Covance Earnings Beat, Revenues Meet Estimates, View Tweaked

Covance Inc. (CVD) reported adjusted earnings per share (EPS) of 95 cents in the second quarter of 2014, beating the Zacks Consensus Estimate by 2 cents or 2.2%. Adjusted EPS also exceeded the year-ago figure of 78 cents by a robust 21.8%. The year-over-year earnings upside was driven by a better-than-expected performance in Early Development and constant strong growth observed in central laboratories. However, including the impact of certain one-time items containing asset impairment charges of 65 cents, reported earnings in the quarter came in at 29 cents, down 59.7% from the prior-year equivalent number.

However, this positive piece of news failed to boost investors' confidence. The company's share price has dropped 4% since the announcement of the second quarter results to close at $85.39 yesterday.

Revenues

Total revenue in the reported quarter grossed $687.1 million, up 6.7% year over year. Net revenue increased 8% from the year-ago quarter to reach $639.5 million (favorable foreign exchange contributed 270 basis points to this growth rate) approximately in line with the Zacks Consensus Estimate.

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 and clinical development. Additionally, market access services delivered year-over-year growth in 2Q14, following several quarters of decline, which also contributed to growth in Late-Stage Development. On the other hand, after several quarters of drag in sales, the Early Development segment is gradually returning to a positive growth trajectory.

Early Development

Net revenue from continuing operations in Early Development rose 7.7% year over year on a reported basis to $231.2 million in the quarter. Despite a decline in discovery support and the impact of the sale of the Seattle genomics laboratory, growth in clinical pharmacology and toxicology boosted sales in this segment. Moreover, favorable foreign exchange contributed 250 basis points (bps) to this segment's growth rate.

Early Development adjusted operating margin was 13.3%, up 200 bps from the year-ago quarter.

Late-Stage Development

Net revenue from Late-Stage Development climbed 8.1% year over year to $408.3 million. This was driven by growth of 11% in central laboratories and 4% in clinical development as well as growth in market access services. Moreover, the quarter received a 270 basis points favorable impact from foreign exchange.

Adjusted operating margin in this segment expanded 70 bps on a year-over-year basis to 22.1%.

Consolidated Margins

Gross margin remained flat at 35%. Adjusted operating margin improved about 220 bps to 11.1% with a 32.2% rise in adjusted operating income to $76 million.

Balance Sheet

Covance exited the quarter with cash and cash equivalents and short-term investments of $647.8 million, up 45.3% year over year. Operating cash flow of $68 million and capital expenditure of $38 million in second-quarter 2014 resulted in free cash flow of $30 million.

Guidance

Covance revised its guidance for 2014. It narrowed its revenue growth expectation to the band of 6% to 8% from the earlier guided range of 6% to 9%.This expectation takes into account a headwind from the sale of the Seattle genomics laboratory.

The company has revised its full year adjusted EPS expectation to $3.78−$3.92 in comparison with the previous range of $3.70−$3.95. Currently, the Zacks Consensus Estimate for 2014 EPS is pegged at $3.82, well within the guided range. The Zacks Consensus Estimate for revenues of $2.61 billion stands at the upper-end of the guided range.

Our Take

We are impressed with Covance's strong second-quarter 2014 results propelled by healthy growth across both its segments. During the quarter, sequential growth in the Early Development segment was driven by constant strong growth in clinical pharmacology, stronger than expected growth in toxicology and an increase in pharmaceutical chemistry and discovery support.

Late-Stage Development continues to grow steadily on the back of strong central laboratories and the continued sturdy performance of clinical development services. The company has won new orders recently and has been experiencing a significant increase in proposal volumes. On account of this, management is confident that Covance will continue to acquire profitable market share in central laboratories.

Zacks Rank

Covance currently carries a Zacks Rank #3 (Hold). Some better-placed stocks in the medical services industry that warrant a look are PAREXEL International Corporation (PRXL), Omnicare Inc. (OCR) and iKang Healthcare Group, Inc. (KANG). While PAREXEL sports a Zacks Rank #1 (Strong Buy), Omnicare and iKang Healthcare hold a Zacks Rank #2 (Buy).