Charles River Laboratories International Inc. (CRL) reported third quarter 2011 earnings (excluding special items) of 57 cents per share, just a penny short of the Zacks Consensus Estimate of 58 cents.
Moreover, the earnings per share dropped 13 cents on a sequential basis. Decline in the top line and operating margin led to the shortfall in earnings. Earnings were however above the year-ago figures of 46 cents per share.
Quarterly revenues of $277.6 million climbed 2.5% over the prior-year quarter, benefiting from a positive impact of foreign exchange (Fx). However, excluding the impact of Fx, revenues were down 1.2% due to lower revenue in Preclinical Services (PCS) segment. Revenues also fell short of the Zacks Consensus Estimate of $280 million.
The Quarter in Detail
The company operates through two segments – Research Models and Services (RMS) and Preclinical Services (PCS).
Revenue from the RMS segment was $171.5 million in the third quarter, up 7.7% over the prior-year period, benefiting primarily from the positive impact of Fx. Excluding the 4.6% gain from Fx, RMS segment revenue moved up 3.1% year over year. Segment revenue was boosted by strong sales of In Vitro and Avian products and RMS services.
Among the RMS services, the genetically engineered model services, or GEMS was the strongest. Sales of research models were down in all geographic regions, except for Japan, due to the anticipated RMS seasonality and pricing pressure. RMS seasonality refers to fewer shipments of small models during vacation and holiday periods in the third and fourth quarters of the year. RMS revenue was however down 3.9% sequentially.
Revenue from the PCS segment was $106.1 million in the third quarter, down 4.9% from the prior-year period (down 7.3% excluding the positive impact of Fx). Revenue also declined 3.6% sequentially. Unfavorable sales mix, comprising a greater proportion of shorter-term less complex studies, adversely affected the revenue performance.
Soft demand from small and mid-tier pharmaceutical clients (due to lack of funds), particularly for GLP safety assessment studies also negatively impacted revenues.
During the third quarter conference call, management discussed the evolution of the large biopharmaceutical clients’ drug development models. Management pointed out that large pharma companies are trying to reduce costs by restructuring including workforce and capacity reduction.
Moreover, these companies are also eliminating compounds/ biologics early in the development stage if they cannot prove their efficacy. This increases the demand of services for earlier stages of business like the smaller non-GLP services, which are witnessing growth. This, however, reduces the number of candidates that progress to regulated safety assessment studies, and hence the reduction in demand for Charles River’s larger safety assessment studies.
As a result of this, management anticipates long-term growth for its early-stage services, as demonstrated by the recent expansion of an existing preferred provider agreement with a large pharma company.
To elaborate, Charles River announced that it has expanded a preferred provider agreement with a large pharma company, to make Charles River its primary in vivo biology partner, including studies in non-GLP pharmacology, Drug Metabolism and Pharmacokinetics (DMPK) studies, and GLP safety assessments.
Earlier, Charles River was the primary provider for GLP safety assessment, and also provided DMPK services. The expanded agreement will result in double sales volume from the client, amounting to greater than 5% of total sales by 2013.
Consolidated operating margin was 16.2% in the quarter, declining 10 basis points from prior-year quarter and 300 basis points sequentially, due to anticipated seasonal decline in the RMS segment and lower sales in the PCS segment.
Also, during the conference call, management announced that it will reduce its workforce by approximately 2%, mainly in the PCS segment to accommodate for future client demand. The layoffs are expected to result in annual cost savings of approximately $7.5 million from 2012.
2011 Guidance
Management maintained its 2011 revenue guidance. For 2011, the company expects revenue growth to be slightly higher than 2010 levels, primarily due to favorable exchange rates which could add up to 2.5% to the revenue growth.
The RMS segment is expected to witness moderate sequential increase in the fourth quarter. The fourth quarter sales performance at the PCS segment is expected to remain flat from the third-quarter levels.
The company tightened its adjusted earnings per share guidance to $2.40-$2.45 from the prior range of $2.38-$2.48 for 2011, as it believes the upper end of the previous guidance is not achievable due to weakness in the PCS segment.
The guidance however assumes that normal seasonality in the RMS segment in the fourth quarter and one extra week (with light sales and normal costs) in the year will negatively impact the operating margin in the fourth quarter. This in turn is expected to result in flat-to-slightly lower EPS in the fourth quarter from the third-quarter level. The current Zacks Consensus Estimate for 2011, at $2.47, is above company’s guidance range.
Free cash flow is still expected to range from $165 million to $175 million in 2011.
Our Recommendation
We currently have a Neutral recommendation on Charles River. The stock carries a Zacks #3 Rank, which tantamount to a short-term Hold rating.
Despite consistent performance in the RMS segment, the PCS business fails to show any definite sign of recovery, thus keeping us on the sidelines.
