Charles River Laboratories (CRL) has launched another round of initiatives to reduce costs and boost shareholder value, as major investors lean on the US-based contract research organisation (CRO) to cut its losses and sell all or part of the company.
Announcing its financial guidance for 2011, CRL said it was “intensifying its focus on four key initiatives to drive shareholder value” under difficult economic conditions. These include pursuing “strategic alternatives for certain non-strategic or underperforming Preclinical Services assets”, including a Phase I clinic in the US and a preclinical facility in China.
The moves come shortly after two investor groups, Relational Investors and California State Teachers’ Retirement System, notified the US Securities and Exchange Commission (SEC) that they had increased their holding in CRL, believed the company’s shares were undervalued, and had met with the Charles River management and board to argue for strategic remedies including a sale of all or “pieces of” the business.
CRL had already announced job cuts and facility closures with its third-quarter results, which showed operating income down by 88.5% year on year to US$5.1 million on a 7.2% decline in net sales. The drop in income was aggravated by a US$30.0 million break-up fee for the termination of CRL’s acquisition agreement with Chinese CRO WuXi PharmaTech in the face of shareholder opposition last August.
The four new initiatives specifically address:
• Improving CRL’s consolidated operating margin. The company has set a goal of pushing its non-GAAP (Generally Accepted Accounting Principles) operating margin up to 20% within three to five years, “depending on the strength of recovery in demand for preclinical services”.
It aims to do this by “continuing to aggressively manage our cost structure and drive operating efficiencies”. The last two years have already seen marked efforts to cut costs in a waning market for preclinical trials, including the measures announced with CRL’s third-quarter results in November. These were designed to trim around US$40 million from costs in 2011.
As part of the cost-cutting programme, CRL will look at strategic alternatives for the Preclinical Services assets described above. It expects to eliminate around US$10 million in combined operating losses on a non-GAAP basis from the two aforementioned facilities during 2011. The moves will also contribute to improved cash flow, the company added.
CRL already announced in January that it would suspend by mid-year operations at its US Preclinical Services (PCS) facility in Shrewsbury, Massachusetts. At the third-quarter stage, the company said it was closing down a leased satellite PCS facility in Laval, Canada as part of a string of measures to be taken during the fourth quarter to “align [its] infrastructure to the current operating environment”.
• Improving the generation of free cash flow. CRL believes it has adequate capacity to support revenue growth in both business segments (i.e., PCS and Research Models and Services (RMS)) without significant additional investment for expansion. “With improved operating margins, elimination of the specified operating losses and minimal requirements for capital expansion, the Company expects to continue to generate strong cash flow,” it stated.
• Disciplined investment in growth businesses. The plan is to invest in “those areas of our existing business which will generate the greatest sales growth and profitability, such as Discovery Services, In Vitro products and Biopharmaceutical Services”. Sales efforts will be focused on reinvigorating growth in CRL’s core research models and preclinical services businesses.
• Returning value to shareholders. Under the current US$750 million authorisation from its board of directors, CRL has launched a “substantial” stock repurchase programme aimed at driving immediate shareholder value and earnings per share accretion. It intends to complete the initial US$500 million of the board’s stock repurchase authorisation by the end of 2011.
According to chairman, president and chief executive officer James Foster, the initial benefits of CRL’s “intensified focus on cost management and capital allocation” are to be seen in its enhanced financial guidance, which includes non-GAAP earnings per share (EPS) increasing to US$2.20 to US$2.40 in 2011, “or a robust 20% at the midpoint compared to our 2010 guidance”.
Analysts polled by Thomson Reuters were expecting EPS of US$2.46 for next year, Bloomberg reported.
Charles River’s guidance for 2011 excludes the results of its US Phase I clinic as a discontinued operation, while non-GAAP results omit the operating loss of the preclinical facility in China. Sales overall in 2011 are expected to be more or less flat against the current year, with a 2-4% increase for the RMS segment but a 3-5% decline in Preclinical Services.
GAAP earnings per share in 2011 are projected to be in the range of US$1.55 to US$1.75. For the current year, CRL has adjusted its financial guidance to treat the US Phase I business as a discontinued operation, giving GAAP EPS of US$0.28 to US$0.33 compared with the forecast of US$0.25 to US$0.30 provided in November.
Sales in 2010 are now expected to be US$1,115 million to US$1,125 million, compared with US$1,135 million to US$1,145 million previously, while the guidance for non-GAAP EPS has been raised from US$1.85 to US$1.90 in November to US$1.88 to US$1.93 now. The analyst consensus was for EPS of US$1.87.
SEC Filing
In their SEC filing, representatives of Relational Investors and California State Teachers’ Retirement System expressed concern that the cash flows from CRL’s high-return RMS were subsidising investments in the underperforming preclinical business.
Moreover, the “attempt to acquire WuXi AppTec, another large investment in the pre-clinical business, destroyed our confidence in the Company’s current management and board of directors, and their capital allocation discipline and stewardship over the Company’s assets”, the filing noted.
The investors believe the CRL board should “promptly form a committee of independent directors to consider broad strategic alternatives for maximising shareholder value, including a sale of the Company”. Citing the “robust activity of private equity sponsors”, they have encouraged Charles River “to assess the feasibility of a going-private transaction as a way of maximising shareholder value
