Washington, D.C. 20549
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
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.
The following table presents restructuring costs by reportable segment for these productivity improvement initiatives:
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:
16. LEASES
Right-of-use lease assets and lease liabilities are reported in the Company’s unaudited condensed consolidated balance sheets as follows:
|
| | | | | | | | |
| | June 29, 2019 |
| | Three Months Ended |
| Six Months Ended |
| | (in thousands) |
Operating lease costs | | $ | 7,887 |
| | $ | 15,594 |
|
Finance lease costs: | | | | |
Amortization of right-of-use assets | | 931 |
| | 1,852 |
|
Interest on lease liabilities | | 345 |
| | 641 |
|
Short-term lease costs | | 204 |
| | 396 |
|
Variable lease costs | | 930 |
| | 1,265 |
|
Sublease income | | (45 | ) | | (91 | ) |
Total lease costs | | $ | 10,252 |
| | $ | 19,657 |
|
27
Other information related to leases was as follows:
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 28, 2020 | | March 30, 2019 |
| | (in thousands) | | |
Operating lease costs | | $ | 8,077 | | | $ | 7,706 | |
Finance lease costs: | | | | |
Amortization of right-of-use assets | | 951 | | | 921 | |
Interest on lease liabilities | | 340 | | | 296 | |
Short-term lease costs | | 589 | | | 192 | |
Variable lease costs | | 1,045 | | | 335 | |
Sublease income | | (586) | | | (46) | |
Total lease costs | | $ | 10,416 | | | $ | 9,404 | |
Other information related to leases was as follows:
Supplemental cash flow information
| | | | | | | | | | | | | | |
| | Three Months Ended | | |
| | March 28, 2020 | | March 30, 2019 |
| | (in thousands) | | |
Cash flows included in the measurement of lease liabilities: | | | | |
Operating cash flows from operating leases | | $ | 6,974 | | | $ | 6,533 | |
Operating cash flows from finance leases | | 340 | | | 352 | |
Finance cash flows from finance leases | | 1,572 | | | 838 | |
| | | | |
Non-cash leases activity: | | | | |
Right-of-use lease assets obtained in exchange for new operating lease liabilities | | $ | 25,407 | | | $ | 1,688 | |
Right-of-use lease assets obtained in exchange for new finance lease liabilities | | 593 | | | — | |
|
| | | | |
| | Six Months Ended |
| | June 29, 2019 |
| | (in thousands) |
Cash flows included in the measurement of lease liabilities: | | |
Operating cash flows from operating leases | | $ | 13,214 |
|
Operating cash flows from finance leases | | 715 |
|
Finance cash flows from finance leases | | 1,842 |
|
| | |
Non-cash leases activity: | | |
Right-of-use lease assets obtained in exchange for new operating lease liabilities | | $ | 5,028 |
|
Right-of-use lease assets obtained in exchange for new finance lease liabilities | | 4,508 |
|
Lease term and discount rate
| | | | | | | | |
| | As of |
| | As ofMarch 28, 2020 |
| | June 29, 2019 |
Weighted-average remaining lease term (in years) | | |
Operating lease | | 7.498.40 |
Finance lease | | 12.9412.71 |
Weighted-average discount rate | | |
Operating lease | | 4.484.24 | |
Finance lease | | 4.604.54 | |
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.
As of June 29, 2019, minimum futureMarch 28, 2020, maturities of operating and finance lease payments under non-cancellable leasesliabilities for each of the following five years and a total thereafter were as follows:
|
| | | | | | | | |
| | Operating Leases | | Finance Leases |
| | (in thousands) |
2019 (excluding the six months ended June 29, 2019) | | $ | 11,180 |
| | $ | 2,119 |
|
2020 | | 24,038 |
| | 4,800 |
|
2021 | | 22,418 |
| | 3,786 |
|
2022 | | 18,740 |
| | 3,754 |
|
2023 | | 14,740 |
| | 2,857 |
|
Thereafter | | 59,675 |
| | 25,038 |
|
Total minimum future lease payments | | 150,791 |
| | 42,354 |
|
Less: Imputed interest | | 23,075 |
| | 10,843 |
|
Total lease liabilities | | $ | 127,716 |
| | $ | 31,511 |
|
28
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
| | | | | | | | | | | | | | |
| | Operating Leases | | Finance Leases |
| | (in thousands) | | |
2020 (excluding the three months ended March 28, 2020) | | $ | 21,347 | | | $ | 3,063 | |
2021 | | 27,308 | | | 3,804 | |
2022 | | 23,483 | | | 3,754 | |
2023 | | 19,810 | | | 2,898 | |
2024 | | 19,168 | | | 2,146 | |
Thereafter | | 76,170 | | | 22,531 | |
Total minimum future lease payments | | 187,286 | | | 38,196 | |
Less: Imputed interest | | 31,377 | | | 9,388 | |
Total lease liabilities | | $ | 155,909 | | | $ | 28,808 | |
Total minimum future lease payments (predominantly operating leases) of approximately $33.0$48 million for leases that have not commenced as of June 29, 2019,March 28, 2020, as the Company does not yet control the underlying assets, are not included in the unaudited condensed consolidated financial statements. These leases are expected to commence between fiscal years 20192020 and 20212024 with lease terms of 3approximately 2 to 1115 years.
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:
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
|
| | | | | | | | |
| | Operating Leases (1) | | Finance Leases (1) |
| | (in thousands) |
2019 | | $ | 25,411 |
| | $ | 3,972 |
|
2020 | | 22,400 |
| | 3,759 |
|
2021 | | 21,544 |
| | 2,869 |
|
2022 | | 18,535 |
| | 2,967 |
|
2023 | | 15,398 |
| | 2,209 |
|
Thereafter | | 66,870 |
| | 24,304 |
|
Total minimum future lease payments | | $ | 170,158 |
| | $ | 40,080 |
|
(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. COMMITMENTS 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.
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 2018.2019. 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 onincluded elsewhere within this Form 10-K for fiscal year 2018.10-Q. 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, and Research Products 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). Research Products supplies controlled, consistent, customized primary cells and blood components derived from normal and mobilized peripheral blood, bone marrow, and cord blood. 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; and Avian Vaccine Services (Avian), which supplies specific-pathogen-free chicken eggs and chickens.
COVID-19
Overview
On March 11, 2020, the World Health Organization declared the outbreak of a strain of novel coronavirus disease, COVID-19, a global pandemic. The COVID-19 pandemic is dynamic and expanding, and its ultimate scope, duration and effects are uncertain. This pandemic has had and continues to result in direct and indirect adverse effects on our industry and customers, which in turn has impacted our business, results of operations, and financial condition. Further, the COVID-19 pandemic may also affect our operating and financial results in ways that are and are not presently known to us, or that we currently do not expect to present significant risks to our operations or financial results but which may in fact turn out to negatively affect us to a magnitude greater than anticipated. Refer to Item 1A, Risk Factors, included herein for risk factors reflecting the impact of the COVID-19 pandemic. Giving consideration to each of these risk factors, the following is our current estimate and belief of the impact of the COVID-19 pandemic during the first quarter of fiscal 2020 and how it may continue to affect us in subsequent periods.
Business continuity
To date, we generally have not experienced significant challenges in implementing our business continuity plans. Many government agencies have provided guidance permitting “essential” or “critical” business operations to remain open. As of the date of this quarterly report, in the geographies where business restrictions have been imposed, we believe all of our business operations have satisfied the requirements to be designated to be “essential” or “critical” according to the guidance provided by
government, health and other regulatory agencies with authority over such matters. As a result, all of our operating sites remain open and adequately staffed as of the date of this quarterly report. For certain operations or sites experiencing logistical delays, we have experienced some inefficiencies as it relates to completing work or fulfilling orders; however, we do not believe material expenditures will be required or material resource constraints will occur. Logistical delays include a small number of sites that have experienced reduced operations (including as a result of increased employee absenteeism) or voluntarily closed, as well as delays in transportation activities.
We have comprehensive business continuity plans in place for each site globally and are continuously updating these to address the evolving COVID-19 pandemic situation. We implemented our initial plans in China beginning in January 2020, and have continuously refined our plans for other regions as the virus has spread. We have encouraged and expressed our expectations that employees work remotely whenever possible; and for those employees who need to come into our sites to fulfill their responsibilities, we are adhering to guidelines from government, health, and other regulatory agencies. This includes social distancing, flexible scheduling such as split shifts, restricting visitors, enhanced cleaning, and providing personal protective equipment (PPE), such as masks and gloves, to employees. Due to the nature of our business, many employees already work in biosecure environments that require PPE and adhere to other procedures to safely accomplish their daily responsibilities. Accordingly, to date, we believe we have been able to efficiently implement the additional safety precautions.
Supply chain
We are focused on ensuring that we have adequate inventory and supplies on hand given the potential disruption of the COVID-19 pandemic to our suppliers and their supply chain. Accordingly, we have and expect to continue to increase inventory and supplies through the second quarter of 2020 and beyond as deemed appropriate. We proactively engaged with our suppliers beginning in January 2020 to limit any potential disruption to our supply chain. However, notwithstanding generally successful efforts to maintain supply chain continuity, we have experienced and expect to experience increased costs and potential delays throughout our supply chain during the pandemic.
Financial condition and results of our global operations
We are a global company that operates in over 90 facilities across over 20 countries worldwide. As we perform business across various borders, we are experiencing a continuum of impacts in each location as the COVID-19 pandemic has impacted the global economy in different phases. We are continuing to see demand for products and services across all of our businesses, although as described below theimpact of the COVID-19 pandemic on the level of demand varies with our different businesses. While there is uncertainty, our clients are still in need of the products and services we provide to biomedical research to advance discovery and develop new therapies for the treatment of disease, including the COVID-19 pandemic. Due to certain restrictions in place at the various sites of our clients and suppliers (including client and supplier site closures), there have been challenges relating to timely receiving and shipping products globally in all businesses. Should these restrictions continue, demand/supply issues may persist and could impact revenue growth, operating income (including operating income margins) and cash flows. We have observed some impact due to constraints from internal site restrictions, remote work, resources, and productivity. However, we believe the impact to us has not been as significant as to companies in many other industries because of the nature of our businesses, the classification of our businesses as essential or critical, as the case may be, and our business continuity plans.
Our RMS business was moderately impacted by the COVID-19 pandemic during the three months ended March 28, 2020, although the impact accelerated during the final month of the quarter. Demand for research models began to decline due primarily to the physical shutdown of our client’s facilities, principally academic institutions. While many of our clients are deemed essential businesses as well, we began to experience a slowdown, initially in China in January 2020, and then across Europe and North America later in the period, as measures were implemented by various governments to slow the spread of the COVID-19 pandemic. We expect this trend of reduced demand for research models to continue in upcoming quarters, which will negatively impact revenue, operating income, operating income margins, and cash flows. An increase in demand is not expected until our clients reopen impacted sites and resume their research activity. Research models services, specifically our GEMS and Insourcing Solutions businesses, experienced higher revenues in the three month period ended March 28, 2020 compared to the corresponding prior period.
Our DSA business was not significantly impacted by the COVID-19 pandemic during the three months ended March 28, 2020. Towards the end of the first fiscal quarter of 2020, we experienced some client work shifting towards subsequent quarters of fiscal year 2020 due to the various actions and restrictions put in place by governments around the world intended to slow the spread of the COVID-19 pandemic. The work performed in our Discovery Services and Safety Assessment businesses are largely dependent on our internal sites being open. Therefore, to the extent that clients require work to be completed, we have
been able to maintain the ability to continue to meet client demands and perform the work so long as our work force at the specific site the work is done is not significantly adversely impacted by the COVID-19 pandemic. This trend is expected to continue as government actions to slow the spread of the COVID-19 pandemic begin to subside, employees return to work, and economies across the world begin to reopen. Costs of supply are expected to increase as we procure the materials required to
perform our work. We expect a small-to-modest adverse impact to our revenue growth, operating income, operating margin and cash flow through the rest of the year.
Our Manufacturing business was not significantly impacted by the COVID-19 pandemic during the three months ended March 28, 2020. We expect to see a minor negative impact due to the COVID-19 pandemic as our customers experience minor disruptions in their manufacturing operations. We expect Manufacturing products, such as Microbial Solutions endotoxin products and avian products, to see continued demand through the remainder of fiscal 2020. Our Biologics testing facilities remain open and performing services for our clients. Similar to our other services businesses, our ability to perform work is contingent on our internal facilities and our work force not being significantly adversely impacted by the COVID-19 pandemic. We expect a small adverse impact to our revenue growth, operating income, operating margin and cash flows through the rest of the year.
Liquidity, capital and financial resources
We require cash to fund working capital needs as well as capital expansion, acquisitions, venture capital and strategic investments, debt obligations, leases, and pension obligations. The principal sources of liquidity have been cash flows from operations, supplemented by long-term borrowings. In fiscal year 2019, we issued $500 million Senior Notes, repaid part of our term loan for $500 million, and increased our multi-currency revolving facility by $500 million, from $1.55 billion to $2.05 billion. As of March 28, 2020, we had $2.4 billion of debt outstanding, of which $44.7 million is current. Available on the revolving line of credit (Revolver) is approximately $900 million, which matures on March 26, 2023 and does not require scheduled payments before that date should additional borrowings occur. The term loan facility matures in 19 quarterly installments with the last installment due March 26, 2023. The Senior Notes become due in 2026 and 2028.
Due to the uncertainty resulting from the COVID-19 pandemic, we borrowed an additional $150 million from the Revolver during the three months ended March 28, 2020. While there remains uncertainty for the remainder of 2020, we currently do not anticipate needing to use these borrowings to fund operations. The purpose of borrowing the additional funds was to protect against any prolonged adverse impacts on liquidity markets that are currently unforeseeable. We expect to generate cash inflows from our operating activities sufficient to satisfy our working capital needs as well as to service our debt, pension, and venture capital obligations. Due to this higher debt, we do expect an increase to interest expense, however, this additional charge is not expected to materially adversely impact us. We do not currently anticipate we will need to borrow additional funds during 2020. However, we have analyzed the cash flows and debt balances noting there is significant capacity on the remaining Revolver assuming we achieve the results of operations consistent with what we have described herein. Accordingly, we do not anticipate a material risk of non-compliance with our debt covenants based on our current estimate of future earnings. Our debt levels consist of a combination of fixed and variable debt, which include $1.0 billion of fixed senior notes (2026 and 2028 Senior Notes). To protect against adverse liquidity concerns, there are various mechanisms for us to improve cash flows. To date we have implemented cost reduction plans including delaying compensation related increases, implementing hiring restrictions, reducing working hours, reducing all non-essential travel, and reducing certain discretionary spending. Additionally, we have reduced our investment activity, including planned acquisitions and capital projects.
As of the date these unaudited condensed consolidated financial statements are issued, based on our current and expected liquidity position, we do not believe there is significant uncertainty in our ability to continue as a going concern.
Recoverability and/or impairment of assets
The COVID-19 pandemic did not, nor is expected to impact, the ability to timely account for assets on our balance sheet. There are judgments involved as it relates to reviewing our allowance for doubtful accounts, valuation of inventory, and valuations/recovery of investments. We believe we have the necessary support for estimates derived for these account balances. We have reviewed the collectability and valuation of the assets through the date of financial statement issuance, noting no significant recoverability concerns or any impairments identified. Gains and losses on certain investments in venture capital funds are recorded on a quarterly lag due to the availability of the funds’ financial information, which is consistent with our venture capital investment accounting policy described in our Annual Report on Form 10-K for fiscal 2019. We did not identify any triggering events when reviewing impairment indicators for our goodwill and long-lived assets (tangible and intangible) that would indicate an impairment may exist. Review of impairment indicators and quantifying any impact will continue to be a focus throughout fiscal year 2020. Should a prolonged disruption occur where there is a material change from our current expectation of future cash flows, we could experience additional write-offs of client receivables or impairments to certain asset balances due to collectability and valuation issues.
Internal controls over financial reporting in a remote work environment
Internal controls over financial reporting are a focus for us to ensure they continue to be designed and operating effectively. As of March 28, 2020 and through the issuance of these unaudited condensed consolidated financial statements, we did not have any material changes to our internal controls over financial reporting. For personnel responsible for internal control activities
and working remote, the ability to work effectively enabled us to continue to maintain effective internal control over financial reporting. System and efficiency programs implemented in recent years, as well as those implemented as part of business continuity plans, have enabled us to effectively complete our financial reporting process in a similar way we completed it prior to the COVID-19 pandemic despite a largely remote working environment. Although there is uncertainty over the duration of the COVID-19 pandemic disruption, we do not anticipate any adverse impact to relevant systems or to the operating effectiveness of internal controls over financial reporting.
Recent Acquisitions
Our strategy is to augment internal growth of existing businesses with complementary acquisitions. Our recent acquisitions are described below.
On January 3, 2020, we acquired HemaCare Corporation (HemaCare), a business specializing in the production of human-derived cellular products for the cell therapy market. The acquisition of HemaCare expands our comprehensive portfolio of early-stage research and manufacturing support solutions to encompass the production and customization of high-quality, human derived cellular products to better support clients’ cell therapy programs. The purchase price of HemaCare was $379.8 million in cash. The acquisition was funded through a combination of cash on hand and proceeds from our Credit Facility under the multi-currency revolving facility. This business is reported as part of our RMS reportable segment.
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 purchase price was $23.4 million, net of a $4.0 million pre-existing relationship for a supply agreement settled upon acquisition. 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 $528.1$527.1 million in cash, subject to certain post-closing adjustments that may change the purchase price.cash. The acquisition was funded through a combination of cash on hand and proceeds from our $2.3 billion credit facility ($2.3B Credit Facility)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-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 $2.3B Credit Facility as well as the issuance of the Company’s Senior Notes. 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 June 29, 2019March 28, 2020 was $657.6$707.1 million compared to $585.3$604.6 million in the corresponding period in 2018.2019. This increase of $72.3$102.5 million, or 12.3%17.0%, was primarily due to the recent acquisitionacquisitions of Citoxlab and HemaCare as well as growth in our DSA and Manufacturing segments; partially offset by a reduction in RMS product revenue due to the impact of the COVID-19 pandemic, and by the negative effect of changes in foreign currency exchange rates which decreased revenue by $11.0$4.6 million, or 1.9%0.7%, when compared to the corresponding period in 2018. Revenue for the six months ended June 29, 2019 was $1.3 billion compared to $1.1 billion in the corresponding period in 2018. The increase of $182.8 million, or 16.9%, was primarily due to the reasons described above as well as the recent acquisition of MPI Research; partially offset by the negative effect of changes in foreign currency exchange rates, which decreased revenue by $24.9 million, or 2.4%, when compared to the corresponding period in 2018.2019.
In the three months ended June 29, 2019,March 28, 2020, our operating income and operating income margin were $79.8$94.3 million and 12.1%13.3%, respectively, compared with $76.7$69.8 million and 13.1%11.5%, respectively, in the corresponding period of 2018. In the six months ended June 29, 2019, our2019. The increases in operating income and operating income margin were $149.6 million and 11.8%, respectively, compared with $144.5 million and 13.4%, respectively, in the corresponding period of 2018. The increases in operating income were primarily due to contributions from our recent acquisitions of CitoxlabDSA segment, partially offset by lower RMS operating income and MPI Research. The decreases in operating income margin were primarily due to the impact of the COVID-19 pandemic, as well as increased amortization expense and costs related to our recent acquisitions; as well as continued investments to support future growthacquisition of the businesses, which includes increased investments in personnel (staffing levels and hourly wage increases) and facility expansions.HemaCare.
Net income attributable to common shareholders decreased to $43.7$50.8 million in the three months ended June 29, 2019,March 28, 2020, from $53.7$55.1 million in the corresponding period of 2018. Net income attributable to common shareholders decreased to $98.9 million in the six months ended June 29, 2019, from $106.3 million in the corresponding period of 2018.2019. The decreasesdecrease in Net income attributable to common shareholders was primarily due to lower net gainslosses on our venture capital investments and life insurance policy investments for the three months ended March 28, 2020 as compared to net gains for both investments in the corresponding period in 2019; partially offset by the increases inhigher operating income discussed above.mentioned above compared to the corresponding period in 2019.
During the first sixthree months of 2019,2020, our cash flows from operations was $144.4$68.6 million compared with $183.9$14.9 million for the same period in 2018.2019. The decreaseincrease was primarily driven by unfavorablehigher net income adjusted for non-cash items and certain favorable changes in operating assets and liabilities, specifically related to theworking capital items, including favorable timing of net contract balances from contracts with customers (collectively trade receivables, net; deferred revenue; and customer contract deposits), and higherlower compensation payments compared to the prior year period.period; partially offset by the unfavorable timing of vendor and supplier payments compared to the same period in 2019.
On
Results of Operations
Three Months Ended March 26, 2018,28, 2020 Compared to the Three Months Ended March 30, 2019
Revenue and Operating Income
The following tables present consolidated revenue by type and by reportable segment:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change |
| (in millions, except percentages) | | | | | | |
Service revenue | $ | 546.6 | | | $ | 451.0 | | | $ | 95.6 | | | 21.2 | % |
Product revenue | 160.5 | | | 153.6 | | | 6.9 | | | 4.5 | % |
Total revenue | $ | 707.1 | | | $ | 604.6 | | | $ | 102.5 | | | 17.0 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) | | | | | | | | |
RMS | $ | 146.0 | | | $ | 137.2 | | | $ | 8.8 | | | 6.4 | % | | (0.9) | % |
DSA | 438.7 | | | 354.2 | | | 84.5 | | | 23.9 | % | | (0.5) | % |
Manufacturing | 122.4 | | | 113.2 | | | 9.2 | | | 8.1 | % | | (1.5) | % |
Total revenue | $ | 707.1 | | | $ | 604.6 | | | $ | 102.5 | | | 17.0 | % | | (0.7) | % |
The following table presents operating income by reportable segment:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change |
| (in millions, except percentages) | | | | | | |
RMS | $ | 27.4 | | | $ | 37.8 | | | $ | (10.4) | | | (27.6) | % |
DSA | 72.3 | | | 46.7 | | | 25.6 | | | 54.8 | % |
Manufacturing | 41.1 | | | 31.5 | | | 9.6 | | | 30.5 | % |
Unallocated corporate | (46.5) | | | (46.2) | | | (0.3) | | | 0.5 | % |
Total operating income | $ | 94.3 | | | $ | 69.8 | | | $ | 24.5 | | | 35.1 | % |
Operating income % of revenue | 13.3 | % | | 11.5 | % | | | | 1.8 | % |
The following presents and discusses our consolidated financial results by each of our reportable segments:
RMS
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) | | | | | | | | |
Revenue | $ | 146.0 | | | $ | 137.2 | | | $ | 8.8 | | | 6.4 | % | | (0.9) | % |
Cost of revenue (excluding amortization of intangible assets) | 95.9 | | | 82.8 | | | 13.1 | | | 15.7 | % | | |
Selling, general and administrative | 19.1 | | | 16.2 | | | 2.9 | | | 18.6 | % | | |
Amortization of intangible assets | 3.6 | | | 0.4 | | | 3.2 | | | 923.6 | % | | |
Operating income | $ | 27.4 | | | $ | 37.8 | | | $ | (10.4) | | | (27.6) | % | | |
Operating income % of revenue | 18.7 | % | | 27.6 | % | | | | (8.9) | % | | |
RMS revenue increased $8.8 million due primarily to the recent acquisition of HemaCare which contributed $12.3 million to revenue growth; and higher research model services revenue, specifically our Insourcing Solutions and GEMS businesses. Partially offsetting these increases were lower research model product revenue across the majority of our locations due to the
impact of the COVID-19 pandemic, largely driven by many closures of academic clients, and the effect of changes in foreign currency exchange rates.
RMS operating income decreased $10.4 million compared to the corresponding period in 2019. RMS operating income as a percentage of revenue for the three months ended March 28, 2020 was 18.7%, a decrease of 8.9% from 27.6% for the corresponding period in 2019. Operating income and operating income as a percentage of revenue decreased primarily due to lower operating income on lower sales volume for research model products due to the COVID-19 pandemic as described above and due to the recent acquisition of HemaCare, which increased amortization of intangible assets and an inventory fair value adjustment; partially offset by higher revenue described above.
DSA
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) | | | | | | | | |
Revenue | $ | 438.7 | | | $ | 354.2 | | | $ | 84.5 | | | 23.9 | % | | (0.5) | % |
Cost of revenue (excluding amortization of intangible assets) | 301.1 | | | 252.2 | | | 48.9 | | | 19.4 | % | | |
Selling, general and administrative | 43.3 | | | 38.6 | | | 4.7 | | | 12.1 | % | | |
Amortization of intangible assets | 22.0 | | | 16.7 | | | 5.3 | | | 31.6 | % | | |
Operating income | $ | 72.3 | | | $ | 46.7 | | | $ | 25.6 | | | 54.8 | % | | |
Operating income % of revenue | 16.5 | % | | 13.2 | % | | | | 3.3 | % | | |
DSA revenue increased $84.5 million due primarily to the recent acquisition of Citoxlab which contributed $45.3 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 revenue was not significantly impacted by the COVID-19 pandemic during the three months ended March 28, 2020.
DSA operating income increased $25.6 million during the three months ended March 28, 2020 compared to the corresponding period in 2019. DSA operating income as a percentage of revenue for the three months ended March 28, 2020 was 16.5%, an increase of 3.3% from 13.2% for the corresponding period in 2019. These increases were primarily attributable to higher revenues described above, realizing the favorable impact of recent cost saving efficiencies, and lower acquisitions related costs, partially offset by higher amortization of intangible assets related to our recent acquisitions.
Manufacturing
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) | | | | | | | | |
Revenue | $ | 122.4 | | | $ | 113.2 | | | $ | 9.2 | | | 8.1 | % | | (1.5) | % |
Cost of revenue (excluding amortization of intangible assets) | 58.0 | | | 57.8 | | | 0.2 | | | 0.4 | % | | |
Selling, general and administrative | 21.0 | | | 21.6 | | | (0.6) | | | (2.7) | % | | |
Amortization of intangible assets | 2.3 | | | 2.3 | | | — | | | (3.3) | % | | |
Operating income | $ | 41.1 | | | $ | 31.5 | | | $ | 9.6 | | | 30.5 | % | | |
Operating income % of revenue | 33.6 | % | | 27.8 | % | | | | 5.8 | % | | |
Manufacturing revenue increased $9.2 million due primarily to higher demand for products in both our Microbial Solutions’ Endotoxin business and our Avian business, and higher service revenue in the Biologics business due to our facility in Pennsylvania being fully operational in 2020 compared to 2019 where work continued to be transitioned from a legacy facility; partially offset by lower product revenue in our Microbial Solutions’ Bioburden business, specifically due to the timing of a large stocking order from a strategic partner in 2019, which did not recur in 2020 and the effect of changes in foreign currency
exchange rates. Manufacturing revenue was not significantly impacted by the COVID-19 pandemic during the three months ended March 28, 2020.
Manufacturing operating income increased $9.6 million during the three months ended March 28, 2020 compared to the corresponding period in 2019. Manufacturing operating income as a percentage of revenue for the three months ended March 28, 2020 was 33.6%, an increase of 5.8% from 27.8% for the corresponding period in 2019. 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 March 28, 2020 compared to the same period in 2019.
Unallocated Corporate
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| March 28, 2020 | | March 30, 2019 | | $ change | | % change |
| (in millions, except percentages) | | | | | | |
Unallocated corporate | $ | 46.5 | | | $ | 46.2 | | | $ | 0.3 | | | 0.5 | % |
Unallocated corporate % of revenue | 6.6 | % | | 7.6 | % | | | | (1.0) | % |
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 $0.3 million, or 0.5%, compared to the corresponding period in 2019 is 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. Costs as a percentage of revenue for thethree months ended March 28, 2020 was 6.6%, a decrease of 1.0% from 7.6% for the corresponding period in 2019.
Interest Income
Interest income, which represents earnings on cash, cash equivalents, and time deposits was $0.3 million and $0.2 million for the three months ended March 28, 2020 and the corresponding period in 2019, respectively.
Interest Expense
Interest expense for thethree months ended March 28, 2020 was $15.1 million, an increase of $5.1 million, or 50.9%, compared to $10.0 million for the corresponding period in 2019. The increase was due primarily to higher interest expense from increased debt to fund our recent acquisitions and a lower foreign currency gain recognized in connection with a debt-related foreign exchange forward contract.
Other (Expense) Income, Net
Other expense, net, was $24.1 million for the three months ended March 28, 2020, a decrease of $30.4 million, or 481.7%, compared to Other income, net of $6.3 million for the corresponding period in 2019. The decrease was due primarily to net losses on our venture capital investments and life insurance policy investments for the three months ended March 28, 2020 as compared to net gains for both investments in the corresponding period in 2019.
Income Taxes
Income tax expense for the three months ended March 28, 2020 was $4.6 million, a decrease of $6.0 million compared to $10.6 million for the corresponding period in 2019. Our effective tax rate was 8.3% for the three months ended March 28, 2020, compared to 16.0% for the corresponding period in 2019. The decrease in our effective tax rate in the 2020 period compared to the 2019 period was primarily attributable to increased tax benefits from stock-based compensation deductions.
Liquidity and Capital Resources
We currently require cash to fund our working capital needs, capital expansion, acquisitions, and to pay our debt, lease, venture capital investment, 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 amendedbelieve that our existing funds, when combined with cash generated from operations and restated our $1.65 billionaccess to financing resources, are sufficient to fund our operations for the foreseeable future as previously discussed in our section on the COVID-19 pandemic impacts.
The following table presents our cash, cash equivalents and short-term investments:
| | | | | | | | | | | |
| March 28, 2020 | | December 28, 2019 |
| (in millions) | | |
Cash and cash equivalents: | | | |
Held in U.S. entities | $ | 197.8 | | | $ | 56.5 | |
Held in non-U.S. entities | 174.6 | | | 181.5 | |
Total cash and cash equivalents | 372.4 | | | 238.0 | |
Short-term investments: | | | |
Held in non-U.S. entities | 1.0 | | | 1.0 | |
Total cash, cash equivalents and short-term investments | $ | 373.4 | | | $ | 239.0 | |
Borrowings
We have a credit facility, creating a $2.3B Credit Facility. The $2.3B Credit Facility provides forwhich consists of a $750.0 million term loan, of which $184.4 million remains outstanding as of March 28, 2020, and a $1.55$2.05 billion multi-currency revolving facility.facility (Credit 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. 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,We also have an indenture that allows for senior notes offerings under supplemental indentures. In 2018, we issuedentered into our first supplemental indenture and raised $500.0 million in aggregate principal amount of 5.5% Senior Notes (Seniordue in 2026 (2026 Senior Notes) due 2026 in an unregistered offering. InterestUnder 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.
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.
We continue to move aggressively to further secure our information systems, which includes adding enhanced security features and monitoring procedures to further protect our client data. While we have taken substantial steps to minimize unauthorized access into our information systems, until our ongoing remediation process is complete, we will be unable to determine that this incident has been entirely remediated. We have not observed any further indications of continued unauthorized activity in our information systems.
Results of Operations
Three Months Ended June 29, 2019 Compared to the Three Months Ended June 30, 2018
Revenue and Operating Income
The following tables present consolidated revenue by type and by reportable segment:
|
| | | | | | | | | | | | | | |
| Three Months Ended | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change |
| (in millions, except percentages) |
Service revenue | $ | 505.9 |
| | $ | 438.5 |
| | $ | 67.4 |
| | 15.4 | % |
Product revenue | 151.7 |
| | 146.8 |
| | 4.9 |
| | 3.3 | % |
Total revenue | $ | 657.6 |
| | $ | 585.3 |
| | $ | 72.3 |
| | 12.3 | % |
|
| | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
RMS | $ | 136.1 |
| | $ | 130.4 |
| | $ | 5.7 |
| | 4.3 | % | | (2.5 | )% |
DSA | 405.5 |
| | 346.4 |
| | 59.1 |
| | 17.1 | % | | (1.2 | )% |
Manufacturing | 116.0 |
| | 108.5 |
| | 7.5 |
| | 7.0 | % | | (3.1 | )% |
Total revenue | $ | 657.6 |
| | $ | 585.3 |
| | $ | 72.3 |
| | 12.3 | % | | (1.9 | )% |
The following table presents operating income by reportable segment:
|
| | | | | | | | | | | | | | |
| Three Months Ended | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change |
| (in millions, except percentages) |
RMS | $ | 31.5 |
| | $ | 34.2 |
| | $ | (2.7 | ) | | (8.0 | )% |
DSA | 63.5 |
| | 56.6 |
| | 6.9 |
| | 12.2 | % |
Manufacturing | 33.1 |
| | 34.1 |
| | (1.0 | ) | | (2.9 | )% |
Unallocated corporate | (48.3 | ) | | (48.2 | ) | | (0.1 | ) | | 0.3 | % |
Total operating income | $ | 79.8 |
| | $ | 76.7 |
| | $ | 3.1 |
| | 4.0 | % |
Operating income % of revenue | 12.1 | % | | 13.1 | % | | | | (1.0 | )% |
The following presents the results from operating income by each of our reportable segments:
RMS
|
| | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
Revenue | $ | 136.1 |
| | $ | 130.4 |
| | $ | 5.7 |
| | 4.3 | % | | (2.5 | )% |
Cost of revenue (excluding amortization of intangible assets) | 84.1 |
| | 79.4 |
| | 4.7 |
| | 5.9 | % | | |
Selling, general and administrative | 20.2 |
| | 16.3 |
| | 3.9 |
| | 22.8 | % | | |
Amortization of intangible assets | 0.3 |
| | 0.5 |
| | (0.2 | ) | | (14.5 | )% | | |
Operating income | $ | 31.5 |
| | $ | 34.2 |
| | $ | (2.7 | ) | | (8.0 | )% | | |
Operating income % of revenue | 23.2 | % | | 26.3 | % | | | | (3.1 | )% | | |
RMS revenue increased $5.7 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 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 $2.7 million compared to the corresponding period in 2018. RMS operating income as a percentage of revenue for the three months ended June 29, 2019 was 23.2%, a decrease of 3.1% from 26.3% 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 in the three months ended June 29, 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.
DSA
|
| | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
Revenue | $ | 405.5 |
| | $ | 346.4 |
| | $ | 59.1 |
| | 17.1 | % | | (1.2 | )% |
Cost of revenue (excluding amortization of intangible assets) | 277.5 |
| | 239.2 |
| | 38.3 |
| | 16.0 | % | | |
Selling, general and administrative | 44.7 |
| | 34.6 |
| | 10.1 |
| | 29.5 | % | | |
Amortization of intangible assets | 19.8 |
| | 16.0 |
| | 3.8 |
| | 23.2 | % | | |
Operating income | $ | 63.5 |
| | $ | 56.6 |
| | $ | 6.9 |
| | 12.2 | % | | |
Operating income % of revenue | 15.7 | % | | 16.3 | % | | | | (0.6 | )% | | |
DSA revenue increased $59.1 million due primarily to the recent acquisition of Citoxlab which contributed $30.9 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 favorable pricing of services. These increases were partially offset by the effect of changes in foreign currency exchange rates.
DSA operating income increased $6.9 million during the three months ended June 29, 2019 compared to the corresponding period in 2018. DSA operating income as a percentage of revenue for the three months ended June 29, 2019 was 15.7%, a decrease of 0.6% from 16.3% for the corresponding period in 2018. The increase to operating income was primarily
attributable to contributions from our recent acquisition of Citoxlab. 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 three months ended June 29, 2019 compared to the same period in 2018.
Manufacturing
|
| | | | | | | | | | | | | | | | | |
| Three Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
Revenue | $ | 116.0 |
| | $ | 108.5 |
| | $ | 7.5 |
| | 7.0 | % | | (3.1 | )% |
Cost of revenue (excluding amortization of intangible assets) | 57.9 |
| | 50.7 |
| | 7.2 |
| | 14.1 | % | | |
Selling, general and administrative | 22.7 |
| | 21.3 |
| | 1.4 |
| | 6.4 | % | | |
Amortization of intangible assets | 2.3 |
| | 2.4 |
| | (0.1 | ) | | (0.3 | )% | | |
Operating income | $ | 33.1 |
| | $ | 34.1 |
| | $ | (1.0 | ) | | (2.9 | )% | | |
Operating income % of revenue | 28.6 | % | | 31.5 | % | | | | (2.9 | )% | | |
Manufacturing revenue increased $7.5 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 decreased $1.0 million during the three months ended June 29, 2019 compared to the corresponding period in 2018. Manufacturing operating income as a percentage of revenue for the three months ended June 29, 2019 was 28.6%, a decrease of 2.9% from 31.5% for the corresponding period in 2018. The decrease was due primarily to the 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). These increased costs collectively decreased operating income as a percentage of revenue in the three months ended June 29, 2019 compared to the same period in 2018.
Unallocated Corporate
|
| | | | | | | | | | | | | | |
| Three Months Ended | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change |
| (in millions, except percentages) |
Unallocated corporate | $ | 48.3 |
| | $ | 48.2 |
| | $ | 0.1 |
| | 0.3 | % |
Unallocated corporate % of revenue | 7.4 | % | | 8.2 | % | | | | (0.8 | )% |
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 June 29, 2019 compared to the same period in 2018 remained consistent. Costs as a percentage of revenue for thethree months ended June 29, 2019 was 7.4%, a decrease of 0.8% from 8.2% for the corresponding period in 2018, which resulted from cost saving initiatives.
Interest Income
Interest income, which represents earnings on cash, cash equivalents, and time deposits remained consistent at $0.3 million and $0.2 million for the three months ended June 29, 2019 and the corresponding period in 2018, respectively.
Interest Expense
Interest expense for thethree months ended June 29, 2019 was $20.8 million, an increase of $2.2 million, or 11.8%, compared to $18.6 million for the corresponding period in 2018. The increase was due primarily to higher debt to fund our recent
acquisitions and a foreign currency loss recognized in connection with an interest rate forward contract; partially offset by higher debt issuance costs incurred in the corresponding period in 2018.
Other Income (Expense), Net
Other expense, net, was $0.2 million for the three months ended June 29, 2019, a decrease of $12.2 million, or 101.8%, compared to Other income, net of $12.0 million for the corresponding period in 2018. The decrease was due to a net loss on our venture capital investments compared to a net gain in the corresponding period in 2018; partially offset by a foreign currency gain recognized in the three months ended June 29, 2019 in connection with a U.S. dollar denominated loan borrowed by a non-U.S. entity with a different functional currency.
Income Taxes
Income tax expense for the three months ended June 29, 2019 was $14.7 million, a decrease of $2.7 million compared to $17.4 million for the corresponding period in 2018. Our effective tax rate was 24.9% for the three months ended June 29, 2019, compared to 24.8% for the corresponding period in 2018. The slight increase in our effective tax rate in the 2019 period compared to the 2018 period was primarily attributable to increased non-deductible transaction costs in the second quarter of 2019, partially offset by increased research and development credits and the acquisition of Citoxlab.
Six Months Ended June 29, 2019 Compared to the Six Months Ended June 30, 2018
Revenue and Operating Income
The following tables present consolidated revenue by type and by reportable segment:
|
| | | | | | | | | | | | | | |
| Six Months Ended | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change |
| (in millions, except percentages) |
Service revenue | $ | 956.8 |
| | $ | 783.9 |
| | $ | 172.9 |
| | 22.1 | % |
Product revenue | 305.3 |
| | 295.4 |
| | 9.9 |
| | 3.4 | % |
Total revenue | $ | 1,262.1 |
| | $ | 1,079.3 |
| | $ | 182.8 |
| | 16.9 | % |
|
| | | | | | | | | | | | | | | | | |
| Six Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
RMS | $ | 273.2 |
| | $ | 264.4 |
| | $ | 8.8 |
| | 3.3 | % | | (2.8 | )% |
DSA | 759.7 |
| | 606.4 |
| | 153.3 |
| | 25.3 | % | | (1.6 | )% |
Manufacturing | 229.2 |
| | 208.5 |
| | 20.7 |
| | 9.9 | % | | (3.8 | )% |
Total revenue | $ | 1,262.1 |
| | $ | 1,079.3 |
| | $ | 182.8 |
| | 16.9 | % | | (2.4 | )% |
The following table presents operating income by reportable segment:
|
| | | | | | | | | | | | | | |
| Six Months Ended | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change |
| (in millions, except percentages) |
RMS | $ | 69.3 |
| | $ | 72.8 |
| | $ | (3.5 | ) | | (4.7 | )% |
DSA | 110.2 |
| | 97.5 |
| | 12.7 |
| | 13.1 | % |
Manufacturing | 64.6 |
| | 62.6 |
| | 2.0 |
| | 3.2 | % |
Unallocated corporate | (94.5 | ) | | (88.4 | ) | | (6.1 | ) | | 7.1 | % |
Total operating income | $ | 149.6 |
| | $ | 144.5 |
| | $ | 5.1 |
| | 3.5 | % |
Operating income % of revenue | 11.8 | % | | 13.4 | % | | | | (1.6 | )% |
The following presents the results from operating income by each of our reportable segments:
RMS
|
| | | | | | | | | | | | | | | | | |
| Six Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
Revenue | $ | 273.2 |
| | $ | 264.4 |
| | $ | 8.8 |
| | 3.3 | % | | (2.8 | )% |
Cost of revenue (excluding amortization of intangible assets) | 167.0 |
| | 159.7 |
| | 7.3 |
| | 4.6 | % | | |
Selling, general and administrative | 36.2 |
| | 31.1 |
| | 5.1 |
| | 16.4 | % | | |
Amortization of intangible assets | 0.7 |
| | 0.8 |
| | (0.1 | ) | | (14.2 | )% | | |
Operating income | $ | 69.3 |
| | $ | 72.8 |
| | $ | (3.5 | ) | | (4.7 | )% | | |
Operating income % of revenue | 25.4 | % | | 27.5 | % | | | | (2.1 | )% | | |
RMS revenue increased $8.8 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 and strong client demand in the GEMS business resulting from increased research and development activity conducted across 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 $3.5 million compared to the corresponding period in 2018. RMS operating income as a percentage of revenue for the six months ended June 29, 2019 was 25.4%, a decrease of 2.1% from 27.5% 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 in the six months ended June 29, 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.
DSA
|
| | | | | | | | | | | | | | | | | |
| Six Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
Revenue | $ | 759.7 |
| | $ | 606.4 |
| | $ | 153.3 |
| | 25.3 | % | | (1.6 | )% |
Cost of revenue (excluding amortization of intangible assets) | 529.7 |
| | 422.6 |
| | 107.1 |
| | 25.3 | % | | |
Selling, general and administrative | 83.3 |
| | 62.7 |
| | 20.6 |
| | 32.9 | % | | |
Amortization of intangible assets | 36.5 |
| | 23.6 |
| | 12.9 |
| | 54.7 | % | | |
Operating income | $ | 110.2 |
| | $ | 97.5 |
| | $ | 12.7 |
| | 13.1 | % | | |
Operating income % of revenue | 14.5 | % | | 16.1 | % | | | | (1.6 | )% | | |
DSA revenue increased $153.3 million due primarily to the recent acquisitions of MPI Research and Citoxlab, which contributed $73.0 million and $30.9 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 favorable pricing of services. These increases were partially offset by the effect of changes in foreign currency exchange rates.
DSA operating income increased $12.7 million during the six months ended June 29, 2019 compared to the corresponding period in 2018. DSA operating income as a percentage of revenue for the six months ended June 29, 2019 was 14.5%, a decrease of 1.6% from 16.1% for the corresponding period in 2018. The increase to operating income was primarily attributable to contributions from our recent acquisitions of MPI Research and Citoxlab. 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 six months ended June 29, 2019 compared to the same period in 2018.
Manufacturing
|
| | | | | | | | | | | | | | | | | |
| Six Months Ended | | | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change | | Impact of FX |
| (in millions, except percentages) |
Revenue | $ | 229.2 |
| | $ | 208.5 |
| | $ | 20.7 |
| | 9.9 | % | | (3.8 | )% |
Cost of revenue (excluding amortization of intangible assets) | 115.6 |
| | 99.5 |
| | 16.1 |
| | 16.2 | % | | |
Selling, general and administrative | 44.3 |
| | 41.7 |
| | 2.6 |
| | 6.2 | % | | |
Amortization of intangible assets | 4.7 |
| | 4.7 |
| | — |
| | — | % | | |
Operating income | $ | 64.6 |
| | $ | 62.6 |
| | $ | 2.0 |
| | 3.2 | % | | |
Operating income % of revenue | 28.2 | % | | 30.0 | % | | | | (1.8 | )% | | |
Manufacturing revenue increased $20.7 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 $2.0 million during the six months ended June 29, 2019 compared to the corresponding period in 2018. Manufacturing operating income as a percentage of revenue for the six months ended June 29, 2019 was 28.2%, a decrease of 1.8% from 30.0% 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). These increased costs collectively decreased operating income as a percentage of revenue in the six months ended June 29, 2019 compared to the same period in 2018.
Unallocated Corporate
|
| | | | | | | | | | | | | | |
| Six Months Ended | | | | |
| June 29, 2019 | | June 30, 2018 | | $ change | | % change |
| (in millions, except percentages) |
Unallocated corporate | $ | 94.5 |
| | $ | 88.4 |
| | $ | 6.1 |
| | 7.1 | % |
Unallocated corporate % of revenue | 7.5 | % | | 8.2 | % | | | | (0.7 | )% |
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 $6.1 million is consistent with the allocated selling, general, and administrative expense increases discussed above and are primarily related an increase in costs associated with the evaluation and integration of our recent acquisitions; an increase in compensation, benefits, and other employee-related expenses to support the growth of the Company; and costs related to the remediation of the unauthorized access into our information systems. Costs as a percentage of revenue for thesix months ended June 29, 2019 was 7.5%, a decrease of 0.7% from 8.2% for the corresponding period in 2018, which resulted from cost saving initiatives.
Interest Income
Interest income, which represents earnings on cash, cash equivalents, and time deposits remained consistent at $0.5 million for each of the six months ended June 29, 2019 and the corresponding period in 2018.
Interest Expense
Interest expense for thesix months ended June 29, 2019 was $30.8 million, an increase of $1.0 million, or 3.3%, compared to $29.8 million for the corresponding period in 2018. The increase was due primarily to higher debt to fund our recent acquisitions; partially offset by a foreign currency gain recognized in connection with an interest rate forward contract and the absence of debt issuance costs that were incurred in the corresponding period in 2018.
Other Income (Expense), Net
Other income, net, was $6.1 million for the six months ended June 29, 2019, a decrease of $12.1 million, or 66.4%, compared to $18.2 million for the corresponding period in 2018. The decrease was due to lower net gains on our venture capital investments compared to the corresponding period in 2018 and a foreign currency loss recognized in the six months ended June 29, 2019 in connection with a U.S. dollar denominated loan borrowed by a non-U.S. entity with a different functional currency; partially offset by higher net gains on our life insurance policy investments compared to the corresponding period in 2018.
Income Taxes
Income tax expense for the six months ended June 29, 2019 was $25.3 million, a decrease of $1.9 million compared to $27.2 million for the corresponding period in 2018. Our effective tax rate was 20.2% for the six months ended June 29, 2019 compared to 20.4% for the corresponding period in 2018. The slight decreased tax rate is primarily attributable to increased research and development credits and the acquisition of Citoxlab, partially offset by increased non-deductible transaction costs in the second quarter of 2019.
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:
|
| | | | | | | |
| June 29, 2019 | | December 29, 2018 |
| (in millions) |
Cash and cash equivalents: | | | |
Held in U.S. entities | $ | 39.2 |
| | $ | 67.3 |
|
Held in non-U.S. entities | 161.4 |
| | 128.1 |
|
Total cash and cash equivalents | 200.6 |
| | 195.4 |
|
Investments: | | | |
Held in non-U.S. entities | 0.9 |
| | 0.9 |
|
Total cash, cash equivalents and investments | $ | 201.5 |
| | $ | 196.3 |
|
Borrowings
On March 26, 2018, we amended and restated our $1.65 billion credit facility, creating our $2.3B Credit Facility which extended the maturity date for the credit facility. The $2.3B Credit Facility provides 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 April 3, 2018, we entered into our second supplemental indenture and raised an indenture (Indenture) with MUFG Union Bank, N.A., in connection with the offering ofadditional $500.0 million in aggregate principal amount of the4.25% Senior Notes due in 20262028 (2028 Senior Notes) in an unregistered offering. Under the terms of the Indenture,second supplemental indenture, interest on the 2028 Senior Notes is payable semi-annually on AprilMay 1 and OctoberNovember 1, beginning on OctoberMay 1, 2018.2020.
Amounts outstanding under our credit facilities and both the 2026 Senior Notes and the 2028 Senior Notes were as follows:
| | | | | | | | | | | |
| March 28, 2020 | | December 28, 2019 |
| (in millions) | | |
Term loans | $ | 184.4 | | | $ | 193.8 | |
Revolving facility | 1,168.1 | | | 676.1 | |
2026 Senior Notes | 500.0 | | | 500.0 | |
2028 Senior Notes | 500.0 | | | 500.0 | |
Total | $ | 2,352.5 | | | $ | 1,869.9 | |
|
| | | | | | | |
| June 29, 2019 | | December 29, 2018 |
| (in millions) |
Term loans | $ | 712.5 |
| | $ | 731.3 |
|
Revolving facility | 839.2 |
| | 397.5 |
|
Senior Notes | 500.0 |
| | 500.0 |
|
Total | $ | 2,051.7 |
| | $ | 1,628.8 |
|
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. The interest rates applicable to the term loan and revolving facility under the $2.3B 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 six months ended June 29, 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 $2.3B Credit Facility.
The acquisition of Citoxlab on April 29, 2019 for $528.1 million in cash was funded through a combination of cash on hand and proceeds from our $2.3B Credit Facility under the multi-currency revolving facility.
Repurchases of Common Stock
During the sixthree months ended June 29, 2019,March 28, 2020, we did not repurchase any shares under our authorized stock repurchase program. As of June 29, 2019,March 28, 2020, 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 2019.2020. 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 sixthree months ended June 29, 2019,March 28, 2020, we acquired $0.10.1 million shares for $17.9$23.7 million through such netting.
Cash Flows
The following table presents our net cash provided by operating activities:
| | | | | | | | | | | |
| Three Months Ended | | |
| March 28, 2020 | | March 30, 2019 |
| (in millions) | | |
Net income | $ | 50.8 | | | $ | 55.7 | |
Adjustments to reconcile net income to net cash provided by operating activities | 87.8 | | | 55.1 | |
Changes in assets and liabilities | (70.0) | | | (95.9) | |
Net cash provided by operating activities | $ | 68.6 | | | $ | 14.9 | |
|
| | | | | | | |
| Six Months Ended |
| June 29, 2019 | | June 30, 2018 |
| (in millions) |
Income from continuing operations | $ | 100.0 |
| | $ | 106.1 |
|
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities | 119.5 |
| | 84.1 |
|
Changes in assets and liabilities | (75.1 | ) | | (6.3 | ) |
Net cash provided by operating activities | $ | 144.4 |
| | $ | 183.9 |
|
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 net income from continuing operations for (1) non-cash operating items such as depreciation and amortization, stock-based compensation, deferred income taxes, gains and/or losses on venture capital investments, and impairment charges, 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 sixthree months ended June 29, 2019,March 28, 2020, compared to the sixthree months ended JuneMarch 30, 2018,2019, the decreaseincrease in net cash provided by operating activities was primarilywas driven by unfavorablehigher net income adjusted for non-cash items. While net income was slightly less compared to the prior year, the non-cash items adjusting net income were higher, specifically venture capital and life insurance investment losses of approximately $18 million in three months ended March 28, 2020 compared to gains of approximately $13 million in the corresponding period in 2019. We experienced certain favorable changes in operating assets and liabilities, specifically related to theworking capital items, including favorable timing of net contract balances from contracts with customers (collectively trade receivables, net; deferred revenue; and customer contract deposits), and higherlower compensation payments compared to the prior year period.period; partially offset by the unfavorable timing of vendor and supplier payments compared to the same period in 2019.
The following table presents our net cash used in investing activities:
| | | Six Months Ended | | Three Months Ended | |
| June 29, 2019 | | June 30, 2018 | | March 28, 2020 | | March 30, 2019 |
| (in millions) | | (in millions) | |
Acquisitions of businesses and assets, net of cash acquired | $ | (492.4 | ) | | $ | (821.4 | ) | Acquisitions of businesses and assets, net of cash acquired | $ | (382.3) | | | $ | (1.0) | |
Capital expenditures | (41.5 | ) | | (48.9 | ) | Capital expenditures | (25.7) | | | (16.7) | |
Investments, net | (14.7 | ) | | 19.4 |
| Investments, net | (4.6) | | | (2.4) | |
Other, net | (0.6 | ) | | (0.1 | ) | Other, net | (1.1) | | | (0.7) | |
Net cash used in investing activities | $ | (549.2 | ) | | $ | (851.0 | ) | Net cash used in investing activities | $ | (413.7) | | | $ | (20.8) | |
For the sixthree months ended June 29, 2019,March 28, 2020, the primary use of cash used in investing activities related to the acquisition of Citoxlab,HemaCare, capital expenditures to support the growth of the business, and investments in certain venture capital and other equity investments. For the sixthree months ended JuneMarch 30, 2018,2019, 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.business.
The following table presents our net cash provided by (used in) financing activities:
| | | Six Months Ended | | Three Months Ended | |
| June 29, 2019 | | June 30, 2018 | | March 28, 2020 | | March 30, 2019 |
| (in millions) | | (in millions) | |
Proceeds from long-term debt and revolving credit facility | $ | 1,485.7 |
| | $ | 2,392.6 |
| Proceeds from long-term debt and revolving credit facility | $ | 1,409.8 | | | $ | 290.1 | |
Payments on long-term debt, revolving credit facility, and finance lease obligations | | Payments on long-term debt, revolving credit facility, and finance lease obligations | (925.1) | | | (360.7) | |
Proceeds from exercises of stock options | 23.9 |
| | 24.2 |
| Proceeds from exercises of stock options | 22.6 | | | 21.8 | |
Payments on long-term debt, revolving credit facility and finance lease obligations | (1,076.8 | ) | | (1,680.2 | ) | |
Payments on debt financing costs | — |
| | (18.3 | ) | |
Purchase of treasury stock | (17.9 | ) | | (13.7 | ) | Purchase of treasury stock | (23.7) | | | (17.8) | |
Other, net | (10.5 | ) | | — |
| Other, net | (4.4) | | | (2.5) | |
Net cash provided by financing activities | $ | 404.4 |
| | $ | 704.6 |
| |
Net cash provided by (used in) financing activities | | Net cash provided by (used in) financing activities | $ | 479.2 | | | $ | (69.1) | |
For the sixthree months ended June 29, 2019,March 28, 2020, net cash provided by financing activities reflected the net proceeds of $408.9$484.7 million on our $2.3B Credit Facility and finance lease obligations. Included in the net proceeds are the following amounts:
•Proceeds of approximately $950$415 million from our revolving Credit Facility to fund our recent acquisitions. Additionally, towards the end of the fiscal quarter, we borrowed an additional $150 million from our revolving Credit Facility to secure cash on hand in response to uncertainties due to the COVID-19 pandemic; partially offset by,
•Payments of approximately $10 million on our term loan and payments of $70 million to our revolving Credit Facility in the normal course of business throughout the fiscal quarter;
•Additionally, we had $798 million of gross payments, partially offset by $794 million of gross proceeds and payments on the revolving credit facility, which resulted fromin connection with a non-U.S. Euro functional currency entity repaying an existing Euro loanloans and replacing the Euro loanloans with a U.S. dollar denominated loan.loans. 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. activities.
Net cash providedprovided by financing activities also reflected proceeds from exercises of employee stock options of $23.9 million. Net cash provided by financing activities was partially$22.6 million, offset by treasury stock purchases of $17.9$23.7 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.requirements.
For the sixthree months ended JuneMarch 30, 2018,2019, net cash provided byused in financing activities reflected the incremental proceeds from the refinancingnet payments of $70.6 million on our previous $1.65 Billion Credit Facility to the $2.3 Billion Credit Facility and finance lease obligations. Included in the net proceeds fromare the following amounts:
•Payments of $9 million on our $500.0term loan and payments of $3 million Senior Notes; and proceeds from exercisesto our revolving Credit Facility in the normal course of employee stock optionsbusiness throughout the fiscal quarter;
•Additionally, we had $343 million of $24.2 million;gross payments, partially offset by $285 million of gross proceeds in connection with a non-U.S. Euro functional currency entity repaying Euro loans and replacing the Euro loans with U.S. dollar denominated loans. 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 on debtare presented as gross financing costs of $18.3 million andactivities.
Net cash used in financing activities also reflected treasury stock purchases of $13.7$17.8 million made due to the netting of common stock upon vesting of stock-based awards in order to satisfy individual statutory tax withholding requirements.requirements; partially offset by proceeds from exercises of employee stock options of $21.8 million.
Contractual Commitments and Obligations
The disclosure of our contractual commitments and obligations was reported in our Annual Report on Form 10-K for fiscal 2018.2019. There have been no material changes from the contractual commitments and obligations previously disclosed in our Annual Report on Form 10-K for fiscal 20182019 other than the changes described in Note 2, “Business Acquisitions,Combinations,” 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.
Off-Balance Sheet Arrangements
As of June 29, 2019,March 28, 2020, 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 June 29, 2019March 28, 2020 was $128.6$128.4 million, of which we funded $75.4$82.9 million through June 29, 2019.March 28, 2020. 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 June 29, 2019March 28, 2020 were $6.7$8.3 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 ourthe application of the followingour 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.results. Our significant accounting policies are described in Note 1, “Description of Business and Summary of Significant Accounting Policies” to our Annual Report on Form 10-K for fiscal year 2018 as well as Note 16, “Leases” in this Quarterly Report on Form 10-Q.2019.
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 sixthree months ended June 29, 2019March 28, 2020 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 June 29, 2019,March 28, 2020, 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 $15.5$13.5 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, and Chinese Yuan Renminbi, and Japanese Yen. DuringRenminbi. During the sixthree months ended June 29, 2019,March 28, 2020, the most significant drivers of foreign currency translation adjustment the Company recorded as part of Other comprehensive income (loss) were the Euro,Canadian Dollar, British Pound, Canadian Dollar,Hungarian Forint, Chinese Yuan Renminbi, Brazilian real, and Japanese Yen.Euro.
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, assets, liabilities, and cash flows will generally increase when reported in U.S. dollars. For the sixthree months ended June 29, 2019,March 28, 2020, our revenue would have increased by $41.8$21.9 million and our operating income would have decreased by $0.1$1.1 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 sixthree months ended June 29, 2019,March 28, 2020, 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 $2.3B Credit Facility. We did not have any significant foreign currency contracts open asRefer to Note 14, “Foreign Currency Contracts” in this Quarterly Report on Form 10-Q for additional information regarding these types of June 29, 2019.forward contracts.
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 June 29, 2019,March 28, 2020, 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 Company continued to execute a plan to centralize certain accounting transaction processing functions to internal shared service centers during the three months ended June 29, 2019.March 28, 2020. 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 June 29, 2019March 28, 2020 that materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.
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 additionSet forth below, elsewhere in this Form 10-Q and in other documents we file with the SEC are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Form 10-Q. We note that factors set forth below, individually or in the aggregate, as well as additional risks and uncertainties either not presently known or that are currently believed to not be material to the business, may cause our actual results to differ materially from expected and historical results. You should understand that it is not possible to predict or identify all such factors. Consequently, you should not consider the following to be a complete discussion of all potential risks or uncertainties and the risks described below should be carefully considered together with the other information set forth in this report you should carefully considerand in future documents we file with the factors discussedSEC.
The COVID-19 pandemic is dynamic and expanding. The continuation of this outbreak likely will have, and the emergence of other epidemic or pandemic crises could have, material adverse effects on our business, results of operations, or financial condition.
On March 11, 2020, the World Health Organization declared the outbreak of a strain of novel coronavirus disease, COVID-19, a global pandemic. The COVID-19 pandemic is dynamic and expanding, and its ultimate scope, duration and effects are uncertain. This pandemic has and continues to result in, Part I, “Item 1A.and any future epidemic or pandemic crises may potentially result in, direct and indirect adverse effects on our industry and customers, which in turn has (with respect to COVID-19) and may (with respect to future epidemics or crises) impact our business, results of operations and financial condition. Further, the COVID-19 pandemic may also affect our operating and financial results in a manner that is not presently known to us. Effects of the current pandemic include, or may include, among others:
•deterioration of worldwide, regional or national economic conditions and activity, which could adversely affect global demand for our products and services;
•disruptions to our operations as a result of the potential health impact on our employees and crew, and on the workforces of our customers and business partners;
•temporary and/or partial closures of our facilities or the facilities of our customers (including academic institutions, government laboratories and private foundations) and third-party service providers;
•interruption of the operations of global supply chains and those of our suppliers;
•disruptions to our business from, or additional costs related to, new regulations, directives or practices implemented in response to the pandemic, such as travel restrictions, shelter in place/stay in place/work from home orders, increased inspection regimes, hygiene measures (such as quarantining and physical distancing) or increased implementation of remote working arrangements;
•potential reduced cash flows and financial condition, including potential liquidity constraints;
•reduced access to capital, including the ability to refinance any existing obligations, as a result of any credit tightening generally or due to continued declines in global financial markets, including to the prices of publicly-traded equity securities of us, our peers and of listed companies generally;
•potential deterioration in the financial condition and prospects of our customers or attempts by customers, suppliers or service providers to invoke force majeure contractual clauses, or the legal doctrines of impossibility or impracticability (or other similar doctrines) as a result of delays or other disruptions;
•potential delays in the commencement of, or the suspension or cancellation of, client studies; and
•the effects described elsewhere in these Risk Factors” inFactors.
The COVID-19 pandemic has caused us to modify our Annual Report on Form 10-K for fiscal year 2018, whichbusiness practices, including but not limited to health management of employees, customers and suppliers, management of production inventory, supply chain risk management, compensation practices and capital expenditure planning. We have formed a tiered structure of designated COVID-19 crisis management teams throughout our organization to identify, implement and monitor such actions as required by the dynamic exigencies arising from the pandemic. Such measures and others may not be sufficient to mitigate all the risks posed by COVID-19, and our ability to perform critical functions could be materially adversely affected.
Although disruption and effects from the COVID-19 pandemic may be temporary, given the dynamic nature of these circumstances and the worldwide nature of our business and operations, the duration of any business disruption and the related financial impact to us cannot be reasonably estimated at this time but could materially affect our business, results of operations and financial condition,condition.
Changes and uncertainties in the economy have harmed and could continue to harm our operating results.
As the COVID-19 pandemic is still ongoing and may worsen, there is significant uncertainty surrounding its developments and impacts, including whether the current epidemic or continued spread of COVID-19 will cause a broader economic slowdown or a global recession, and we cannot predict at this time the impact it will have on our business or results of operations. Changes and uncertainties in the economy have harmed and could continue to harm our operating results. As a result of the continuing economic uncertainties, our operating results, and the economic strength of our customers and suppliers, are increasingly difficult to predict. Sales of our products and services, as well as access to our products and services within our supply chain, are affected by many factors, including, among others, general economic conditions, interest rates, inflation, liquidity in the credit markets, unemployment trends, shipping costs, geopolitical events, and other factors. If economic conditions significantly weaken on a global scale it may cause some of our customers to experience a slowdown, from time to time, which may in turn have an adverse effect on our sales and operating results. Changes and uncertainties in the economy also increase the risk of uncollectible accounts receivable. The pricing we receive from suppliers may also be impacted by general economic conditions. Continued and future changes and uncertainties in the economic climate in the United States and elsewhere could have a similar negative impact on the rate and amounts of purchases by our current and potential customers, create price inflation for our products, or otherwise have a negative impact on our expenses, gross margins and revenues, and could hinder our growth.
A reduction in demand may adversely affect our business.
Our business could be adversely affected by any significant decrease in drug R&D expenditures by pharmaceutical and biotechnology companies, as well as by academic institutions, government laboratories or private foundations. Similarly, economic factors and industry trends that affect our clients in these industries (including the COVID-19 pandemic and the impact of measures intended to reduce the spread of COVID-19) also affect their R&D budgets and, consequentially, our business as well.
Our clients include researchers at pharmaceutical and biotechnology companies. Our ability to continue to grow and win new business is dependent in large part upon the ability and willingness of the pharmaceutical and biotechnology industries to continue to spend on molecules in the non-clinical phases of R&D (and in particular discovery and safety assessment) and to outsource the products and services we provide. Furthermore, our clients (particularly larger biopharmaceutical companies) continue to search for ways to maximize the return on their investments with a focus on lowering R&D costs per drug candidate. Fluctuations in the expenditure amounts in each phase of the R&D budgets of these researchers and their organizations could have a significant effect on the demand for our products and services. R&D budgets fluctuate due to changes in available resources, mergers of pharmaceutical and biotechnology companies, spending priorities (including available resources of our biotechnology clients, particularly those that are cash-negative, who may be highly focused on rationing their liquid assets in a challenging funding environment), general economic conditions, institutional budgetary policies and the impact of government regulations, including potential drug pricing legislation. Available funding for biotechnology clients in particular may be affected by the capital markets, investment objectives of venture capital investors and priorities of biopharmaceutical industry sponsors.
For additional discussion of the factors that we believe have recently been influencing R&D budgets at our clients, please see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Form 10-Q in addition to the sections entitled “Our Strategy” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Form 10-K for the fiscal year ended December 28, 2019, filed with the Commission on February 11, 2020.
Further, our Research Products operations are structured to produce particular blood products based on customers’ existing demand, and perceived potential changes in demand, for these products. Sudden or unexpected changes in demand for these products could have an adverse impact on our profitability. Increasing demand could harm relationships with customers if we are unable to alter production capacity, or purchase products from other suppliers, to fill orders adequately. This could result in a decrease in overall revenue and profits. The impact of measures intended to reduce the spread of COVID-19 has caused us to temporarily suspend blood donations at our Research Products facilities, further limiting our ability to respond to changes in demand. Lack of access to sufficient capital, or lack of adequate time to properly (or the failure to adequately) respond to changes in demand, could result in declining revenue and profits, as customers transfer to other suppliers.
A reduction or delay in government funding of R&D may adversely affect our business.
A portion of revenue, predominantly in our RMS segment, is derived from clients at academic institutions and research laboratories whose funding is partially dependent on both the level and timing of funding from government sources such as the
U.S. National Institutes of Health (NIH) and similar domestic and international agencies, which can be difficult to forecast. We also sell directly to the NIH and these other agencies. Government funding of R&D is subject to the political process, which is inherently fluid and unpredictable. Our revenue may be adversely affected if our clients delay purchases as a result of uncertainties surrounding the approval of government budget proposals, included reduced allocations to government agencies that fund R&D activities. Government proposals to reduce or eliminate budgetary deficits have sometimes included reduced allocations to the NIH and other government agencies that fund R&D activities, or NIH funding may not be directed towards projects and studies that require the use of our products and services, both of which could adversely affect our business and our financial results. Furthermore, changes in government budgetary priorities as a result of the COVID-19 pandemic and the impact of measures intended to reduce the spread of COVID-19 could reduce government funding of R&D that is unrelated to the disease, which could adversely affect our business and our financial results.
Several of our product and service offerings are dependent on a limited source of supply that, when interrupted, adversely affects our business.
We depend on a limited international source of supply for certain products, such as large research models. Disruptions to their continued supply from time to time arise from health problems (including as a result of the COVID-19 pandemic and the spread of other diseases), export or import laws/restrictions or embargoes, tariffs, international trade regulations, foreign government or economic instability, severe weather conditions, increased competition among suppliers for models, disruptions to the air travel system, activist campaigns, commercial disputes, supplier insolvency, geopolitical disputes, measures intended to slow the spread of COVID-19 or other ordinary course or unanticipated events. Any disruption of supply could materially harm our business if we cannot remove the disruption or are unable to secure an alternative or secondary supply source on comparable commercial terms. While we continue to take steps to find alternative supply channels and lock in supply with preferred sources through multi-year and/or future results. The risks describedminimum commitment contracts, such mitigating efforts may not prove successful at ensuring a steady and timely supply or may require (and in the past have required) us to pay significantly higher prices for such products during periods of global shortage or restrictions on the transportation of products. In addition, limited global supply or regional restrictions on transportation for certain products may require us to source products from non-preferred vendors.
Further, our Annual ReportResearch Products business depends on Form 10-Kthe availability of appropriate donors. As a result of the COVID-19 pandemic and the impact of measures intended to reduce the spread of COVID-19 we have chosen to temporarily suspend blood donations at our Research Products facilities, thus limiting our access to new donors. As donor participation declines, we may not be able to reduce costs sufficiently to maintain profitability of the Research Products business. Regulations intended to reduce the risk of introducing infectious diseases in the blood supply (including COVID-19) could also result in a decreased pool of potential donors or integrity of inventory. Due to any pandemic, epidemic or outbreak in one or more regions in which our Research Products business operates, the portion of the public that typically donates may be unable, or unwilling to donate, thereby significantly reducing the availability of research products upon which we rely. In addition, the heightened fear and health concerns among the public resulting from widespread media coverage may result in a dramatic decline in donations when our blood donation facilities re-open.
We bear financial risk for contracts that may be terminated or reduced in scope, underpriced, subject to cost overruns or delayed.
Many of our agreements, including those which underlie our strategic relationships with some of our more significant clients, provide for termination or reduction in scope with little or no notice. In addition, we sell our products and services to our competitors, and similarly they sell products and services to us. For instance, we have historically entered into, and currently are party to, contracts with certain of our competitors to distribute specialty research models in locations where our competitors may not have distribution capabilities.
Our counterparties (including our clients who are competitors) may elect to terminate their agreements with us for various reasons including:
•the invocation of force majeure clauses, or the legal doctrines of impossibility or impracticability (or other similar legal doctrines), as a result of the COVID-19 pandemic;
•the products being tested fail to satisfy safety requirements;
•unexpected or undesired study results;
•production problems resulting in shortages of the drug being tested;
•a client’s decision to forego or terminate a particular study;
•our competitors’ establishment of alternative distribution channels;
•dissatisfaction with our performance under the agreement;
•the loss of funding for the particular research study; or
•general convenience/counterparty preference.
If a counterparty terminates a contract with us, we are typically entitled under the terms of the contract to receive revenue earned to date as well as certain other costs and, in some cases, termination fees; however, in many cases we are not entitled to any termination fees in the only risks we face. Additional risks and uncertainties not currently known to usevent of a termination as a result of force majeure. Cancellation of a large contract or that we currently deem to be immaterial also mayproximate delay, cancellation or conclusion of multiple contracts could materially adversely affect our business and, therefore, may adversely affect our operating results.
Furthermore, many of our contracts provide for services on a fixed price or fee-for-service with a cap basis and, accordingly, we bear the financial risk if we initially underprice our contracts or otherwise overrun our cost estimates. Such underpricing or significant cost overruns could have an adverse effect on our business, results of operations, 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.and cash flows.
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 stealingto steal data or disruptingdisrupt the systems. systems or for financial gain. Like other companies, we have on occasion experienced, and will continue to experience, threats and incursions to our data and systems, including malicious codes and viruses, phishing, business email compromise and social engineering attacks or other cyber-attacks. The number and complexity of these threats continue to increase over time.
While we have taken measures to protect themour information systems from intrusion, in March 2019, we detected evidence that an unauthorized third party, haswho we believe was well resourced and highly sophisticated, accessed certain of our information systems and acquiredcopied data. The Company’s investigation is ongoing, but we believe that the incident is attributable to a sophisticated intruder. We are workingworked with a leading datacyber security firm to assist in our investigation and are also coordinatingcoordinated with law enforcement authorities. TheOur investigation indicatesindicated that the affected information included client information.
In December 2019, we disclosed that we had completed our remediation of the incident identified in March of 2019. While we have implemented additional security safeguards, including:
•remediation of the March 2019 incident;
•cooperation with U.S. Federal authorities’ investigation into the incident and established an ongoing relationship to better understand the ever-changing nature of cybersecurity related threats;
•additional visibility into our network and environment;
•additional monitoring of our environment;
•active threat hunting in our environment;
•a reduction of our footprint of externally facing technology;
•enhanced protection for externally facing web applications;
•the addition of Multi-Factor Authentication to ingress points;
•the addition of denial of service attack protection; and
•increased network segmentation,
such efforts may not be successful, in which case we could suffer significant harm.
Further, we are at risk of being targeted, and we have in the past been victim to, business email compromise fraud, which results in payments being made to illegitimate bank accounts. Although these instances have not resulted in our incurring material losses, if similar instances occur in the future, we may incur such losses.
Our contracts with our clients typically contain provisions that require us to keep confidential the information generated from the studies we conduct. TheIn the event the confidentiality of such information is compromised, whether by unauthorized access detected, as well as any futureor other breaches, we could expose usbe exposed 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.other parties. In addition, we may face investigations by government regulators and agencies as a result of this incidenta breach.
Further, we are required to comply with the data privacy and security laws in many jurisdictions. For example, we are required to comply with the European Union (EU) General Data Protection Regulation (GDPR), which became effective on May 25, 2018 and imposes heightened obligations and enhanced penalties for noncompliance (including up to four percent (4%) of global revenue). The cost of compliance, and the potential for fines and penalties for non-compliance, with GDPR may have a significant adverse effect on our business and operations. Also, the California legislature passed the California Consumer Privacy Act (CCPA), which became effective January 1, 2020. The CCPA creates new transparency requirements and grants
California residents several new rights with regard their personal information. Failure to comply with the CCPA may result in, among other things, significant civil penalties and injunctive relief, or potential statutory or actual damages. We have made changes to, and investments in, our business practices and will continue to monitor developments and make appropriate changes to help attain compliance with these evolving and complex regulations. Additionally, while collecting research products from donors, we may collect, use, disclose, maintain and transmit patient information in ways that will be subject to many of the numerous state, federal and international laws and regulations governing the collection, use, disclosure, storage, transmission or confidentiality of patient-identifiable health information.
Contaminations in our animal populations can damage our inventory, harm our reputation for contaminant-free production, result in decreased sales and cause us to incur additional costs.
Our research models and fertile chicken eggs must be free of certain infectious agents, such as certain viruses and bacteria, because the presence of these contaminants can distort or compromise the quality of research results and could adversely impact human or animal health. The presence of these infectious agents in our animal production facilities and certain service operations could disrupt our contaminant-free research model and fertile egg production as well as our animal services businesses, including GEMS, harm our reputation for contaminant-free production and result in decreased sales. There also exists a risk that contaminations from models that we produce may affect our client’s facilities, with similar impact to them for which we could be liable for damages. In some cases, we may produce or import animals carrying infectious agents capable of causing disease in humans; and in the case of such a contamination or undiagnosed infection, there could be a possible risk of human exposure and infection and liability for damages to infected persons.
We are also subject to similar contamination risks with respect to our large research models. While some of these models are owned by us and maintained at our facilities, others are reserved for us and maintained at sites operated by the original provider. Accordingly, risk of contamination may be outside of our control, and we depend on the practices and protocols of third parties to ensure a contamination-free environment. A contamination may require extended CDC quarantine with subsequent reduced sales as a result of future incidents.
Whilelost client orders, as well as the Company is inpotential for complete inventory loss and disinfection of the process of implementing additional security safeguards, it is expectedaffected quarantine rooms. Furthermore, while we often negotiate for contractual risk indemnification, the third party may refuse 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 willfulfill its indemnification obligation or may be unable to determineas a result of insolvency or other impediments.
Contaminations are unanticipated and difficult to predict and could adversely impact our financial results. If they occur, contaminations typically require cleaning up, renovating, disinfecting, retesting and restarting production or services. Such clean-ups result in inventory loss, clean-up and start-up costs, and reduced sales as a result of lost client orders and potentially credits for prior shipments. In addition to microbiological contaminations, the potential for genetic mix-ups or mis-matings also exists and may require us to restart the applicable colonies, and would likely result in inventory loss, additional start-up costs and possibly reduced sales. Contaminations also expose us to risks that this matterclients will request compensation for damages in excess of our contractual indemnification requirements.
Further, many of our operations are comprised of complex mechanical systems that are subject to periodic failure, including aging fatigue. Such failures are unpredictable, and while we have made significant capital expenditures designed to create redundancy within these mechanical systems, strengthen our biosecurity, improve our operating procedures to protect against such contaminations, and replace impaired systems and equipment in advance of such events, failures and/or contaminations may still occur.
Any failure by us to comply with applicable regulations and related guidance could harm our reputation and operating results, and compliance with new regulations and guidance may result in additional costs.
Any failure on our part to comply with applicable regulations could result in the termination of ongoing research or the disqualification of data for submission on behalf of our clients to regulatory authorities. This could harm our reputation, our prospects for future work and our operating results. For example, the issuance of a notice of objectionable observations or a warning letter from the FDA based on a finding of a material violation affecting data integrity by us for GLP or cGMP requirements that are not addressed to the regulatory monitoring authorities’ satisfaction could materially and adversely affect us. If our operations are found to violate any applicable law or other governmental regulations, we might be subject to civil and criminal penalties, damages and fines or the temporary closure of our facilities. Any action against us for violation of these laws or regulations, even if we successfully defend against it, could cause us to incur significant legal expenses, divert our management’s attention from the operation of our business and damage our reputation.
In recent years FDA has issued guidance that now requires submissions to be presented in a format that conforms with the FDA’s SEND (Standardization for Exchange of Nonclinical Data) standards that apply to our clients’ NDA and IND submissions and require us to provide electronic data in specific formats that will allow for more efficient, higher quality regulatory reviews. Accordingly, our clients expect us to timely deliver their nonclinical data compliant with SEND. Notwithstanding, some of these standards require additional operating and capital expenses that will impact not only us and our industry competitors, but clients in the biomedical research community. Non-compliance with any of these expectations could lead to official action by a government authority, damage to our reputation and a potential loss of business.
In addition, regulations and guidance worldwide concerning the production and use of laboratory animals for research purposes continue to evolve. Similarly, guidance has been entirely contained untiland continues to be developed for other areas that impact the biomedical research community on both a national and international basis including transportation, mandated contingency planning, euthanasia guidance, import and export requirements of biological materials, health monitoring requirements and the use of disinfectants.
Our Research Products business is subject to extensive and complex regulation by federal, state and local governments in the U.S. and in the other countries in which it operates. This business requires us to obtain many licenses, permits, authorizations, approvals, certificates and other types of governmental permissions and to comply with various regulations in every jurisdiction in which we operate. Federal, state and local regulations change often, and new regulations are frequently adopted. Changes in the regulations could require us to change the way in which we operate our business and the cost of compliance with new or changed regulations could be significant.
Our donor collection centers are registered with the FDA and the FDA periodically conducts inspections of those facilities and operations. At the conclusion of each inspection, the FDA provides us with a list of observations of regulatory issues discovered during the inspection that could result in additional stepsregulatory action. Failure to securecomply with the regulations of the FDA could result in sanctions and/or remedies and have a material adverse effect on us.
The outsourcing trend in non-clinical (discovery and safety assessment) stages of drug discovery and development may decrease, which could impair our information systemsgrowth.
Over the past decade, pharmaceutical and biotechnology companies have been fully implemented.generally increased their outsourcing of non-clinical research support activities, such as discovery and safety assessment. While many industry analysts expect the outsourcing trend to continue to increase for the next several years (although with different growth rates for different phases of drug discovery and development), decreases in such outsourcing may result in a diminished growth rate in the sales of any one or more of our service lines and may adversely affect our financial condition and results of operations. For additional discussion of the factors that we believe have recently influenced outsourcing demand from our clients, please see the section entitled “Our Strategy” included in our Form 10-K for the fiscal year ended December 28, 2019, filed with the Commission on February 11, 2020.
Changes in government regulation or in practices relating to the pharmaceutical or biotechnology industries, including potential healthcare reform, could decrease the need for the services we provide.
Governmental agencies throughout the world strictly regulate the drug development process. Our business involves helping our customers navigate these regulatory processes. Accordingly, many regulations, and often new regulations, are expected to result in higher regulatory standards and often additional revenues for companies that service these industries. However, some changes in regulations, such as a relaxation in regulatory requirements or the introduction of streamlined or expedited drug approval procedures, or an increase in regulatory requirements that we have difficulty satisfying or that make our services less competitive, could eliminate or substantially reduce the demand for our services.
Although we believe we are currently in compliance in all material respects with applicable national, regional and local laws, as well as other accepted guidance used by oversight bodies (including the USDA, the standards set by the International Air Transport Association, the Convention on International Trade in Endangered Species of Wild Fauna and Flora, U.S. Fish and Wildlife Service, The Centers for Disease Control, the Department of Transportation, the Department of State, the office of Laboratory Animal Welfare of NIH, the Drug Enforcement Agency, as well as numerous other oversight agencies in the jurisdictions in which we operate), failure to comply could subject us to denial of the right to conduct business, fines, criminal penalties and other enforcement actions. In addition, thereif regulatory authorities were to mandate a significant reduction in safety assessment procedures that utilize laboratory animals (as has been advocated by certain groups), certain segments of our business could be materially adversely affected.
In March 2010, the U.S. Congress enacted healthcare reform legislation, the Patient Protection and Affordable Care Act (ACA), which includes provisions impacting drug manufacturers, such as (1) the expansion of access to health insurance coverage, (2) the expansion of the Medicaid program, (3) the enactment of an industry fee on pharmaceutical companies and (4) the imposition of an excise tax on the sale of medical devices. In addition, the Tax Cuts and Jobs Act, enacted in 2017, repeals the ACA’s individual health insurance mandate, which is considered a key component of the ACA. Since the ACA and its implementation continue to face challenges in Congress and federal courts, and from certain state governments, opposition advocacy groups and some small business organizations, the ultimate effects of this legislation are unclear on our business and are unable to predict what legislative proposals will be adopted in the future.
Implementation of healthcare reform legislation may have certain benefits, but also may contain costs that could limit the profits that can be no assurancemade from the development of new drugs. This could adversely affect R&D expenditures by pharmaceutical and biotechnology companies, which could in turn decrease the business opportunities available to us both in the U.S. and abroad. In addition, new laws or regulations may create a risk of liability, increase our costs or limit our service offerings.
Furthermore, if health insurers were to change their practices with respect to reimbursements for pharmaceutical products, our clients may spend less or reduce their growth in spending on R&D.
While it is not possible to predict whether and when any such changes will occur, changes at the local, state or federal level, or in laws and regulations in effect in foreign jurisdictions in which we operate or have business relationships, may significantly impact our domestic and foreign businesses and/or those of our clients. Furthermore, modifications to international trade policy, public company reporting requirements, environmental regulation and antitrust enforcement may have a materially adverse impact on us, our suppliers or our clients.
If we are not successful in selecting and integrating the businesses and technologies we acquire, or in managing our current and future divestitures, our business may be adversely impacted.
During the last two decades, we have steadily expanded our business through numerous acquisitions, including our recent acquisitions of Citoxlab and HemaCare. However, businesses and technologies may not be available on terms and conditions we find acceptable. We risk spending time and money investigating and negotiating with potential acquisition or alliance partners, but not completing transactions. Further, while we plan to continue to acquire businesses and technologies and form strategic alliances, we have recently reduced the pace of this activity as we assess the impact of the COVID-19 pandemic.
Acquisitions and alliances involve numerous risks which may include:
•difficulties in achieving business and financial success (including as a result of COVID-19 pandemic and the long-term economic impact of the pandemic);
•difficulties and expenses incurred in assimilating and integrating operations, services, products, information technology platforms, technologies or pre-existing relationships with our clients, distributors and suppliers;
•challenges with developing and operating new businesses, including those that are materially different from our existing businesses and that may require the additional security safeguards willdevelopment or acquisition of new internal capabilities and expertise;
•potential losses resulting from undiscovered liabilities of acquired companies that are not covered by the indemnification we may obtain from the seller or the insurance we acquire in connection with the transaction;
•loss of key employees;
•the presence or absence of adequate internal controls and/or significant fraud in the financial systems of acquired companies;
•diversion of management’s attention from other business concerns;
•a more expansive regulatory environment;
•acquisitions could be successful. In the event that additional data is accessed priordilutive to the full implementation of these additional security safeguardsearnings, or in the event of acquisitions made through the issuance of our common stock to the shareholders of the acquired company, dilutive to the percentage of ownership of our existing shareholders;
•differences in foreign business practices, customs and importation regulations, language and other cultural barriers in connection with the acquisition of foreign companies;
•new technologies and products may be developed that cause businesses or assets we acquire to become less valuable; and
•disagreements or disputes with prior owners of an acquired business, technology, service or product that may result in litigation expenses and diversion of our management’s attention.
If an acquired business, technology or an alliance does not meet our expectations, our results of operations may be adversely affected.
Some of the same risks exist when we decide to sell a business, site or product line. In addition, divestitures could involve additional risks, including the following:
•difficulties in the separation of operations, services, products, and personnel;
•diversion of management’s attention from other business concerns; and
•the need to agree to retain or assume certain current or future liabilities in order to complete the divestiture.
We continually evaluate the performance and strategic fit of our businesses (including specific product lines and service offerings) to determine whether any divestitures are appropriate. Any divestitures may result in significant write-offs, including those related to goodwill and other intangible assets and which could have an adverse effect on our results of operations and financial condition. In addition, we may encounter difficulty in finding buyers or alternative exit strategies at acceptable prices
and terms, and in a timely manner. We may not be successful in managing these or any other significant risks that we encounter in divesting a business, site or product line or service offering and, as a result, we may not achieve some or all of the expected benefits of the divestiture.
Impairment of goodwill or other intangible assets may adversely impact future results of operations.
We have intangible assets, including goodwill, on our balance sheet due to our acquisitions of businesses. The initial identification and valuation of these intangible assets and the determination of the estimated useful lives at the time of acquisition involve use of management judgments and estimates. These estimates are based on, among other factors, projections of cash flows that arise from identifiable intangible assets of acquired businesses and discount rates based on an analysis of our weighted average cost of capital, adjusted for specific risks associated with the assets. Disruptions in global financial markets and deterioration of economic conditions (including as a result of the COVID-19 pandemic and the impact of measures intended to reduce the spread of COVID-19) could, among other things, impact the discount rate. Other assumptions used in the valuations and actual cash flows arising from a particular intangible asset could vary from projected cash flows, which could imply different carrying values from those established at the dates of acquisition and which could result in impairment of such assets.
If the future growth and operating results of our business are not as strong as anticipated, overall macroeconomic or industry conditions deteriorate and/or our market capitalization declines, this could impact the assumptions used in establishing the carrying value of goodwill or other intangible assets. Should the COVID-19 pandemic have a prolonged impact on our industry, triggering events may arise resulting in intangible asset or goodwill impairments. To the extent goodwill or other intangible assets are impaired, their carrying value will be written down to their implied fair values and a charge will be made to our income from continuing operations. Such an impairment charge could materially and adversely affect our operating results. As of March 28, 2020, the carrying amount of goodwill and other intangibles on our consolidated balance sheet was $2.6 billion.
Our business is subject to changes in foreign currency exchange rates and other risks relating to operating internationally.
A significant part of our revenue is derived from operations outside the U.S. We expect that international revenue will continue to account for a significant percentage of our total revenue for the foreseeable future.
Changes in foreign currency exchange rates, could materially adversely impact our results. Foreign currencies we receive for sales and in which we record expenses outside the U.S. could be subject to unfavorable exchange rates with the U.S. dollar, resulting in a reduction in the amount of revenue and cash flow (and an increase in the amount of expenses) that we recognize and causing fluctuations in reported financial results. We also carry foreign currency exposure associated with differences between where we conduct business. For example, certain contracts are frequently denominated in currencies other than the currency in which we incur expenses related to those contracts. Where expenses are incurred in currencies other than those in which contracts are priced, fluctuations in the relative value of those currencies could have a material adverse effect on our results of operations.
Our exposure to currency exchange rate fluctuations results from the currency translation exposure associated with the preparation of our consolidated financial statements, as well as from the exposure associated with transactions of our subsidiaries that are denominated in a currency other than the respective subsidiary’s functional currency. While our financial results are reported in U.S. Dollars, the financial statements of many of our subsidiaries outside the U.S. are prepared using the local currency as the functional currency. During consolidation, these results are translated into U.S. Dollars by applying appropriate exchange rates. As a result, fluctuations in the exchange rate of the U.S. Dollar relative to the local currencies in which our foreign subsidiaries report could cause significant fluctuations in our reported results. Moreover, as exchange rates vary, revenue and other operating results may differ materially from our expectations. Adjustments resulting from financial statement translations are included as a separate component of shareholders’ equity.
Other risks associated with our international business include:
•general economic and political conditions in the markets in which we operate, including implications of Brexit and the COVID-19 pandemic;
•potentially negative consequences from changes in U.S. and/or foreign tax laws, or interpretations thereof, notably tax regulations issued and to-be-issued with respect to U.S. Tax Reform and the EU Anti-Tax Avoidance Directives I and II;
•potential international conflicts, including terrorist acts;
•exchange controls, adverse tax consequences and legal restrictions on the repatriation of funds into the U.S.;
•difficulties and costs associated with staffing and managing foreign operations, including risks of COVID-19 pandemic related suspensions of operations, work stoppages and/or strikes, as well as violations of local laws or anti-
bribery laws such as the U.S. Foreign Corrupt Practices Act (FCPA), the U.K. Bribery Act and the OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions;
•unexpected changes in regulatory requirements (including as a result of the COVID-19 pandemic);
•the difficulties of compliance with a wide variety of foreign laws and regulations (including those relating to the COVID-19 pandemic);
•unfavorable labor regulations in foreign jurisdictions (including those relating to the COVID-19 pandemic);
•longer accounts receivable cycles in certain foreign countries (including as a result of the COVID-19 pandemic and the impact of measures intended to reduce the spread of COVID-19); and
•compliance with export controls, import requirements and other trade regulations, including those relating to certain products of which there is limited supply.
These risks, individually or in the aggregate, could have an adverse effect on our results of operations and financial condition. For example, as mentioned above, we are subject to compliance with the FCPA and similar anti-bribery laws, which generally prohibit companies and their third-party intermediaries from making improper payments to foreign government officials for the purpose of obtaining or retaining business. While our employees, distributors and agents are required to comply with these laws, we cannot be sure that our internal policies and procedures will always protect us from violations of these laws despite our commitment to legal compliance and corporate ethics. The occurrence or allegation of these types of risks may adversely affect our business, performance, prospects, value, financial condition and results of operations.
Our operations might be affected by the occurrence of a natural disaster or other catastrophic event, and have been (and will continue to be) affected by the COVID-19 pandemic.
We depend on our customers and facilities for the continued operation of our business. While we maintain disaster recovery plans, they might not adequately protect us. Despite any precautions we take for natural disasters or other catastrophic events, these events, including terrorist attack, a pandemic (including the COVID-19 pandemic), epidemic or outbreak of a disease, hurricanes, fire, floods and ice and snow storms, could result in damage to and closure of our or our customers’ facilities or the infrastructure on which such facilities rely. As described herein, the COVID-19 pandemic has already, and will continue to, materially disrupt our operations, though the full extent of such impact remains uncertain. Such disruptions could include significant delays in the shipments of our products, reduce our capacity to provide services, eradicate unique manufacturing capabilities, result in our customers’ inability to pay for our products or services and, ultimately, result in the loss of revenue and clients. Although we carry business interruption insurance policies and typically have provisions in our contracts that protect us in certain events, our coverage might not be adequate to compensate us for all losses that may occur. Any natural disaster or catastrophic event affecting us or our customers could have a significant negative impact on our operations and financial performance.
Failure to comply with U.S., state, local or international environmental, health and safety laws and regulations, including regulations issued by the Occupational Safety and Health Administration, Environmental Protection Agency, Nuclear Regulatory Agency and Department of Transportation, could result in fines and penalties and loss of licensure, and have a material adverse effect upon the Company’s business.
We are subject to licensing and regulation under laws and regulations relating to the protection of the environment and human health and safety, including laws and regulations relating to the handling, transportation and disposal of medical specimens, infectious and hazardous waste and radioactive materials, as well as regulations relating to the safety and health of laboratory employees and protecting employees from the spread of COVID-19. Failure to comply with these laws and regulations could subject us to denial of the right to conduct business, fines, criminal penalties and/or other enforcement actions that could have a material adverse effect on our business. In addition, compliance with future legislation could impose additional requirements on us that may be costly.
New technologies may be developed, validated and increasingly used in biomedical research, which could reduce demand for some of our products and services.
The scientific and research communities continue to explore methods to develop improved cellular and animal model systems that would increase the translation to human studies and vice-versa and possibly replace or supplement the use of traditional living animals as test platforms in biomedical research. Some companies have developed techniques in these areas that may have scientific merit to improve translation between species. In addition, technological improvements to existing or new processes, such as imaging and other translational biomarker technologies, could result in the refinement and utility for the number of animal research models necessary to improve the translation from non-clinical to clinical studies. There is an increasing push to focus on in vitro technologies such that employ human biospecimens, stem cell technologies and genome editing.
It is our strategy to explore these in vitro technologies to refine and potentially reduce the utilization of animal models as these new methods become validated. For example, our Discovery and Safety Assessment businesses have programs to evaluate the utility of induced pluripotent stems cells, advanced in vitro models, artificial intelligence and machine learning in discovery and preclinical development. Successful commercialization of alternatives to traditional research models may not be sufficient to fully offset reduced sales or profits from research models. In addition, alternative research methods could decrease the need for future research models, and we may not be able to develop new products effectively or in a timely manner to replace any lost sales. Lastly, other companies or entities may develop research models with characteristics different than the ones that we produce, and which may be viewed as more desirable by some of our clients.
Negative attention from special interest groups may impair our business.
The products and services that we provide our clients are essential to the drug discovery, development and manufacturing processes, and a significant amount are mandated by law. Notwithstanding, certain special interest groups categorically object to the use of animals for valid research purposes. Historically, our core research model activities with rats, mice and other rodents have not been the subject of significant animal rights media attention. However, research activities with animals have been the subject of adverse attention, including shareholder proposals and attempts to disrupt air carriers from transporting research models, impacting the industry. This has included periodic demonstrations near facilities operated by us and at our annual meetings, as well as shareholder proposals we received for some of our past Annual Meetings of Shareholders. Any negative attention, threats or acts of vandalism directed against either our animal research activities or our third-party service providers, such as our airline carriers, in the future could impair our ability to operate our business efficiently.
Our debt level could adversely affect our business and growth prospects.
As of March 28, 2020, we had $2.4 billion of debt. Our debt could have significant adverse effects on our business, including making it more difficult for us to obtain additional financing on favorable terms; requiring us to dedicate a substantial portion of our cash flows from operations to the repayment of debt and the interest on this debt; limiting our ability to capitalize on significant business opportunities; and making us more vulnerable to rising interest rates. For additional information regarding our debt, please see Note 9, “Long-Term Debt and Finance Lease Obligations”, included in the notes to our unaudited condensed consolidated financial statements included elsewhere in this Form 10-Q.
The interest rate on our credit facility (Credit Facility), which matures in fiscal year 2023, is linked to LIBOR. As of March 28, 2020, amounts outstanding on our Credit Facility were $184.4 million on our term loan and $1.2 billion on our revolving credit facility, for which there is an aggregate available borrowing capacity of $2.05 billion. In 2017, the Financial Conduct Authority (FCA) in the U.K. announced that it would phase out LIBOR as a benchmark by the end of 2021. It is unclear whether new methods of calculating LIBOR will be established such that it continues to exist after 2021, or whether different benchmark rates used to price indebtedness will develop. If LIBOR ceases to exist, the method and rate used to calculate our interest rates and/or payments on our debt in the future may result in interest rates and/or payments that are higher than, or that do not otherwise correlate over time with, the interest rates and/or payments that would have been applicable to our obligations if LIBOR was available in its current form, which could have a material adverse effect on our financial position, results of operations and liquidity. While we continue to take steps to mitigate the impact of the phase-out or replacement of LIBOR, such efforts may not prove successful. In addition, the overall financial market may be disrupted as a result of the phase-out or replacement of LIBOR. Disruption in the financial market could also have a material adverse effect on our financial position, results of operations and liquidity.
Costs increasing more rapidly than market prices could reduce profitability.
The cost of collecting, processing and testing blood products has risen significantly in recent years and will likely continue to increase. These cost increases are related to new and improved testing procedures, increased regulatory requirements related to blood safety, and higher staff and supply costs related to collecting and processing blood products. Competition and fixed price contracts may limit our ability to maintain existing operating margins. Some competitors have greater resources than us to sustain periods of marginally profitable or unprofitable sales. Costs increasing more rapidly than market prices may reduce profitability and may have a material adverse impact on our business and results of operations.
The industries in which we operate are highly competitive.
The industries in which we operate are highly competitive. We compete for business with other CROs and blood product and therapeutic services companies, as well as internal discovery and development departments within our larger clients, who may have greater resources than ours. We also compete with universities and teaching hospitals for outsourced services. We compete on a variety of factors, including:
•reputation for on-time quality performance;
•reputation for regulatory compliance;
•expertise and experience in multiple specialized areas;
•scope and breadth of service and product offerings across the drug discovery and development spectrum;
•scope and breadth of service and product offerings across the manufacturing support spectrum;
•ability to provide flexible and customized solutions to support our clients’ drug discovery, non-clinical development, and manufacturing support needs;
•broad geographic availability (with consistent quality);
•price/value, spend and flexibility;
•technological and scientific expertise and efficient drug development processes;
•quality of facilities;
•financial stability;
•size;
•ability to acquire, process, analyze and report data in an accurate manner; and
•accessibility of client data through secure portals.
If we do not compete successfully, our business will suffer. Increased competition might lead to price and other concessions that could adversely affect our operating results. The drug discovery and development services industry has continued to see a trend towards consolidation, particularly among the biotechnology companies, which are targets for each other and for large pharmaceutical companies. If this trend continues, it is likely to produce more competition among the larger companies and CROs generally, with respect to both clients and acquisition candidates. In addition, small, specialized entities considering entering the CRO industries will continue to find lower barriers to entry, and private equity firms may determine that there are opportunities to acquire and consolidate these companies, thus further increasing possible competition. More generally, our competitors or others might develop technologies, services or products that are more effective or commercially attractive than our current or future technologies, services or products, or that render our technologies, services or products less competitive or obsolete. If competitors introduce superior technologies, services or products and we cannot make enhancements to ours to remain competitive, our competitive position, and in turn our business, revenue and financial condition, would be materially and adversely affected. In the aggregate, these competitive pressures may affect the attractiveness of our technologies, services or products and could adversely affect our financial results.
Changes in U.S. and International Tax Law.
In 2017, significant U.S. tax law changes from the Tax Cuts and Jobs Act of 2017 (U.S. Tax Reform) went into effect and reduced the U.S. federal statutory tax rate, broadened the corporate tax base through the elimination or reduction of deductions, exclusions and credits, limited the ability of U.S. corporations to deduct interest expense and allowed for the repatriation of foreign earnings to the U.S. with a 100% federal dividends received deduction prospectively. In addition, U.S. Tax Reform required a one-time transitional tax on foreign cash equivalents and previously unremitted earnings. Several of the new provisions enacted as part of U.S. Tax Reform still require clarification and guidance from the Internal Revenue Service (IRS) and Treasury Department. These or other changes in U.S. tax laws could impact our profits, effective tax rate and cash flows.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which is aimed at providing emergency assistance and health care for individuals, families, and businesses affected by the COVID-19 pandemic and generally supporting the U.S. economy went into effect. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer side social security safeguardspayments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. We are unsuccessful,analyzing the different aspects of the CARES Act to determine the extent to which any specific provisions may impact us.
Additionally, the OECD, the European Commission (EC) and individual taxing jurisdictions have recently focused on issues related to the taxation of multinational corporations. The OECD released its comprehensive plan to create an agreed set of rules to address concerns regarding base erosion and profit shifting (BEPS). This initiative resulted in proposed and enacted changes to tax laws in various countries including France, Germany, Luxembourg, Netherlands and the U.K. In addition, the OECD and EC and individual countries are examining how taxing rights should be allocated among countries considering the digital economy. Future changes to tax laws or interpretation of tax laws resulting from enacted laws could increase our effective tax rate, which would affect our profitability.
We receive substantial tax credits in Canada, from both the Canadian federal and Quebec governments, France and the U.K. Any reduction in the availability or amount of these tax credits or increase to tax rates due to tax law changes or outcomes of tax controversies could have a material adverse effect on our profits, cash flows and effective tax rate.
Contract research services create a risk of liability.
As a CRO, we face a range of potential liabilities, which may include:
•risks associated with errors or omissions in reporting of study detail in non-clinical studies that may lead to inaccurate reports, which may undermine the usefulness of a study or data from the study, or which may potentially advance studies absent the necessary support or inhibit studies from proceeding to the next level of testing;
•risks associated with our possible failure to properly care for our clients’ property, such as research models and samples, study compounds, records, work in progress, other archived materials or goods and materials in transit, while in our possession;
•risks that models in our breeding facilities or in facilities that we manage may be infected with diseases that may be harmful and even lethal to them or humans, despite preventive measures for the quarantine and handling of imported animals;
•risks that we may have errors and omissions and/or product liabilities related to our products designed to conduct lot release testing of medical devices, injectable drugs, food, beverages and home and beauty products (primarily through our Microbial Solutions business), or in the testing of biologics and other services performed by our Biologics business, which could result in us or our clients failing to identify unsafe or contaminated materials; and
•risk of transmitting dangerous infectious diseases, as a result of the failure of our screening and testing processes, or new pathogens that may be undetected by such processes.
While we attempt to mitigate these risks through a variety of methods, it is impossible to completely eradicate such risks. In our RMS business, we mitigate these risks to the best of our abilities through our regimen of animal testing, quarantine procedures and veterinary staff vigilance, through which we seek to control the exposure of animal related disease or infections. In our DSA and Manufacturing businesses, we attempt to reduce these risks by contractual risk transfer provisions entitling us to be indemnified by our clients and subject to a limitation of liability, by insurance maintained by our clients and/or by us and by various regulatory requirements we must follow in connection with our business.
Contractual risk transfer indemnifications generally do not protect us against liability arising from certain of our own actions, such as negligence or misconduct. We could be materially and adversely affected if we are required to pay damages or bear the costs of defending any claim that is outside any contractual indemnification provision, or if a party does not fulfill its indemnification obligations or the damage is beyond the scope or level of insurance coverage. We also often contractually indemnify our clients (subject to a limitation of liability), similar to the way they indemnify us, and we may be materially adversely affected if we have to fulfill our indemnity obligations. Furthermore, either we or a party required to indemnify us may not be able to maintain such insurance coverage (either at all or on terms acceptable to us).
Upgrading and integrating our business systems could result in implementation issues and business disruptions.
In recent years, we have been updating and consolidating systems and automating processes in many parts of our business with a variety of systems, including in connection with the integration of acquired businesses. The expansion and ongoing implementation of the systems may occur at a future date based on value to the business. In general, the process of planning and preparing for these types of integrated, wide-scale implementations is extremely complex and we are required to address a number of challenges, including information security assessment and remediation, data conversion, network and system cutover and user training. Problems in any of these areas could cause operational problems during implementation including delayed shipments, missed sales, billing errors and accounting errors.
The failure to successfully obtain, maintain and enforce intellectual property rights and defend against challenges to our intellectual property rights could adversely affect us.
Many of our services, products and processes rely on intellectual property. In some cases, that intellectual property is owned by another party and licensed to us, sometimes exclusively. To protect our intellectual property rights, we primarily rely upon trade secret law, confidentiality agreements and policies, invention assignments and other contractual arrangements, along with patent, copyright and trademark laws. Existing laws of certain countries outside of the United States in which we operate offer only limited protection, and these are subject to change at any time. In addition, the agreements upon which we rely to protect our intellectual property might be breached, or might not be fully enforceable. Our intellectual property rights might not prevent our competitors from independently developing intellectual property that is similar to or duplicative of ours. Also, enforcing our intellectual property rights might also require substantial time, money and oversight, and we might not be successful in enforcing our rights. If we are unable to obtain or maintain the proprietary rights to our intellectual property, if we are unable to prevent attempted infringement against our intellectual property, or if we are unable to defend against claims that we are infringing on another party’s intellectual property, we could sufferbe adversely affected. These adverse effects could include us having to abandon, alter or delay the deployment of products, services or processes that rely on such intellectual property;
having to procure and pay for licenses from the holders of intellectual property rights that we seek to use; and having to pay damages, fines, court costs and attorney's fees in connection with intellectual property litigation.
Further, the drug discovery and development industry has a history of patent and other intellectual property litigation and these lawsuits will likely continue. Legal proceedings relating to intellectual property are expensive, take significant harm.time, and divert management’s attention from other business concerns, whether we win or lose. If we do not prevail in an infringement lawsuit brought against us, we may have to pay substantial damages, including treble damages, and we could be required to stop the infringing activity or obtain a license to use technology on unfavorable terms.
We may not be able to successfully develop and market new services and products. We may seek to develop and market new services and products that complement or expand our existing business or service offerings. We believe our ability to in-license new technologies from third parties will be critical to our ability to offer new products and services to our clients. Our ability to gain access to technologies that we need for new products and services depends, in part, on our ability to convince inventors and their agents or assignees that we can successfully commercialize their inventions. We cannot guarantee that we will be able to identify new technologies of interest to our clients. Even if we are able to identify new technologies of interest, we may not be able to negotiate license agreements on acceptable terms, or at all. If we are unable to develop new services and products and/or create demand for those newly developed services and products, our future business, results of operations, financial condition and cash flows could be adversely affected.
The decision by British voters to exit the European Union may adversely affect our business.
The first stage of the U.K.’s withdrawal from the European Union (“Brexit”) took place on January 31, 2020, when the U.K. left the European Union and entered a transition phase. During the transition phase, the U.K. needs to negotiate the terms of its future trading and other relationships with the European Union. The scope and timing of these negotiations have created significant uncertainty and continue to do so. The U.K. Prime Minister has said that a trade agreement needs to be reached by December 31, 2020. There is currently no mechanism to automatically extend the transition period, but there is a possibility that the transition period may be extended by agreement between the U.K. and the European Union.
Given the continuing uncertainty concerning the terms of the U.K.’s future relationship with the European Union, including the possibility that there may still be no negotiated agreement despite the results of the December 2019 general election, we have formed a committee (comprised of senior managers across our business functions) to address key risks among four main themes: (1) trade and customs, (2) employees and immigration, (3) strategy and business planning and (4) legislative changes. That committee will continue until the situation is clarified.
In the absence of a trade deal in the short to medium term, the U.K.’s trade with the European Union and the rest of the world would be subject to tariffs and duties set by the World Trade Organization. Additionally, the movement of goods between the U.K. and the remaining member states of the European Union will be subject to additional inspections and documentation checks, leading to possible delays at ports of entry and departure. These changes to the trading relationship between the U.K and European Union would likely result in increased cost of goods imported into and exported from the U.K. and may decrease the profitability of our U.K. and other operations. Additional currency volatility could drive a weaker British pound, which increases the cost of goods imported into our U.K. operations and may decrease the profitability of our U.K. operations. A weaker British pound versus the U.S. dollar also causes local currency results of our U.K. operations to be translated into fewer U.S. dollars during a reporting period. Although we are undertaking efforts to mitigate those risks within our control, a failure to adequately mitigate such risks or other factors outside our control could adversely affect our business, business opportunities, results of operations, financial condition and cash flows.
We depend on key personnel and may not be able to retain these employees or recruit additional qualified personnel, which would harm our business.
Our success depends to a significant extent on the continued services of our senior management and other members of management. James C. Foster, our Chief Executive Officer and President since 1992 and Chairman since 2000, has held various positions with us for four decades. While we entered into an employment agreement with Mr. Foster in 2018, most members of our senior management do not have employment agreements. If Mr. Foster or other members of senior management do not continue in their present positions, our business may be adversely impacted.
Because of the specialized scientific nature of our business, we are highly dependent upon attracting and retaining qualified scientific, technical and managerial personnel. While we have a strong record of employee retention, and we strive to reduce the impact of the potential loss of existing employees by having an established organizational talent review process that identifies successors and potential talent needs, there is still significant competition for qualified personnel in the veterinary, pharmaceutical and biotechnology fields. Therefore, we may not be able to attract and retain the qualified personnel necessary for the development of our business. The loss of the services of existing personnel, as well as the failure to recruit additional key scientific, technical and managerial personnel in a timely manner, could harm our business.
Our quarterly operating results may vary, which could negatively affect the market price of our common stock.
Our results of operations in any quarter may vary from quarter to quarter and are influenced by the risks discussed above, as well as:
•changes in the general global economy;
•changes in the mix of our products and services;
•cyclical buying patterns of our clients;
•the financial performance of our venture capital investments; and
•the occasional extra week (“53rd week”) that we recognize in a fiscal year (and fourth fiscal quarter thereof) due to our fiscal year ending on the last Saturday in December.
We believe that operating results for any particular quarter are not necessarily a meaningful indication of future results. Nonetheless, fluctuations in our quarterly operating results could negatively affect the market price of our common stock.
Since we do not expect to pay any cash dividends for the foreseeable future, our shareholders will benefit from an investment in our common stock only if it appreciates in value.
We have not declared or paid any cash dividends on our common stock, and do not anticipate that we will pay any dividends to holders of our common stock for the foreseeable future. Any payment of cash dividends will be at the discretion of our Board of Directors and will depend on our financial condition, capital requirements, legal requirements, earnings and other factors. Consequently, our shareholders should not rely on dividends to receive a return on their investment.
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 June 29, 2019.March 28, 2020.
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| | | | | | | | | | | | | |
| Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs |
| | | | | | | (in thousands) |
March 31, 2019 to April 27, 2019 | 59 |
| | $ | 145.50 |
| |
|
| | $ | 129,105 |
|
April 28, 2019 to May 25, 2019 | 700 |
| | 136.89 |
| |
|
| | 129,105 |
|
May 26, 2019 to June 29, 2019 | 147 |
| | 125.45 |
| |
|
| | 129,105 |
|
Total | 906 |
| | |
| | — |
| | |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Approximate Dollar Value of Shares That May Yet Be Purchased Under the Plans or Programs |
| | | | | | | (in thousands) |
December 29, 2019 to January 25, 2020 | — | | | $ | — | | | — | | | $ | 129,105 | |
January 26, 2020 to February 22, 2020 | 102,072 | | | 161.37 | | | — | | | 129,105 | |
February 23, 2020 to March 28, 2020 | 42,315 | | | 170.23 | | | — | | | 129,105 | |
Total | 144,387 | | | | | — | | | |
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 June 29, 2019,March 28, 2020, we did not repurchase any shares of common stock under our stock repurchase program or in open market trading. As of June 29, 2019,March 28, 2020, we had $129.1 million remaining on the authorized stock repurchase program.
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.
Item 6. Exhibits
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| | | | | | | | | | |
(a) Exhibits | | Description of Exhibits | |
4.1*+10.1+* | | | |
10.1*+31.1+ | | |
10.2*+ | | |
31.1+ | | | |
31.2+ | | | |
32.1+ | | | |
101.INS | | 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 | |
101.SCH | | XBRL Taxonomy Extension Schema Document | |
101.CAL | | XBRL Taxonomy Calculation Linkbase Document | |
101.DEF | | XBRL Taxonomy Definition Linkbase Document | |
101.LAB | | XBRL Taxonomy Label Linkbase Document | |
101.PRE | | XBRL Taxonomy Presentation Linkbase Document | |
| | | |
+ Furnished herein. | | | |
* Management contract or compensatory plan, contract or arrangement. |
+ Furnished herein. | | |
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.
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| | CHARLES RIVER LABORATORIES INTERNATIONAL, INC. | |
| | | |
| May 7, 2020 | CHARLES RIVER LABORATORIES INTERNATIONAL, INC. |
| | |
| July 31, 2019 | /s/ JAMES C. FOSTER | |
| | James C. Foster Chairman, President and Chief Executive Officer |
| | |
| July 31, 2019 | | |
| May 7, 2020 | /s/ DAVID R. SMITH | |
| | David R. Smith
Corporate Executive Vice President and Chief Financial Officer | |