Charles River Laboratories International, Inc. — Q2 2017 Form 10-Q
Business context and reporting period
The filing covers the 13 weeks and six months ended July 1, 2017; comparatives are the periods ended June 25, 2016. Charles River provides research models, drug discovery and safety assessment services, and products and services supporting client manufacturing. Its reportable segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing. Financial statements are unaudited.
Key financial metrics
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $469.1 million | $434.1 million | $914.9 million | $788.9 million |
| Operating income | $81.3 million | $58.1 million | $150.8 million | $109.5 million |
| Operating margin | 17.3% | 13.4% | 16.5% | 13.9% |
| Net income attributable to common shareholders | $54.0 million | $35.2 million | $100.7 million | $72.4 million |
| Diluted EPS | $1.12 | $0.73 | $2.08 | $1.51 |
| Operating cash flow | Not provided quarterly | Not provided quarterly | $134.4 million | $126.0 million |
| Capital expenditures | Not provided quarterly | Not provided quarterly | $31.9 million | $20.0 million |
Q2 revenue rose 8.1% year over year, with service revenue up 12.5% and product revenue down 1.0%. For the six months, revenue rose 16.0%, including service revenue growth of 23.4%. Foreign exchange reduced revenue growth by 1.9 percentage points in Q2 and 2.0 points for the six months. Six-month operating cash flow less capital expenditures was approximately $102.4 million, versus $105.9 million in the prior-year period.
Q2 segment revenue and operating income were: RMS $124.0 million and $33.6 million; DSA $252.1 million and $51.7 million; Manufacturing $93.0 million and $29.0 million. DSA was the principal growth driver.
Financial position, liquidity, and debt
At July 1, 2017, cash and cash equivalents were $116.5 million and investments were $23.5 million. Current assets were $738.1 million against current liabilities of $424.1 million. Total debt was approximately $1.119 billion, including $617.5 million of term loans and $498.3 million outstanding on the revolving facility; the debt carrying value was $1.088 billion net of discounts and issuance costs. The weighted-average debt interest rate was 2.34%. Long-term debt and capital leases are reported separately in the balance sheet.
Management said existing funds, operating cash generation, and access to financing should be sufficient for operations for the foreseeable future. The company was compliant with its credit-facility covenants at quarter-end. Debt is primarily floating-rate; a 100-basis-point rate increase would raise annual pretax interest expense by an estimated $11.2 million.
Material changes and unusual items
- Q2 operating income increased 40.0% year over year, while diluted EPS increased from $0.73 to $1.12. For the six months, operating income increased 37.7% and diluted EPS rose from $1.51 to $2.08.
- DSA growth reflected demand from biotechnology and biopharmaceutical clients, higher legacy safety-assessment study volumes, and acquisitions. For the first half, WIL Research contributed $62.5 million and Agilux $18.6 million of service revenue growth. The comparison also reflects the 2016 WIL Research acquisition.
- The company sold its CDMO business in February 2017 for $75.0 million in proceeds and recorded a $10.6 million gain. The disposal contributed to investing cash inflow; the gain is included in first-half other income.
- Q2’s effective tax rate was 28.9%, versus 34.6% a year earlier, partly reflecting a $1.3 million excess tax benefit from stock compensation. The first-half rate was 34.4%, versus 31.0%, reflecting tax on the divestiture gain, partly offset by $8.8 million in stock-compensation tax benefits.
- During the first half, the company repurchased 0.6 million shares for $54.6 million under its program and spent $70.8 million on treasury-stock purchases in total, including shares withheld for employee tax obligations. The authorization was increased by $150 million; $165.1 million remained at quarter-end.
- After quarter-end, on August 4, 2017, the company acquired Brains On-Line for approximately €18 million in cash, with potential additional performance-based payments of up to €6.7 million.
Outlook, risks, and contingencies
The filing provides no numerical revenue or earnings guidance. Management cited current demand from mid-tier biotechnology and global biopharmaceutical clients, and stated that capital from the CDMO divestiture could be redeployed to other long-term growth opportunities. Forward-looking results remain subject to client spending and outsourcing trends, acquisition integration, competition and pricing, foreign exchange, and execution of cost and efficiency initiatives.
Management estimated that a 10% strengthening of the U.S. dollar, with other variables held constant, would reduce six-month revenue by approximately $34.9 million and operating income by approximately $2.8 million. Various ordinary-course lawsuits and tax controversies are pending; management did not expect their resolution to have a material adverse effect. Unrecognized tax benefits were $26.0 million, and the company said they could decrease by up to $5.0 million over the next twelve months. Venture-fund commitments totaled $87.7 million, of which $45.5 million had been funded. Letters of credit were $4.9 million. Management reported effective disclosure controls and no material changes to the risk factors in its 2016 Form 10-K.
Important facts for investors to verify
- How much reported DSA growth reflects durable underlying demand versus acquisitions, currency movements, and the prior-year acquisition comparison.
- Whether operating cash generation continues to cover capital investment, buybacks, and debt reduction as working-capital balances change.
- Floating-rate debt exposure, covenant headroom, and the effect of interest-rate increases on earnings and cash flow.
- The effect of the CDMO divestiture and related tax items on comparable results, and the integration and performance of Brains On-Line and other acquired businesses.
- Progress on tax matters, venture-capital commitments, and other disclosed contingencies.