Covance Inc. (CVD) reported adjusted earnings per share (EPS) of 87 cents in the fourth quarter of 2013. The results beat the year-ago figure by 18.6% and was ahead of the Zacks Consensus Estimate by 3 cents. The upside was driven by an improved top line. Including the impact of certain one-time items, reported earnings in the quarter came in at 80 cents, registering a 9.6% beat over the year-ago figure. For the full year, adjusted EPS surged 19.6% to reach $3.23.
Revenues
Net revenue increased 10.8% from the year-ago quarter to reach $623.1 million (up 11.1% on an adjusted basis), beating the Zacks Consensus Estimate of $622 million. For the full year, net revenues were $2.4 billion, up 10.2% over the prior year (or up 10.6% on an adjusted basis).
Covance primarily derives its revenues from two segments, Early Development and Late-Stage Development. During the reported quarter, solid sales performance was seen in Late-Stage Development backed by accelerated revenues in central laboratories. On the other hand, after several quarters of drag in sales, Early Development segment is gradually returning to a positive growth trajectory.
Early Development
Net revenue from continuing operation in Early Development rose 5.0% year over year on a reported basis (up 5.7% from adjusted revenues in the year-ago quarter) to $228.3 million in the quarter. The increase was driven primarily by growth in clinical pharmacology services and improved results in toxicology, which were partially offset by decline in discovery support and certain pharmaceutical chemistry services.
Early Development pro forma operating margin was 12.1%, up 10 basis points (bps) year over year.
Late-Stage Development
Net revenue from Late-Stage Development surged 14.5% year over year to $394.8 million on the back of continued strong performance in central labs and clinical development, where net revenue were up 17% and 13% year over year, respectively. Pro forma operating margin expanded 140 bps on a year-over-year basis to 22.7%. Year-over-year increase in profits in both clinical development and central laboratories neutralized the increase in strategic IT spending.
Consolidated Margins
Gross margin contracted 24 bps to 34.8%. Adjusted operating margin improved about 100 bps to 10.4% with 23.2% rise in adjusted operating income to $64.7 million.
Balance Sheet
Covance exited 2013 with cash and cash equivalents and short-term investments of $729.0 million, up 47.9% year over year. Operating cash flow of $405.6 million and capital expenditure of $58 million in second-quarter 2013 resulted in free cash flow of $134 million.
Guidance
Covance initiated its guidance for 2014. It expects 2014 revenues to grow in the range of 6% to 10%. Adjusted earnings per share is expected to remain within $3.65−$4.00 (assuming foreign exchange rates remain at the current level). Currently, the Zacks Consensus Estimate for 2014 EPS is pegged at $3.82, well within the guided range. However, the Zacks Consensus Estimate for revenues of $2.65 billion remains ahead of the projected range.
For the first quarter of 2014, Covance expects sequential growth in revenues. It also expects a rise of around 2 cents on a sequential basis. The company estimates this quarter to show an increase in Late-Stage Development net revenue and earnings, partially offset by seasonally weaker first-quarter Early Development performance.
Our Take
Covance has managed to post better-than-expected fourth-quarter results with modest top- and bottom-line beats on healthy growth across both its segments. Late-Stage Development continues to grow steadily. Despite increased spending on strategic IT projects, the segment witnessed growth on the back of better-than-estimated kit volumes in central laboratories and the continued strong performance of Phase II-IV clinical development services. Over the past few quarters, Covance was suffering from sluggish early-stage research and development spending by the biopharmaceutical industry, which resulted in overcapacity in this segment. However, of late the company is showing signs of recovery with improvement in Early Development performance owing to robust growth in clinical pharmacology and a substantial increase in toxicology orders.
The stock presently carries a Zacks Rank #2 (Buy). Other top-ranked medical stocks such as Affymetrix Inc. (AFFX), Covidien plc (COV) and Stryker Corporation (SYK) are also expected to do well. While AFFX carries a Zacks Rank #1 (Strong Buy), COV and SYK hold the same Zacks Rank as Covance.
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