CRL Charles River Laboratories International Inc

Charles River Laboratories International Inc. (CRL) reported second quarter 2011 earnings (excluding special items) of 70 cents per share, above the Zacks Consensus Estimate of 60 cents and year-ago earnings of 50 cents per share. Earnings were boosted by factors like share repurchases, expansion in operating income and foreign exchange benefits rather than an improvement in the demand environment for the company’s services.

Quarterly revenue of $288.3 million was almost flat over the prior year (down 4% excluding the positive impact of foreign exchange) due to a decline in Preclinical Services (PCS) segment revenues. Revenue was nominally above the Zacks Consensus Estimate of $288 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 $178.4 million in the second quarter, up 6.6% over the prior-year period benefitting primarily from the positive impact of foreign exchange. Excluding the 5.3% gain from foreign exchange, RMS segment revenues were up 1.3% year over year and 2.7% sequentially. Revenue in the segment was boosted by strong sales of In Vitro products and RMS services. The latter benefited from increased outsourcing by large biopharmaceutical clients, as it is operationally more beneficial than conducting such services in-house. Sales of outbred rats continued to remain soft due to weakness in demand for toxicology services.

Sales of research models were down in all geographic regions except for Europe. In the US, sales were down due to a higher proportion of sales to large pharma companies whose business is being significantly affected by mergers and acquisitions in the sector. These companies are also moving the development of their pipeline slowly. European sales however climbed due to sales to diverse entities like large pharma, private companies and government-funded academic research. In Japan, revenue was down less than $1 million sequentially affected by the natural disaster.

Revenue from the PCS segment was $110.1 million in the second quarter, down 9.3% from the prior-year period (down 12.2% excluding the positive impact of foreign exchange). Revenues also declined sequentially. Revenues were affected by an unfavorable sales mix comprising a greater proportion of shorter-term-studies and general toxicology. Continued soft demand from large pharmaceutical clients also negatively impacted revenues. The timing of an improvement in the PCS business is still unclear.

Consolidated operating margin was 19.2% in the quarter, expanding 240 basis points sequentially, driven by cost savings.

Share Repurchase

Charles River had announced a $150 million accelerated share repurchase (ASR) program in February 2011, which was completed in May 2011. The company repurchased a total of 3.8 million shares under the ASR program and has $205.0 million remaining under its $750 million repurchase program.

2011 Guidance

Despite the lukewarm quarter, Charles River increased its revenue and adjusted earnings guidance.

For 2011, the company expects revenue growth to be slightly higher than 2010 levels primarily due to favorable exchange rates which could add upto 2% to revenue growth (old guidance: revenue to remain flat with 2010 levels). The RMS segment is expected to witness slightly lesser sales in the latter half than the first half due to normal seasonality affecting the second half figures. RMS seasonality refers to fewer shipments of small models during vacation and holiday periods in the third and fourth quarters of the year. Second half sales performance at the PCS segment is expected to remain unremitting, similar to the first half.

The company aims to achieve adjusted earnings per share of $2.38–$2.48 (old guidance: $2.20–$2.40) for 2011. Earnings growth is expected to be driven by improving operating efficiencies and a lower share count. The guidance however assumes that normal seasonality in the RMS segment in the second half and one extra week (with light sales and normal costs) in the year will negatively impact the operating margin in the second half. RMS operating margin is expected to average at or slightly dip below 30%, an estimated decline from the 31.9% operating margin reported in the first half. Accordingly, Charles River expects lower earnings in the second half due to RMS operating margin headwinds. Adjusted earnings in both the third and fourth quarters are expected to fare at par. The current Zacks Consensus Estimate for 2011, at $2.41, is on the lower end of company’s guidance range.

Free cash flow is expected to range from $165 million to $175 million in 2011, up from the prior guidance of $150 million to $170 million. Capital expenditure guidance was maintained at approximately $50 million for 2011.

Charles River is looking for strategic acquisitions and in-licensing opportunities to boost its RMS offerings. It hopes to complete one or more deals before the end of the year. The company also aims to increase sales growth by focusing on small and mid-sized pharmaceutical and biotechnology companies by allocating more sales force resources to this group.

Our Recommendation

We currently have a Neutral recommendation on Charles River. The stock carries a Zacks #4 Rank which tantamount to a short-term Sell 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.

 
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