Charles River Laboratories International, Inc. — Q1 2011 Form 10-Q
Reporting period: Three months ended March 26, 2011; comparative period ended March 27, 2010. Amounts below are in millions of U.S. dollars unless noted. The statements are unaudited.
Business context and performance
Charles River provides research models and services (RMS) and outsourced preclinical services (PCS) to customers involved in drug discovery and development. Management said market conditions appeared to be stabilizing, but customer spending constraints and demand uncertainty continued. The company operated approximately 68 facilities in 16 countries.
Key financial metrics
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Product sales | $121.4 | $121.1 | Up $0.3 |
| Service sales | $164.4 | $171.2 | Down $6.8 |
| Total net sales | $285.8 | $292.3 | Down 2.2% |
| Gross margin | 35.9% | 33.9% | Up 2.0 percentage points |
| Operating income | $42.3 | $30.2 | Up 39.9% |
| Operating margin | 14.8% | 10.3% | Up 4.5 percentage points |
| Continuing-operations income, net of tax | $35.4 | $17.3 | Up $18.0 |
| Net income attributable to common shareowners | $31.3 | $17.4 | Up 80.3% |
| Diluted EPS | $0.57 | $0.26 | Up $0.31 |
| Operating cash flow | $21.4 | $27.9 | Down $6.5 |
| Capital expenditures | $6.8 | $9.3 | Down $2.5 |
Cash flow from continuing operations less capital expenditures was approximately $14.6 million, versus $18.6 million a year earlier. Cash and cash equivalents were $158.7 million at quarter-end, down from $179.2 million at December 25, 2010. Current assets were $560.6 million and current liabilities $307.8 million.
Total debt and capital leases were $856.8 million, compared with $700.9 million at year-end; cash less debt and leases was approximately negative $698.1 million. The company reported $761.3 million of long-term debt and leases and $95.5 million current. It was in compliance with credit-agreement financial covenants at March 26, 2011. The amended facility was $900 million, including a $350 million revolving facility; no revolver balance was reported. The filing states a hypothetical 100-basis-point interest-rate increase would add approximately $8.9 million of annual pretax interest expense.
Material changes versus prior year
- RMS sales rose 0.7% to $173.4 million; operating income rose 3.5% to $51.7 million. Its gross margin declined to 42.6% from 43.1%, while operating margin increased to 29.8% from 29.0%.
- PCS sales fell 6.3% to $112.5 million, mainly from lower demand, volume, and pricing. Operating income improved to $9.3 million from $0.4 million, with operating margin rising to 8.3% from 0.4%, principally due to cost actions.
- Lower cost of services and products, reduced selling, general and administrative expense, and lower amortization supported the consolidated margin improvement. Management attributed the gains primarily to cost-savings and efficiency measures.
- Interest expense increased to $10.0 million from $6.0 million, primarily reflecting increased borrowing, fees, and higher rates associated with the amended credit agreement.
- The effective tax rate was a benefit of 8.3%, compared with a 28.0% expense rate. The 2011 result included an $11.1 million tax benefit related to the Phase I clinical business disposition and increased Canadian research-credit benefits.
- Weighted-average diluted shares fell to 54.6 million from 65.8 million, alongside substantial repurchases, including a $150 million accelerated share repurchase (ASR). The company repurchased 5.29 million shares for $192.8 million during the quarter.
Outlook, risks, and unusual items
- Management expected preclinical demand to recover as customers rebuild early-stage pipelines and increase outsourcing, but said the timing was difficult to predict. No numerical revenue or earnings guidance was provided.
- Management’s priorities were improving operating margins and free cash flow, investing selectively in growth areas, and returning value to shareholders. It projected approximately $50 million of 2011 capital expenditures and said existing capacity could support growth without significant expansion investment.
- The Phase I clinical business was classified as discontinued operations and disposed of on March 28, 2011. Q1 discontinued operations had a $3.9 million after-tax loss, including $3.9 million of additional asset impairment charges; the filing also describes a $5.2 million pretax operating loss.
- Operating cash flow was pressured by tax payments and lower deferred revenue. Days sales outstanding increased to 49 days from 45 at year-end; management estimated each one-day DSO movement changes operating cash flow by about $3 million. The Phase I-related tax benefit was expected to be realized in cash in future quarters.
- The company held $11.3 million of auction-rate securities whose failed auctions could limit liquidity; it said available cash, expected operating cash flow, and other funding sources meant this was not expected to disrupt operations.
- Japan’s March 2011 earthquake and tsunami caused only minor damage to the company’s nearest facility, which was remediated; four other Japanese RMS facilities were undamaged. Management did not then expect a material overall impact, but noted uncertainty around customers, power disruptions, and safety conditions. Japan represented about 6.5% of 2010 sales.
- Tax matters included a German assessment under appeal, for which the company paid assessed tax and interest, and disputes over Canadian and Quebec research credits. Management did not expect these matters to have a material financial impact. It reported $34.8 million of unrecognized tax benefits.
- Other risks include customer R&D spending and outsourcing trends, industry pricing and capacity, foreign exchange, interest rates, and the execution and effects of cost actions and share repurchases. Management reported disclosure controls were effective and no material changes in internal controls during the quarter.
Important facts for investors to verify
- Whether PCS demand, volume, and pricing recover as management anticipates, and whether cost savings can sustain improved margins.
- Cash conversion and working-capital trends, particularly DSO, deferred revenue, tax payments, and the projected $50 million capital expenditure program.
- Debt balances, maturities, covenant headroom, variable-rate exposure, and funding used for the ASR and other capital returns.
- The final financial and cash-flow effects of the March 28 Phase I disposal and realization of the associated tax benefit.
- Liquidity and valuation developments for auction-rate securities, and outcomes of the German and Canadian tax disputes.