Charles River Laboratories International, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 29, 2013; comparisons are with the corresponding 2012 periods. The company provides research models and related services and outsourced preclinical services. Amounts below are in millions of dollars except per-share data and percentages.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First half 2013 | First half 2012 |
|---|---|---|---|---|
| Net sales | $292.9 | $284.7 | $584.2 | $570.7 |
| Operating income | $43.2 | $49.3 | $86.0 | $93.0 |
| Net income attributable to common shareholders | $27.3 | $30.5 | $52.9 | $56.9 |
| Diluted EPS | $0.56 | $0.63 | $1.09 | $1.17 |
| Operating margin | 14.7% | 17.3% | 14.7% | 16.3% |
- Q2 revenue increased 2.9%; first-half revenue increased 2.4%. Foreign currency translation reduced growth by 1.1% and 1.0%, respectively.
- Q2 gross margin fell to 35.0% from 36.4%; first-half cost of products and services was 64.6% of sales versus 63.6%.
- Q2 operating income declined 12.4%. First-half operating income fell 7.6%; common-shareholder net income was approximately level with the prior-year first half.
- Q2 effective tax rate was 22.3%, down from 23.6%; the first-half rate rose to 24.7% from 24.1%, partly reflecting discrete tax costs.
Segments and notable comparisons
- Research Models and Services (RMS): Q2 sales rose 3.1% to $179.0 million, supported by Vital River and Accugenix acquisitions and stronger EMD and Avian Vaccine sales. Lower legacy research-model sales and government-contract billing adjustments weighed on results. Q2 operating margin declined to 27.7% from 32.0%.
- Preclinical Services (PCS): Q2 sales rose 2.6% to $114.0 million, primarily on market-share gains with large biopharma and mid-tier clients. Operating margin was 9.6%, versus 9.7%; less favorable study mix and pricing pressure affected margins.
- For the first half, RMS sales rose 1.3% and operating income declined 8.8%; PCS sales rose 4.1% and operating income increased to $19.0 million from $15.0 million.
Cash flow, balance sheet and debt
- First-half operating cash flow was $78.9 million, compared with $82.6 million. Investing used $40.0 million, including $24.2 million for the Vital River acquisition; capital expenditures were $16.2 million. Financing used $29.4 million, including $26.9 million of treasury-stock purchases.
- Cash and cash equivalents were $113.5 million at June 29, 2013, versus $109.7 million at year-end 2012. Of the June balance, $104.5 million was held by non-U.S. subsidiaries; the company stated foreign subsidiary earnings were indefinitely reinvested.
- Total debt was $635.2 million. On May 29, the company refinanced its credit agreement with a $970 million facility, comprising a $420 million term loan and $550 million multicurrency revolver, both maturing in May 2018. The $350 million convertible notes due in June were retired using facility proceeds and cash. The company reported compliance with financial covenants; $4.9 million of letters of credit was outstanding.
- The filing reports a 100-basis-point adverse interest-rate change could increase annual pretax interest expense by approximately $9.7 million. Days sales outstanding rose to 54 from 51 at year-end 2012 and 48 a year earlier.
Outlook, risks and unusual items
- Management described client demand as stabilizing, while noting continued uncertainty from measured R&D spending, delayed client decisions, cost and pricing pressure, industry excess capacity, biotechnology funding conditions and industry consolidation. The filing does not provide a specific revenue or earnings forecast.
- Management projected 2013 capital expenditures of approximately $50 million. In July 2013 it committed to consolidate U.S. research-model production; analysis of the financial impact was ongoing, with up to approximately $15 million of accelerated depreciation expected over the next several quarters.
- The company identified approximately $1.5 million of excess billings since 2007 on a small subset of government contracts, reserved that amount and reported the matter to government authorities. It was cooperating with the agencies; potential additional loss could not be estimated. The issue reduced Q2 RMS sales by $1.5 million.
- A buyer of the discontinued Phase I clinical business filed for Chapter 11 bankruptcy in April. The company recorded an additional $1.3 million charge related to its facility-lease guarantee; the June 29 liability was $11.1 million.
- Disclosure controls were deemed ineffective at a reasonable-assurance level because of an existing material weakness in IT and financial-reporting controls, including access, segregation-of-duties, master-data, transaction and close controls. Remediation continued; management said additional procedures supported the fair presentation of the interim statements.
- Other notable actions: Vital River, a 75%-owned China research-model business, was acquired in January. The board increased the share-repurchase authorization to $850 million on July 30, from $750 million.
Important facts for investors to verify
- Progress and final financial impact of the government-contract billing investigation, including any loss beyond the $1.5 million reserve.
- Execution costs, timing and expected benefits of the U.S. research-model production consolidation and related accelerated depreciation.
- Remediation and independent assessment of the material weakness in financial-reporting controls.
- Cash conversion and receivables collection trends, given higher DSO and the concentration of cash outside the United States.
- Debt, covenant headroom and sensitivity to variable interest rates under the refinanced credit facility.
- Whether client spending, pricing and study mix improve, and whether acquisitions and PCS market-share gains offset pressure in legacy research models.