CRL 9.27.2014 10Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________
FORM 10-Q
(Mark One)
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 27, 2014
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                                    TO                                   
Commission File No. 001-15943
CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
06-1397316
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
251 Ballardvale Street
Wilmington, Massachusetts
(Address of Principal Executive Offices)
 
01887
(Zip Code)
____________________________________________________________________________
(Registrant's telephone number, including area code): (781) 222-6000
_________________________________________________________
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files. Yes ý No o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ý
 
Accelerated filer o
 
Non-accelerated filer o
(Do not check if smaller
reporting company)
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o    No ý
As of October 16, 2014, there were 46,921,688 shares of the Registrant's common stock outstanding.



CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
FORM 10-Q
For the Quarterly Period Ended September 27, 2014
TABLE OF CONTENTS

 
 
 
Page
Part I.
Financial Information
 
 
Item 1.
Financial Statements
 
 
 
Condensed Consolidated Statements of Income (Unaudited) for the three and nine months ended September 27, 2014 and September 28, 2013
 
 
Condensed Consolidated Statements of Comprehensive Income (Unaudited) for the three and nine months ended September 27, 2014 and September 28, 2013
 
 
Condensed Consolidated Balance Sheets (Unaudited) as of September 27, 2014 and December 28, 2013
 
 
Condensed Consolidated Statements of Cash Flows (Unaudited) for the nine months ended September 27, 2014 and September 28, 2013
 
 
Condensed Consolidated Statement of Changes in Equity and Noncontrolling Interests (Unaudited) for the nine months ended September 27, 2014
 
 
Notes to Unaudited Condensed Consolidated Financial Statements
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3.
Quantitative and Qualitative Disclosure About Market Risk
 
Item 4.
Controls and Procedures
Part II.
Other Information
 
 
Item 1A.
Risk Factors
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
 
Item 6.
Exhibits

1



Special Note on Factors Affecting Future Results
This Quarterly Report on Form 10-Q contains forward-looking statements regarding future events and the future results of Charles River Laboratories International, Inc. that are based on our current expectations, estimates, forecasts, and projections about the industries in which we operate and the beliefs and assumptions of our management. Words such as “expect,” “anticipate,” “target,” “goal,” “project,” “intend,” “plan,” “believe,” “seek,” “estimate,” “will,” “likely,” “may,” “designed,” “would,” “future,” “can,” “could” and other similar expressions that are predictions of or indicate future events and trends or which do not relate to historical matters are intended to identify such forward-looking statements. These statements are based on our current expectations and beliefs and involve a number of risks, uncertainties, and assumptions that are difficult to predict. For example, we may use forward-looking statements when addressing topics such as: goodwill and asset impairments still under review; future demand for drug discovery and development products and services, including the outsourcing of these services; our expectations regarding stock repurchases, including the number of shares to be repurchased, expected timing and duration, the amount of capital that may be expended and the treatment of repurchased shares; present spending trends and other cost reduction activities by our clients; future actions by our management; the outcome of contingencies; changes in our business strategy, business practices and methods of generating revenue; the development and performance of our services and products; market and industry conditions, including competitive and pricing trends; our strategic relationships with venture capital limited partnerships and leading pharmaceutical companies and opportunities for future similar arrangements; our cost structure; the impact of acquisitions (including Argenta and BioFocus, and VivoPath see Note 2, "Business Acquisitions" and ChanTest, see Note 16, "Subsequent Events"); our expectations with respect to revenue growth and operating synergies (including the impact of specific actions intended to cause related improvements); the impact of specific actions intended to improve overall operating efficiencies and profitability (and our ability to accommodate future demand with our infrastructure) including gains and losses attributable to businesses we plan to close, consolidate or divest; changes in our expectations regarding future stock option, restricted stock, performance share units and other equity grants to employees and directors; expectations with respect to foreign currency exchange; assessing (or changing our assessment of) our tax positions for financial statement purposes; and our liquidity. In addition, these statements include the impact of economic and market conditions on our clients; the effects of our cost-saving actions and the steps to optimize returns to shareholders on an effective and timely basis and our ability to withstand the current market conditions. You should not rely on forward-looking statements because they are predictions and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this document or in the case of statements incorporated by reference, on the date of the document incorporated by reference. Factors that might cause or contribute to such differences include, but are not limited to, those discussed in our Annual Report on Form 10-K for the year ended December 28, 2013 under the sections entitled “Our Strategy,” “Risks Related to Our Business and Industry,” "Management's Discussion and Analysis of Financial Condition and Results of Operations” and in our press releases and other financial filings with the Securities and Exchange Commission. We have no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or risks. New information, future events or risks may cause the forward-looking events we discuss in this report not to occur.




2


Part I. Financial Information
Item 1. Financial Statements

CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(in thousands, except per share amounts)
 
Three Months Ended
 
Nine Months Ended
 
September 27,
2014
 
September 28,
2013
 
September 27,
2014
 
September 28,
2013
Product revenue
$
122,816

 
$
116,732

 
$
380,015

 
$
364,877

Service revenue
204,751

 
175,397

 
588,099

 
511,423

Total revenue
327,567

 
292,129

 
968,114

 
876,300

Costs and expenses:
 
 
 
 
 
 
 
Cost of products sold
65,246

 
70,294

 
199,423

 
202,954

Cost of services provided
144,053

 
121,909

 
415,976

 
366,639

Selling, general and administrative
64,476

 
54,903

 
196,999

 
167,021

Amortization of intangible assets
7,620

 
4,180

 
18,813

 
12,892

Operating income
46,172

 
40,843

 
136,903

 
126,794

Other income (expense):
 
 
 
 
 
 
 
Interest income
376

 
143

 
803

 
476

Interest expense
(2,997
)
 
(2,319
)
 
(9,171
)
 
(18,143
)
Other income, net
331

 
4,059

 
8,874

 
6,094

Income from continuing operations, before income taxes
43,882

 
42,726

 
137,409

 
115,221

Provision for income taxes
11,582

 
11,390

 
36,021

 
29,331

Income from continuing operations, net of income taxes
32,300

 
31,336

 
101,388

 
85,890

Income (loss) from discontinued operations, net of income taxes
52

 
(113
)
 
(862
)
 
(1,183
)
Net income
32,352

 
31,223

 
100,526

 
84,707

Less: Net income attributable to noncontrolling interests
(316
)
 
(356
)
 
(994
)
 
(978
)
Net income attributable to common shareholders
$
32,036

 
$
30,867

 
$
99,532

 
$
83,729

Earnings per common share
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Continuing operations attributable to common shareholders
$
0.70

 
$
0.65

 
$
2.15

 
$
1.77

Discontinued operations
$

 
$

 
$
(0.02
)
 
$
(0.02
)
Net income attributable to common shareholders
$
0.70

 
$
0.64

 
$
2.13

 
$
1.75

Diluted:
 
 
 
 
 
 
 
Continuing operations attributable to common shareholders
$
0.68

 
$
0.64

 
$
2.11

 
$
1.75

Discontinued operations
$

 
$

 
$
(0.02
)
 
$
(0.02
)
Net income attributable to common shareholders
$
0.68

 
$
0.64

 
$
2.09

 
$
1.72





See Notes to Unaudited Condensed Consolidated Financial Statements.

3


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(in thousands)



 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
Net income
$
32,352

 
$
31,223

 
$
100,526

 
$
84,707

Foreign currency translation adjustment
(31,635
)
 
16,371

 
(23,751
)
 
(9,653
)
Defined benefit plan gains and prior service costs not yet recognized as components of net periodic pension cost:
 
 
 
 
 
 
 
Amortization of prior service costs and net gains and losses (Note 11)
291

 
752

 
871

 
2,249

Comprehensive income, before tax
1,008

 
48,346

 
77,646

 
77,303

Income tax expense (benefit) related to items of other comprehensive income (Note 10)
$
125

 
$
(326
)
 
$
273

 
$
874

Comprehensive income, net of tax
883

 
48,672

 
77,373

 
76,429

Less: comprehensive income related to noncontrolling interests
(712
)
 
(454
)
 
(852
)
 
(1,260
)
Comprehensive income attributable to common shareholders
$
171

 
$
48,218

 
$
76,521

 
$
75,169


























See Notes to Unaudited Condensed Consolidated Financial Statements.

4


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except share and per share amounts)
 
September 27,
2014
 
December 28,
2013
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
130,747

 
$
155,927

Trade receivables, net
275,024

 
220,630

Inventories
92,695

 
89,396

Other current assets
106,718

 
85,847

Current assets of discontinued businesses
835

 
750

Total current assets
606,019

 
552,550

Property, plant and equipment, net
671,244

 
676,182

Goodwill, net
289,356

 
230,701

Other intangibles, net
167,545

 
84,537

Deferred tax asset
21,215

 
23,671

Other assets
83,873

 
61,964

Long-term assets of discontinued businesses
3,106

 
3,151

Total assets
$
1,842,358

 
$
1,632,756

Liabilities and Equity
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt and capital leases
$
31,917

 
$
21,437

Accounts payable
27,547

 
31,770

Accrued compensation
69,616

 
58,461

Deferred revenue
66,920

 
54,177

Accrued liabilities
69,516

 
56,712

Other current liabilities
15,508

 
22,546

Current liabilities of discontinued businesses
2,059

 
1,931

Total current liabilities
283,083

 
247,034

Long-term debt and capital leases
754,799

 
642,352

Other long-term liabilities
98,219

 
70,632

Long-term liabilities of discontinued businesses
7,876

 
8,080

Total liabilities
1,143,977

 
968,098

Commitments and contingencies (Notes 8, 10, and 13)
 
 
 
Redeemable noncontrolling interest
24,550

 
20,581

Shareholders' equity:
 
 
 
Preferred stock, $0.01 par value; 20,000,000 shares authorized; no shares issued and outstanding

 

Common stock, $0.01 par value; 120,000,000 shares authorized; 83,942,118 issued and 46,766,227 shares outstanding at September 27, 2014 and 82,522,905 issued and 47,553,841 shares outstanding at December 28, 2013
839

 
825

Additional paid-in capital
2,276,279

 
2,206,155

Accumulated deficit
(165,941
)
 
(265,473
)
Treasury stock, at cost, 37,175,891 shares and 34,969,064 shares at September 27, 2014 and December 28, 2013, respectively
(1,423,227
)
 
(1,305,880
)
Accumulated other comprehensive income
(17,654
)
 
5,357

Total shareholders' equity
670,296

 
640,984

Noncontrolling interests
3,535

 
3,093

Total shareholder's equity, including noncontrolling interests
698,381

 
664,658

Total liabilities and equity
$
1,842,358

 
$
1,632,756

See Notes to Unaudited Condensed Consolidated Financial Statements.

5


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
 
Nine Months Ended
 
September 27,
2014
 
September 28,
2013
Cash flows relating to operating activities
 
 
 
Net income
$
100,526

 
$
84,707

Less: Loss from discontinued operations
(862
)
 
(1,183
)
Income from continuing operations
101,388

 
85,890

Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
 
 
 
Depreciation and amortization
70,435

 
67,336

Amortization of debt issuance costs and discounts
1,298

 
9,124

Stock-based compensation
23,132

 
18,231

Deferred income taxes
1,140

 
8,675

Gain on investments in limited partnerships
(7,377
)
 
(4,832
)
Other, net
(1,546
)
 
2,336

Changes in assets and liabilities:
 
 
 
Trade receivables
(40,961
)
 
(22,663
)
Inventories
(4,573
)
 
1,445

Other assets
(15,055
)
 
(7,917
)
Accounts payable
(1,779
)
 
(7,688
)
Accrued compensation
10,795

 
10,500

Deferred revenue
8,826

 
(2,289
)
Accrued liabilities
13,355

 
3,285

Taxes payable and prepaid taxes
(3,953
)
 
(9,557
)
Other liabilities
(2,842
)
 
(5,326
)
Net cash provided by operating activities
152,283

 
146,550

Cash flows relating to investing activities
 
 
 
Acquisition of businesses and assets, net of cash acquired
(183,151
)
 
(24,218
)
Capital expenditures
(29,907
)
 
(25,319
)
Purchases of investments
(18,171
)
 
(15,341
)
Proceeds from sale of investments and distributions from investments in limited partnerships
15,964

 
10,437

Other, net
(1,924
)
 
108

Net cash used in investing activities
(217,189
)
 
(54,333
)
Cash flows relating to financing activities
 
 
 
Proceeds from long-term debt and revolving credit agreement
247,920

 
467,804

Proceeds from exercises of stock options
46,741

 
58,986

Payments on long-term debt, capital lease obligations and revolving credit agreement
(132,431
)
 
(502,241
)
Purchase of treasury stock
(121,985
)
 
(91,703
)
Other, net
4,051

 
(1,176
)
Net cash provided by (used in) financing activities
44,296

 
(68,330
)
Discontinued operations
 
 
 
Net cash used in operating activities
(570
)
 
(1,533
)
Net cash used in discontinued operations
(570
)
 
(1,533
)
Effect of exchange rate changes on cash and cash equivalents
(4,000
)
 
(1,585
)
Net change in cash and cash equivalents
(25,180
)
 
20,769

Cash and cash equivalents, beginning of period
155,927

 
109,685

Cash and cash equivalents, end of period
$
130,747

 
$
130,454




See Notes to Unaudited Condensed Consolidated Financial Statements.

6


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY AND NONCONTROLLING INTERESTS (UNAUDITED)
(in thousands)


 
Total
 
Accumulated
Deficit
 
Accumulated
Other
Comprehensive
Income
 
Common
Stock
 
Additional Paid-in Capital
 
Treasury
Stock
 
Non-controlling
Interests
December 28, 2013
$
664,658

 
$
(265,473
)
 
$
5,357

 
$
825

 
$
2,206,155

 
$
(1,305,880
)
 
$
23,674

Components of comprehensive income, net of tax:
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
100,526

 
99,532

 

 

 

 

 
994

Other comprehensive loss
(23,153
)
 

 
(23,011
)
 

 

 

 
(142
)
Total comprehensive income
77,373

 

 

 

 

 

 
852

Adjustment of redeemable noncontrolling interest to fair value

 

 

 

 
(3,559
)
 

 
3,559

Tax benefit associated with stock issued under employee compensation plans
3,751

 

 

 

 
3,751

 

 

Issuance of stock under employee compensation plans
46,814

 

 

 
14

 
46,800

 

 

Acquisition of treasury shares
(117,347
)
 

 

 

 

 
(117,347
)
 

Stock-based compensation
23,132

 

 

 

 
23,132

 

 

September 27, 2014
$
698,381

 
$
(165,941
)
 
$
(17,654
)
 
$
839

 
$
2,276,279

 
$
(1,423,227
)
 
$
28,085




















See Notes to Unaudited Condensed Consolidated Financial Statements.

7


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.
BASIS OF PRESENTATION
The condensed consolidated interim financial statements of Charles River Laboratories International, Inc. (the Company) are unaudited, and certain information and footnote disclosures related thereto normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP) have been omitted in accordance with Rule 10-01 of Regulation S-X. In the opinion of management, the accompanying unaudited condensed consolidated financial statements were prepared following the same policies and procedures used in the preparation of the audited financial statements and reflect all adjustments (consisting of normal recurring adjustments) considered necessary to state fairly the Company's financial position and results of operations. The results of operations for the interim periods are not necessarily indicative of the results for the entire fiscal year. These condensed consolidated financial statements should be read in conjunction with the Company's Annual Report on Form 10-K for the year ended December 28, 2013. Certain reclassifications have been made to prior periods' financial statements to conform with the current period presentation.
During the quarter ended June 28, 2014, the Company revised its reportable segments to ensure alignment with the Company's view of the business following its acquisition of the contract research organization (CRO) services division of Galapagos N.V. (Early Discovery). The Company reviewed the new and existing markets addressed by the business, the recently revised go-to-market strategy, long-term operating margins, the discrete financial information available to its Chief Operating Decision Maker (CODM) and considered how its businesses aggregate based on these qualitative and quantitative factors. Based on this review, the Company identified three reportable segments: Research Models and Services (RMS), Discovery and Safety Assessment (DSA) and Manufacturing Support (Manufacturing). The Company reported segment results on this basis beginning in the quarter ended June 28, 2014 and retrospectively for all comparable prior periods.
The revised reportable segments are as follows:
Research Models and Services
Discovery and Safety Assessment
Manufacturing Support
Research Models
Discovery Services (1)
Endotoxin and Microbial Detection
Research Model Services (2)
Safety Assessment
Avian Vaccine Services
 
 
Biologics Testing Solutions
(1) Discovery Services includes the Early Discovery businesses, which were acquired on April 1, 2014.
(2) Research Model Services include Genetically Engineered Models and Services (GEMS), Research Animal Diagnostic Services (RADS), and Insourcing Solutions (IS).

Prior to recasting the reportable segments, the businesses were reported in two segments as follows:
Research Models and Services
Preclinical Services
Research Models (3)
Discovery Services
Research Model Services (4)
Safety Assessment
Endotoxin and Microbial Detection
Biologics Testing Solutions
(3) Research Models included Avian Vaccine Services.
(4) Research Model Services included GEMS, RADS, IS and Discovery Research Services.


8


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Use of Estimates
The preparation of condensed consolidated financial statements in accordance with U.S. GAAP requires that the Company makes estimates and judgments that may affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, impairment of long-lived assets, purchase accounting for acquired businesses, equity investments, income taxes including the valuation allowance for deferred tax assets, defined benefit pension plans, contingencies and share-based compensation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.
Summary of Significant Accounting Policies
The Company’s significant accounting policies are described in Note 1, “Description of Business and Summary of Significant Accounting Policies,” in the 2013 Annual Report on Form 10-K.
Consolidation
The Company's condensed consolidated financial statements reflect its financial statements, those of its wholly-owned subsidiaries and those of certain variable interest entities where the Company is the primary beneficiary. For consolidated entities in which the Company owns or is exposed to less than 100% of the economics, the Company records net income (loss) attributable to noncontrolling interests in its condensed consolidated statements of income equal to the percentage of the economic or ownership interest retained in such entities by the respective noncontrolling parties. Intercompany balances and transactions are eliminated in consolidation.
In determining whether the Company is the primary beneficiary of an entity and therefore required to consolidate, the Company applies a qualitative approach that determines whether it has both (1) the power to direct the economically significant activities of the entity and (2) the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to that entity. The Company continuously assesses whether it is the primary beneficiary of a variable interest entity as changes to existing relationships or future transactions may result in the Company consolidating or deconsolidating certain of its variable interest entities.
Recent Accounting Pronouncements
In April 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-08, "Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity." ASU 2014-08 changes the criteria for determining which disposals can be presented as discontinued operations and modifies related disclosure requirements. The ASU is effective for annual and interim periods beginning after December 15, 2014. The Company does not expect the impact of the adoption of this standard to be material to its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers."  The standard requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The standard will replace most existing revenue recognition guidance in U.S. GAAP when it becomes effective and permits the use of either the retrospective or cumulative effect transition method. Early adoption is not permitted. The ASU is effective for annual and interim periods beginning after December 15, 2016. The Company has not yet selected a transition method and is evaluating the impact the adoption will have on its consolidated financial statements and related disclosures.

2. BUSINESS ACQUISITIONS

Early Discovery
On April 1, 2014, the Company acquired Early Discovery consisting of (1) 100% of the shares of the United Kingdom (U.K.) based entities Argenta and BioFocus, and (2) certain Dutch assets. These businesses have formed the core of the Company's Early Discovery business. With this acquisition, the Company has enhanced its position as a full service, early-stage CRO, with integrated in vitro and in vivo capabilities from target discovery through preclinical development. The preliminary purchase price of the acquisition is $191.3 million, including $0.9 million in contingent consideration. The acquisition was funded by cash on hand and borrowings on the Company's revolving credit facility. The purchase price includes payment for estimated

9


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

working capital, which is subject to final adjustment based on the actual working capital of the acquired business. The businesses are reported in the Company's DSA segment.

The contingent consideration is a one-time payment that could become payable based on the achievement of a revenue target for the twelve-month period following the acquisition. If achieved, the payment would become due in the second quarter of 2015. The aggregate, undiscounted amount of contingent consideration that the Company would pay is €5.0 million ($6.3 million as of September 27, 2014). The Company estimated the fair value of this contingent consideration based on a probability-weighted set of outcomes.

The preliminary purchase price allocation of $183.1 million, net of $8.2 million of cash acquired, is as follows:
 
April 1, 2014
 
(in thousands)
Current assets (excluding cash)
$
31,257

Property, plant and equipment
21,008

Other long term assets
11,549

Definite-lived intangible assets
104,270

Goodwill
66,330

Current liabilities
(14,299
)
Long term liabilities
(36,973
)
Total purchase price allocation
$
183,142


The purchase price allocations were prepared on a preliminary basis and are subject to change as additional information becomes available concerning the fair value and tax basis of the assets acquired and liabilities assumed. During the third quarter of 2014, we recorded measurement period adjustments related to the Early Discovery acquisition that resulted in an immaterial change to the purchase price allocation. Any additional adjustments to the purchase price allocation will be made as soon as practicable but no later than one year from the date of acquisition.

The breakout of definite-lived intangible assets acquired is as follows:

 

April 1, 2014
 
Weighted average amortization life
 
(in thousands)
 
 
Client relationships
$
94,000

 
18 years
Backlog
5,700

 
1 year
Trademark and trade names
1,170

 
3 years
Leasehold interests
1,000

 
13 years
Other intangible assets
2,400

 
19 years
Total definite-lived intangible assets
$
104,270

 
 

The goodwill resulting from the transaction is primarily attributed to the potential growth in the Company's DSA businesses from customers introduced through the Early Discovery business, the assembled workforce of the acquired businesses and expected cost synergies. The goodwill attributable to Argenta and BioFocus is not deductible for tax purposes. The Company incurred transaction and integration costs in connection with the acquisition of $0.5 million and $5.4 million during the three and nine months ended September 27, 2014, respectively, which are included in selling, general and administrative expenses.

The following selected unaudited pro forma consolidated results of operations are presented as if the Early Discovery acquisition had occurred as of the beginning of the period immediately preceding the period of acquisition after giving effect to certain adjustments, including amortization of intangible assets and depreciation of fixed assets of $3.7 million and other one-time costs. These pro forma are for informational purposes only and do not necessarily reflect the results of operations had the

10


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

companies operated as one entity during the periods reported. No effect has been given for synergies, if any, that may have been realized through the acquisition.

 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Revenue
$
327,567

 
$
313,460

 
$
993,223

 
$
935,693

Net income
32,036

 
29,098

 
101,029

 
76,705

Earnings per common share
 
 
 
 
 
 
 
Basic
$
0.70

 
$
0.61

 
$
2.16

 
$
1.60

Diluted
$
0.68

 
$
0.60

 
$
2.12

 
$
1.58

  
These pro forma results of operations have been prepared for comparative purposes only, and they do not purport to be indicative of the results of operations that actually would have resulted had the acquisition occurred on the date indicated or that may result in the future. Early Discovery revenue and operating loss for the three months ended September 27, 2014 are $23.3 million and $0.4 million, respectively. Early Discovery revenue and operating loss for the nine months ended September 27, 2014 are $46.8 million and $0.4 million, respectively.

VivoPath
In June 2014, the Company acquired substantially all of the assets of VivoPath, LLC, a discovery service company specializing in the rapid, in vivo compound evaluation of molecules in the therapeutic areas of metabolism, inflammation and oncology. The preliminary purchase price was $2.3 million, including $1.6 million in contingent consideration, and was allocated primarily to the intangible assets acquired. The aggregate, undiscounted amount of contingent consideration that could become payable is a maximum of $2.4 million payable over the next three years based on the achievement of revenue growth targets. The Company estimated the fair value of this contingent consideration based on a probability-weighted set of outcomes. The business is reported in the Company's DSA segment.
3. RESTRUCTURING AND ASSET IMPAIRMENTS
Facilities
RMS Japan
In the second quarter of 2014, the Company committed to a plan to consolidate certain research model operations in Japan. As a result, the Company adjusted the carrying value of certain facilities impacted by the consolidation plan. During the three and nine months ended September 27, 2014, the Company recorded $1.3 million and $1.7 million of accelerated depreciation, respectively. Additional accelerated depreciation for 2014 will amount to approximately $1.2 million.

RMS North America
In the first quarter of 2014, the Company committed to a plan to close its research model production facility located in Michigan by the end of 2014 and to reassign the sourcing of research models to other facilities in the United States (U.S.). As a result of these actions, the Company reviewed the long-lived assets of this asset group, consisting of land improvements, building and equipment, for potential impairment based on the undiscounted cash flows of the group and considered the potential redeployment and future utilization of the facility's machinery and equipment. During the three and nine months ended September 27, 2014, the Company recorded $0.3 million and $1.3 million of asset impairments and other charges, respectively, as well as $0.3 million and $0.9 million of accelerated depreciation, respectively. Additional accelerated depreciation for 2014 will amount to approximately $0.2 million.

RMS Europe
In 2012, the Company commenced a consolidation of certain research model operations in Europe. As a result, the Company adjusted the carrying value of certain facilities impacted by the consolidation plan to fair value through an asset impairment charge in 2012. During the second quarter of 2014, the Company recorded an additional impairment charge of $0.3 million related to certain facilities and also recorded a gain of $1.1 million on the sale of another facility.

11


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Staffing Reductions
The Company has periodically implemented staffing reductions to improve operating efficiency and profitability at various sites. As a result of these actions, for the nine months ended September 27, 2014 and September 28, 2013, the Company recorded severance and retention charges as shown below. As of September 27, 2014, $2.4 million was included in accrued compensation and $0.9 million in other long-term liabilities on the Company's consolidated balance sheet.
The following table rolls forward the Company's severance and retention cost liability:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Balance, beginning of period
$
3,823

 
$
2,917

 
$
2,782

 
$
3,636

Expense
574

 
476

 
5,363

 
1,058

Payments/Utilization
(1,117
)
 
(783
)
 
(4,865
)
 
(2,084
)
Balance, end of period
$
3,280

 
$
2,610

 
$
3,280

 
$
2,610


The following table presents severance and retention costs by classification on the income statement:

 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Severance charges included in cost of revenue
$
367

 
$
476

 
$
3,121

 
$
989

Severance charges included in selling, general and administrative expense
207

 

 
2,242

 
69

Total expense
$
574

 
$
476

 
$
5,363

 
$
1,058

The following table presents severance and retention cost by segment:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Research models and services
$
379

 
$
32

 
$
3,974

 
$
301

Discovery and safety assessment
69

 
398

 
1,118

 
711

Manufacturing support
126

 
46

 
150

 
46

Corporate

 

 
121

 

Total expense
$
574

 
$
476

 
$
5,363

 
$
1,058

        


12


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. SUPPLEMENTAL BALANCE SHEET INFORMATION
The composition of trade receivables, net is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Client receivables
$
229,366

 
$
190,423

Unbilled revenue
50,670

 
35,184

Total
280,036

 
225,607

Less allowance for doubtful accounts
(5,012
)
 
(4,977
)
Trade receivables, net
$
275,024

 
$
220,630


The composition of inventories is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Raw materials and supplies
$
15,583

 
$
15,028

Work in process
12,053

 
11,715

Finished products
65,059

 
62,653

Inventories
$
92,695

 
$
89,396


The composition of other current assets is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Prepaid assets
$
31,466

 
$
20,058

Deferred tax asset
31,636

 
29,139

Time deposits
14,577

 
11,158

Prepaid income tax
25,747

 
25,247

Restricted cash
3,292

 
245

Other current assets
$
106,718

 
$
85,847



13


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The composition of property, plant and equipment, net is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Land
$
39,452

 
$
40,157

Buildings
701,160

 
694,074

Machinery and equipment
385,222

 
367,244

Leasehold improvements
40,150

 
37,959

Furniture and fixtures
23,796

 
24,013

Vehicles
3,836

 
3,859

Computer hardware and software
117,889

 
112,328

Construction in progress (1)
31,862

 
42,075

Total
1,343,367

 
1,321,709

Less accumulated depreciation
(672,123
)
 
(645,527
)
Property, plant and equipment, net
$
671,244

 
$
676,182

(1) Includes the leased facility under construction. See Note 8, "Long-Term Debt and Capital Lease Obligations."
Depreciation expense for the three months ended September 27, 2014 and September 28, 2013 was $18.4 million and $22.7 million, respectively. Depreciation expense for the nine months ended September 27, 2014 and September 28, 2013 was $51.6 million and $54.4 million, respectively.
The composition of other assets is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Deferred financing costs
$
5,828

 
$
7,126

Cash surrender value of life insurance policies
27,267

 
26,507

Investments in limited partnerships
23,432

 
17,911

Other assets
27,346

 
10,420

Other assets
$
83,873

 
$
61,964

The composition of other current liabilities is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Accrued income taxes
$
13,667

 
$
18,773

Current deferred tax liability
1,652

 
1,960

Accrued interest and other
189

 
1,813

Other current liabilities
$
15,508

 
$
22,546



14


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The composition of other long-term liabilities is as follows:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Deferred tax liability
$
30,764

 
$
14,988

Long-term pension liability
14,822

 
16,219

Accrued Executive Supplemental Life Insurance Retirement Plan and Deferred Compensation Plan
30,559

 
28,708

Other long-term liabilities
22,074

 
10,717

Other long-term liabilities
$
98,219

 
$
70,632

    
5. INVESTMENTS IN LIMITED PARTNERSHIPS
The Company has invested in several venture capital limited partnerships that invest in start-up companies in the life sciences industry. The Company's total commitment to these entities as of September 27, 2014 was $55.0 million, of which the Company has funded $18.0 million through the third quarter of 2014. During the three and nine months ended September 27, 2014, the Company received dividends in cash and in securities totaling $0 and $7.4 million, respectively. The Company's ownership interest in these limited partnerships ranges from 3.8% to 12.1%. These limited partnerships prepare quarterly financial statements following investment company accounting guidelines, whereby investments are adjusted to fair value with resulting gains and losses recorded in earnings. These entities estimate the fair value of non-publicly traded investments based on all available information, including value implied by the pricing of subsequent preferred share offerings and the net present value of future cash flows.
The Company accounts for these investments under the equity-method, whereby the Company records its portion of the investment gains and losses as reported in the fund's financial statements on a quarterly lag each reporting period. In addition, the Company adjusts the carrying value of these investments to reflect its estimate of changes to fair value since the fund's financial statements based information from the fund's management team, market prices of known public holdings of the fund and other information.
The Company's investments in these limited partnerships are subject to a high degree of volatility and are generally higher risk relative to other investments the Company may hold. The Company reports gains and losses from its limited partnership investments in other income, net. The Company recognized gains (losses) related to these investments of $(0.8) million and $3.5 million for the three months ended September 27, 2014 and September 28, 2013, respectively. The Company recognized gains related to these investments of $7.4 million and $4.8 million for the nine months ended September 27, 2014 and September 28, 2013, respectively. As of September 27, 2014 and December 28, 2013, these investments had a carrying value of $23.4 million and $17.9 million, respectively, which is reported in other assets on the condensed consolidated balance sheets.
6. FAIR VALUE
Valuation methodologies used for assets and liabilities measured or disclosed at fair value are as follows:
Cash equivalents - Valued at quoted market prices determined through third party pricing services.
Investments in life insurance policies—Valued at cash surrender value based on fair value of underlying investments.
Redeemable noncontrolling interest—Valued primarily using the income approach based on estimated future cash flows of the underlying business based on the Company's projected financial data discounted by a weighted average cost of capital. Significant assumptions include a discount rate of 17.5% and a long-term pretax operating margin of 32%.
Contingent consideration—Valued based on a probability-weighting of the future cash flows associated with the potential outcomes.

15


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The fair value hierarchy level is determined by asset and liability class based on the lowest level of significant input. The observability of inputs may change for certain assets or liabilities. This condition could cause an asset or liability to be reclassified between levels. During the periods ended September 27, 2014, there were no transfers between levels.
Assets and liabilities measured at fair value on a recurring basis are summarized below:
 
Fair Value Measurements at September 27, 2014
 
Quoted Prices in Active Markets for Identical Assets Level 1
 
Significant Other Observable Inputs Level 2
 
Significant Unobservable Inputs Level 3
 
Assets and Liabilities at Fair Value
 
(in thousands)
Cash equivalents
$

 
$
1,851

 
$

 
$
1,851

Life insurance policies

 
20,193

 

 
20,193

Total assets measured at fair value
$

 
$
22,044

 
$

 
$
22,044

 
 
 
 
 
 
 
 
Redeemable noncontrolling interest

 

 
24,550

 
24,550

Contingent consideration

 

 
2,548

 
2,548

Total liabilities measured at fair value
$

 
$

 
$
27,098

 
$
27,098


 
Fair Value Measurements at December 28, 2013
 
Quoted Prices in Active Markets for Identical Assets Level 1
 
Significant Other Observable Inputs Level 2
 
Significant Unobservable Inputs Level 3
 
Assets and Liabilities at Fair Value
 
(in thousands)
Cash equivalents
$

 
$
1,851

 
$

 
$
1,851

Life insurance policies

 
19,534

 

 
19,534

Total assets measured at fair value
$

 
$
21,385

 
$

 
$
21,385

 
 
 
 
 
 
 
 
Redeemable noncontrolling interest

 

 
20,581

 
20,581

Total liabilities measured at fair value
$

 
$

 
$
20,581

 
$
20,581

    
The book value of the Company's term and revolving loans, which are variable rate loans carried at amortized cost, approximates fair value based on current market pricing of similar debt. As the fair value is based on significant other observable inputs, including current interest and foreign currency exchange rates, it is deemed to be Level 2.

Concurrent with the acquisition of Vital River in 2013, the Company entered into a joint venture agreement with the noncontrolling interest holders that provides it with the right to purchase the remaining 25% of the entity for cash at its then appraised value beginning in January 2016. Additionally, the noncontrolling interest holders were granted the right to require the Company to purchase the remaining 25% of the entity at its then appraised value beginning in January 2016 for cash. These rights are accelerated in certain events. As the noncontrolling interest holders can require the Company to purchase for cash the remaining 25% interest, the Company classifies the carrying amount of the noncontrolling interest above the equity section and below liabilities on the consolidated balance sheet and adjusts the carrying amount to fair value each quarter end. Adjustments to fair value, which is deemed to be Level 3 as the fair value is based on unobservable inputs, are recorded through additional paid-in capital.

16


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Redeemable Noncontrolling Interest (Liability)
 
Nine Months Ended

September 27, 2014
 
September 28, 2013
 
(in thousands)
Beginning balance
$
20,581

 
$

Additions

 
8,963

Total gains or losses (realized/unrealized):
 
 
 
  Net income attributable to noncontrolling interest
523

 
476

  Foreign currency translation
(113
)
 
233

  Change in fair value, included in additional paid-in capital
3,559

 
4,905

Ending balance
$
24,550

 
$
14,577


As part of the Company's acquisitions of Early Discovery and VivoPath, it agreed to make cash payments upon the satisfaction of certain future financial measures. The carrying amount of these obligations is adjusted to fair value each quarter end. As the fair value is based on unobservable inputs, it is deemed to be Level 3.
 
Contingent Consideration (Liability)
 
Nine Months Ended

September 27, 2014
 
September 28, 2013
 
(in thousands)
Beginning balance
$

 
$

Additions
2,428

 

Total gains or losses (realized/unrealized):
 
 
 
Change in fair value
120

 

Ending balance
$
2,548

 
$


The significant unobservable inputs used in the fair value measurement of the Company's contingent consideration are the probabilities of successful achievement of certain revenue targets and a discount rate. Significant increases or decreases in any of the probabilities of success would result in a significantly higher or lower fair value measurement, respectively. Significant increases or decreases in the discount rate would result in a significantly lower or higher fair value measurement, respectively.

The Company enters into derivative instruments to hedge foreign currency exchange risk to reduce the impact of changes to foreign currency rates on its financial statements. During both three and nine months ended September 27, 2014, the Company recognized $0.7 million of net hedge losses associated with forward currency contracts. During the three and nine months ended September 28, 2013, the Company recognized $(0.5) million and $0.3 million of hedge (gains) losses associated with forward currency contracts, respectively. As of September 27, 2014 and September 28, 2013, there were no open forward currency contracts.


17


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table displays the gross carrying amount and accumulated amortization of definite-lived intangible assets by major class:
 
September 27, 2014
 
December 28, 2013
 
Gross Carrying Amount
 
Accumulated Amortization & Impairment Loss
 
Gross Carrying Amount
 
Accumulated Amortization & Impairment Loss
 
(in thousands)
Backlog
$
8,391

 
$
(5,309
)
 
$
2,916

 
$
(2,507
)
Client relationships
395,221

 
(243,004
)
 
311,507

 
(238,002
)
Trademarks and trade names
6,521

 
(5,214
)
 
5,399

 
(4,997
)
Standard operating procedures
2,748

 
(1,934
)
 
2,754

 
(1,498
)
Other identifiable intangible assets
13,675

 
(6,988
)
 
10,432

 
(4,905
)
Total other intangible assets
$
426,556

 
$
(262,449
)
 
$
333,008

 
$
(251,909
)
Additionally, as of both September 27, 2014 and December 28, 2013, other intangible assets, net, included $3.4 million of indefinite-lived intangible assets.
The changes in the gross carrying amount and accumulated impairment loss of goodwill are as follows:
 
 
 
 
Adjustments to Goodwill
 
 
 
 
December 28, 2013
 
Acquisitions
 
Transfers
 
Foreign Exchange
 
September 27, 2014
 
 
(in thousands)
Research Models and Services
 
 
 
 
 
 
 
 
 
 
Gross carrying amount
 
$
83,551

 
$

 
$
(23,172
)
 
$
(650
)
 
$
59,729

Discovery and Safety Assessment
 
 
 
 
 
 
 
 
 
 
Gross carrying amount
 
1,152,150

 
67,244

 
(8,131
)
 
(8,160
)
 
1,203,103

Accumulated impairment loss
 
(1,005,000
)
 

 

 

 
(1,005,000
)
Manufacturing Support
 
 
 
 
 
 
 
 
 
 
Gross carrying amount
 

 

 
31,303

 
221

 
31,524

Total
 
 
 
 
 
 
 
 
 
 
Gross carrying amount
 
1,235,701

 
67,244

 

 
(8,589
)
 
1,294,356

Accumulated impairment loss
 
(1,005,000
)
 

 

 

 
(1,005,000
)
Goodwill, net
 
$
230,701

 
 
 
 
 
 
 
$
289,356


In the second quarter of 2014, the Company revised its reportable segments to align with the view of the business following its Early Discovery acquisition. See Note 1, "Basis of Presentation." As a result of this reorganization, goodwill was allocated from the Company's prior reporting segments to new reporting segments, as shown in the preceding table within "transfers." The allocation was based on the fair value of each business group within its original reporting segment relative to the fair value of that reporting segment. In addition, the Company completed an assessment of any potential goodwill impairment for all reporting units immediately prior to the reallocation and determined that no impairment existed.


18


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-Term Debt
Long-term debt consists of the following:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Term loans
$
388,500

 
$
409,500

Revolving credit facility
380,914

 
253,308

Other long-term debt
223

 
241

Total debt
769,637

 
663,049

Less: current portion of long-term debt
(31,723
)
 
(21,241
)
Long-term debt
$
737,914

 
$
641,808

In 2013, the Company amended and restated its credit agreement creating a $970.0 million agreement ($970M Credit Facility) that provides for a $420.0 million U.S. term loan facility and a $550.0 million multi-currency revolving credit facility. The revolving credit facility may be drawn in U.S. Dollars, Euros, Pound Sterling, or Japanese Yen, subject to sub-limits by currency. Under specified circumstances, the Company has the ability to expand the term loan and/or revolving credit facility by up to $350.0 million in the aggregate.
The interest rates applicable to the $970M Credit Facility are variable and are based on an applicable rate plus a spread determined by the Company's leverage ratio. As of September 27, 2014, the interest rate spread for the adjusted LIBOR was 1.250%.
The $970M Credit Facility includes certain customary representations and warranties, events of default, notices of material adverse changes to the Company's business and negative and affirmative covenants. As of September 27, 2014, the Company was compliant with all financial covenants specified in the credit agreement.
At September 27, 2014, the Company had $5.0 million outstanding under letters of credit.
Principal maturities of existing debt for the periods set forth in the table below, are as follows:
Twelve Months Ending
 
September 27, 2014
 
 
(in thousands)
September 2015
 
$
31,723

September 2016
 
42,000

September 2017
 
63,000

September 2018
 
632,914

September 2019 and beyond
 

Total
 
$
769,637

Capital Lease Obligations
The Company acquired a build-to-suit lease as part of its acquisition of Early Discovery. The Company is the deemed owner of the asset during the construction period for accounting purposes due to its involvement during the construction period. The Company capitalized $16.0 million related to this construction at September 27, 2014 along with a corresponding financing obligation of the same amount. See Note 13, "Commitments and Contingencies."
Capital lease obligations amounted to $17.1 million and $0.7 million at September 27, 2014 and December 28, 2013, respectively.


19


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9. EQUITY

Earnings Per Share
Basic earnings per share for the three and nine months ended September 27, 2014 and September 28, 2013 was computed by dividing earnings available to common shareholders for these periods by the weighted average number of common shares outstanding in the respective periods adjusted for contingently issuable shares, such as unvested restricted stock. The weighted average number of common shares outstanding for the three and nine months ended September 27, 2014 and September 28, 2013 has been adjusted to include common stock equivalents for the purpose of calculating diluted earnings per share for these periods.

Options to purchase 931,626 and 2,652,660 shares were outstanding in each of the three months ended September 27, 2014 and September 28, 2013, respectively, but were not included in computing diluted earnings per share because their inclusion would have been anti-dilutive. For the nine months ended September 27, 2014 and September 28, 2013, anti-dilutive options outstanding were 785,880 and 2,363,878 shares, respectively. Basic weighted average shares outstanding for the three and nine months ended September 27, 2014 and September 28, 2013 excluded the weighted average impact of 1,190,400 and 1,107,313 shares, respectively, of non-vested restricted stock awards.
The following table reconciles the numerator and denominator in the computations of the basic and diluted earnings per share.
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands, except share amounts)
Numerator:
 
 
 
 
 
 
 
Net income from continuing operations attributable to common shareholders
$
31,984

 
$
30,980

 
$
100,394

 
$
84,912

Income (loss) from discontinued operations, net of income taxes
52

 
(113
)
 
(862
)
 
(1,183
)
Net income attributable to common shareholders
$
32,036

 
$
30,867

 
$
99,532

 
$
83,729

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Weighted-average shares outstanding—Basic
46,016,036

 
47,910,649

 
46,682,826

 
47,950,018

Effect of dilutive securities:
 
 
 
 
 
 
 
Stock options and contingently issuable restricted stock
861,694

 
530,516

 
883,008

 
704,118

Weighted-average shares outstanding—Diluted
46,877,730

 
48,441,165

 
47,565,834

 
48,654,136


Treasury Shares
In July 2010, the Company's Board of Directors authorized a $500.0 million stock repurchase program, and subsequently approved increases to the stock repurchase program of $250.0 million in 2010 and of $250.0 million in 2013 for an aggregate authorization of $1.0 billion. As of September 27, 2014, the Company had $28.5 million remaining on the authorized stock repurchase program. The Company's 2007 Incentive Plan permits the netting of common stock upon vesting of restricted stock awards in order to satisfy individual tax withholding requirements.


20


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Share repurchases for the three and nine months ended September 27, 2014 and September 28, 2013 were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands, except share amounts)
Stock Repurchase Program:
 
 
 
 
 
 
 
Number of shares of common stock repurchased
380,300

 
1,398,346

 
2,093,200

 
1,945,021

Total cost of repurchase
$
20,364

 
$
65,515

 
$
110,645

 
$
88,553

 
 
 
 
 
 
 
 
Netted for taxes:
 
 
 
 
 
 
 
Number of shares of common stock repurchased
199

 

 
113,627

 
112,748

Total cost of repurchase
$
11

 
$

 
$
6,702

 
$
4,519

 
 
 
 
 
 
 
 
Total:
 
 
 
 
 
 
 
Number of shares of common stock repurchased
380,499

 
1,398,346

 
2,206,827

 
2,057,769

Total cost of repurchase
$
20,375

 
$
65,515

 
$
117,347

 
$
93,072


10. INCOME TAXES
The following table provides a reconciliation of the provision for income taxes on the condensed consolidated statements of income:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Income from continuing operations before income taxes
43,882

 
42,726

 
137,409

 
115,221

Effective tax rate
26.4
%
 
26.7
%
 
26.2
%
 
25.5
%
Provision for income taxes
11,582

 
11,390

 
36,021

 
29,331

The Company's overall effective tax rate was 26.4% for the three months ended September 27, 2014 and 26.7% for the three months ended September 28, 2013. The decrease was primarily attributable to a prior year discrete tax cost of $2.0 million related to an ongoing transfer pricing controversy with the Canadian Revenue Agency (CRA) in excess of current year tax costs, associated with tax law changes, including a statutory 25% decrease in the Canadian Scientific Research and Experimental Development (SR&ED) credit and a decrease in the deductibility of interest expense in France.
The Company's overall effective tax rate was 26.2% and 25.5% for each of the nine months ended September 27, 2014 and September 28, 2013, respectively. The increase reflects the items above as well as a discrete tax cost of $1.4 million related to the nondeductible transaction costs incurred in 2014 for the acquisition of the Early Discovery businesses and a discrete tax cost of $1.2 million related to the write-off of deferred tax assets as a result of the reorganization of the Company's RMS U.K. entities. These increases were partially offset by an ability to offset the tax on a capital gain from an investment in a limited partnership with the release of an uncertain tax position of $2.1 million in the nine months ended September 27, 2014.

21


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

During the third quarter of 2014, the Company's unrecognized tax benefits recorded decreased by $0.5 million to $34.3 million primarily due to the foreign currency translation on pre-acquisition tax positions taken by the newly acquired Early Discovery businesses, offset by a new unrecognized tax benefit related to an ongoing audit in Germany. The amount of unrecognized income tax benefits that would impact the effective tax rate decreased by $0.7 million to $32.2 million. The amount of accrued interest on unrecognized tax benefits is $1.3 million at the end of the third quarter of 2014. The Company believes that it is reasonably possible that the Company's unrecognized tax benefits (and a corresponding indemnification asset) will decrease by up to $11.6 million, including $0.5 million of interest expense, over the next twelve-month period as a result of the expiration of the statute of limitations on an issue related to the forgiveness of debt and an additional decrease by up to $0.4 million over the next twelve-month period as a result of the settlement of a German audit.

In July 2013, the FASB issued ASU 2013-11 “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The ASU requires an entity to present an unrecognized tax benefit as a reduction of the deferred tax asset for a net operating loss, or similar loss or tax credit carryforward, as opposed to a liability, unless certain circumstances exist. The ASU became effective during the Company's first fiscal quarter and the Company adopted the provisions of ASU 2013-11 retrospectively. The adoption of the ASU decreased net non-current deferred tax assets and decreased the associated long-term tax liabilities related to unrecognized tax benefits by $16.1 million and $11.9 million as of September 27, 2014 and December 28, 2013, respectively.

The Company conducts business in a number of tax jurisdictions. As a result, it is subject to tax audits in jurisdictions including the U.S., U.K., Japan, France, Germany, and Canada. With few exceptions, the Company is no longer subject to U.S. and international income tax examinations for years before 2010 although carryforward attributes that were generated prior to 2010 may still be adjusted upon examination by taxing authorities if they either have been, or will be, used in a future period. As of September 27, 2014, the statute of limitations has expired for a year which includes an uncertain tax position associated with an acquisition agreement termination fee. However, the Company does not expect the liability associated with this uncertain tax position to decrease until the statute expires on the year in which a carryforward attribute is utilized.

The Company and certain of its subsidiaries are currently under audit by various tax authorities in Canada, Germany, and France. The Company does not believe that resolution of these controversies will have a material impact on its financial position or results of operations.

On June 4, 2014, the Quebec government furthered a proposed tax law change on its SR&ED credit that, if passed, would provide a one-time benefit to operating income in the year of enactment and would provide a corresponding increase to the Company's effective tax rate. If passed as proposed, this tax law change would also provide for a reduction in benefit to operating income in 2015 and an additional corresponding increase to the Company's effective tax rate in 2015 and beyond.

In accordance with the Company's policy, the remaining undistributed earnings of its non-U.S. subsidiaries remain indefinitely reinvested as of the end of the third quarter of 2014 as they are required to fund needs outside the U.S. and cannot be repatriated in a manner that is substantially tax free.

The income tax expense (benefit) related to items of other comprehensive income are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Income tax expense (benefit) related to foreign currency translation adjustment
$

 
$
(615
)
 
$
(105
)
 
$
42

Income tax expense related to change in unrecognized pension gains, losses and prior service costs
125

 
289

 
378

 
832

Income tax expense (benefit) related to items of other comprehensive income
$
125


$
(326
)

$
273


$
874


22


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. EMPLOYEE BENEFITS
The following table provides the components of net periodic cost (benefit) for the Company's defined benefit plans for the three-month period ended:
 
Pension Benefits
 
Supplemental Retirement Benefits
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Service cost
$
880


$
822

 
$
190


$
160

Interest cost
3,211


2,762

 
252


177

Expected return on plan assets
(4,540
)

(3,593
)
 



Amortization of prior service cost (credit)
(166
)

(147
)
 
159


165

Amortization of net loss
238


671


60


63

Net periodic cost (benefit)
$
(377
)

$
515


$
661


$
565


The following table provides the components of net periodic cost (benefit) for the Company's defined benefit plans for the nine-month period ended:
 
Pension Benefits
 
Supplemental Retirement Benefits
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Service cost
$
2,565

 
$
2,492

 
569

 
$
482

Interest cost
9,633

 
8,334

 
757

 
531

Expected return on plan assets
(13,095
)
 
(10,842
)
 

 

Amortization of prior service cost (credit)
(484
)
 
(444
)
 
489

 
495

Amortization of net loss
684

 
2,043

 
185

 
189

Net periodic cost (benefit)
$
(697
)
 
$
1,583

 
$
2,000

 
$
1,697

During 2014, the Company expects to contribute $6.5 million to its pension plans.

12. STOCK PLANS AND STOCK-BASED COMPENSATION

The Company has stock-based compensation plans under which employees and non-employee directors may be granted stock-based awards such as stock options, restricted stock and performance share units.

The following table provides the financial statement line items in which stock-based compensation is reflected:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Stock-based compensation expense included in:
 
 
 
 
 
 
 
Cost of revenue
$
1,337

 
$
1,332

 
$
4,008

 
$
4,051

Selling, general and administration
6,914

 
4,715

 
19,124

 
14,180

Stock-based compensation, before income taxes
8,251

 
6,047

 
23,132

 
18,231

Provision for income taxes
(2,943
)
 
(2,103
)
 
(8,271
)
 
(6,422
)
Stock-based compensation, net of tax
$
5,308

 
$
3,944

 
$
14,861

 
$
11,809


23


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Performance Based Stock Award Program
In the first quarters of 2014 and 2013, the Company issued performance share units (PSUs) to certain employees. The number of shares of common stock issued for each PSU is adjusted based on a performance condition linked to the Company's financial performance. Certain awards are further adjusted based on a market condition, which is calculated based on the Company's stock price performance relative to a peer group over the three-year vesting period. The fair value of the market condition is reflected in the fair value of the award at grant date. Each reporting period, the Company records a ratable amount of stock-based compensation for the estimated number of common shares expected to be issued upon the vesting of the PSUs based on the Company's estimated outcome for the performance condition.

During the three months ended March 29, 2014, the Company issued 214,823 PSUs using a fair value per share of $67.82. The maximum amount of common shares to be issued upon vesting of these PSUs is 429,646. During the first quarter of 2013, the Company issued 163,847 PSUs using a fair value per share of $44.47. The maximum amount of common shares to be issued upon vesting of these PSUs is 327,694. During the three months ended June 28, 2014, the Company issued 5,800 PSUs using a fair value per share of $61.25. These 5,800 PSUs are not adjusted based on a market condition and have a maximum amount of common shares to be issued upon vesting of 5,800. For the three and nine months ended September 27, 2014, the Company recognized $2.6 million and $6.3 million, respectively, of stock-based compensation related to PSUs granted in 2014 and 2013. For the three and nine months ended September 28, 2013, the Company recognized $0.6 million and $1.5 million, respectively, of stock-based compensation related to PSUs granted in 2013.

13. COMMITMENTS AND CONTINGENCIES
Various lawsuits, claims and proceedings of a nature considered normal to the Company's business are pending against it. In the opinion of management, the outcome of such proceedings and litigation currently pending will not materially affect the Company's consolidated financial statements.
In early May 2013, the Company commenced an investigation into inaccurate billing with respect to certain government contracts.  The Company promptly reported these matters to the relevant government contracting officers, the Department of Health and Human Services' Office of the Inspector General, and the Department of Justice, and the Company is cooperating with these agencies to ensure the proper repayment and resolution of this matter. The Company identified approximately $1.5 million in excess amounts billed on these contracts since January 1, 2007 and reserved such amount.  Because of the early stage of discussions with the government and complex nature of this matter, the Company believes that it is reasonably possible that additional losses may be incurred. However, the Company cannot at this time estimate the potential range of loss beyond the current reserve of $1.5 million.
In July 2012, a Mauritius supplier of large animal models submitted an Application for Arbitration with The Permanent Secretariat, The Permanent Court of Arbitration, The Mauritius Chamber of Commerce and Industry in Port Louis, Mauritius.  The supplier asserted that the Company failed to pay certain invoices and the supplier was therefore permitted to terminate the supply agreement.  The Company filed a counterclaim asserting that the supplier had failed to meet its contractual obligations under the supply agreement.  The arbitration hearing relating to this contract dispute took place in Mauritius in August 2013 and final arguments were presented in March 2014. In May 2014 and August 2014, the arbitrator issued the final rulings, ordering the Company to pay the supplier (1) the sum of $1.2 million and (2) all of the supplier's arbitration costs, in each case with interest. In September 2014, the Company paid the supplier $1.6 million in accordance with the arbitration ruling.

As a result of the Company's April 1, 2014 Early Discovery acquisition, the Company became the obligor for an aggregate of approximately $82.4 million in minimum lease payments under non-cancellable operating and capital leases payable over a period of up to 20 years.


24


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

14. BUSINESS SEGMENT INFORMATION
During the quarter ended June 28, 2014, the Company revised its reportable segments to align with its view of the business following its Early Discovery acquisition. See Note 1, "Basis of Presentation." The Company reports segment results on this basis beginning in the quarter ended June 28, 2014 and retrospectively for all comparable prior periods.
The following table presents revenue and other financial information by reportable segment.
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Research Models and Services
 
 
 
 
 
 
 
Revenue
$
124,021

 
$
124,236

 
$
389,636

 
$
388,868

Gross margin
45,295

 
39,127

 
149,392

 
143,603

Operating income
28,056

 
23,803

 
97,734

 
97,576

Depreciation and amortization
7,277

 
13,548

 
20,277

 
27,642

Capital expenditures
4,110

 
4,208

 
11,528

 
10,417

Discovery and Safety Assessment
 
 
 
 
 
 
 
Revenue
$
140,862

 
$
112,627

 
$
388,614

 
$
321,908

Gross margin
39,968

 
33,061

 
105,084

 
81,112

Operating income
19,329

 
18,968

 
48,840

 
38,672

Depreciation and amortization
13,340

 
9,486

 
33,867

 
28,269

Capital expenditures
3,436

 
2,459

 
11,330

 
7,315

Manufacturing Support
 
 
 
 
 
 
 
Revenue
62,684

 
55,266

 
189,864

 
165,524

Gross margin
33,005

 
27,738

 
98,239

 
81,992

Operating income
19,220

 
16,125

 
58,091

 
46,576

Depreciation and amortization
3,513

 
3,881

 
10,625

 
11,424

Capital expenditures
1,463

 
2,429

 
5,444

 
7,587

A reconciliation of segment operating income to consolidated operating income is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Total segment operating income
$
66,605

 
$
58,896

 
$
204,665

 
$
182,824

Unallocated corporate overhead
(20,433
)
 
(18,053
)
 
(67,762
)
 
(56,030
)
Consolidated operating income
$
46,172

 
$
40,843

 
$
136,903

 
$
126,794


25


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Revenue for each significant product or service area is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Research models
$
81,705

 
$
81,366

 
$
256,501

 
$
257,582

Research model services
42,316

 
42,870

 
133,135

 
131,286

Total research models and services
124,021

 
124,236

 
389,636

 
388,868

Total discovery and safety assessment
140,862

 
112,627

 
388,614

 
321,908

Endotoxin and Microbial Detection
31,834

 
28,331

 
97,879

 
83,214

Other manufacturing support
30,850

 
26,935

 
91,985

 
82,310

Total manufacturing support
$
62,684

 
$
55,266

 
$
189,864

 
$
165,524

Total revenue
$
327,567

 
$
292,129

 
$
968,114

 
$
876,300

A summary of unallocated corporate overhead consists of the following:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Stock-based compensation expense
$
4,918

 
$
3,260

 
$
13,525

 
$
9,927

Salary, bonus and fringe
5,892

 
5,636

 
23,597

 
18,776

Consulting, audit and professional services
3,053

 
2,250

 
8,721

 
6,578

IT related expenses
1,767

 
3,002

 
4,667

 
8,448

Depreciation expense
1,954

 
1,570

 
5,666

 
4,712

Costs associated with evaluation and integration of acquisitions
580

 
306

 
5,256

 
986

Other general unallocated corporate expenses
2,269

 
2,029

 
6,330

 
6,603

Total unallocated corporate overhead costs
$
20,433

 
$
18,053

 
$
67,762

 
$
56,030

Other general unallocated corporate expenses consist of various departmental costs including those associated with senior executives, corporate accounting, legal, tax, human resources and treasury.

15. DISCONTINUED OPERATIONS
On March 28, 2011, the Company disposed of its Phase I clinical business though the Company remained the guarantor of a facility lease that runs through January 2021 with remaining lease payments of $10.3 million at September 27, 2014. The lease liability for the Company's obligation under the lease is presented net of estimated sublease income and reflected on the consolidated balance sheet as a liability of discontinued operations.

26


CHARLES RIVER LABORATORIES INTERNATIONAL, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The consolidated financial statements classify, as discontinued operations, the assets and liabilities, operating results and cash flows, of businesses that are discontinued for all periods presented. Operating results from discontinued operations are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 27, 2014
 
September 28, 2013
 
September 27, 2014
 
September 28, 2013
 
(in thousands)
Loss from operations of discontinued businesses, before income taxes
$
(38
)
 
$
(172
)
 
$
(1,614
)
 
$
(1,894
)
Benefit for income taxes
90

 
59

 
752

 
711

Income (loss) from operations of discontinued businesses, net of taxes
$
52

 
$
(113
)
 
$
(862
)
 
$
(1,183
)
Assets and liabilities of discontinued operations at September 27, 2014 and December 28, 2013 consisted of the following:
 
September 27, 2014
 
December 28, 2013
 
(in thousands)
Current assets
$
835

 
$
750

Long-term assets
3,106

 
3,151

Total assets
$
3,941

 
$
3,901

 
 
 
 
Current liabilities
$
2,059

 
$
1,931

Long-term liabilities
7,876

 
8,080

Total liabilities
$
9,935

 
$
10,011


Current and long-term assets include deferred tax assets. Current and long-term liabilities consist primarily of estimated lease payments, less sublease income, for the Phase I facility.

16. SUBSEQUENT EVENTS
On October 29, 2014, we acquired ChanTest Corporation (ChanTest), a leading provider of ion channel testing services to the pharmaceutical and biotech industry. We expect that the acquisition will augment our early discovery capabilities, enhancing our ability to support our clients’ target discovery and lead optimization efforts. The preliminary purchase price of the acquisition is $52.0 million in cash and up to an additional $2.0 million in contingent consideration. The purchase price is subject to an adjustment based on the final determined net working capital as of the closing date.

27


Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with our condensed consolidated financial statements and accompanying footnotes of this quarterly report on Form 10-Q and our audited consolidated financial statements and related footnotes included in our Annual Report on Form 10-K for the year ended December 28, 2013.
Overview
We are a leading full-service contract research organization (CRO) with integrated early-stage capabilities to support the drug discovery and early-stage development process. We provide our products and services to pharmaceutical and biotechnology companies, government agencies, leading hospitals and academic institutions around the world in order to bring drugs to market faster and more efficiently. We have built upon our 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 are able to support our clients from target identification through preclinical development. 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. We have been in business for over 65 years and currently operate more than 70 facilities in 17 countries worldwide.
In the second quarter of 2014, we revised our reportable segments to ensure alignment with our view of the business following our acquisition of the CRO services division of Galapagos N.V. (Early Discovery). We reviewed the new and existing markets addressed by the business, the recently revised go-to-market strategy, long-term operating margins and the discrete financial information available to our Chief Operating Decision Maker and considered how our businesses aggregate based on these qualitative and quantitative factors. Based on this review, we identified three reportable segments: Research Models and Services (RMS), Discovery and Safety Assessment (DSA) and Manufacturing Support (Manufacturing). We reported segment results on this basis beginning in the second quarter of 2014 and retrospectively for all comparable prior periods. The change to our reportable segments did not impact our historical consolidated operating results previously reported.
The revised reportable segments are as follows:
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