Quarterly Report — Form 10-Q — Sect. 13 / 15(d) – SEA’34 Filing Table of Contents
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Assets (Details)
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of Estimated Revenue Related to Performance
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of Client Receivables, Contract Assets and
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34: R47 SEGMENT INFORMATION - Narrative (Details) HTML 31K
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Information by Reportable Segment (Details)
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Operating Income, Depreciation and Amortization,
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83: R58 GOODWILL AND INTANGIBLE ASSETS - Rollforward of HTML 45K
Goodwill (Details)
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Intangible Assets (Details)
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Schedule of Long-Term Debt (Details)
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Narrative (Details)
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Other Comprehensive Income (Loss) (Details)
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(Exact
Name of Registrant as Specified in Its Charter)
iDelaware
i06-1397316
(State
or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification No.)
i251 Ballardvale Street
iWilmington
iMassachusetts
i01887
(Address
of Principal Executive Offices)
(Zip Code)
(Registrant’s telephone number, including area code): (i781) i222-6000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Ticker symbol(s)
Name of each exchange on which registered
iCommon
stock, $0.01 par value
iCRL
iNew York Stock Exchange
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☑ No ☐
Indicate by check mark whether the registrant has submitted electronically
every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files. iYes☑ No ☐
Indicate by check mark whether the Registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
iLarge accelerated filer
☑
Accelerated
filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by a check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐No ☑
This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events and the future results of Charles River Laboratories International, Inc. that are based on our current expectations, estimates, forecasts and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expect,”“anticipate,”“target,”“goal,”“project,”“intend,”“plan,”“believe,”“seek,”“estimate,”“will,”“likely,”“may,”“designed,”“would,”“future,”“can,”“could,” and other similar expressions
which are predictions of, indicate future events and trends or which do not relate to historical matters, are intended to identify such forward-looking statements. These statements are based on our current expectations and beliefs and involve a number of risks, uncertainties and assumptions that are difficult to predict. These statements also include statements regarding risks and uncertainties associated with the unauthorized access into our information systems reported on April 30, 2019, including the timing and effectiveness of adding enforced security features and monitoring procedures, and the potential revenue and financial impact related to the incident.
For example, we may use forward-looking statements when addressing topics such as: goodwill and asset impairments still under review; future demand for drug discovery and development products and
services, including the outsourcing of these services; our expectations regarding stock repurchases, including the number of shares to be repurchased, expected timing and duration, the amount of capital that may be expended and the treatment of repurchased shares; present spending trends and other cost reduction activities by our clients; future actions by our management; the outcome of contingencies; changes in our business strategy, business practices and methods of generating revenue; the investment in, and the development and performance of, our services and products; market and industry conditions, including competitive and pricing trends; our strategic relationships with leading pharmaceutical and biotechnology companies, venture capital investments, and opportunities for future similar arrangements; our cost structure; the impact of acquisitions, including Citoxlab; our expectations with respect to revenue growth and operating synergies (including the impact of
specific actions intended to cause related improvements); the impact of specific actions intended to improve overall operating efficiencies and profitability (and our ability to accommodate future demand with our infrastructure), including gains and losses attributable to businesses we plan to close, consolidate, divest or repurpose; changes in our expectations regarding future stock option, restricted stock, performance share units, and other equity grants to employees and directors; expectations with respect to foreign currency exchange; assessing (or changing our assessment of) our tax positions for financial statement purposes; and our liquidity. In addition, these statements include the impact of economic and market conditions on us and our clients; the effects of our cost saving actions and the steps to optimize returns to shareholders on an effective and timely basis; and our ability to withstand the current market conditions.
You
should not rely on forward-looking statements because they are predictions and are subject to risks, uncertainties, and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document, or in the case of statements incorporated by reference, on the date of the document incorporated by reference.
Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 29, 2018, under the sections entitled “Our
Strategy,”“Risk Factors,”“Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and in this Quarterly Report on Form 10-Q, under the sections entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors,” in our press releases, and other financial filings with the Securities and Exchange Commission. We have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or risks. New information, future events, or risks may cause the forward-looking events we discuss in this report not to occur.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CHARLES RIVER LABORATORIES INTERNATIONAL, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Liabilities,
Redeemable Noncontrolling Interests and Equity
Current liabilities:
Current portion of long-term debt and finance leases
$
i33,611
$
i31,416
Accounts
payable
i107,231
i66,250
Accrued
compensation
i130,292
i137,212
Deferred
revenue
i166,095
i145,139
Accrued
liabilities
i130,015
i106,925
Other
current liabilities
i114,402
i71,280
Total
current liabilities
i681,646
i558,222
Long-term
debt, net and finance leases
i1,882,593
i1,636,598
Operating
lease right-of-use liabilities
i116,868
—
Deferred tax liabilities
i165,480
i143,635
Other
long-term liabilities
i171,243
i179,121
Total
liabilities
i3,017,830
i2,517,576
Commitments
and contingencies (Note 17)
i
i
Redeemable
noncontrolling interests
i28,345
i18,525
Equity:
Preferred
stock, $0.01 par value; 20,000 shares authorized; no shares issued and outstanding
i—
i—
Common
stock, $0.01 par value; 120,000 shares authorized; 48,976 shares issued and 48,837 shares outstanding as of September 28, 2019, and 48,210 shares issued and 48,209 shares outstanding as of December 29, 2018
Balances
may differ compared to prior condensed consolidated balance sheets due to rounding.
See
Notes to Unaudited Condensed Consolidated Financial Statements.
9
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. iBASIS
OF PRESENTATION
The accompanying condensed consolidated financial statements are unaudited and have been prepared by Charles River Laboratories International, Inc. (the Company) in accordance with accounting principles generally accepted in the United States (U.S. GAAP) and pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). The year-end condensed consolidated balance sheet data was derived from the Company’s audited consolidated financial statements, but does not include all disclosures required by U.S. GAAP. These unaudited condensed consolidated financial statements should be read in conjunction with the
Company’s Annual Report on Form 10-K for fiscal year 2018. The unaudited condensed consolidated financial statements, in the opinion of management, reflect all normal and recurring adjustments necessary for a fair statement of the Company’s financial position and results of operations.
Use of Estimates
i
The preparation of unaudited condensed consolidated financial statements in accordance with U.S. GAAP requires that the
Company make estimates and judgments that may affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, judgments, and methodologies. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.
Consolidation
i
The
Company’s unaudited condensed consolidated financial statements reflect its financial statements and those of its subsidiaries in which the Company holds a controlling financial interest. For consolidated entities in which the Company owns or is exposed to less than 100% of the economics, the Company records net income (loss) attributable to noncontrolling interests in its consolidated statements of income equal to the percentage of the economic or ownership interest retained in such entities by the respective noncontrolling parties. Intercompany balances and transactions are eliminated in consolidation.
i
The
Company’s fiscal year is typically based on 52-weeks, with each quarter composed of 13 weeks ending on the last Saturday on, or closest to, March 31, June 30, September 30, and December 31.
Summary of Significant Accounting Policies
The Company’s significant accounting policies are described in Note 1, “Description of Business and Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for fiscal year 2018 as well as Note 16, “Leases” in this Quarterly Report on Form 10-Q.
Newly Adopted Accounting Pronouncements
i
In
June 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-07, “Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.” ASU 2018-07 aligns the accounting for share-based payment awards issued to employees and nonemployees as well as improves financial reporting for share-based payments to nonemployees. This standard became effective for the Company in the three months ended March 30, 2019 and did not have a material impact on the consolidated financial statements and related disclosures.
In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815) Targeted Improvements to Accounting for Hedging Activities.” ASU 2017-12 refines and expands hedge accounting for both financial
and commodity risks. It also creates more transparency around how economic results are presented, both on the face of the financial statements and in the disclosures. In addition, this ASU makes certain targeted improvements to simplify the application of hedge accounting guidance. This standard became effective for the Company in the three months ended March 30, 2019 and did not have a material impact on the consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU 2016-02, “Leases.” The standard, including subsequently issued amendments, collectively referred to as Accounting Standards Codification (ASC) 842, “Leases”, established the principles that lessees and lessors will apply to report useful information to users of financial statements
about the amount, timing and uncertainty of cash flows arising from a lease. The Company adopted this standard using the modified retrospective transition approach as applied to leases existing as of or entered into after the adoption date (December 30, 2018) in the three months ended March 30, 2019. See Note 16, “Leases” for a discussion of the Company’s adoption of this standard and its impact on the consolidated financial statements and related disclosures.
Newly Issued Accounting Pronouncements
In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal-Use Software (Subtopic
350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computer Arrangement that is a Service Contract.” ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and
10
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
hosting
arrangements that include an internal-use software license). The ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years and will be applied either retrospectively or prospectively. Early adoption is permitted. The Company is still evaluating the impact this standard will have on its consolidated financial statements and related disclosures, but does not believe there will be a material impact upon adoption.
In August 2018, the FASB issued ASU 2018-14, “Compensation Retirement Benefits - Defined Benefit Plans -General (Subtopic 715-20).” ASU 2018-14 removes the requirements to disclose the amounts in Accumulated other comprehensive income (loss) expected to be recognized as components of net periodic benefit cost over the next
fiscal year and the related party disclosures about the amount of future annual benefits covered by insurance contracts. In addition, the ASU adds the requirement to disclose an explanation for any significant gains and losses related to changes in the benefit obligation for the period. The ASU is effective for fiscal years ending after December 15, 2020 and will be applied on a retrospective basis to all periods presented. Early adoption is permitted. The Company is still evaluating the impact this standard will have on its consolidated financial statements and related disclosures.
In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement
(Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” ASU 2018-13 removes the disclosure requirement for the amount and reasons for transfers between Level 1 and Level 2 fair value measurements as well as the process for Level 3 fair value measurements. In addition, the ASU adds the disclosure requirements for changes in unrealized gains and losses included in Other comprehensive income (loss) for recurring Level 3 fair value measurements held at the end of the reporting period as well as the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years and will be applied on a retrospective basis to all periods presented. Early adoption is permitted. The
Company is still evaluating the impact this standard will have on its consolidated financial statements and related disclosures, but does not believe there will be a material impact upon adoption.
In January 2017, the FASB issued ASU 2017-04, “Simplifying the Test for Goodwill Impairment.” The standard simplifies the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test, which requires a hypothetical purchase price allocation. This standard is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019, and will be applied on a prospective basis. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this standard is not expected to have a material impact
on the Company’s consolidated financial statements and related disclosures, but does not believe there will be a material impact upon adoption.
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses.” The standard, including subsequently issued amendments, requires a financial asset measured at amortized cost basis, such as accounts receivable, to be presented at the net amount expected to be collected based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years, and requires the modified retrospective approach.
Early adoption is permitted. The Company is still evaluating the impact this standard will have on its consolidated financial statements and related disclosures, but does not believe there will be a material impact upon adoption.
2. iBUSINESS ACQUISITIONS
Citoxlab
On April 29,
2019, the Company acquired Citoxlab, a non-clinical CRO, specializing in regulated safety assessment services, non-regulated discovery services, and medical device testing. With operations in Europe and North America, the acquisition of Citoxlab further strengthens the Company’s position as a leading, global, early-stage CRO by expanding its scientific portfolio and geographic footprint, which enhances the Company’s ability to partner with clients across the drug discovery and development continuum. The preliminary purchase price for Citoxlab was $i527.7
million in cash, subject to certain post-closing adjustments that may change the purchase price. The acquisition was funded through a combination of cash on hand and proceeds from the Company’s Credit Facility under the multi-currency revolving facility. This business is reported as part of the Company’s DSA reportable segment.
i
The
preliminary purchase allocation of $i491.0 million, net of $i36.7
million of cash acquired was as follows:
/
11
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The
preliminary purchase price allocation is subject to change as additional information becomes available concerning the fair value and tax basis of the assets acquired and liabilities assumed, including certain contracts and obligations. Any additional adjustments to the purchase price allocation will be made as soon as practicable but no later than one year from the date of acquisition.
The breakout of definite-lived intangible assets acquired was as follows:
Definite-Lived
Intangible Assets
Weighted Average Amortization Life
(in thousands)
(in years)
Client relationships
$
i134,600
i13
Developed
technology
i19,900
i3
Backlog
i7,900
i1
Total
definite-lived intangible assets
$
i162,400
i12
The
goodwill resulting from the transaction, $i7.2 million of which is deductible for tax purposes due to a prior asset acquisition, is primarily attributable to the potential growth of the Company’s DSA business from customers introduced through Citoxlab and the assembled workforce of the acquired
business.
The Company incurred transaction and integration costs in connection with the acquisition of $i1.9 million and $i19.1
million for the three and nine months ended September 28, 2019, respectively, which were primarily included in Selling, general and administrative expenses within the unaudited condensed consolidated statements of income.
Beginning on April 29, 2019, Citoxlab has been included in the operating results of the Company. Citoxlab revenue for the three and nine months ended September 28, 2019 was $i44.0
million and $i74.9 million, respectively. Citoxlab operating income for the three and nine months ended September 28, 2019 was $i0.2
million and $i2.2 million, respectively.
The following selected unaudited pro forma consolidated results of operations are presented as if the Citoxlab acquisition had occurred as of the beginning of the period immediately preceding the period of acquisition, which is December
31, 2017, after giving effect to certain adjustments. For the nine months ended September 28, 2019, these adjustments included additional amortization of intangible assets and depreciation of fixed assets of $i4.8
million, additional interest expense on borrowings of $i1.2 million, elimination of intercompany activity and other one-time costs, and the tax impacts of these adjustments. iFor
the nine months ended September 29, 2018, these adjustments included additional amortization of intangible assets and depreciation of fixed assets of $i7.3 million,
additional interest expense on borrowings of $i3.1 million, elimination of intercompany activity and other one-time costs, and the tax impacts of these adjustments.
12
CHARLES
RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
These
unaudited pro forma results of operations have been prepared for comparative purposes only, and they do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on the dates indicated or that may result in the future. No effect has been given for synergies, if any, that may be realized through the acquisition.
MPI Research
On April 3, 2018, the Company acquired MPI Research, a non-clinical CRO providing comprehensive testing services to biopharmaceutical and medical device companies worldwide. The acquisition enhances the Company’s position as a leading
global early-stage CRO by strengthening its ability to partner with clients across the drug discovery and development continuum. The purchase price for MPI Research was $i829.7 million in cash. The acquisition was funded by borrowings on the Credit Facility as well as the issuance of the Company’s Senior Notes. See Note 9, “Long-Term Debt and Finance Lease
Obligations.” This business is reported as part of the Company’s DSA reportable segment.
The purchase allocation of $i800.8 million, net of $i27.7
million of cash acquired and a final net working capital adjustment of $i1.2 million, was as follows:
From the date of the acquisition through March 30,
2019, the Company recorded measurement-period adjustments related to the acquisition that resulted in an immaterial change to the purchase price allocation on a consolidated basis. No further adjustments will be made to the purchase price allocation.
i
The breakout of definite-lived intangible assets acquired was as follows:
Definite-Lived
Intangible Assets
Weighted Average Amortization Life
(in thousands)
(in years)
Client relationships
$
i264,900
i13
Developed
technology
i23,400
i3
Backlog
i20,900
i1
Total
definite-lived intangible assets
$
i309,200
i12
/
The
goodwill resulting from the transaction, $i4.1 million of which is deductible for tax purposes due to a prior asset acquisition, is primarily attributable to the potential growth of the Company’s DSA business from customers introduced through MPI Research and the assembled workforce of the
acquired business.
13
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
iNosignificant integration costs were incurred in connection with the acquisition for the three and nine months ended September 28, 2019. The Company incurred transaction and integration costs in connection with the acquisition of $i0.8
million and $i15.3 million for the three and nine months ended September 29, 2018, respectively, which were primarily included in Selling, general and administrative expenses within the unaudited condensed consolidated statements of income.
The following
selected unaudited pro forma consolidated results of operations are presented as if the MPI Research acquisition had occurred as of the beginning of the period immediately preceding the period of acquisition, which is January 1, 2017, after giving effect to certain adjustments. For the nine months ended September 29, 2018, these adjustments included additional amortization of intangible assets and depreciation of fixed assets of $i11.8
million, additional interest expense on borrowings of $i2.8 million, elimination of intercompany activity and other one-time costs, and the tax impacts of these adjustments.
These
unaudited pro forma results of operations have been prepared for comparative purposes only, and they do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on the dates indicated or that may result in the future. No effect has been given for synergies, if any, that may be realized through the acquisition.
KWS BioTest Limited
On January 11, 2018, the Company acquired KWS BioTest Limited (KWS BioTest), a CRO specializing in in vitro and in vivo discovery testing services for immuno-oncology, inflammatory and infectious diseases. The acquisition
enhances the Company’s discovery expertise, with complementary offerings that provide the Company’s customers with additional tools in the active therapeutic research areas of oncology and immunology. The purchase price for KWS BioTest was $i20.3 million in cash
and was funded by the Company’s various borrowings. In addition to the initial purchase price, the transaction includes aggregate, undiscounted contingent payments of up to £i3.0 million based on future performance. During the three months ended September 29, 2018, the terms of these contingent
payments were amended, resulting in a fixed payment of £i2.0 million, or $i2.6
million, which was paid during the three months ended March 30, 2019. The KWS BioTest business is reported as part of the Company’s DSA reportable segment.
The purchase price allocation of $i21.5
million, net of $i1.0 million of cash acquired and a final net working capital adjustment of $i0.4
million, was as follows:
From
the date of the acquisition through December 29, 2018, the Company recorded measurement-period adjustments related to the acquisition that resulted in an immaterial change to the purchase price allocation on a consolidated basis. No further adjustments will be made to the purchase price allocation.
The only definite-lived intangible asset relates to client relationships, which will be amortized over a weighted average life of i12
years.
The goodwill resulting from the transaction is primarily attributable to the potential growth of the Company’s DSA business from customers introduced through KWS BioTest and the assembled workforce of the acquired business. The goodwill attributable to KWS BioTest is not deductible for tax purposes.
14
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
iNo
significant integration costs were incurred in connection with the acquisition for the three and nine months ended September 28, 2019. The Company incurred transaction and integration costs of $i0.1 million and $i0.6
million in connection with the acquisition for the three and nine months ended September 29, 2018, respectively, which were included in Selling, general and administrative expenses, within the unaudited condensed consolidated statements of income.
Pro forma financial information as well as actual revenue and operating income have not been included because KWS BioTest’s financial results are not significant when compared to the Company’s consolidated financial results.
Other Acquisition
On August 28, 2019, the
Company acquired an i80% ownership interest in a supplier that supports the Company’s DSA reportable segment. The remaining i20%
interest is a redeemable non-controlling interest. See Note 10, “Equity and Noncontrolling Interests.” The preliminary purchase price was $i23.4 million, net of a $i4.0
millionpre-existing relationship for a supply agreement settled upon acquisition, and subject to certain post-closing adjustments that may change the purchase price. The acquisition was funded through a combination of cash on hand and proceeds from the Company’s Credit Facility under the multi-currency revolving facility. The business is reported as part of the Company’s DSA reportable segment.
The preliminary purchase allocation of $i23.1
million, net of $i0.3 million of cash acquired was as follows:
The
purchase price allocation is subject to change as additional information becomes available concerning the fair value and tax basis of the assets acquired and liabilities assumed, including certain contracts and obligations. Any additional adjustments to the purchase price allocation will be made as soon as practicable but no later than one year from the date of acquisition.
The Company incurred transaction and integration costs in connection with the acquisition of $i2.1
million and $i3.2 million for the three and nine months ended September 28, 2019, respectively, which are primarily included in Selling, general and administrative expenses within the unaudited condensed statements of income.
Pro forma financial information
as well as the disclosure of actual results have not been included because these financial results are not significant when compared to the Company’s consolidated financial results.
Revenue is recognized when, or as, obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to customers. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products or services to a customer (“transaction price”).
To the extent the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing the amount to which the
Company expects to be entitled. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the Company’s anticipated performance and all information (historical, current and forecasted) that is reasonably available. Sales, value add, and other taxes collected on behalf of third parties are excluded from revenue.
When determining the transaction price of a contract,
an adjustment is made if payment from a customer occurs either significantly before or significantly after performance, resulting in a significant financing component. Generally, the Company
15
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
does not extend payment terms beyond one year. Applying the practical expedient, the Company does not assess whether a significant financing component exists if the period between
when the Company performs its obligations under the contract and when the customer pays is one year or less. None of the Company’s contracts contained a significant financing component for the nine months ended September 28, 2019 and September 29, 2018.
Contracts with customers may contain multiple performance obligations. For such arrangements,
the transaction price is allocated to each performance obligation based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation. The Company determines standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, the Company estimates the standalone selling price taking into account available information such as market conditions and internally approved pricing guidelines related to the performance obligations.
Contracts are often modified to account for changes in contract
specifications and requirements. Contract modifications exist when the modification either creates new, or changes existing, enforceable rights and obligations. Generally, when contract modifications create new performance obligations, the modification is considered to be a separate contract and revenue is recognized prospectively. When contract modifications change existing performance obligations, the existing transaction price and measure of progress for the performance obligation to which it relates is recognized as an adjustment to revenue (either as an increase in or a reduction of revenue) on a cumulative
catch-up basis.
Product revenue is generally recognized when the customer obtains control of the Company’s product, which occurs at a point in time, and may be upon shipment or upon delivery based on the contractual shipping terms of a contract. Service revenue is generally recognized over time as the services are delivered to the customer based on the extent of progress towards completion of the performance obligation. The selection of the method to measure progress towards completion requires judgment and is based on the nature of the products or services to be provided. Depending on which better depicts the transfer of value to the customer, the Company generally
measures its progress using either cost-to-cost (input method) or right-to-invoice (output method). The Company uses the cost-to-cost measure of progress when it best depicts the transfer of value to the customer which occurs as the Company incurs costs on its contract, generally related to fixed fee service contracts. Under the cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs at completion of the performance obligation. The costs calculation
includes variables such as labor hours, allocation of overhead costs, research model costs, and subcontractor costs. Revenue is recorded proportionally as costs are incurred. The right-to-invoice measure of progress is generally related to rate per unit contracts, as the extent of progress towards completion is measured based on discrete service or time-based increments, such as samples tested or labor hours incurred. Revenue is recorded in the amount invoiced since that amount corresponds directly to the value of the Company’s performance to date.
Disaggregation of Revenue
i
The
following tables disaggregate the Company’s revenue by major business line and timing of transfer of products or services:
Services
and products transferred at a point in time
i76,303
i77,394
i237,395
i244,248
DSA
Services
and products transferred over time
i419,445
i352,203
i1,178,874
i958,174
Services
and products transferred at a point in time
i634
i54
i919
i491
Manufacturing
Services
and products transferred over time
i36,308
i31,420
i102,674
i92,978
Services
and products transferred at a point in time
i79,018
i74,807
i241,849
i221,728
Total
revenue
$
i667,951
$
i585,295
$
i1,930,088
$
i1,664,566
RMS
The
RMS business generates revenue through the commercial production and sale of research models and the provision of services related to the maintenance and monitoring of research models and management of clients’ research operations. Revenue from the sale of research models is recognized at a point in time when the customer obtains control of the product, which may be upon shipment or upon delivery based on the shipping terms of a contract. Revenue generated from research models services is recognized over time and is typically based on a right-to-invoice measure of progress (output method) as invoiced amounts correspond directly to the value of the Company’s performance to date.
DSA
The
Discovery and Safety Assessment business provides a full suite of integrated drug discovery services directed at the identification, screening and selection of a lead compound for drug development and offers a full range of safety assessment services including bioanalysis, drug metabolism, pharmacokinetics, toxicology and pathology. Discovery and Safety Assessment services revenue is generally recognized over time using the cost-to-cost or right to invoice measures of progress, primarily representing fixed fee service contracts and per unit service contracts, respectively.
Manufacturing
The Manufacturing business includes Microbial Solutions, which provides
in vitro (non-animal) lot-release testing products, microbial detection products, and species identification services; Biologics Testing Services (Biologics), which performs specialized testing of biologics; and Avian Vaccine Services (Avian), which supplies specific-pathogen-free chicken eggs and chickens. Species identification service revenue is generally recognized at a point in time as identifications are completed by the Company. Biologics service revenue is generally recognized over time using the cost-to-cost measure of progress. Microbial Solutions and Avian product sales are generally recognized at a point in time when the customer obtains control of the product, which may be upon shipment or upon delivery based on the contractual shipping terms of a contract.
Transaction
Price Allocated to Future Performance Obligations
The Company discloses the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as of September 28, 2019. Excluded from the disclosure is the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less and (ii) contracts for which revenue is recognized at the amount to which the Company has the right to invoice
for services performed.
i
The following table includes estimated revenue expected to be recognized in the future related to performance obligations that are unsatisfied (or partially satisfied) as of September 28, 2019:
Revenue
Expected to be Recognized in Future Periods
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The timing of revenue recognition, billings and cash collections results in billed receivables (client receivables), contract assets (unbilled revenue), contract liabilities (current and non-current deferred revenue), and customer
deposits on the unaudited condensed consolidated balance sheets. The Company’s payment terms are generally i30 days in the United States and consistent with prevailing practice in international markets. A contract asset is recorded when a right to consideration in exchange for goods or services transferred to a customer is conditioned other than the passage
of time. Client receivables are recorded separately from contract assets since only the passage of time is required before consideration is due. Acontract liability is recorded when consideration is received, or such consideration is unconditionally due, from a customer prior to transferring goods or services to the customer under the terms of a contract. Contract liabilities are recognized as revenue after control of the products or services is transferred to the customer and all revenue recognition criteria have been met. iThe
following table provides information about client receivables, contract assets, and contract liabilities from contracts with customers:
When
the Company does not have the unconditional right to advanced billings, both advanced client payments and unpaid advanced client billings are excluded from deferred revenue, with the advanced billings also being excluded from client receivables. As of September 28, 2019, the Company excluded approximately $i21
million of unpaid advanced client billings from both client receivables and deferred revenue and approximately $i36 million of advanced client payments have been presented as customer contract deposits within other current liabilities in the accompanying unaudited condensed consolidated balance sheets.
Other changes in the contract
asset and the contract liability balances during the nine months ended September 28, 2019 were as follows:
(i) Changes due to business combinations:
See Note 2. “Business Acquisitions” for client receivables, contract assets, and contract liabilities that were acquired as part of the Citoxlab acquisition on April 29, 2019.
(ii) Cumulative catch-up adjustments to revenue
that affect the corresponding contract asset or contract liability, including adjustments arising from a change in the measure of progress, a change in an estimate of the transaction price (including any changes in the assessment of whether an estimate of variable consideration is constrained), or a contract modification:
During the nine months ended September 28, 2019, an immaterial cumulative catch-up adjustment to revenue was recorded.
(iii) A change in the time
frame for a right to consideration to become unconditional (that is, for a contract asset to be recorded as a client receivable):
(iv) A change in the time frame for a performance obligation to be satisfied (that is, for the recognition of revenue arising from a contract liability):
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
4. iSEGMENT
INFORMATION
The Company’s ithree reportable segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing Support (Manufacturing).
i
The
following table presents revenue and other financial information by reportable segment:
Reconciliations
of segment operating income, depreciation and amortization, and capital expenditures to the respective consolidated amounts are as follows:
Compensation,
benefits, and other employee-related expenses
i18,770
i20,464
i54,561
i56,375
External
consulting and other service expenses
i4,156
i4,767
i12,060
i12,711
Information
technology
i3,534
i3,070
i10,811
i8,723
Depreciation
i975
i1,639
i3,256
i5,058
Acquisition
and integration
i5,679
i1,122
i23,621
i15,678
Other
general unallocated corporate
i3,965
i4,962
i8,421
i9,225
Total
unallocated corporate expense
$
i45,831
$
i43,934
$
i140,474
$
i132,287
/
Other
general unallocated corporate expense consists of costs associated with departments such as senior executives, corporate accounting, legal, tax, human resources, treasury, and investor relations.
Included
in the Asia Pacific category above are operations located in China, Japan, Korea, Australia, Singapore, and India. Included in the Other category above are operations located in Brazil and Israel. Revenue represents sales originating in entities physically located in the identified geographic area.
20
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
5. iSUPPLEMENTAL
BALANCE SHEET INFORMATION
i
The composition of trade receivables, net is as follows:
Accrued
executive supplemental life insurance retirement plan
i37,328
i36,086
Long-term
deferred revenue
i25,348
i34,420
Other
i27,473
i31,880
Other
long-term liabilities
$
i171,243
$
i179,121
/
6.
iVENTURE CAPITAL AND OTHER INVESTMENTS
The Company invests in several venture capital funds that invest in start-up companies, primarily in the life sciences industry. The Company’s ownership interest in these funds ranges from less than i1%
to i12.0%. The Company accounts for the investments in limited partnerships (LPs), which are variable interest entities, under the equity method of accounting. For publicly-held investments in the LPs, the Company adjusts for changes in fair market value based on reported share holdings at the end of each fiscal
quarter. The Company is not the primary beneficiary because it has no power to direct the activities that most significantly affect the LPs’ economic performance. The Company accounts for the investments in limited liability companies, which are not variable interest entities, under the equity method of accounting.
Venture capital investments were $i100.6
million and $i87.5 million as of September 28, 2019 and December 29, 2018, respectively. The Company’s total commitment to the venture capital
funds as of September 28, 2019 was $i128.1 million, of which the Company funded $i77.4
million through that date. The Company received dividends totaling $i0.2 million and $i5.6
million for the three months ended September 28, 2019 and September 29, 2018, respectively. The Company received dividends totaling $i1.8 million and $i14.1
million for the nine months ended September 28, 2019 and September 29, 2018, respectively. The Company recognized losses of $i0.6 million and gains of $i5.4
million related to the venture capital investments for the three months ended September 28, 2019 and September 29, 2018, respectively. The Company recognized gains of $i5.7 million and $i22.8
million related to the venture capital investments for the nine months ended September 28, 2019 and September 29, 2018, respectively. Gains and losses are recorded in Other income, net in the accompanying unaudited condensed consolidated statements of income.
The Company also invests, with minority positions, directly in equity of predominantly privately-held companies. These investments are reported at fair value or under the equity method of accounting, as appropriate. Equity investments that do not have readily determinable fair values are generally recorded at cost, plus or minus certain adjustments. Other investments were $i13.0
million and $i1.0 million as of September 28, 2019 and December 29, 2018, respectively. The Company recognized an insignificant amount of gains
and losses related to these investments for the three and nine months ended September 28, 2019 and September 29, 2018. Gains and losses from other investments are recorded in Other income, net in the accompanying unaudited consolidated statements of income.
7. iFAIR VALUE
The
Company has certain assets and liabilities recorded at fair value, which have been classified as Level 1, 2, or 3 within the fair value hierarchy:
•
Level 1 - Fair values are determined utilizing prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access,
•
Level 2 - Fair values are determined by utilizing quoted prices for identical or similar assets and liabilities in active markets
or other market observable inputs such as interest rates, yield curves, and foreign currency spot rates,
•
Level 3 - Prices or valuations that require inputs that are both significant to the fair value measurement and unobservable.
The fair value hierarchy level is determined by asset and class based on the lowest level of significant input. The observability of inputs may change for certain assets or liabilities. This condition could cause an asset or liability to be reclassified between levels. The Company recognizes transfers between levels within the fair value hierarchy, if any, at the end of
each quarter. During the nine months ended September 28, 2019 and September 29, 2018, there were no transfers between levels.
22
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Valuation methodologies used for assets and liabilities measured or disclosed at fair value are as follows:
•
Cash
equivalents - Valued at market prices determined through third-party pricing services;
•
Mutual funds - Valued at the unadjusted quoted net asset value of shares held by the Company;
•
Foreign currency forward contracts - Valued using market observable inputs, such as forward foreign exchange points and foreign exchanges rates;
•
Life
insurance policies - Valued at cash surrender value based on the fair value of underlying investments;
•
Debt instruments - The book value of the Company’s term and revolving loans, which are variable rate loans carried at amortized cost, approximates the fair value based on current market pricing of similar debt. The book value of the Company’s i5.5%
Senior Notes (Senior Notes) due in 2026, which are fixed rate debt, are carried at amortized cost. Fair value of the Senior Notes is based on quoted market prices and on borrowing rates available to the Company; and
•
Contingent consideration - Valued based on a probability weighting of the future cash flows associated with the potential outcomes.
i
Assets
and liabilities measured at fair value on a recurring basis are summarized below:
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Contingent Consideration
i
The following table provides a rollforward of the contingent consideration related to previous business acquisitions. See Note 2, “Business Acquisitions.”
The
unobservable inputs used in the fair value measurement of the Company’s contingent consideration are the probabilities of successful achievement of certain financial targets and a discount rate. Increases or decreases in any of the probabilities of success would result in a higher or lower fair value measurement, respectively. Increases or decreases in the discount rate would result in a lower or higher fair value measurement, respectively.
Debt Instruments
The book value of the Company’s term and revolving loans, which are variable rate loans carried at amortized cost, approximates the fair value based on current market pricing of similar debt. As the fair value is based on significant other observable inputs,
including current interest and foreign currency exchange rates, it is deemed to be Level 2 within the fair value hierarchy.
As of both September 28, 2019 and December 29, 2018, the book value of the Company’s Senior Notes, which is a fixed rate obligation carried at amortized cost, was $i500.0
million. The fair value of the Company’s Senior Notes as of September 28, 2019 and December 29, 2018 was $i530.0
million and $i495.0 million, respectively. Fair value is based on quoted market prices as well as borrowing rates available to the Company. As the fair value is based on significant other observable outputs, it is deemed to be Level 2
within the fair value hierarchy.
8. iGOODWILL AND INTANGIBLE ASSETS
Goodwill
i
The
following table provides a rollforward of the Company’s goodwill:
The
increase in goodwill during the nine months ended September 28, 2019 related primarily to the acquisition of Citoxlab in the DSA reportable segment and the impact of foreign exchange.
24
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Intangible Assets, Net
i
The
following table displays intangible assets, net by major class:
On March 26, 2018, the Company amended and restated its$i1.65 billioncredit facility creating a $i2.3 billion credit facility (Credit Facility). The amendment extended the maturity date and provided for a $i750.0
million term loan and a $i1.55 billion multi-currency revolving facility. The amendment was accounted for as a debt modification. In connection with the transaction, the
Company capitalized approximately $i6.2 million within Long-term debt, net and finance leases in the accompanying unaudited condensed consolidated balance sheets and expensed approximately $i1.0
million of debt issuance costs recorded within Interest expense in the accompanying unaudited condensed consolidated statements of income for the year ended 2018. On September 25, 2019the Company amended and restated the Credit Facility for certain administrative matters.
The term loan facility matures in i19
quarterly installments with the last installment due March 26, 2023. The revolving facility matures on March 26, 2023, and requires no scheduled payment before that date.
On October 23, 2019, the Company prepaid $i500.0
million of the term loan with proceeds from a $i500.0 million unregistered private offering (see 2028 Senior Notes Offering below). Additionally, on November 4, 2019, the
Company amended and
25
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
restated the Credit Facility to increase the multi-currency revolving facility by $i500.0
million, from $i1.55 billion to $i2.05
billion. The amount outstanding under the multi-currency revolving facility has not significantly changed since September 28, 2019. Under specified circumstances, the Company has the ability to increase the term loan and/or revolving facility by up to $i1.0
billion in the aggregate.
The interest rates applicable to the term loan and revolving facility under the Credit Facility are, at the Company’s option, equal to either the base rate (which is the higher of (1) the prime rate, (2) the federal funds rate plus i0.50%,
or (3) the one-month adjusted LIBOR rate plus i1.0%) or the adjusted LIBOR rate, plus an interest rate margin based upon the Company’s leverage ratio.
The Credit Facility
includes certain customary representations and warranties, events of default, notices of material adverse changes to the Company’s business and negative and affirmative covenants. These covenants include (1) maintenance of a ratio of consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) less capital expenditures to consolidated cash interest expense, for any period of four consecutive fiscal quarters, of no less than i3.50
to 1.0 as well as (2) maintenance of a ratio of consolidated indebtedness to consolidated EBITDA for any period of four consecutive fiscal quarters, of no more than i4.00 to 1.0. As of September 28, 2019,
the Company was compliant with all covenants.
The obligations of the Company under the Credit Facility are collateralized by substantially all of the assets of the Company.
During the three and nine months ended September 28, 2019, the Company had multiple U.S. dollar denominated loans borrowed by a non-U.S. Euro functional currency entity under the
Company’s Credit Facility, which ranged from $i300 million to $i350
million. This resulted in foreign currency losses recognized in Other income, net of $i12.1 million during the three months ended September 28, 2019 and $i14.9
million during the nine months ended September 28, 2019. The Company entered into foreign exchange forward contracts to limit its foreign currency exposures related to these borrowings. As of September 28, 2019, the Company did not have any outstanding borrowings in a currency different than its respective functional currency. See Note 14, “Foreign Currency Contracts”, for further discussion.
The Indenture contains certain covenants including, but not limited to, limitations and restrictions on the ability of the Company and its U.S. subsidiaries to (i) create certain liens, (ii) enter into any Sale and Leaseback Transaction (as defined in the Indenture) with respect to any property, and (iii) merge, consolidate, sell or otherwise dispose of all
or substantially all of their assets. These covenants are subject to a number of conditions, qualifications, exceptions and limitations. Any event of default, as defined, could result in the acceleration of the repayment of the obligations.
2026 Senior Notes Offering
On April 3, 2018, the Company entered into the first supplemental indenture (First Supplemental Indenture) with the Trustee in connection with an offering of $i500.0
million in aggregate principal amount of the Company’s i5.5% Senior Notes (2026 Senior Notes), due in 2026, in an unregistered offering. Under the terms of the First Supplemental Indenture,
interest on the Senior Notes is payable semi-annually on April 1 and October 1, beginning on October 1, 2018. The 2026 Senior Notes are guaranteed fully and unconditionally, jointly and severally on a senior unsecured basis by the Company and certain of its U.S. subsidiaries. In connection with the transaction, the Company incurred $i7.4
million of debt issuance costs within Long-term debt, net and finance leases in the accompanying unaudited condensed consolidated balance sheets.
The Company may redeem all or part of the 2026 Senior Notes at any time prior to April 1, 2021, at its option, at a redemption price equal to i100%
of the principal amount of such Senior Notes plus the Applicable Premium (as defined in the First Supplemental Indenture). The Company may also redeem up to i40%
of the Senior Notes with the proceeds of certain equity offerings completed before April 1, 2021, at a redemption price equal to i105.5% of the principal amount of such 2026 Senior Notes. On or after April
1, 2021, the Company may on any one or more occasions redeem all or a part of the 2026 Senior Notes, at the redemption prices specified in the Indenture based on the applicable date of redemption. Upon the occurrence of a Change of Control Triggering Event (as defined in the Indenture), the Company will be required to offer to repurchase the 2026 Senior Notes at a purchase price equal to i101%
of the aggregate principal amount of such 2026 Senior Notes. Any redemption of the 2026 Senior Notes would also require settlement of accrued and unpaid interest, if any, up to but excluding the redemption date.
Net proceeds from the 2026 Senior Notes of $i493.8 million were used to partially repay the outstanding revolving credit facility on April
3, 2018 as well as fund the acquisition of MPI Research.
2028 Senior Notes Offering
On October 23, 2019, the Company entered into a second supplemental indenture (Second Supplemental Indenture) with the Trustee in connection with the offering of $i500.0
million in aggregate principal amount of the Company’s i4.25% Senior Notes
26
CHARLES
RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(2028 Senior Notes), due in 2028, in an unregistered offering. Under the terms of the Second Supplemental Indenture, interest on the 2028 Senior Notes is payable semi-annually on May 1 and November 1, beginning on May 1, 2020. The 2028 Senior Notes are guaranteed fully and unconditionally, jointly and severally on a senior unsecured basis by the Company and certain of its U.S. subsidiaries.
In connection with the transaction, the Company incurred approximately $i6 million of debt issuance costs, which were capitalized upon the 2028 Senior Notes issuance on October 23, 2019.
The
Company may redeem all or part of the 2028 Senior Notes at any time prior to May 1, 2023, at its option, at a redemption price equal to i100% of the
principal amount of such 2028 Senior Notes plus the Applicable Premium (as defined in the Indenture). The Company may also redeem up to i40%
of the 2028 Senior Notes with the proceeds of certain equity offerings completed before May 1, 2023, at a redemption price equal to i104.25% of the principal
amount of such 2028 Senior Notes. On or after May 1, 2023, the Company may on any one or more occasions redeem all or a part of the 2028 Senior Notes, at the redemption prices specified in the Indenture based on the applicable date of redemption. Upon the occurrence of a Change of Control Triggering Event (as defined in the Indenture), the Company will be required to offer to repurchase the Senior Notes at a purchase price equal to i101%
of the aggregate principal amount of such Senior Notes. Any redemption of the Senior Notes would also require settlement of accrued and unpaid interest, if any, up to but excluding the redemption date.
Net proceeds from the 2028 Senior Notes of approximately $i494 million and available cash were used to prepay
a portion of the term loan on October 23, 2019.
Commitment Letter
On February 12, 2018, the Company secured an $i830 million
commitment under a 364-day senior unsecured bridge loan facility (the Bridge Facility) for the purpose of financing the acquisition of MPI Research. The Bridge Facility was terminated as of April 3, 2018 upon the successful acquisition of MPI Research. Debt issuance costs of $i1.8 million, which were capitalized upon the execution of the Bridge Facility,
were expensed upon termination of the agreement on April 3, 2018. In addition, the Company incurred and expensed $i2.0 million of fees pertaining to a temporary backstop facility related to the negotiation of the Credit Facility during the three months ended March
31, 2018. These costs were included in Interest expense in the accompanying unaudited condensed consolidated statements of income.
Income from continuing operations, net of income taxes
$
i73,552
$
i60,902
$
i173,549
$
i167,020
Income
from discontinued operations, net of income taxes
i—
i—
i—
i1,506
Less:
Net income attributable to noncontrolling interests
i742
i534
i1,878
i1,818
Net
income attributable to common shareholders
$
i72,810
$
i60,368
$
i171,671
$
i166,708
Denominator:
Weighted-average
shares outstanding - Basic
i48,818
i48,310
i48,682
i48,098
Effect
of dilutive securities:
Stock options, restricted stock units, performance share units and restricted stock
i897
i1,016
i945
i1,020
Weighted-average
shares outstanding - Diluted
i49,715
i49,326
i49,627
i49,118
/
27
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Options to purchase i0.4
million and i0.5 million shares for the three months ended September 28, 2019 and September 29, 2018,
respectively, as well as a non-significant number of restricted shares, restricted stock units (RSUs), and performance share units (PSUs), were not included in computing diluted earnings per share because their inclusion would have been anti-dilutive.Options to purchase i0.4 million
and i0.5 million shares for the nine months ended September 28, 2019 and September 29, 2018, respectively, as well as a non-significant number of restricted shares,
RSUs and PSUs, were not included in computing diluted earnings per share because their inclusion would have been anti-dilutive. Basic weighted-average shares outstanding for both the nine months ended September 28, 2019 and September 29, 2018 excluded the impact of i1.0
million shares of non-vested restricted stock and RSUs.
The
Company’s stock-based compensation plans permit the netting of common stock upon vesting of RSUs and PSUs in order to satisfy individual statutory tax withholding requirements. During the nine months ended September 28, 2019 and September 29, 2018, the Company acquired i0.1
million shares for $i18.0 million and i0.1
million shares for $i13.8 million, respectively, from such netting.
Accumulated Other Comprehensive Income (Loss)
i
Changes
to each component of accumulated other comprehensive income (loss), net of income taxes, are as follows:
The Company has an investment in an entity whose financial results are consolidated in the Company’s financial statements, as it has the ability to exercise control over this entity. The interest of the noncontrolling party in this entity has been recorded as noncontrolling interest. The activity within the nonredeemable noncontrolling interest was immaterial during the three and nine months ended September 28, 2019and September 29, 2018.
Redeemable
Noncontrolling Interests
On June 13, 2019, the Company purchased an additional i5% equity interest in Vital River for $i7.9
million, resulting in total ownership of i92%. The Company recorded a $i0.8
million gain in equity equal to the excess fair value of the i5% equity interest over the purchase price. Concurrent with the transaction, the pre-existing agreement was further amended to provide the Company with the right to purchase, and the noncontrolling interest holders with the right to sell,
the remaining i8% equity interest (redeemable noncontrolling interest) at a contractually defined redemption value, subject to a redemption floor, which represents a derivative embedded within the equity instrument. These rights are exercisable beginning in 2022 and are accelerated in certain events. The Company recorded a charge of $i2.2
million in Selling, general and administrative expenses within the unaudited condensed consolidated statements of income, equal to the excess fair value of the hybrid instrument (equity interest with embedded derivative) over the fair value of the i8% equity interest. The redeemable noncontrolling interest is measured at the greater of the amount that would be paid if settlement occurred as of the balance
sheet date based on the contractually defined redemption value ($i14.5 million as of September 28, 2019) and the carrying amount adjusted for net income (loss) attributable to the noncontrolling interest. As the noncontrolling interest holders have the ability to require the
Company to purchase the remaining i8% interest, the noncontrolling interest is classified in the mezzanine section of the unaudited condensed consolidated balance sheets, which is presented above the equity section and below liabilities. The agreement does not limit the amount that the Company could be required to pay to purchase the remaining
i8% equity interest.
28
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
As
part of the Citoxlab acquisition on April 29, 2019, the Company acquired a less than wholly owned subsidiary that is fully consolidated under the voting interest model. The Company acquired a i90%
equity interest, which includes a i10% redeemable noncontrolling interest. The noncontrolling interest holders have the ability to require the Company to purchase the remaining i10%
interest at certain dates in the future between 2021 through 2023. The noncontrolling interest is classified in the mezzanine section of the unaudited condensed consolidated balance sheets and is approximately $i4 million as of September 28, 2019.
On August 28,
2019, the Company acquired an i80% equity interest in a supplier, which included a i20%
redeemable noncontrolling interest. The contract provides the Company the right to purchase, and the noncontrolling interest holders with the right to sell, the remaining i20% equity interest at its appraised value. These rights are exercisable beginning in 2022.
The redeemable noncontrolling interest is measured at the greater of the amount that would be paid if settlement occurred as of the balance sheet date based on the appraised value and the carrying amount adjusted for net income (loss) attributable to the noncontrolling interest or a pre-determined floor value. As the noncontrolling interest holders have the ability to require the Company to purchase the remaining i20%
interest, the noncontrolling interest is classified in the mezzanine section of the unaudited condensed balance sheets, which is presented above the equity section and below liabilities. The agreement does not limit the amount that the Company could be required to pay to purchase the remaining i20% equity interest.
i
The
following table provides a rollforward of the activity related to the Company’s redeemable noncontrolling interests:
Change
in fair value of Vital River 8% equity interest, included in additional-paid-in-capital
i2,708
i—
Modification
of Vital River 8% purchase option
i2,196
i—
Acquisition
of a 10% non-controlling interest through acquiring Citoxlab
i4,035
i—
Acquisition
of a 20% non-controlling interest through acquiring a supplier
i8,740
i—
Net
income attributable to noncontrolling interests
i249
i543
Foreign
currency translation
(i814
)
(i932
)
Ending
balance
$
i28,345
$
i17,331
/
11.
iINCOME TAXES
The Company’s effective tax rates for the three months ended September 28, 2019 and September 29, 2018 were (i0.4)%
and i16.9%, respectively. The Company’s effective tax rates for the nine months ended September 28, 2019 and September 29, 2018 were i12.6%
and i19.2%, respectively. For the three and nine months ended September 28, 2019, the change in the effective tax rates from the prior year periods were primarily attributable to recognizing a $i20.4
million deferred tax asset in the three months ended September 28, 2019 for net operating losses expected to be utilized in the future due to changes in the Company’s international financing structure.
For the three months ended September 28, 2019, the Company’s unrecognized tax benefits decreased by $i5.8
million to $i19.0 million, primarily due to the lapse of statutes of limitations, offset by an additional quarter of Canadian Scientific Research and Experimental Development Credit reserves. For the three months ended September 28, 2019, the unrecognized income tax benefits that would impact the effective tax rate decreased by $i6.1
million to $i16.6 million, for the same reasons discussed above. The accrued interest on unrecognized tax benefits was $i2.2
million at September 28, 2019. The Company estimates that it is reasonably possible that the unrecognized tax benefits will decrease by up to $i1.6 million over the next twelve-month period, primarily due to the outcome of pending tax audits.
The
Company conducts business in several tax jurisdictions. As a result, it is subject to tax audits in jurisdictions including the U.S., U.K., China, France, Germany, Canada, Japan and India. With few exceptions, the Company is no longer subject to U.S. and international income tax examinations for years before 2016.
The Company and certain of its subsidiaries have ongoing tax controversies with various tax authorities in the U.S., Canada, Japan, India, China, and France. The Company does not anticipate resolution of these audits will have a material impact on its financial statements.
29
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
12. iPENSION AND OTHER POST-RETIREMENT BENEFIT PLANS
i
The
following table provides thecomponents of net periodic cost for the Company’s pension, deferred compensation and executive supplemental life insurance retirement plans:
Service
cost is recorded as an operating expense within the accompanying unaudited condensed consolidated statements of income. All other components of net periodic costs are recorded in Other income, net in the accompanying unaudited condensed consolidated statements of income. The net periodic cost for the Company’s other post-retirement benefit plan for the three and nine months ended September 28, 2019 and September 29, 2018 was not significant.
13. iSTOCK-BASED
COMPENSATION
The Company has stock-based compensation plans under which employees and non-employee directors may be granted stock-based awards such as stock options, restricted stock, RSUs, and PSUs.
i
The following table provides stock-based compensation by the financial statement line item in which it is reflected:
During
the nine months ended September 28, 2019, the Company granted stock options representing i0.5 million common shares with a per-share weighted-average grant date fair value
of $i33.97, RSUs representing i0.2
million common shares with a per-share weighted-average grant date fair value of $i142.89, and PSUs representing i0.2
million common shares with a per-share weighted-average grant date fair value of $i162.74. The maximum number of common shares to be issued upon vesting of PSUs granted during the nine
months ended September 28, 2019 is i0.3 million.
The Company entered into foreign exchange forward contracts during the nine months ended September 28, 2019 and three months ended December 29, 2018 to limit its foreign currency exposure related to a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency entity under the Credit Facility. These contracts
are not designated as hedging instruments. Any gains or losses on these forward contracts are recognized immediately in Interest expense.
The open contract at December 29, 2018, which had a duration of approximately 3 months, was recorded at fair value in the Company’s accompanying unaudited condensed consolidated balance sheets. iThe
notional amount and fair value of the open contract is summarized as follows:
30
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The Company had no open forward contracts related to a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency at September 28, 2019.
The following table summarizes the effect of the foreign exchange forward contracts entered into to limit its foreign currency exposure related to a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency entity under the Credit Facility on the
Company’s unaudited condensed consolidated statements of income:
The Company also entered into foreign exchange forward contracts during the nine months ended September 28, 2019 to limit its foreign currency exposure related to certain intercompany loans. These contracts are not designated as hedging instruments. Any gains or losses on forward contracts associated with intercompany loans are recognized immediately in Other income, net and are largely offset by the remeasurement of the underlying intercompany loans.
The following table summarizes the effect of the foreign exchange forward contracts entered into in connection with intercompany
loans on the Company’s unaudited condensed consolidated statements of income:
In recent fiscal years, the Company has undertaken productivity improvement initiatives within all reportable segments at various locations across the U.S., Europe, and Japan. This includes workforce right-sizing and scalability initiatives, resulting in severance and transition costs; and cost related
to the consolidation of facilities, resulting in asset impairment and accelerated depreciation charges.
31
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The following table presents a summary of restructuring costs related to these initiatives within the unaudited condensed consolidated statements of income.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
2017 RMS Restructuring Initiative
In the fourth quarter of fiscal year 2017, the Company committed to a plan to further reduce costs and improve operating efficiencies in its RMS reportable segment. The plan included ceasing production within the Company’s facility in Maryland and repurposing it for alternative initiatives, and reducing its workforce
at certain RMS facilities during 2018.
The following table presents a summary of severance and transition costs, and asset impairments (referred to as restructuring costs) during the three and nine months ended September 29, 2018 related to this initiative within the unaudited condensed consolidated statements of income. The Company did inot
incur any restructuring costs in the three and nine months ended September 28, 2019.
Cost of services provided and products sold (excluding amortization of intangible assets)
$
i95
$
i238
$
i333
$
i650
$
i822
$
i1,472
Selling,
general and administrative
(i30
)
i—
(i30
)
i158
i—
i158
Total
$
i65
$
i238
$
i303
$
i808
$
i822
$
i1,630
Cumulative
restructuring costs incurred during 2017 and 2018 were $i20.1 million, which primarily related to non-cash asset impairments and accelerated depreciation charges of $i17.7
million and cash payments for severance and transition costs of $i1.2 million and were recorded in the RMS reportable segment. All severance and transition costs have been paid as of June 29, 2019 and no further restructuring costs related to the
2017 RMS Restructuring Initiative are expected to be incurred.
i
The following table provides a rollforward for all of the Company’s severance and transition costs, and lease obligation liabilities related to all restructuring activities:
As
of September 28, 2019 and September 29, 2018, $i3.8 million and $i2.6
million of severance and other personnel related costs liabilities and lease obligation liabilities, respectively, were included in accrued compensation and accrued liabilities within the Company’s unaudited condensed consolidated balance sheets and izero and $i4.4
million, respectively, were included in other long-term liabilities within the Company’s unaudited condensed consolidated balance sheets.
16. iiLEASES/
Adoption
of ASC Topic 842, “Leases” (ASC 842)
ASC 842 became effective for the Company on December 30, 2018 and was adopted using the modified retrospective method for all leases that had commenced as of the effective date, along with certain available practical expedients. The Company elected to recognize any effects of applying the new standard as a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, which there were none. In addition, the Company elected to adopt the package of practical expedients permitted under the transition guidance within the new standard. The practical
expedient package applied to leases that commenced prior to the effective date of the new standard and permits a reporting entity not to: i) reassess whether any expired or existing contracts are or contain leases, ii) reassess the historical lease classification for any expired or existing leases, and iii) reassess initial direct costs for any existing leases.
33
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
The reporting results for the nine months ended September
28, 2019 reflect the application of ASC 842 guidance while the historical results for fiscal year 2018 were prepared under the guidance of ASC 840. The adoption of the new standard did not have a significant impact upon the Company’s condensed consolidated statements of income and cash flows. The adoption of the new standard resulted in the following impact to the condensed consolidated balance sheet: i) no significant change in the carrying values of assets and liabilities related to the Company’s finance leases, previously referred to as capital leases (See Note 9, “Long-Term Debt and Finance Lease Obligations”), ii) the derecognition of assets and related liabilities pertaining to certain build-to-suit arrangements previously accounted for under ASC 840 and recording
them under the guidance of ASC 842, and iii) the recording of right-of-use assets and corresponding lease liabilities pertaining to the Company’s operating leases on the condensed consolidated balance sheet, adjusted for existing balances of prepaid rent and deferred rent liabilities as of the transition date. iThe cumulative effect of applying ASC 842 to all leases that had commenced as of December
30, 2018 was as follows:
(1) Short term prepaid rent reclassified from Prepaid assets to the Operating lease right-of-use asset.
(2) Derecognition of approximately $26 million of leased properties, recorded in Property, plant and equipment, specifically Construction-in-process, that were recognized under the previously existing build-to-suit accounting rules; partially offset by Prepaid assets related to finance leases reclassified from Prepaid assets.
(3) Recognition of Operating lease right-to-use asset and adjusted for prepaid rent and deferred rent liability reclassification
adjustments identified in adjustments (1)(4)(5).
(4) Long-term prepaid rent reclassified from Other assets to the Operating lease right-of-use asset.
(5) Recognition of short-term portion of the Operating lease right-of-use liabilities offset by reclassification of deferred rent liability to Operating lease right-of-use asset.
(6) Recognition of long-term portion of the Operating
lease right-of-use liabilities.
(7) Derecognition of approximately $26 million of Other debt associated with leased properties that were recognized under the previously existing build-to-suit accounting rules.
Operating and Finance Leases
At inception of a contract, the Company determines if a contract meets the definition of a lease. A lease is a contract,
or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. The Company determines if the contract conveys the right to control the use of an identified asset for a period of time. The Company assesses throughout the period of use whether the Company has both of the following: (1) the right to obtain substantially all of the economic benefits from use of the identified asset, and (2) the right to direct the use
of the identified asset. This determination is reassessed if the terms of the contract are changed. Leases are classified as operating or finance leases based on the terms of the lease agreement and certain characteristics of the identified asset. Right-of-use assets and lease liabilities are recognized at lease commencement date based on the present value of the minimum future lease payments.
The Company leases laboratory, production, and office space (real estate), as well as land, vehicles and certain equipment under non-cancellable operating and finance leases. The carrying value of the Company’s right-of-use lease assets is substantially
concentrated in its real estate leases, while the volume of lease agreements is primarily concentrated in vehicles and equipment leases. The Company’s policy is to not record leases with an original term of twelve months or less on the condensed consolidated balance sheets. The Company recognizes lease expense for these short-term leases on a straight-line basis over the lease term.
Certain lease agreements include rental payments that are adjusted periodically for inflation or other variables. In addition to rent, the leases may require the Company to pay additional amounts for taxes, insurance, maintenance and other expenses,
34
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
which are generally referred to as non-lease components. Such adjustments to rental payments and variable non-lease components are treated as variable lease payments and recognized in the period in which the obligation for these payments was incurred. Variable lease components and variable non-lease components are not measured as part of the right of use asset and liability. Only when lease components and their associated non-lease components are fixed are they accounted for as a single lease component and are recognized as part of a right of use asset and liability. Total contract
consideration is allocated to the combined fixed lease and non-lease component. This policy election applies consistently to all asset classes under lease agreements.
Most leases contain clauses for renewal at the Company’s option with renewal terms that generally extend the lease term from i1 to i5
years. Certain lease agreements contain options to purchase the leased property and options to terminate the lease. Payments to be made in option periods are recognized as part of the right-of-use lease assets and lease liabilities when it is reasonably certain that the option to extend the lease will be exercised or the option to terminate the lease will not be exercised, or is not at the Company’s option. The Company determines whether the reasonably certain threshold is met by considering contract-, asset-, market-, and entity-based factors.
A portfolio approach is applied to certain lease contracts
with similar characteristics. The Company’s lease agreements do not contain any significant residual value guarantees or material restrictive covenants imposed by the leases.
The Company subleases a limited number of lease arrangements. Sublease activity is not material to the condensed consolidated financial statements.
i
Right-of-use lease assets and lease liabilities are reported in the
Company’s unaudited condensed consolidated balance sheets as follows:
At the lease commencement date, the discount rate implicit in the lease is used to discount the lease liability if readily determinable. If not readily determinable or leases
do not contain an implicit rate, the Company’s incremental borrowing rate is used as the discount rate.
ii
As of September 28,
2019, maturities of operating and finance lease liabilities for each of the following five years and a total thereafter were as follows:
Total
minimum future lease payments (predominantly operating leases) of approximately $i47 million for leases that have not commenced as of September 28, 2019, as the Company does not yet control the underlying assets, are not included in the condensed consolidated financial statements. These leases are expected
to commence between fiscal years 2019 and 2024 with lease terms of approximately i3 to i15
years.
ii
As
of December 29, 2018, minimum future lease payments under non-cancellable leases for each of the following five years and a total thereafter were as follows:
/
36
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
Operating
Leases (1)
Finance Leases (1)
(in thousands)
2019
$
i25,411
$
i3,972
2020
i22,400
i3,759
2021
i21,544
i2,869
2022
i18,535
i2,967
2023
i15,398
i2,209
Thereafter
i66,870
i24,304
Total
minimum future lease payments
$
i170,158
$
i40,080
(1) Lease
commitments are presented under the guidance of ASC 840 and includes approximately $14 million of minimum future lease payments for leases that had not commenced as of December 29, 2018. These commitments relate to existing leases for which the Company does not yet control certain expansion space.
17. iCOMMITMENTS
AND CONTINGENCIES
Litigation
Various lawsuits, claims and proceedings of a nature considered normal to its business are pending against the Company. While the outcome of any of these proceedings cannot be accurately predicted, the Company does not believe the ultimate resolution of any of these existing matters would have a material adverse effect on the Company’s business or financial condition.
37
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes of this Quarterly Report on Form 10-Q and our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for fiscal year 2018. The following discussion contains forward-looking statements. Actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause future results to differ materially from those projected in the forward-looking statements include, but are not limited to, those discussed in Item 1A, “Risk Factors” in our Annual Report on Form 10-K for fiscal year 2018.
Certain percentage changes may not recalculate due to rounding.
Overview
We are a full service, early-stage contract research organization (CRO). For over 70 years, we have been in the business of providing the research models required in research and development of new drugs, devices, and therapies. Over this time, we have built upon our original core competency of laboratory animal medicine and science (research model technologies) to develop a diverse portfolio of discovery and safety assessment services, both Good Laboratory Practice (GLP) and non-GLP, that enable us to support our clients from target identification through non-clinical development. We also provide a
suite of products and services to support our clients’ manufacturing activities. Utilizing our broad portfolio of products and services enables our clients to create a more flexible drug development model, which reduces their costs, enhances their productivity and effectiveness, and increases speed to market.
Our client base includes all major global biopharmaceutical companies, many biotechnology companies, CROs, agricultural and industrial chemical companies, life science companies, veterinary medicine companies, contract manufacturing companies, medical device companies, and diagnostic and other commercial entities, as well as leading hospitals, academic institutions, and government agencies around the world.
Segment Reporting
Our three reportable
segments are Research Models and Services (RMS), Discovery and Safety Assessment (DSA), and Manufacturing Support (Manufacturing). Our RMS reportable segment includes the Research Models and Research Model Services businesses. Research Models includes the commercial production and sale of small research models, as well as the supply of large research models. Research Model Services includes: Genetically Engineered Models and Services (GEMS), which performs contract breeding and other services associated with genetically engineered models; Research Animal Diagnostic Services (RADS), which provides health monitoring and diagnostics services related to research models; and Insourcing Solutions (IS), which provides colony management of our clients’ research operations (including recruitment, training, staffing, and management services). Our DSA reportable segment includes services
required to take a drug through the early development process including discovery services, which are non-regulated services to assist clients with the identification, screening, and selection of a lead compound for drug development, and regulated and non-regulated (GLP and non-GLP) safety assessment services. Our Manufacturing reportable segment includes Microbial Solutions, which provides in vitro (non-animal) lot-release testing products, microbial detection products, and species identification services; Biologics Testing Services (Biologics), which performs specialized testing of biologics; Avian Vaccine Services (Avian), which supplies specific-pathogen-free chicken eggs and chickens.
Recent Acquisitions
Our strategy is to augment internal growth of existing businesses with complementary acquisitions. Our recent acquisitions are
described below.
On August 28, 2019, we acquired an 80% ownership interest in a supplier that supports our DSA reportable segment. The remaining 20% interest is a redeemable non-controlling interest. The preliminary purchase price was $23.4 million, net of a $4.0 million pre-existing relationship for a supply agreement settled upon acquisition, and subject to certain post-closing adjustments that may change the purchase price. The acquisition was funded through a combination of cash on hand and proceeds from our Credit Facility under the multi-currency revolving facility. The business is reported as part of our DSA reportable segment.
On April 29,
2019, we acquired Citoxlab, a non-clinical CRO, specializing in regulated safety assessment services, non-regulated discovery services, and medical device testing. With operations in Europe and North America, the acquisition of Citoxlab further strengthens our position as a leading, global, early-stage CRO by expanding our scientific portfolio and geographic footprint, which enhances our ability to partner with clients across the drug discovery and development continuum. The preliminary purchase price for Citoxlab was $527.7 million in cash, subject to certain post-closing adjustments that may change the purchase price. The acquisition was funded through a combination of cash on hand and proceeds from our Credit Facility under the multi-currency revolving facility. Citoxlab is reported as part of our DSA reportable segment.
On April 3,
2018, we acquired MPI Research, a non-clinical CRO providing comprehensive testing services to biopharmaceutical and medical device companies worldwide. The acquisition enhances our position as a leading global early-
38
stage CRO by strengthening our ability to partner with clients across the drug discovery and development continuum. The purchase price for MPI Research was $829.7 million in cash. The acquisition was funded by borrowings on our Credit Facility as well as the issuance of $500.0 million of 5.5% Senior Notes due 2026 (2026 Senior Notes) in an unregistered offering. MPI Research
is reported as part of our DSA reportable segment.
On January 11, 2018, we acquired KWS BioTest Limited (KWS BioTest), a CRO specializing in in vitro and in vivo discovery testing services for immuno-oncology, inflammatory and infectious diseases. The acquisition enhances our discovery expertise, with complementary offerings that provide our customers with additional tools in the active therapeutic research areas of oncology and immunology. The purchase price for KWS BioTest was $20.3 million in cash. In addition to the initial purchase price, the transaction includes aggregate, undiscounted contingent payments of up to £3.0 million based
on future performance. During the three months ended September 29, 2018, the terms of these contingent payments were amended, resulting in a fixed payment of £2.0 million, or $2.6 million, which was paid during the three months ended March 30, 2019. The KWS BioTest business is reported as part of our DSA reportable segment.
Overview of Results of Operations and Liquidity
Revenue for the three months ended September 28, 2019 was $668.0 million compared to $585.3 million
in the corresponding period in 2018. This increase of $82.7 million, or 14.1%, was primarily due to the recent acquisition of Citoxlab as well as growth in our DSA and Manufacturing segments; partially offset by the negative effect of changes in foreign currency exchange rates which decreased revenue by $7.7 million, or 1.3%, when compared to the corresponding period in 2018. Revenue for the nine months ended September 28, 2019 was $1.9 billion compared
to $1.7 billion in the corresponding period in 2018. The increase of $265.5 million, or 16.0%, was primarily due to the reasons described above as well as the acquisition of MPI Research; partially offset by the negative effect of changes in foreign currency exchange rates, which decreased revenue by $32.6 million, or 1.9%, when compared to the corresponding period in 2018.
In the three months ended September 28, 2019, our operating
income and operating income margin were $92.8 million and 13.9%, respectively, compared with $84.4 million and 14.4%, respectively, in the corresponding period of 2018. In the nine months ended September 28, 2019, our operating income and operating margin were $242.4 million and 12.6%, respectively, compared with $228.9 million and 13.8%, respectively, in the corresponding period of 2018. The
increases in operating income were primarily due to contributions from our recent acquisitions of Citoxlab and MPI Research. The decreases in operating income margin were primarily due to increased amortization expense and costs related to our recent acquisitions; as well as continued investments to support future growth of the businesses, which includes increased investments in personnel (staffing levels and hourly wage increases) and facility expansions.
Net income attributable to common shareholders increased to $72.8 million in the three months ended September 28, 2019, from $60.4 million in the corresponding period of 2018.
Net income attributable to common shareholders increased to $171.7 million in the nine months ended September 28, 2019, from $166.7 million in the corresponding period of 2018. The increases in Net income attributable to common shareholders was primarily due to recognizing a$20.4 million deferred tax asset in the three months ended September 28, 2019 for net operating losses expected to be utilized in the future due to changes in the
Company’s international financing structure.
During the first nine months of 2019, our cash flows from operations remained relatively consistent at $300.3 million compared with $301.2 million for the same period in 2018. The slight decrease was primarily driven by unfavorable changes in operating assets and liabilities, specifically related to the timing of net contract balances from contracts with customers (collectively trade receivables, net; deferred revenue; and customer contract
deposits) and higher compensation payments compared to the prior year period; offset by the favorable timing of vendor and supplier payments compared to the same period in 2018.
On October 23, 2019, we issued $500.0 million of 4.25% Senior Notes due in 2028 (2028 Senior Notes) in an unregistered offering. Interest on the 2028 Senior Notes is payable semi-annually on May 1 and November 1, beginning on May 1, 2020. Net proceeds from the 2028 Senior Notes of approximately $494 million and available cash were used to prepay $500.0 million of our term loan under our Credit Facility. Additionally, on November 4,
2019, we amended and restated our Credit Facility by increasing the amount of our multi-currency revolving facility by $500.0 million, from $1.55 billion to $2.05 billion. Under specified circumstances, we have the ability to increase the term loan and/or revolving facility by up to $1.0 billion in the aggregate.
In March 2019, we detected unauthorized access into portions of our information systems and commenced an investigation into the incident, coordinated with U.S. federal law enforcement and leading cybersecurity experts, and promptly implemented a comprehensive containment and remediation plan. While the investigation is ongoing, we have determined that some client data was copied
by a highly sophisticated, well-resourced intruder. We have not yet determined the potential revenue or financial impact related to this incident.
Cost
of revenue (excluding amortization of intangible assets)
81.9
79.2
2.7
3.4
%
Selling,
general and administrative
16.0
15.1
0.9
5.4
%
Amortization
of intangible assets
0.3
0.4
(0.1
)
(11.4
)%
Operating
income
$
34.4
$
32.1
$
2.3
7.0
%
Operating
income % of revenue
25.9
%
25.3
%
0.6
%
40
RMS
revenue increased$5.8 million due primarily to higher research model services revenue and higher research model product revenue in China. Research model services benefited from a large government contract in the IS business. Partially offsetting these increases were the effect of changes in foreign currency exchange rates and lower research model product revenue outside of China, particularly from large biopharmaceutical clients.
RMS operating income increased $2.3 million compared to the corresponding period in 2018. RMS operating income as a percentage of revenue for the three months ended September
28, 2019 was 25.9%, an increase of 0.6% from 25.3% for the corresponding period in 2018. Operating income and operating income as a percentage of revenue increased primarily due to higher revenue described above and the impact of ongoing efficiency initiatives; partially offset due to lower operating income margins on the aforementioned large government contract and lower sales volume for research models outside of China.
Cost
of revenue (excluding amortization of intangible assets)
285.8
239.3
46.5
19.4
%
Selling,
general and administrative
48.0
33.8
14.2
41.8
%
Amortization
of intangible assets
21.3
16.3
5.0
31.2
%
Operating
income
$
65.0
$
62.9
$
2.1
3.3
%
Operating
income % of revenue
15.5
%
17.9
%
(2.4
)%
DSA revenue increased$67.8 milliondue primarily to the recent acquisition of Citoxlab which contributed $44.0 million to service revenue growth. Additionally, service revenue increased in both the Safety Assessment and Discovery Services businesses due to demand from biotechnology clients and increased pricing of services. These increases were partially offset by the effect of changes in foreign currency exchange rates.
DSA operating income increased $2.1 million during the three months ended September 28, 2019 compared to the corresponding period in 2018.
DSA operating income as a percentage of revenue for the three months ended September 28, 2019 was 15.5%, a decrease of 2.4% from 17.9% for the corresponding period in 2018. The increase to operating income was primarily attributable to higher revenues described above. This increase was partially offset by higher amortization of intangible assets and acquisition and integration costs associated with our recent acquisitions. These increased costs collectively decreased operating income as a percentage of revenue in the three months ended September 28, 2019 compared to the same period in 2018.
Cost
of revenue (excluding amortization of intangible assets)
54.1
50.6
3.5
6.9
%
Selling,
general and administrative
19.7
20.1
(0.4
)
(1.9
)%
Amortization
of intangible assets
2.3
2.2
0.1
(0.6
)%
Operating
income
$
39.2
$
33.3
$
5.9
18.0
%
Operating
income % of revenue
34.0
%
31.3
%
2.7
%
41
Manufacturing
revenue increased$9.1 million due primarily to higher demand for endotoxin productin the Microbial Solutions business and higher service revenue in the Biologics business; partially offset by the effect of changes in foreign currency exchange rates.
Manufacturing operating income increased $5.9 million during the three months ended September 28, 2019 compared to the corresponding period in 2018. Manufacturing operating income as a percentage of revenue for the three months ended September
28, 2019 was 34.0%, an increase of 2.7% from 31.3% for the corresponding period in 2018. The increases were due primarily to higher revenues as well as improved production efficiencies and the impact of certain cost savings initiatives in the three months ended September 28, 2019 compared to the same period in 2018.
Unallocated corporate costs consist of selling, general and administrative expenses that are not directly related or allocated to the reportable segments. The amount in the three
months ended September 28, 2019 increased by $1.9 million compared to the same period in 2018 due to the increase in costs associated with the evaluation and integration of our recent acquisition activity and costs related to the remediation of the unauthorized access into our information systems; partially offset by a net decrease in compensation, benefits, and other employee-related expenses related to certain severance and executive transition costs incurred in the corresponding period in 2018. Costs as a percentage of revenue for thethree months ended September 28, 2019 was 6.9%,
a decrease of 0.6% from 7.5% for the corresponding period in 2018.
Interest Income
Interest income, which represents earnings on cash, cash equivalents, and time deposits remained consistent at $0.4 million and $0.2 million for the three months ended September 28, 2019 and the corresponding period in 2018, respectively.
Interest Expense
Interest
expense for thethree months ended September 28, 2019 was $5.7 million, a decrease of $11.5 million, or 66.9%, compared to $17.2 million for the corresponding period in 2018. The decrease was due primarily to a foreign currency gain recognized in connection with an foreign exchange forward contract; partially offset by higher debt to fund our recent acquisitions.
Other Income (Expense), Net
Other
expense, net, was $14.3 million for the three months ended September 28, 2019, a decrease of $20.2 million, or 341.2%, compared to Other income, net of $5.9 million for the corresponding period in 2018. The decrease was due to a foreign currency loss recognized in the three months ended September 28, 2019 in connection with a U.S. dollar denominated loan borrowed by a non-U.S. entity with a different functional currency and a net loss on our venture capital investments compared to a net gain
in the corresponding period in 2018.
Income Taxes
Income tax benefit for the three months ended September 28, 2019 was $0.3 million, a decrease of $12.7 million compared to income tax expense of $12.4 million for the corresponding period in 2018. Our effective tax rate was (0.4)% for the three months ended September 28, 2019, compared to 16.9%
for the corresponding period in 2018. The decrease in our effective tax rate in the 2019 period compared to the 2018 period was primarily due to recognizing a $20.4 million deferred tax asset in the three months ended September 28, 2019 for net operating losses expected to be utilized in the future due to changes in the Company’s international financing structure.
Cost
of revenue (excluding amortization of intangible assets)
248.8
238.8
10.0
4.2
%
Selling,
general and administrative
52.2
46.3
5.9
12.8
%
Amortization
of intangible assets
1.1
1.2
(0.1
)
(13.3
)%
Operating
income
$
103.7
$
104.9
$
(1.2
)
(1.1
)%
Operating
income % of revenue
25.6
%
26.8
%
(1.2
)%
RMS revenue increased$14.6 million due primarily to higher research model services revenue and higher research model product revenue in China. Research model services benefited from a large government contract in the IS business and strong client demand in the GEMS business resulting from increased research and development activity conducted across
43
biotechnology and academic institutional clients. Partially offsetting these increases were the effect of changes in foreign currency exchange rates and lower research model product revenue outside of China, particularly from large biopharmaceutical clients.
RMS operating income decreased $1.2
million compared to the corresponding period in 2018. RMS operating income as a percentage of revenue for the nine months ended September 28, 2019 was 25.6%, a decrease of 1.2% from 26.8% for the corresponding period in 2018. Operating income and operating income as a percentage of revenue decreased primarily due to higher cost of revenue and selling, general, and administrative expenses to support the growth of the businesses, which included the following: a $2.2 million charge recorded within selling, general and administrative costs in the nine months ended September
28, 2019 in connection with the modification of the option to purchase the remaining 8% equity interest in Vital River, increased investments in personnel (staffing levels and hourly wage increases), and facility expansions (primarily in China). In addition, operating income as a percentage of revenue decreased due to lower operating income margins on the aforementioned large government contract, and lower sales volume for research models outside of China.
Cost
of revenue (excluding amortization of intangible assets)
815.5
661.9
153.6
23.2
%
Selling,
general and administrative
131.3
96.5
34.8
36.1
%
Amortization
of intangible assets
57.8
39.9
17.9
44.9
%
Operating
income
$
175.2
$
160.4
$
14.8
9.2
%
Operating
income % of revenue
14.9
%
16.7
%
(1.8
)%
DSA revenue increased$221.1 milliondue primarily to the recent acquisitions of Citoxlab and MPI Research, which contributed $74.9 million and $73.0 million, respectively, to service revenue growth. Additionally, service revenue increased in both the Safety Assessment and Discovery Services businesses due to demand from biotechnology clients and increased pricing of services. These increases were partially offset by the effect of changes in foreign currency exchange rates.
DSA operating income increased $14.8 million during the nine months ended September 28, 2019 compared to the corresponding
period in 2018. DSA operating income as a percentage of revenue for the nine months ended September 28, 2019 was 14.9%, a decrease of 1.8% from 16.7% for the corresponding period in 2018. The increase to operating income was primarily attributable to contributions from our recent acquisitions of Citoxlab and MPI Research. This increase was partially offset by increased costs in both cost of revenue and selling, general, and administrative expenses to support the growth of the businesses, which included the following: increased investments in personnel (staffing levels and hourly wage increases);
increased investments related to facility expansions; and higher amortization of intangible assets and acquisition and integration costs associated with our recent acquisitions. These increased costs collectively decreased operating income as a percentage of revenue in the nine months ended September 28, 2019 compared to the same period in 2018.
Cost
of revenue (excluding amortization of intangible assets)
169.8
150.2
19.6
13.0
%
Selling,
general and administrative
64.0
61.8
2.2
3.6
%
Amortization
of intangible assets
6.8
6.8
—
—
%
Operating
income
$
103.9
$
95.9
$
8.0
8.3
%
Operating
income % of revenue
30.2
%
30.5
%
(0.3
)%
Manufacturing revenue increased$29.8 million due primarily to higher demand for endotoxin products, bioburden products and services, and species identification services in the Microbial Solutions business and higher service revenue in the Biologics business; partially offset by the effect of changes in foreign currency exchange rates.
Manufacturing operating income increased $8.0 million during the nine months ended September 28, 2019 compared to the corresponding period in 2018. Manufacturing operating income as a percentage of revenue for the nine months ended September
28, 2019 was 30.2%, a decrease of 0.3% from 30.5% for the corresponding period in 2018. The increase to operating income was due primarily to the increase in revenue. This increase was partially offset by increased costs in both cost of revenue and selling, general, and administrative expenses to support the growth of the businesses, which included the following: increased investments in process improvements to further enhance Microbial Solutions’ operating efficiency; increased investments in personnel (staffing levels and hourly wage increases), and increased investments related to facility expansions (primarily in Biologics), and certain site consolidation costs. These increased costs collectively decreased
operating income as a percentage of revenue in the nine months ended September 28, 2019 compared to the same period in 2018.
Unallocated corporate costs consist of selling, general and administrative expenses that are not directly related or allocated to the reportable segments. The increase in unallocated corporate
costs of $8.1 million is related to an increase in costs associated with the evaluation and integration of our recent acquisition activity and costs related to the remediation of the unauthorized access into our information systems; partially offset by a net decrease in compensation, benefits, and other employee-related expenses related to certain severance and executive transition costs incurred in the corresponding period in 2018. Costs as a percentage of revenue for thenine months ended September 28, 2019 was 7.3%, a decrease of 0.6% from 7.9%
for the corresponding period in 2018.
Interest Income
Interest income, which represents earnings on cash, cash equivalents, and time deposits remained consistent at $0.8 million and $0.7 million for the nine months ended September 28, 2019 and the corresponding period in 2018, respectively.
Interest Expense
Interest expense for thenine months ended September 28, 2019
was $36.5 million, a decrease of $10.5 million, or 22.3%, compared to $47.0 million for the corresponding period in 2018. The decrease was due primarily to a foreign currency gain recognized in connection with an foreign exchange forward contract and the absence of debt issuance costs that were incurred in the corresponding period in 2018; partially offset by higher debt to fund our recent acquisitions.
Other Income (Expense), Net
45
Other expense, net, was $8.2 million for the nine months ended September 28, 2019, a decrease of $32.3 million, or 133.9%, compared to Other income, net of $24.1 million for the corresponding period in 2018. The decrease was due to a foreign currency loss recognized in the nine months ended September 28, 2019 in connection with a U.S. dollar denominated loan borrowed by a non-U.S. entity with a different
functional currency and lower net gains on our venture capital investments and our life insurance policy investments compared to the corresponding period in 2018.
Income Taxes
Income tax expense for the nine months ended September 28, 2019 was $25.0 million, a decrease of $14.6 million compared to $39.6 million for the corresponding period in 2018. Our effective tax rate was 12.6% for the nine months ended September
28, 2019 compared to 19.2% for the corresponding period in 2018. The decrease in our effective tax rate in the 2019 period compared to the 2018 period was primarily due to recognizing a $20.4 milliondeferred tax asset in the three months ended September 28, 2019 for net operating losses expected to be utilized in the future due to changes in the Company’s international financing structure.
Liquidity
and Capital Resources
We currently require cash to fund our working capital needs, capital expansion, and acquisitions, and to pay our debt and pension obligations. Our principal sources of liquidity have been our cash flows from operations, supplemented by long-term borrowings. Based on our current business plan, we believe that our existing funds, when combined with cash generated from operations and our access to financing resources, are sufficient to fund our operations for the foreseeable future.
The following table presents our cash, cash equivalents and investments:
On
March 26, 2018, we amended and restated our $1.65 billion credit facility, which extended the maturity date and provided for a $750.0 million term loan and a $1.55 billion multi-currency revolving facility. The term loan facility matures in 19 quarterly installments with the last installment due March 26, 2023. The revolving facility matures on March 26, 2023, and requires no scheduled payment before that date. On October 23, 2019, we prepaid $500.0 million of the term loan with proceeds from a $500.0 million unregistered private offering (see 2028 Senior Notes below). Additionally, on November 4,
2019, we further amended and restated the Credit Facility to increase the multi-currency revolving facility by $500.0 million, from $1.55 billion to $2.05 billion. The amount outstanding under the multi-currency revolving facility has not significantly changed since September 28, 2019. Under specified circumstances, we have the ability to increase the term loan and/or revolving facility by up to $1.0 billion in the aggregate.
On April 3, 2018, we entered into an indenture (Base
Indenture) with MUFG Union Bank, N.A. to allow for senior notes offerings under supplemental indentures. Concurrently on April 3, 2018, we entered into our first supplemental indenture and raised $500.0 million in aggregate principal amount of 5.5% Senior Notes due in 2026 (2026 Senior Notes) in an unregistered offering. Under the terms of the first supplemental indenture, interest on the 2026 Senior Notes is payable semi-annually on April 1 and October 1, beginning on October
1, 2018. On October 23, 2019, we entered into our second supplemental indenture and raised an additional $500.0 million in aggregate principal amount of 4.25% Senior Notes due in 2028 (2028 Senior Notes) in an unregistered offering. Under the terms of the second supplemental indenture, interest on the 2028 Senior Notes is payable semi-annually on May 1 and November 1, beginning on May 1, 2020.
Amounts outstanding under our credit facilities and 2026 Senior Notes were as follows:
The
interest rates applicable to the term loan and revolving facility under the Credit Facility are, at our option, equal to either the base rate (which is the higher of (1) the prime rate, (2) the federal funds rate plus 0.50%, or (3) the one-month adjusted LIBOR rate plus 1.0%) or the adjusted LIBOR rate, plus an interest rate margin based upon our leverage ratio.
We entered into foreign exchange forward contracts during the nine months ended September 28, 2019 and three months ended December 29, 2018 to limit our foreign currency exposure related to a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency entity under the
Credit Facility.
The acquisition of Citoxlab on April 29, 2019 for $527.7 million in cash was funded through a combination of cash on hand and proceeds from our Credit Facility under the multi-currency revolving facility.
Repurchases of Common Stock
During the nine months ended September 28, 2019, we did not repurchase any shares under our authorized stock repurchase program. As of September 28, 2019, we had $129.1 million remaining
on the authorized $1.3 billion stock repurchase program and we do not intend to repurchase shares for the remainder of 2019. Our stock-based compensation plans permit the netting of common stock upon vesting of restricted stock, restricted stock units, and performance share units in order to satisfy individual statutory tax withholding requirements. During the nine months ended September 28, 2019, we acquired 0.1 million shares for $18.0 million through such netting.
Cash Flows
The following table presents our net cash provided by operating activities:
Income from continuing operations, net of income taxes
$
173.5
$
167.0
Adjustments
to reconcile net income from continuing operations, net of income taxes, to net cash provided by operating activities
163.8
133.0
Changes in assets and liabilities
(37.0
)
1.2
Net
cash provided by operating activities
$
300.3
$
301.2
Net cash provided by cash flows from operating activities represents the cash receipts and disbursements related to all of our activities other than investing and financing activities. Operating cash flow is derived by adjusting our income from continuing operations for (1) non-cash operating items such as depreciation and amortization, stock-based compensation, deferred income taxes, gains
on venture capital investments, as well as (2) changes in operating assets and liabilities, which reflect timing differences between the receipt and payment of cash associated with transactions and when they are recognized in our results of operations. For the nine months ended September 28, 2019, compared to the nine months ended September 29, 2018, the slight decrease in net cash provided by operating activities was primarily driven by unfavorable changes in operating assets and liabilities, specifically related to the timing of net contract balances from contracts
with customers (collectively trade receivables, net; deferred revenue; and customer contract deposits), and higher compensation payments compared to the prior year period; offset by the favorable timing of vendor and supplier payments compared to the same period in 2018.
47
The following table presents our net cash used in investing activities:
Acquisitions of businesses and assets, net of cash acquired
$
(515.6
)
$
(822.6
)
Capital
expenditures
(76.7
)
(71.4
)
Investments, net
(17.6
)
10.1
Other, net
(0.7
)
(0.1
)
Net
cash used in investing activities
$
(610.6
)
$
(884.0
)
For the nine months ended September 28, 2019, the primary use of cash used in investing activities related to the acquisition of Citoxlab, the acquisition of a supplier, capital expenditures to support the growth of the business, and investments in certain venture capital and other equity investments.
For the nine months ended September 29, 2018, the primary use of cash used in investing activities related primarily to our acquisitions of MPI Research and KWS BioTest, and our capital expenditures to support the growth of the business; partially offset by proceeds from net investments, which primarily related to short-term investments held by our U.K. operations.
The following table presents our net cash provided by financing activities:
Proceeds from long-term debt and revolving credit facility
$
2,071.2
$
2,392.2
Proceeds
from exercises of stock options
27.0
30.2
Payments on long-term debt, revolving credit facility andfinancelease obligations
(1,798.6
)
(1,832.8
)
Payments
on debt financing costs
—
(18.3
)
Purchase of treasury stock
(18.0
)
(13.8
)
Other, net
(10.6
)
—
Net
cash provided by financing activities
$
271.0
$
557.5
For the nine months ended September 28, 2019, net cash provided by financing activities reflected the net proceeds of $272.6 million on our Credit Facility and finance lease
obligations. Included in the net proceeds are approximately $1.6 billion of gross proceeds and payments on the revolving credit facility, which resulted from a non-U.S. Euro functional currency entity repaying an existing Euro loan and replacing the Euro loan with a U.S. dollar denominated loan. A series of forward currency contracts were executed to mitigate any foreign currency gains or losses on the U.S. dollar denominated loans. These proceeds and payments are presented as gross financing activities and net to zero. Net cash provided by financing activities also reflected proceeds from exercises of employee stock options of $27.0 million. Net cash provided by financing activities was partially offset by treasury stock purchases of $18.0 million made due to
the netting of common stock upon vesting of stock-based awards in order to satisfy individual statutory tax withholding requirements and the purchase of an additional 5% equity interest in Vital River for $7.9 million which is included in Other, net.
For the nine months ended September 29, 2018, net cash provided by financing activities reflected the incremental proceeds from the refinancing of our previous $1.65 billion credit facility to the $2.3 billion credit facility and the proceeds from our $500.0 million 2026 Senior Notes; and proceeds from exercises of employee stock options of $30.2 million; partially offset by payments on debt financing costs of $18.3
million and treasury stock purchases of $13.8 million made due to the netting of common stock upon vesting of stock-based awards in order to satisfy individual statutory tax withholding requirements.
Contractual Commitments and Obligations
The disclosure of our contractual commitments and obligations was reported in our Annual Report on Form 10-K for fiscal 2018. There have been no material changes from the contractual commitments and obligations previously disclosed in our Annual Report on Form 10-K for fiscal 2018 other than the changes described in Note 2, “Business Acquisitions,” Note 7, “Fair Value,” Note 9, “Long-Term Debt and Finance Lease Obligations,” Note 16, “Leases,” and Note
17, “Commitments and Contingencies” in our notes to the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q.
48
Off-Balance Sheet Arrangements
As of September 28, 2019, we did not have any significant off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of SEC Regulation S-K promulgated under the Exchange Act, except as disclosed below.
Venture Capital Investments
We invest in several venture capital funds
that invest in start-up companies, primarily in the life sciences industry. Our total commitment to the funds as of September 28, 2019 was $128.1 million, of which we funded $77.4 million through September 28, 2019. Refer to Note 6, “Venture Capital and Other Investments” in this Quarterly Report on Form 10-Q for additional information.
Letters of Credit
Our off-balance sheet commitments related to our outstanding letters of credit as of September 28,
2019 were $6.7 million.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with generally accepted accounting principles in the U.S. The preparation of these financial statements requires us to make certain estimates and assumptions that may affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses during the reported periods and related disclosures. These estimates and assumptions are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on our historical experience,
trends in the industry, and various other factors that are believed to be reasonable under the circumstances. Actual results may differ from our estimates under different assumptions or conditions.
We believe that our application of the following accounting policies, each of which require significant judgments and estimates on the part of management, are the most critical to aid in fully understanding and evaluating our reported financial results: (1) revenue recognition, (2) income taxes, (3) goodwill and intangible assets, (4) valuation and impairment of long-lived assets, (5) pension and other retirement benefit plans, and (6) stock-based compensation. Our significant accounting policies are described in our Annual Report on Form 10-K for fiscal year 2018as well as Note 16, “Leases” in this Quarterly
Report on Form 10-Q.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements please refer to Note 1, “Basis of Presentation,” in this Quarterly Report on Form 10-Q. Other than as discussed in Note 1, “Basis of Presentation,” we did not adopt any other new accounting pronouncements during the nine months ended September 28, 2019 that had a significant effect on our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
We
are exposed to market risk from changes in interest rates and currency exchange rates, which could affect our future results of operations and financial condition. We manage our exposure to these risks through our regular operating and financing activities.
Interest Rate Risk
We are exposed to changes in interest rates while conducting normal business operations as a result of ongoing financing activities. As of September 28, 2019, our debt portfolio was comprised primarily of floating interest rate borrowings. A 100-basis point increase in interest rates would increase our annual pre-tax interest expense by $13.9 million.
Foreign Currency Exchange Rate Risk
We
operate on a global basis and have exposure to some foreign currency exchange rate fluctuations for our financial position, results of operations, and cash flows.
While the financial results of our global activities are reported in U.S. dollars, our foreign subsidiaries typically conduct their operations in their respective local currency. The principal functional currencies of the Company’s foreign subsidiaries are the Euro, British Pound, Canadian Dollar, Chinese Yuan Renminbi, and Japanese Yen. During the nine months ended September 28, 2019, the most significant
drivers of foreign currency translation adjustment the Company recorded as part of Other comprehensive income (loss) were the Euro, British Pound, Canadian Dollar, Chinese Yuan Renminbi, and Japanese Yen.
Fluctuations in the foreign currency exchange rates of the countries in which we do business will affect our financial position, results of operations, and cash flows. As the U.S. dollar strengthens against other currencies, the value of our non-U.S. revenue, expenses, assets, liabilities, and cash flows will generally decline when reported in U.S. dollars. The impact to net income as a result of a U.S. dollar strengthening will be partially mitigated by the value of non-U.S. expenses, which will decline when reported in U.S. dollars. As the U.S. dollar weakens versus other currencies, the value of the non-U.S. revenue, expenses,
49
assets, liabilities, and cash flows will generally increase when reported in U.S. dollars. For the nine months ended September 28, 2019, our revenue would have increased by $65.7 million and our operating income would have increased by $0.9 million, if the U.S. dollar exchange rate had strengthened by 10.0%, with all other variables held constant.
We attempt to minimize this exposure by using certain financial instruments in accordance with our overall risk management and our hedge policy. We do not enter into speculative derivative agreements.
During the nine months ended September
28, 2019, we entered into foreign exchange forward contracts to limit our foreign currency exposure related to both intercompany loans and a U.S. dollar denominated loan borrowed by a non-U.S. Euro functional currency entity under our Credit Facility. Refer to Note 14, “Foreign Currency Contracts” in this Quarterly Report on Form 10-Q for additional information regarding foreign currency contracts open as of September 28, 2019.
Item 4. Controls
and Procedures
(a) Evaluation of Disclosure Controls and Procedures
Based on their evaluation, required by paragraph (b) of Rules 13a-15 or 15d-15, promulgated by the Securities Exchange Act of 1934, as amended (Exchange Act), the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act, are effective, at a reasonable assurance level, as of September 28, 2019, to ensure that information required to be disclosed by the
Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no
matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily was required to apply its judgment in designing and evaluating the controls and procedures.
(b) Changes in Internal Controls
The Companycontinued to execute a plan to centralize certain accounting transaction processing functions to internal shared service centers during the three months ended September 28, 2019.There were no other material changes in the Company’s internal control over financial
reporting identified in connection with the evaluation required by paragraph (d) of the Exchange Act Rules 13a-15 or 15d-15 that occurred during the quarter ended September 28, 2019 that materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.
50
PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
Please refer to Note 17, “Commitments and Contingencies” in our notes to the unaudited condensed consolidated financial statements in this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for fiscal year 2018, which could materially affect our business, financial condition, and/or future results. The risks described in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently
deem to be immaterial also may materially adversely affect our business, financial condition, and/or operating results. There have been no material changes to the risk factors set forth in our Annual Report on Form 10-K for fiscal year 2018, except as disclosed below.
We have in the past experienced and in the future could experience an unauthorized access into our information systems.
We operate large and complex information systems that contain significant amounts of client data. As a routine element of our business, we collect, analyze, and retain substantial amounts of data pertaining to the non-clinical studies we conduct for our clients. Unauthorized third parties could attempt to gain entry to such information systems for the purpose of stealing data or disrupting the systems. While we have taken measures to protect them from
intrusion, in March 2019, we detected evidence that an unauthorized third party has accessed certain of our information systems and acquired data. The Company’s investigation is ongoing, but we believe that the incident is attributable to a sophisticated intruder. We are working with a leading data security firm to assist in our investigation, and are also coordinating with law enforcement authorities. The investigation indicates that the affected information included client information.
Our contracts with our clients typically contain provisions that require us to keep confidential the information generated from the studies we conduct. The unauthorized access detected, as well as any other breaches, could expose us to significant harm including termination
of customer contracts, damage to our customer relationships, damage to our reputation and potential legal claims from customers, employees and others. In addition, we may face investigations by government regulators and agencies as a result of this incident or as a result of future incidents.
While the Company is in the process of implementing additional security safeguards, it is expected to take a number of months for all of these additional security safeguards to be fully implemented. While we have taken steps to limit the unauthorized third party’s access to our computer systems, we will be unable to determine that this matter has been entirely contained until the additional steps to secure our information systems have been fully implemented. In
addition, there can be no assurance that the additional security safeguards will be successful. In the event that additional data is accessed prior to the full implementation of these additional security safeguards or in the event that such additional security safeguards are unsuccessful, we could suffer significant harm.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The following table provides information relating to the purchases of shares of our common stock during the three months ended September 28, 2019.
Our
Board of Directors have authorized up to an aggregate amount of $1.3 billion for our stock repurchase program. During the three months ended September 28, 2019, we did not repurchase any shares of common stock under our stock repurchase program or in open market trading. As of September 28, 2019, we had $129.1 million remaining on the authorized stock repurchase program.
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Additionally, our stock-based compensation plans permit the netting
of common stock upon vesting of restricted stock, restricted stock units, and performance share units in order to satisfy individual statutory tax withholding requirements.
eXtensible Business Reporting Language (XBRL) Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
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XBRL Taxonomy Extension Schema Document
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XBRL Taxonomy Definition Linkbase Document
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* Management
contract or compensatory plan, contract or arrangement.
+ Furnished herein.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.