Charles River Laboratories International, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter ended September 24, 2011; comparative quarter ended September 25, 2010. Nine-month figures are for the periods ended on those dates. Unless stated otherwise, amounts below are in millions of dollars. The company provides research models and related services (RMS) and outsourced preclinical services (PCS).
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $277.6 | $270.9 | $851.7 | $851.8 |
| Operating income | $37.1 | $6.5 | $132.7 | $66.6 |
| Operating margin | 13.4% | 2.4% | 15.6% | 7.8% |
| Net income (loss) attributable to common shareowners | $18.8 | $(24.9) | $82.5 | $6.9 |
| Diluted EPS attributable to common shareowners | $0.37 | $(0.40) | $1.58 | $0.11 |
- Q3 sales rose 2.5%; favorable foreign exchange contributed 3.7%. Product sales increased to $116.9 million from $108.7 million, while service sales declined to $160.6 million from $162.2 million.
- Q3 gross margin was 33.4%, versus 33.8% a year earlier. For the first nine months, it improved to 35.4% from 34.2%, primarily reflecting cost-saving programs.
- Q3 operating income benefited substantially from the absence of the $30.0 million WuXi acquisition termination fee recorded in Q3 2010. Nine-month 2011 operating income also reflected a $7.7 million life-insurance gain and lower corporate and selling, general and administrative costs.
- Q3 income tax expense was $5.6 million, versus $16.7 million; the prior-year quarter’s effective tax rate was distorted by the non-deductible WuXi fee and tax costs related to non-U.S. earnings. The 2011 nine-month effective tax rate was 11.6%, including tax benefits related to the Phase I business disposition, life-insurance proceeds, and German tax-audit settlement.
Segments and material changes
- RMS: Q3 sales increased 7.7% to $171.5 million; operating income was $48.5 million, with a 28.3% operating margin versus 26.9%. Nine-month sales grew 4.9% to $523.0 million.
- PCS: Q3 sales fell 4.9% to $106.1 million and operating income declined to $3.7 million from $5.2 million; operating margin fell to 3.5% from 4.6%. Management cited reduced biopharmaceutical spending and lower capacity utilization. Nine-month sales declined 6.9% to $328.7 million.
- Nine-month total sales were essentially flat as RMS growth was offset by weaker PCS sales. Favorable foreign currency translation contributed 2.9% to reported sales growth.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $134.9 million, compared with $100.8 million. Capital expenditures were $21.7 million; management projected approximately $40.0 million for full-year 2011.
- Cash and cash equivalents were $81.2 million at September 24, 2011, down from $179.2 million at December 25, 2010. Cash declined $97.9 million during the nine-month period, principally amid share repurchases and other financing activity.
- Current assets were $456.3 million and current liabilities $223.8 million. Total debt and capital leases were $740.3 million, including $19.8 million current and $720.5 million long-term; total debt had been $700.9 million at year-end 2010. Interest expense for the first nine months rose to $32.6 million from $25.8 million, primarily due to increased borrowings and higher rates.
- The amended credit agreement extends to September 2016 and provides a $350 million revolving facility. The company reported compliance with financial covenants at quarter-end; $4.5 million of letters of credit were outstanding. It had $22.0 million drawn on the revolving facility.
- Nine-month financing cash outflow was $215.8 million, including $255.6 million of treasury-stock and accelerated-repurchase payments. The company repurchased 7.7 million shares for $277.4 million and reported $141.3 million remaining under its $750 million authorization.
- $11.1 million of auction-rate securities remained illiquid due to failed auctions, despite an AAA rating and federal-program guarantee. Management said it did not expect this restriction to affect normal operations given other liquidity sources.
Outlook, commentary, risks and unusual items
- Management described demand as uncertain amid customer cost constraints, reduced biopharmaceutical funding and spending, industry consolidation, pricing pressure, and excess contract-research capacity. It cited continuing softness in safety-assessment testing as customers emphasize earlier efficacy testing.
- A fourth-quarter 2011 headcount reduction of approximately 2%, primarily in PCS, was expected to generate annual savings of about $7.5 million beginning in 2012, with approximately $3.5 million of severance and other costs expected in Q4. This is a cost-savings outlook, not formal revenue or EPS guidance.
- Management’s priorities included improving operating margins and free cash flow, disciplined investment in growth areas, and returning capital to shareholders. It expected existing capacity to support growth without significant expansion investment.
- The $350 million 2.25% convertible notes mature in June 2013. Management expected to meet the cash principal obligation using cash, operating cash flow, credit capacity and/or other financing alternatives. No conversion triggers were met at quarter-end.
- The Phase I clinical business was disposed of in March 2011. The company remained guarantor of facility lease payments through January 2021; remaining payments totaled $15.1 million, and a $3.0 million net guarantee liability was recorded. The nine-month discontinued-operations loss was $5.7 million.
- Risks include continued weakness in customer R&D spending and PCS utilization, foreign-exchange and variable-interest-rate exposure, and possible disruptions to Japanese operations following the 2011 earthquake and tsunami. The company estimated a 100-basis-point adverse interest-rate change could increase annual pretax interest expense by about $7.4 million.
- The company was contesting Canadian federal and Quebec research-credit reassessments; management did not expect a material financial effect but noted similar adjustments could be proposed for later years. Management also disclosed routine litigation and other contingencies, which it did not expect to materially affect the financial statements.
Most important facts for investors to verify
- Whether PCS demand, capacity utilization and margins stabilize, given the segment’s Q3 sales and margin declines.
- Whether the announced headcount actions deliver the projected $7.5 million annual savings and what restructuring costs are ultimately recorded.
- Cash generation, receivables collection trends (DSO rose to 50 days from 45 at year-end), and the effect of continued share repurchases on liquidity and leverage.
- Debt maturity and refinancing plans for the 2013 convertible notes, along with continued compliance with tightening credit-agreement leverage covenants.
- Liquidity and valuation of the auction-rate securities, outcome of the Canadian tax-credit disputes, and exposure under the Phase I lease guarantee.