Business context and reporting period
Charles River Laboratories International, Inc. is a global early-stage contract research organization providing research models, drug discovery and safety assessment services, and manufacturing-support products and services. This unaudited Form 10-Q covers the three months ended March 31, 2018, compared with the three months ended April 1, 2017.
Financial performance and liquidity
| Metric | Q1 2018 | Prior-year period | Change |
|---|---|---|---|
| Revenue | $494.0 million | $445.8 million | +10.8% |
| Operating income | $67.8 million | $69.7 million | -2.7% |
| Operating margin | 13.7% | 15.6% | -1.9 percentage points |
| Net income attributable to common shareholders | $52.6 million | $46.8 million | +12.5% |
| Diluted EPS | $1.08 | $0.97 | +11.3% |
| Cash provided by operating activities | $60.1 million | $34.0 million | +$26.0 million |
- Revenue by segment: RMS $134.0 million (+5.3%); Discovery and Safety Assessment (DSA) $260.0 million (+14.2%); Manufacturing $100.0 million (+10.1%). Foreign exchange added $20.8 million, or 4.6%, to consolidated revenue growth.
- Margins and costs: Costs of services and products were 63.3% of revenue versus 61.6% a year earlier. SG&A was $103.4 million, or 20.9% of revenue, versus $90.9 million, or 20.4%. Management attributed lower operating income and margin mainly to investment to support future growth.
- Cash and investment: Cash and cash equivalents were $187.8 million at March 31, 2018; cash, cash equivalents and investments totaled $190.3 million. Investing activities used $24.7 million, including $27.7 million of capital expenditures and $20.2 million for acquisitions, partly offset by investment-sale proceeds.
- Debt: Borrowings under the credit facilities were $1.091 billion at quarter-end; the company also reported $18.4 million of other long-term debt and $31.3 million of capital lease obligations. The weighted-average debt interest rate was 2.13%. The company was compliant with its credit-facility covenants at March 31.
- Liquidity: Management said existing funds, operating cash generation and access to financing were sufficient for operations for the foreseeable future. Current liabilities were $407.1 million and current assets were $843.3 million.
Material changes versus the prior comparable period
- Revenue growth was led by DSA, reflecting higher demand from biotechnology and global biopharmaceutical clients, as well as acquisitions and favorable currency effects. Manufacturing growth reflected demand for endotoxin products and higher Avian product revenue.
- Operating income declined despite revenue growth, as operating costs and SG&A increased faster than revenue. The company cited growth investments, currency effects, service mix and costs associated with the planned Maryland RMS production-site closure.
- Net income increased partly because income-tax expense fell to $9.8 million from $31.1 million. The effective tax rate was 15.5% versus 39.8%; the comparison reflects the prior-year tax on the CDMO divestiture gain and $2.7 million of favorable tax rulings in 2018. The prior-year period also included a $10.6 million divestiture gain in other income.
- Operating cash flow improved year over year, which management attributed to higher continuing-operations income and favorable timing of operating asset and liability cash flows.
- The company adopted ASC 606 using the modified retrospective method; the cumulative effect was immaterial, and management reported no material difference in 2018 revenue versus the prior revenue-recognition guidance.
Outlook, management commentary, risks and unusual items
- Acquisition and financing after quarter-end: On April 3, 2018, the company acquired MPI Research for approximately $800 million in cash. It funded the acquisition with a $750 million term-loan draw and a $500 million offering of 5.5% senior notes due 2026; net note proceeds were used partly to repay the revolving facility. The acquisition will be reported in DSA. Purchase-price allocation and pro forma results were not available in the filing.
- Restructuring: The company planned to cease use of its Maryland RMS production facility before year-end 2018 and consolidate production. It recorded $1.0 million of related restructuring costs in Q1 and expected an additional $5.5 million to $6.0 million in 2018; total cash costs were not expected to exceed $8 million. Existing lease obligations at the facility continue through 2028.
- Market risks: Debt was primarily floating-rate; a 100-basis-point rate increase was estimated to raise annual pretax interest expense by $10.9 million. A 10% strengthening of the U.S. dollar was estimated to reduce quarterly revenue by about $20.3 million and operating income by about $1.5 million, all else equal.
- Other exposures: Venture-capital commitments totaled $108.4 million, of which $54.9 million had been funded. The company disclosed ongoing tax controversies and pending tax audits, but did not expect resolution of existing controversies to materially affect financial position or results. It said ordinary-course litigation was not expected to have a material adverse effect. No material changes to the risks in its 2017 Form 10-K were reported.
- Guidance: The filing provides no specific numerical revenue, earnings or cash-flow guidance. Management expressed confidence in liquidity but cautioned that actual results may differ materially from forward-looking statements.
Important facts for investors to verify
- How the approximately $800 million MPI Research acquisition affects post-close leverage, interest expense, integration costs and DSA growth and margins.
- Whether revenue growth converts into improved operating margins, given faster cost growth and the stated investment program.
- Progress, timing and final costs of the Maryland facility closure and related restructuring.
- Floating-rate debt exposure, covenant headroom and the impact of the April 2018 financing on debt and liquidity.
- Whether favorable tax rulings and the provisional accounting for U.S. Tax Reform have recurring or one-time effects on the effective tax rate.