Charles River Laboratories International, Inc. — Q2 2016 Form 10-Q
Business context and reporting period. The company provides early-stage contract research, research models, and manufacturing-support products and services. This unaudited report covers the quarter and six months ended June 25, 2016; comparisons are to the periods ended June 27, 2015. Fiscal 2016 includes an additional week in the fourth quarter.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $434.1M | $339.6M | $788.9M | $660.0M |
| Operating income | $58.1M | $55.7M | $109.5M | $98.7M |
| Operating margin | 13.4% | 16.4% | 13.9% | 15.0% |
| Net income attributable to common shareholders | $35.2M | $48.5M | $72.4M | $80.1M |
| Diluted EPS | $0.73 | $1.02 | $1.51 | $1.68 |
| Operating cash flow | Not stated separately | Not stated separately | $116.5M | $97.6M |
- Q2 service revenue rose 36.6% to $292.9M and product revenue rose 12.8% to $141.2M. For the first half, service revenue increased 24.9% to $513.5M and product revenue increased 10.7% to $275.4M.
- First-half capital expenditures were $20.0M, implying operating cash flow less capital expenditures of $96.5M, versus $73.1M in the prior-year period.
- At June 25, cash and cash equivalents were $154.6M; cash, cash equivalents, and investments totaled $179.6M. Current assets were $701.5M and current liabilities $413.4M.
- Borrowings were $1.343B, including $650.0M in term loans and $692.9M drawn on the revolving facility. The balance sheet reported $1.365B of current and long-term debt and capital leases. The weighted-average debt interest rate was 1.86%; the company reported compliance with its debt covenants.
Changes, drivers, and notable items
- Revenue growth reflected acquisitions, particularly WIL Research, acquired April 4 for approximately $604.8M, as well as increased study volume and pricing in the legacy Safety Assessment business. WIL contributed $51.4M of Q2 revenue growth and $55.2M of revenue since acquisition. Celsis and other acquired businesses also contributed. Foreign exchange reduced first-half revenue growth by $6.4M.
- DSA was the largest growth contributor: Q2 revenue increased 44.1% to $221.1M, and first-half revenue rose 29.2% to $379.0M. RMS first-half revenue increased 4.1% to $248.4M; Manufacturing increased 26.2% to $161.5M.
- Despite higher sales, Q2 operating margin declined to 13.4% from 16.4%, and diluted EPS fell to $0.73 from $1.02. SG&A rose 40.9% to $100.5M, including higher acquisition and integration expenses, severance, and corporate costs. Interest expense more than doubled to $8.9M, and the effective tax rate increased to 34.6% from 18.4%.
- First-half net income was also lower year over year, while operating income and operating cash flow increased. The prior-year comparison included a $9.9M Sunrise bargain-purchase gain and a $10.4M tax benefit from a reduction in unrecognized tax benefits.
- WIL acquisition-related transaction and integration costs were $12.4M for the first half. A $1.9M impairment charge for certain DSA intangible assets was recorded in the first quarter. First-half gains on venture-capital investments contributed to other income.
- On June 27, 2016, after quarter-end, the company acquired Blue Stream for approximately $9.2M cash plus up to $3.0M contingent consideration. On July 7, it bought an additional 12% of Vital River for $10.8M, increasing ownership to 87%.
Outlook, liquidity, and risks
- The filing provides no specific numerical revenue or earnings guidance. Management stated that existing funds, operating cash generation, and access to financing should be sufficient to fund operations for the foreseeable future.
- The $1.65B credit facility matures in 2021 and permits up to $500M of additional commitments under specified conditions. Because borrowings are primarily floating-rate, a 100-basis-point rate increase would raise annual pretax interest expense by approximately $13.4M.
- Management identified foreign-exchange exposure, acquisition integration and expected synergies, client spending and outsourcing trends, and the ability to meet future demand as factors affecting results. The Brexit referendum could increase currency and economic uncertainty and lead customers to reduce budgets.
- Legal matters include IDEXX patent litigation, for which the company said it could not estimate a possible loss range, and an ongoing government-contract billing investigation. The company recorded a $1.5M liability for identified excess billings but said additional losses were reasonably possible and not estimable.
- Unrecognized tax benefits were $25.3M; the company estimated they could decrease by up to $3.0M over the next 12 months. Venture-capital commitments totaled $80.6M, of which $34.0M had been funded.
Important facts for investors to verify
- How much of reported growth and future growth is attributable to acquired revenue versus organic demand, pricing, and study volume.
- Whether integration costs, elevated SG&A, and lower margins moderate as WIL Research and other acquisitions are integrated.
- Debt repayment capacity and sensitivity to floating interest rates, given increased borrowings and acquisition funding.
- Developments in the IDEXX litigation, government billing investigation, tax matters, and Brexit-related currency and customer-spending risks.
- Whether acquisition purchase-price allocations, expected synergies, and the post-quarter Blue Stream and Vital River transactions materially change the outlook.