Charles River Laboratories International, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter ended September 26, 2020; comparisons are with the quarter ended September 28, 2019. Unless noted, amounts are in U.S. dollars.
Business context
Charles River is an early-stage contract research organization serving drug discovery, safety assessment, research models and manufacturing support markets. Its reportable segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing.
Financial performance
| Metric | Q3 2020 | Q3 2019 | First nine months 2020 | First nine months 2019 |
|---|---|---|---|---|
| Revenue | $743.3 million | $668.0 million | $2,132.9 million | $1,930.1 million |
| Operating income | $132.8 million | $92.8 million | $303.8 million | $242.4 million |
| Operating margin | 17.9% | 13.9% | 14.2% | 12.6% |
| Net income attributable to common shareholders | $102.9 million | $72.8 million | $221.1 million | $171.7 million |
| Diluted EPS | $2.03 | $1.46 | $4.39 | $3.46 |
| Operating cash flow | Not stated for the quarter | Not stated for the quarter | $408.2 million | $300.3 million |
- Q3 revenue increased 11.3%; service revenue rose 11.0% and product revenue 12.3%. Nine-month revenue increased 10.5%, driven primarily by services.
- Q3 operating income increased 43.0%. Management cited stronger DSA and Manufacturing results; earnings also benefited from venture investment gains.
- Q3 other income was $21.2 million, versus $14.3 million of expense in the prior-year quarter. The improvement was primarily due to venture capital investment gains. For the nine months, gains on venture capital investments were $31.6 million, versus $5.7 million a year earlier.
- Interest expense was $18.9 million in Q3 and $53.3 million for the first nine months, up from $5.7 million and $36.5 million, respectively. The filing attributes the nine-month increase chiefly to acquisition-related borrowing and foreign-exchange effects.
Segments and material changes
- DSA: Q3 revenue was $461.2 million, up 9.8%, and operating income was $90.3 million, up 39.0%. Nine-month revenue rose 13.8% and operating income rose 34.0%, reflecting acquisition contributions, biotechnology client demand, pricing and efficiency gains.
- Manufacturing: Q3 revenue was $130.2 million, up 12.9%, and operating income was $48.2 million, up 22.9%. Nine-month revenue increased 9.2% and operating income 27.3%, with higher product demand and improved operating efficiencies.
- RMS: Q3 revenue was $151.9 million, up 14.6%, but operating margin fell to 24.4% from 25.9%, partly due to acquired-intangible amortization. For the first nine months, revenue increased 2.1%, while operating income fell 34.1% and margin declined to 16.5% from 25.6%, reflecting pandemic-related lower research-model product sales and acquisition-related costs.
- Q3 revenue growth included contributions from HemaCare, acquired in January 2020, and Cellero, acquired in August 2020. HemaCare contributed $12.8 million of Q3 revenue; Cellero contributed $1.9 million to RMS revenue growth. The company also acquired Citoxlab in 2019, contributing to DSA growth.
Cash, debt and liquidity
- At September 26, 2020, cash and cash equivalents were $242.9 million. Total current assets were $1.14 billion and current liabilities were $787.0 million.
- Total debt and finance leases were $2.03 billion, including $47.9 million due within one year. Long-term debt and finance leases, net, were $1.97 billion. The weighted-average debt interest rate was 3.21%.
- The revolving facility had $836.8 million outstanding and approximately $1.2 billion available; the company reported compliance with debt covenants. A 100-basis-point increase in interest rates would raise annual pretax interest expense by approximately $10 million.
- Nine-month operating cash flow was $408.2 million; investing cash outflow was $513.1 million, including $419.1 million for acquisitions and $78.7 million of capital expenditures. Financing provided $106.5 million. Operating cash flow benefited from higher earnings and favorable timing of certain tax and compensation payments.
- Management said existing funds, operating cash generation and financing access were expected to meet foreseeable needs, and it did not anticipate needing additional borrowing in 2020. The $150 million borrowed early in the year as a precaution was repaid during Q3.
Outlook, risks and unusual items
- No formal quantitative revenue or earnings guidance is provided in the supplied filing text. Management reported that RMS demand improved in Q3 as customers reopened and resumed research. It expected a small adverse impact on revenue growth, operating income, margins and cash flows from COVID-19 through the rest of 2020.
- Management said operating sites remained open and adequately staffed, while noting logistical delays, supply-chain cost increases and potential delays. Pandemic-related restrictions at customer sites had particularly affected RMS product demand; management said DSA and Manufacturing were not significantly impacted in the first nine months.
- Key risks include the uncertain duration and effects of COVID-19, reduced research spending, supply constraints (including large research models and donor-derived products), acquisition integration, foreign exchange, floating-rate debt and the LIBOR transition, and potential impairment of acquired goodwill and intangibles. No goodwill or long-lived-asset impairment trigger was identified through the reporting date; monitoring was to continue.
- The company reported $2.6 billion of goodwill and other intangible assets. Q3 and nine-month results included acquisition-related amortization and restructuring costs; nine-month restructuring costs were $10.5 million.
- After quarter-end, in October 2020, the company settled its U.S. pension plan. It expected a roughly $10 million noncash settlement charge in Q4 and contributed about $1 million to fund the settlement.
- Ordinary-course lawsuits were pending; management did not believe their resolution would materially adversely affect the business or financial condition. Disclosure controls were assessed as effective at a reasonable assurance level.
Important facts for investors to verify
- How much of reported earnings growth reflects recurring operating performance versus venture capital gains and foreign-exchange items.
- Whether RMS recovery continued after Q3, and how COVID-19 affected customer research activity, supply and cash conversion.
- Whether DSA and Manufacturing growth and margin improvements are sustainable, including the effect of acquisition integration and efficiency initiatives.
- Debt, revolver availability, covenant headroom, floating-rate exposure and the transition from LIBOR.
- Acquisition purchase-price allocations, amortization, integration costs, and potential impairment exposure for goodwill and intangible assets.
- The Q4 pension settlement charge and the subsequent-period effects of the settlement.