Charles River Laboratories International, Inc. — Q2 2011 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 25, 2011, compared with the periods ended June 26, 2010. Charles River provides research models and related services (RMS) and outsourced preclinical services (PCS) to drug developers and other organizations.
Key financial metrics
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $288.3m | $288.6m | $574.1m | $580.9m |
| Gross margin | 36.9% | 34.9% | 36.4% | 34.4% |
| Operating income / margin | $53.3m / 18.5% | $30.0m / 10.4% | $95.6m / 16.6% | $60.2m / 10.4% |
| Net income attributable to common shareowners | $32.3m | $14.5m | $63.7m | $31.8m |
| Diluted EPS, continuing operations | $0.66 | $0.24 | $1.30 | $0.50 |
| Cash from operating activities | Not provided separately | Not provided separately | $86.7m | $83.9m |
Six-month capital expenditures were $13.5m; operating cash flow less capital expenditures was $73.2m. Cash and cash equivalents were $145.8m at June 25, down from $179.2m at December 25, 2010. Total debt and capital leases were $789.4m, versus $700.9m at year-end; cash less debt and leases was approximately negative $643.6m. The company reported covenant compliance and no revolver borrowings at quarter-end; $4.5m of letters of credit was outstanding. Current assets were $548.3m and current liabilities $277.1m.
Material changes and drivers
- Q2 sales were essentially flat; first-half sales declined 1.2%. Foreign currency translation added 4.3% to Q2 sales and 2.5% to first-half sales growth.
- RMS sales rose 6.6% in Q2 and 3.6% for the first half, while PCS sales fell 9.3% and 7.9%, respectively. Management attributed PCS weakness mainly to reduced biopharmaceutical spending and lower preclinical demand.
- Operating performance improved largely through cost reductions and expense control. SG&A fell 27.6% in Q2 and 19.9% in the first half. Both segments improved operating margins despite PCS sales declines.
- Q2 operating income included a $7.7m tax-exempt life-insurance gain; the prior-year quarter included $7.3m of costs related to evaluating acquisitions. First-half results also benefited from an $11.1m tax benefit related to the Phase I business disposition. The reported effective tax rates—20.2% for Q2 and 7.9% for the first half—were therefore unusually low.
- Interest expense increased to $10.7m in Q2 and $20.7m for the first half, primarily reflecting increased borrowing; management also cited higher rates for the first-half increase.
Outlook, risks and unusual items
- Management said demand conditions appeared to be stabilizing but remained uncertain. It cited measured customer R&D spending, industry consolidation, patent expirations, delayed decisions, pricing pressure and excess preclinical capacity. It expects longer-term demand support from outsourcing and renewed early-stage drug development, but said timing is difficult to predict. No specific revenue or earnings guidance was provided.
- Management identified four priorities: improve operating margins and free cash flow, invest selectively in growth businesses, and return capital to shareholders. It projected 2011 capital expenditures of approximately $50m and said existing capacity could support growth without significant expansion investment.
- The company sold its Phase I clinical business on March 28, 2011 for a nominal amount. It remains guarantor of facility lease payments totaling $15.8m through January 2021; a $3.0m related liability was recorded. Management planned to complete closure of PCS China in Q3 2011.
- In the first half, the company repurchased 5.8m shares for $213.6m, including an accelerated repurchase; $205.0m remained under the $750m authorization at June 25. The buybacks were funded in part with borrowings and reduced outstanding shares.
- Liquidity considerations include $11.2m of auction-rate securities that may not be readily saleable if auctions continue to fail. The credit agreement is secured by substantially all assets and includes leverage and interest-coverage covenants; the company was compliant at quarter-end.
- Other matters include German and Canadian tax disputes, which management did not expect to materially affect results, and ongoing uncertainty about possible effects of Japan-related disruptions on customers, spending and operations. Management said the five Japanese RMS facilities sustained no material damage, but could not assure that future effects would remain immaterial.
- The company reported a $4.0m settlement of a foreign-exchange hedge terminated after quarter-end, and recognized a $1.1m favorable change in the fair value of acquisition-related contingent consideration during the first half. Management stated pending ordinary-course litigation was not expected to materially affect the financial statements.
Important facts for investors to verify
- How much of the operating and EPS improvement reflects recurring cost efficiencies versus the life-insurance gain, prior-year acquisition costs and tax benefits.
- Whether PCS demand stabilizes and whether RMS growth persists, including the impact of customer spending and foreign currency.
- Debt, interest expense, covenant headroom and liquidity after substantial share repurchases; monitor receivables, as DSO rose to 50 days from 45 at year-end.
- Progress and remaining obligations from the Phase I divestiture and planned PCS China closure, including the long-dated lease guarantee.
- Developments in the German and Canadian tax matters, auction-rate security liquidity, and Japan-related operational or customer impacts.