CHARLES RIVER LABORATORIES INTERNATIONAL, INC. annual report, FY2015

Business context and reporting period

Charles River Laboratories International, Inc. (NYSE: CRL) filed its Form 10-K for the fiscal year ended December 26, 2015. The company is an early-stage contract research organization serving pharmaceutical, biotechnology, academic, and government clients, with three segments: Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing Support. The filing also reports fourth-quarter results.

Financial results and key metrics

Operating margin was 15.1%, compared with 13.7% in 2014. Cash flow from operations less capital expenditures was approximately $225.0 million. Revenue was split between services ($858.2 million) and products ($505.1 million). The effective tax rate fell to 22.2% from 26.8%; the change included a $9.8 million non-taxable bargain-purchase gain and a $10.4 million reduction in unrecognized tax benefits, partly offset by $6.6 million in foreign withholding taxes.

Segment revenue and operating income were: RMS $473.2 million and $121.4 million; DSA $612.2 million and $122.0 million; Manufacturing $277.9 million and $74.2 million. DSA revenue growth reflected higher Safety Assessment study volume and acquisitions. Manufacturing growth included Celsis and Sunrise. RMS revenue declined, principally from foreign exchange and weaker research model services and Japan model sales.

In Q4 2015, revenue was $353.9 million versus $329.5 million in Q4 2014; operating income was $52.3 million versus $40.8 million; and net income attributable to common shareholders was $31.9 million versus $27.2 million. Diluted EPS attributable to common shareholders was $0.67 versus $0.57.

Liquidity, debt and balance sheet

At year-end, cash and cash equivalents were $117.9 million, down from $160.0 million. Total current assets were $559.2 million and current liabilities $311.8 million, a current ratio of about 1.8. Debt and capital lease obligations totaled $863.0 million; reported borrowings under the credit facility were $836.0 million. The company had $138.4 million of cash, cash equivalents and investments combined. Its $1.3 billion credit facility included $400 million of term loans and a $900 million revolving facility; the company reported covenant compliance. Net cash from financing activities was $4.5 million, including net borrowings and $117.5 million of treasury-stock purchases.

Material changes, outlook and risks

• Foreign exchange reduced reported 2015 revenue by $69.4 million, or 5.3%, against the prior year. Excluding FX, reported revenue growth would have been stronger.
• Management described demand for outsourced discovery and safety assessment as improved, especially from biotechnology clients; safety-assessment utilization approached optimal levels at open facilities and pricing improved moderately. Demand for manufacturing-support offerings was also described as robust. No quantified revenue or earnings guidance is provided in the filing.
• Backlog at year-end was $470.6 million, compared with $453.7 million a year earlier. Management cautioned that timing, scope changes, delays, and cancellations limit backlog’s usefulness as a predictor of revenue.
• 2015 acquisitions included Celsis ($214.5 million purchase price), Oncotest (approximately $36.0 million), and Sunrise ($9.6 million). Sunrise generated a $9.8 million bargain-purchase gain. Acquisition costs and integration activity contributed to higher SG&A.
• On January 6, 2016, the company agreed to acquire WIL Research for approximately $585 million in cash, expected to close early in Q2 2016 subject to approvals and customary conditions. Financing was expected to include up to $350 million of additional debt; a $17.5 million termination fee may apply in specified circumstances.
• Key exposures include client R&D spending and outsourcing trends, competition and contract cancellations, animal welfare and contamination events, regulatory compliance, foreign exchange, and acquisition integration. A 100-basis-point increase in rates was estimated to increase annual pretax interest expense by approximately $8.4 million; most debt was floating-rate.
• The company recorded a $1.5 million liability for identified overbilling on certain government contracts and said additional losses were reasonably possible, but could not estimate a range. IDEXX patent litigation was ongoing; the company said it could not estimate a possible loss. Management and the auditor reported effective internal controls; the 2015 acquisitions were excluded from the internal-control assessment.

Most important facts for investors to verify

• Whether underlying demand, pricing, and Safety Assessment utilization continued to support growth after adjusting for FX and acquisitions.
• Whether the WIL Research acquisition closed on expected terms, how it was financed, and its effect on leverage, integration costs, and earnings.
• The outcome and potential financial exposure of the government-contract billing investigation and IDEXX patent case.
• Debt covenant headroom, floating-rate sensitivity, and the company’s ability to fund investment and obligations while maintaining liquidity.
• Whether backlog converted to revenue as anticipated, given that contracts may be delayed, reduced, or terminated.