still I had a few. So what is the long view to take the guidance out for you, you’re getting more revenues from Mala has been you anticipate or help us understand what’s enabling you to take up the guidance?

Michael McKelvey

Well, as I mentioned as earlier, we believe that our picture of our assess is more optimistic than we had looked when we about three months, the revenue profit of the business is very strong and we think now that we’ve got one more under belt and getting into the second and third months that we felt that was necessary to reflect that in our guidance.

Raghavan Sarathy – Dougherty & Company

Right. So I know you haven’t talked about 2011, where you said you’re expecting 30 to 35% growth on this business for this year but then you had, I think there are some cancellations that led to a very strong first quarter growth. So given what you’ve just saw on the business, how should we think about the growth on a steady state.

Michael McKelvey

Yeah. While you can quantify the 30 to 35% because of the cancellations in the first quarter of 2009. It’s probably too early, we haven’t talked about 2011 and so I think it would be premature for us to comment on that.

Raghavan Sarathy – Dougherty & Company

Right. Just the one final question for Keith. So Keith, when you walk to services revenue, can you walk us through again, I heard something about cardiac services, can you walk through the details on that? And then where are they including the revenues from RS, is it included in site support?

Michael McKelvey

Well, first of all, the products revenues are site support, correct.

Raghavan Sarathy – Dougherty & Company

Hey, what sort of margin is that for the product?

Michael McKelvey

We don’t – I’m sorry what sort of the margins?

Raghavan Sarathy – Dougherty & Company

Yeah, from product revenues from RS.

Michael McKelvey

Let me go back to the prepared remarks rather. Gross margin percentage on services was 55.5%, gross margin percentage on site support was 52.3% that includes products right? That includes product extract and then it also includes the equivalent to the 800 – half of the 833.000 in each of those categories of amortization.

Keith Schneck

Got it. Right.

Raghavan Sarathy – Dougherty & Company

So what sort of margins do you have for the product from…?

Michael McKelvey

Yeah. We don’t disclose that separately the product margins versus site support. It included in the site support launch. So…

Raghavan Sarathy – Dougherty & Company

Okay. All right. Can you walk us through again some of the moving?

Michael McKelvey

We basically said services revenue compared to a year ago reflects, 2.6 million of RS contributions for June. Legacy ERT services decreased slightly by 0.1 and of that ePRO was a 0.4 million increase offset by a 0.5 million decrease.

Raghavan Sarathy – Dougherty & Company

Got it. Thank you.

Michael McKelvey

Compared to that – that’s comparisons to a year ago.

Raghavan Sarathy – Dougherty & Company

Yeah. I got it.

Michael McKelvey

Okay.

Keith Schneck

Operator?

Operator

At this time, we’re going to turn the call back over to Michael McKelvey for any closing remarks.

Michael McKelvey

Well thank you. Thank you all very much for your attention today and your involvement with ERT. We appreciate your vote of confidence over the years and keep an eye, as well as all members of ERT’s management team are deeply committed to the company and to the integration and are continuing our momentum and progress on generating results. Have a very great evening and a great rest of the week. Thank you very much.

Operator

The conference is now concluded. We thank you for attending today’s presentation. You may now disconnect your telephone lines.

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