Charles River Laboratories International, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Unaudited results cover the three and nine months ended September 29, 2018, compared with periods ended September 30, 2017. Charles River is an early-stage contract research organization serving drug discovery and development, with Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing segments. The 2018 results include MPI Research from its April 3 acquisition and KWS BioTest from January 11.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $585.3M | $464.2M | $1,664.6M | $1,379.1M |
| Operating income | $84.4M | $74.1M | $228.9M | $225.5M |
| Operating margin | 14.4% | 16.0% | 13.8% | 16.3% |
| Net income attributable to common shareholders | $60.4M | $52.5M | $166.7M | $153.2M |
| Diluted EPS attributable to common shareholders | $1.22 | $1.08 | $3.39 | $3.16 |
| Interest expense | $17.2M | $7.7M | $47.0M | $22.1M |
| Effective tax rate | 16.9% | 27.3% | 19.2% | 32.2% |
For the first nine months, operating cash flow was $301.2M (prior year $193.8M); investing cash outflow was $884.0M (prior year $39.8M), including $822.6M for acquisitions and $71.4M in capital expenditures. Financing provided $557.5M, mainly reflecting acquisition-related borrowings and the 2018 refinancing and notes issuance. Operating cash flow less capital expenditures was approximately $229.8M, versus $139.9M in the prior-year period.
At September 29, 2018, cash and cash equivalents were $138.9M and current assets and current liabilities were $838.2M and $539.6M, respectively. Reported debt was $1,670.6M, excluding $30.8M of capital lease obligations; the weighted-average debt interest rate was 3.72%. Total assets were $3,796.7M, including goodwill of $1,252.7M and net intangible assets of $629.7M.
Material changes versus the prior comparable period
- Q3 revenue rose 26.1%; nine-month revenue rose 20.7%. Management attributed growth primarily to acquisitions and demand in DSA and Manufacturing. MPI Research contributed $70.2M of Q3 and $136.8M of nine-month revenue.
- DSA was the largest growth contributor: revenue increased 42.6% in Q3 and 31.9% over nine months. Q3 RMS revenue increased 3.9% and Manufacturing increased 11.5%.
- Operating income increased modestly, but operating margin fell in both comparisons. Management cited acquired-business costs and amortization, investment in personnel, facilities, IT and infrastructure; volume, mix, pricing and productivity gains partly offset these pressures.
- Net income growth benefited from lower tax rates, including U.S. Tax Reform effects, while higher debt-related interest expense offset some benefit. Nine-month 2018 other income included $22.8M of venture-capital investment gains; the prior-year period included a $10.6M gain on the CDMO divestiture.
- The MPI Research acquisition was funded with borrowings and $500M of 5.5% senior notes due 2026. Debt rose from $1,120.5M at year-end 2017 to $1,670.6M at September 29, 2018. The credit facility was amended to $2.3B and matures in 2023.
Outlook, management commentary and risks
Management stated that existing funds, operating cash generation and access to financing should be sufficient for operations for the foreseeable future. The filing provides no specific revenue, earnings or margin guidance. Management described demand growth across biotechnology and global biopharmaceutical clients and cited opportunities to leverage acquired capabilities and business synergies.
The company was compliant with its credit-facility covenants at quarter-end. Those covenants include minimum interest coverage of 3.50-to-1.0 and a maximum debt-to-EBITDA ratio of 4.50-to-1.0, stepping down to 3.50-to-1.0 by Q1 2020. A 100-basis-point increase in interest rates would raise annual pretax interest expense by an estimated $11.5M. Management estimated that a 10% strengthening of the U.S. dollar would reduce nine-month revenue by approximately $61.1M and operating income by approximately $4.7M, all else equal.
Other items to monitor include the still-preliminary MPI purchase-price allocation and integration, acquisition-related amortization and costs, and remaining restructuring costs. The Maryland RMS production facility plan was revised to repurpose the site; remaining 2018 costs were expected not to exceed $1.0M, with cash costs for the initiative not expected to exceed $2.5M. Litigation was described as ordinary-course, with no material adverse outcome anticipated by management; the filing reports no material changes to the prior annual report’s risk factors. Tax audits and controversies remain ongoing, and unrecognized tax benefits were $20.1M. Holders of the remaining 13% interest in Vital River may require the company to purchase it beginning in 2019; the reported redemption value was $17.3M and the agreement does not cap the potential payment.
Key facts for investors to verify
- How much of DSA growth and future performance reflects acquired revenue versus organic demand, and whether expected integration synergies materialize.
- Whether margins recover as acquisition, amortization, staffing, facility and infrastructure costs evolve.
- Debt repayment capacity, covenant headroom, and sensitivity to floating rates and foreign exchange changes.
- The durability of operating cash flow: the period benefited from increased deferred revenue and customer deposits, including a one-time upfront payment under a strategic agreement.
- Potential cash needs from the Vital River redemption right, contingent acquisition payments, and remaining restructuring or lease commitments.