Charles River Laboratories International, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter ended June 26, 2010; six-month results compared with the periods ended June 27, 2009. Amounts below are in U.S. dollars; financial statement figures are rounded to millions unless otherwise noted.
Business context
Charles River provides research models and related services, and outsourced preclinical research services, to pharmaceutical, biotechnology, government, hospital, and academic customers. It reports two segments: Research Models and Services (RMS) and Preclinical Services (PCS). Management described customer spending restraint, industry consolidation, delayed commitments, excess preclinical capacity, and pricing pressure as continuing headwinds.
Financial results
| Metric | Q2 2010 | Q2 2009 | First half 2010 | First half 2009 |
|---|---|---|---|---|
| Net sales | $292.1m | $308.2m | $589.4m | $609.7m |
| Operating income | $28.2m | $50.7m | $57.7m | $90.6m |
| Operating margin | 9.7% | 16.4% | 9.8% | 14.9% |
| Net income attributable to common shareowners | $14.5m | $34.2m | $31.8m | $59.6m |
| Diluted EPS | $0.22 | $0.52 | $0.48 | $0.91 |
| Gross margin | 34.4% | 37.1% | 34.0% | 36.5% |
| Operating cash flow | Not presented by quarter | $83.8m | $107.3m |
Segment performance: Q2 RMS sales rose 0.9% to $167.1m, while operating income fell to $47.3m from $50.9m. PCS sales declined 12.3% to $125.0m, and operating income dropped to $4.7m from $16.3m. PCS was affected by lower pricing and a less favorable mix of shorter, less complex studies; RMS growth reflected 2009 acquisitions and favorable in-vitro sales, partly offset by lower model shipments.
Balance sheet and liquidity at June 26, 2010: Cash and cash equivalents were $219.1m, versus $182.6m at year-end 2009. Current assets were $608.0m and current liabilities $246.1m. Total debt was $436.1m, plus $0.1m of capital leases; long-term debt and leases were $409.4m. The company generated $83.8m of operating cash, used $63.2m in financing activities, and reported $23.5m of net cash provided by investing activities in the first half. Capital expenditures were $17.7m.
Material changes and unusual items
- Q2 sales fell 5.2% and first-half sales fell 3.3%; operating income declined 44.3% and 36.3%, respectively. The filing attributes weakness principally to PCS pricing and demand, and lower RMS demand.
- SG&A increased 16.9% in Q2 and 8.9% in the first half. Higher corporate costs included acquisition evaluation and ERP implementation expenses.
- First-half operating cash flow declined year over year, primarily due to lower earnings and changes in receivables. Days sales outstanding increased to 51 days from 43 at year-end 2009; management cited slower collections and lower deferred revenue.
- The company recorded $4.8m of first-half severance costs associated mainly with suspending operations at its Shrewsbury, Massachusetts PCS facility, and a $1.0m impairment related to its Arkansas facility.
- The Q2 effective tax rate was 31.7%, compared with 28.8% a year earlier. The company recorded approximately $2.7m of tax expense after deciding to repatriate about $27m of non-U.S. earnings previously considered permanently reinvested.
Outlook, risks, and contingencies
- Management anticipated that demand, particularly for PCS, would begin to recover as customers resumed drug development efforts and increased strategic outsourcing. This is a qualitative outlook; the filing provides no specific revenue or EPS guidance.
- Management projected 2010 capital expenditures of $60m–$70m and expected to fund them through operating cash flow, marketable securities, and existing credit facilities.
- On July 29, 2010, after quarter-end, the company and WuXi PharmaTech terminated their acquisition agreement. Charles River agreed to pay a $30m breakup fee; the planned shareholder meeting was canceled.
- Also on July 29, the board authorized a new $500m share-repurchase program. The company was considering execution methods and funding sources; timing and actual purchases were not assured.
- The company held $16.5m of auction rate securities, classified as Level 3 fair-value assets. Failed auctions could restrict liquidity; management said available cash, expected operating cash flows, and other sources should allow normal operations. A $5.5m redemption was called at par and received in early July.
- Credit agreements required specified leverage and interest-coverage ratios; the company reported compliance with all financial covenants at June 26, 2010. It also faced tax audits and disputes, including Canadian research-credit reassessments, which management did not expect to have a material effect, while noting possible similar adjustments for later years.
- Management reported no material changes to the risk factors in the 2009 Form 10-K. It stated that disclosure controls were effective; ERP implementation modified or redesigned certain controls, but was not undertaken in response to an identified control deficiency.
Most important facts for investors to verify
- Whether PCS demand, pricing, and study mix improve, and whether RMS growth can offset continued PCS weakness.
- Whether slower receivable collections and higher DSO reverse, and how operating cash flow develops.
- The timing and cash impact of the $30m WuXi termination fee and the funding and execution of the $500m repurchase authorization.
- Liquidity and fair-value assumptions for the remaining auction rate securities, and debt maturities, covenants, and financing costs.
- Progress on Shrewsbury cost actions, ERP deployment, and the Canadian tax-credit disputes and other tax exposures.