Charles River Laboratories International, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter ended September 28, 2013; comparisons are with the quarter ended September 29, 2012. Nine-month results compare the corresponding periods. Amounts below are in U.S. dollars; financial statement amounts are converted to millions unless otherwise stated.
Business context and results
Charles River provides research models and related services, endotoxin and microbial detection products and services, and outsourced preclinical services to pharmaceutical, biotechnology, government, hospital, and academic clients. It reported two segments: Research Models and Services (RMS) and Preclinical Services (PCS).
- Q3 revenue: $292.1 million, up 4.8%. Product sales were $116.7 million and service sales were $175.4 million. Foreign currency translation reduced reported growth by 0.8%.
- Q3 earnings: Operating income was $40.8 million, up 8.2%, and operating margin was 14.0%, versus 13.5%. Net income attributable to common shareholders was $30.9 million, versus $22.0 million; diluted EPS was $0.64, versus $0.46.
- Nine-month results: Revenue was $876.3 million, up 3.2%; operating income was $126.8 million, down from $130.7 million; operating margin was 14.5%, versus 15.4%. Net income attributable to common shareholders was $83.7 million, versus $78.9 million; diluted EPS was $1.72, versus $1.63.
- Q3 segments: RMS revenue increased 4.2% to $173.4 million, but operating income declined 7.2% to $40.3 million and operating margin fell to 23.2% from 26.1%. PCS revenue increased 5.8% to $118.7 million; operating income rose to $18.6 million from $11.0 million, with operating margin increasing to 15.7% from 9.8%.
- Cash flow: Nine-month operating cash flow was $146.6 million, compared with $143.7 million. Capital expenditures were $25.3 million, making operating cash flow less capital expenditures $121.2 million, versus $109.9 million in the prior period.
Financial position and liquidity
- At September 28, 2013, cash and cash equivalents were $130.5 million, total debt and capital leases were approximately $640.5 million, and shareholders’ equity including noncontrolling interests and redeemable noncontrolling interests was $674.0 million. Cash included $122.8 million held by non-U.S. subsidiaries; undistributed foreign earnings were designated indefinitely reinvested.
- The company had a $970 million credit facility, comprising a $420 million term loan and a $550 million multicurrency revolving facility, maturing in May 2018. Debt carrying value was $639.7 million; the company reported compliance with financial covenants. The $350 million 2.25% convertible notes matured and were retired in June 2013.
- Current assets were $547.8 million and current liabilities were $235.2 million. The increase in cash during the first nine months was primarily from operating cash flow, partly offset by repurchases, acquisitions, capital spending, and debt repayments.
- The company repurchased 2.06 million shares for $93.1 million in the first nine months. The board increased the repurchase authorization to $850 million in July 2013.
Material changes, outlook, and notable items
- Management described demand as stabilized but still uncertain, citing clients’ measured R&D spending, pricing pressure, delayed commitments, industry capacity, and pharmaceutical and biotechnology consolidation. It saw demand opportunities in outsourced services, including non-GLP in vivo pharmacology and DMPK.
- Management’s priorities were improving operating margin and free cash flow, investing selectively for growth, and returning capital to shareholders. It projected 2013 capital expenditures of approximately $50 million. The filing did not provide a numerical revenue or EPS forecast.
- A plan to consolidate U.S. research-model production led to $6.8 million of accelerated depreciation in Q3; up to approximately $7 million of additional accelerated depreciation was anticipated in Q4 2013. Management said the charge pressured RMS margins.
- Q3 and nine-month profit comparisons benefited from lower interest expense following debt refinancing and retirement of the convertible notes, and from increased equity-method investment income. Q3 and nine-month PCS margins also benefited from tax-related items, including a Canadian tax settlement and a U.K. R&D tax-law change. The Q3 effective tax rate was 26.7%, versus 21.2%; the nine-month rate was 25.5%, versus 23.3%.
- On October 4, 2013, the company acquired a Singapore EMD provider for approximately $5 million, subject to closing adjustments. The January 2013 acquisition of a 75% interest in China’s Vital River contributed to RMS growth.
- Contingencies: The company identified approximately $1.5 million in excess billings on certain government contracts, reserved that amount, and reported that additional losses were reasonably possible but not estimable. A Mauritius supplier arbitration followed an August 2013 hearing; the company could not estimate a possible loss. The company also described a Canadian transfer-pricing dispute and a German tax audit notice.
- Controls: Management reported disclosure controls were not effective at a reasonable assurance level because of a previously identified material weakness in internal control over financial reporting. Remediation work was ongoing; management said additional procedures supported the fair presentation of the reported financial statements.
Important facts for investors to verify
- Whether the U.S. research-model production consolidation delivers expected savings and how much further accelerated depreciation or other implementation cost is recorded.
- Whether PCS margin gains persist after the effects of tax settlements, tax-law changes, and favorable study mix.
- Developments and potential financial exposure from the government-contract billing investigation, the Canadian tax matters, and the Mauritius arbitration.
- Progress in remediating the material weakness and whether management later concludes disclosure controls and internal controls are effective.
- Cash availability and debt capacity, including the concentration of cash outside the United States, variable-rate exposure, and the effect of ongoing share repurchases and acquisitions.