Charles River Laboratories International, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter ended September 28, 2019; comparisons are with the quarter ended September 29, 2018. Year-to-date figures cover the first nine months of each fiscal year. Amounts are in U.S. dollars.
Business context and performance
Charles River is an early-stage contract research organization serving drug discovery, safety assessment, research-model, and manufacturing markets. Its reportable segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing.
- Quarterly revenue was $668.0 million, up 14.1%; service revenue rose 18.1% and product revenue rose 1.8%. Management attributed growth mainly to Citoxlab and stronger DSA and Manufacturing activity. Foreign exchange reduced quarterly revenue by $7.7 million.
- Nine-month revenue was $1.930 billion, up 16.0%. Citoxlab and MPI Research together contributed $147.9 million of DSA service revenue growth; foreign exchange reduced revenue by $32.6 million.
- Q3 revenue by segment: RMS $132.5 million, DSA $420.1 million, and Manufacturing $115.3 million. DSA was the largest segment and grew 19.3% year over year.
Financial results and liquidity
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $668.0M | $585.3M | $1,930.1M | $1,664.6M |
| Operating income | $92.8M | $84.4M | $242.4M | $228.9M |
| Operating margin | 13.9% | 14.4% | 12.6% | 13.8% |
| Net income attributable to common shareholders | $72.8M | $60.4M | $171.7M | $166.7M |
| Diluted EPS attributable to common shareholders | $1.46 | $1.22 | $3.46 | $3.39 |
| Cash from operating activities | — | — | $300.3M | $301.2M |
- Q3 pretax income was essentially flat at $73.2 million versus $73.3 million. The $20.4 million deferred tax asset recognized in the quarter, related to expected use of net operating losses following changes to the international financing structure, was the primary reason for the lower tax expense and higher net income.
- Nine-month investing cash outflow was $610.6 million, including $515.6 million for acquisitions and $76.7 million of capital expenditures. Financing cash inflow was $271.0 million. Cash and cash equivalents were $164.8 million at quarter-end, down from $195.4 million at year-end 2018.
- At September 28, total debt and finance lease obligations were $1.930 billion, including $500 million of 5.5% notes due 2026; the weighted-average debt interest rate was 3.33%. The company reported compliance with credit-facility covenants. It said available funds, operating cash generation, and financing access should fund operations for the foreseeable future.
- Operating lease right-of-use assets and liabilities were $140.4 million and $136.9 million, respectively, following adoption of the new lease accounting standard; management reported no significant impact on income or cash flows.
Material changes and management commentary
- Operating income increased, but consolidated operating margin declined by 0.5 percentage point in Q3 and 1.2 points year to date. Management cited higher amortization, acquisition and integration costs, and investment in personnel and facility capacity.
- DSA margins weakened: Q3 operating margin was 15.5%, down 2.4 points; nine-month margin was 14.9%, down 1.8 points. RMS nine-month margin declined to 25.6% from 26.8%; Manufacturing nine-month margin was 30.2% versus 30.5%.
- Citoxlab was acquired on April 29 for a preliminary cash purchase price of $527.7 million. It contributed $44.0 million of Q3 revenue and $0.2 million of Q3 operating income. A supplier supporting DSA was also acquired in August for a preliminary purchase price of $23.4 million, net of settlement of a pre-existing supply agreement.
- Nine-month operating cash flow was nearly unchanged year over year. Management cited unfavorable timing in customer contract balances and compensation payments, partly offset by favorable vendor-payment timing.
- The company did not repurchase shares under its authorized program during the first nine months and said it did not intend to repurchase shares for the remainder of 2019. The $18.0 million of treasury-stock purchases reflected withholding shares for employee tax obligations.
Outlook, risks, and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management expressed confidence in liquidity for the foreseeable future.
- A cybersecurity incident detected in March 2019 involved unauthorized access to information systems; the company determined that some client data had been copied. The investigation and remediation were ongoing, and the potential revenue or financial impact had not been determined. Management warned of possible customer, reputational, legal, and regulatory consequences and said full implementation of additional safeguards would take months.
- Q3 other expense, net, was $14.3 million, compared with $5.9 million of other income in the prior-year quarter. The 2019 amount included foreign-currency losses on U.S.-dollar borrowings at a non-U.S. entity and losses on venture-capital investments. Management also reported $12.1 million of such foreign-currency losses in Q3.
- After quarter-end, the company issued $500 million of 4.25% senior notes due 2028 and used proceeds and available cash to prepay $500 million of term loans. On November 4, 2019, it increased its revolving-facility commitment by $500 million to $2.05 billion.
- Other risks include floating-rate debt and foreign-exchange exposure; a 100-basis-point rate increase was estimated to raise annual pretax interest expense by $13.9 million. The company reported ordinary-course litigation and tax audits, but did not expect existing matters to materially affect its financial statements.
Important facts for investors to verify
- Whether the cybersecurity investigation identified further data access or measurable client, legal, or financial consequences.
- How much reported growth reflects acquisitions versus underlying demand, pricing, and foreign exchange, particularly in DSA.
- Whether DSA and consolidated operating margins stabilize as acquisition costs, amortization, staffing, and facility investments evolve.
- Whether operating cash conversion improves given receivables, deferred revenue, and customer-deposit timing, while acquisition and capital-spending needs continue.
- The effects of post-quarter debt refinancing on interest expense, leverage, covenant headroom, and future liquidity.