Charles River Laboratories International, Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 29, 2014; comparisons are with the three months ended March 30, 2013. The company is a global contract research organization with Research Models and Services (RMS) and Preclinical Services (PCS) segments. Figures below are in U.S. dollars; financial statement amounts are in millions unless stated otherwise.
Financial performance and position
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $299.4 | $291.2 | +2.8% |
| Gross margin | 36.3% | 35.8% | +0.5 percentage points |
| Operating income / margin | $39.7 / 13.3% | $42.8 / 14.7% | Income down 7.2% |
| Net income attributable to common shareholders | $32.2 | $25.6 | +25.8% |
| Diluted EPS from continuing operations | $0.67 | $0.53 | Up |
| Cash from operating activities | $28.5 | $30.0 | Down 5.0% |
| Cash and cash equivalents at period-end | $169.9 | $155.9 at Dec. 28, 2013 | Up $13.9 |
| Total debt at period-end | $640.1 | $663.0 at Dec. 28, 2013 | Down $22.9 |
Revenue growth included a 0.4% favorable foreign-exchange effect. Product revenue was $127.0 million and service revenue was $172.3 million. Other income was $5.9 million, including $6.1 million of gains on venture-capital limited-partnership investments; interest expense fell to $2.8 million from $8.3 million, chiefly following retirement of the 2013 convertible debentures. These items helped net income and EPS rise despite lower operating income.
Operating cash flow was affected by working-capital movements, including lower taxes payable and higher receivables. Capital expenditures were $11.2 million. Investing cash flow was a $6.5 million outflow, compared with a $28.8 million outflow a year earlier, which included the Vital River acquisition. Financing cash flow was a $6.1 million outflow; the company reported a $23.2 million net debt paydown and $20.8 million of treasury-stock purchases. Cash and marketable securities totaled $181.3 million, most of the cash held by non-U.S. subsidiaries and described as indefinitely reinvested.
Debt consisted primarily of $404.3 million in term loans and $235.6 million drawn on the revolving credit facility. The $970 million credit facility matures in May 2018; the company reported compliance with its financial covenants. Current assets were $590.7 million and current liabilities were $239.3 million at quarter-end.
Material changes and segment results
- RMS: Revenue increased 1.7% to $185.6 million, but operating income declined 3.3% to $53.5 million. Research-model revenue fell 3.6%, primarily on lower volume amid biopharmaceutical industry consolidation and reduced U.S. government sales. EMD revenue rose 19.1%.
- PCS: Revenue increased 4.6% to $113.8 million and operating income increased 48.1% to $12.0 million. Management cited higher study volume, improved biologics-testing profitability, favorable Canadian foreign exchange, and higher UK research and development tax credits.
- Consolidated operating income was pressured by corporate overhead, up 25.2% to $25.9 million, including acquisition evaluation and integration costs, and by RMS efficiency-related charges. Gross margin improved mainly because of PCS performance.
- SG&A rose 13.3% to $64.8 million, or 21.6% of revenue versus 19.6% a year earlier.
Outlook, commentary, risks and unusual items
- No specific full-year revenue, earnings, or cash-flow guidance is provided in the filing. Management cautions that interim results are not necessarily indicative of full-year results.
- The company acquired Galapagos N.V.’s CRO services division, including BioFocus and Argenta, on April 1, 2014, after quarter-end, for a preliminary $190.7 million cash purchase price plus up to $6.9 million contingent consideration. Management expects the deal to expand integrated early-stage CRO capabilities. It was funded with approximately $75 million of cash and $116 million of additional revolver borrowings.
- The planned Portage, Michigan facility closure and transfer of production will generate restructuring and impairment costs. Q1 included $0.7 million of impairment and other charges, $0.3 million of accelerated depreciation, and approximately $1.0 million of severance; further 2014 charges are expected, including about $0.8 million of additional accelerated depreciation.
- Limited-partnership investment gains are subject to substantial volatility; management expects related other income or expense to remain volatile and unpredictable.
- The company reserved $1.5 million for excess billings identified on certain government contracts since 2007. It stated additional losses are reasonably possible but could not estimate a range beyond the reserve. A separate Mauritius supplier arbitration had concluded its hearing and final arguments; the company could not estimate a possible loss.
- The company remains guarantor of a lease for a disposed Phase I clinical facility; the carrying liability was $9.3 million and remaining lease payments totaled $11.1 million. It also reported tax audits and potential uncertainty around future interpretations of French and German tax rules, while stating it did not expect current audits to materially affect results.
- A hypothetical 100-basis-point increase in interest rates would raise annual pretax interest expense by approximately $9.5 million. No foreign-exchange contracts were open at quarter-end.
Most important facts for investors to verify
- Whether underlying operating performance can improve after the decline in consolidated operating margin, particularly given rising corporate costs and weaker RMS operating income.
- The sustainability of earnings growth: Q1 net income benefited from investment gains, lower interest expense, and tax-related items.
- Post-quarter acquisition integration, final purchase-price allocation, and the effect of the $190.7 million acquisition and related borrowing on leverage and liquidity.
- Actual remaining costs and operating benefits from the Portage closure and other efficiency initiatives.
- Resolution and potential exposure from the government-contract billing matter and Mauritius arbitration, as well as the continuing Phase I lease obligation.
- Cash accessibility: most cash is held outside the U.S. and is indefinitely reinvested; also monitor floating-rate debt exposure and investment valuation volatility.