Covance Inc. (CVD) reported adjusted earnings per share (EPS) of 98 cents in the third quarter of 2014, exceeding the year-ago equivalent tally of 83 cents by a solid 18.1%. However, adjusted earnings were in line with the Zacks Consensus Estimate.
The year-over-year earnings upside was driven by operating income and margins leverage in Early Development and lower corporate expenses during the quarter.
However, including the impact of certain one-time adjustments, reported earnings in the quarter came in at $1.16, up 48.7% from the prior-year equivalent number.
Covance also announced that it has signed an agreement with Laboratory Corporation of America Holdings (LH), under which LabCorp will buy Covance for a total enterprise value of $5.6 billion.
Revenues
Total revenue in the reported quarter grossed $671 million, up 3.7% year over year. Net revenue (excluding Reimbursable Out-of-Pockets) increased 3.4% from the year-ago quarter to reach $627.1 million. However, the top line (net revenue) missed the Zacks Consensus Estimate of $661 million.
Covance primarily derives its revenues from two segments, Early Development and Late-Stage Development. During the quarter, the company's sales growth from the Early Development segment met management's expectations. However, this positive revenue growth was partially neutralized by lower-than-expected growth in the Late-Stage Development segment and the strength of the US dollar in the reported quarter, which resulted in consolidated revenue growth of 3.4%.
Early Development
Net revenue from continuing operations in Early Development rose 6.6% year over year on a reported basis to $234.8 million in the quarter. Despite a decline in research products and the adverse impact of the sales of Covance's Seattle genomics laboratory and antibody products service line, a strong growth in clinical pharmacology and toxicology boosted sales in this segment. Moreover, a favorable foreign exchange contributed 190 basis points (bps) to this segment's growth rate.
Early Development adjusted operating margin was 14.3%, up 120 bps from the year-ago quarter.
Late-Stage Development
Net revenue from Late-Stage Development grew 1.5% year over year to $392.3 million. This was driven by growth of 3% in central laboratories revenues. However, this growth was partially offset by an unexpected decline in clinical development revenues due to the combined impact of cancellations and continued slow backlog conversion. Moreover, the company received a 110 bps favorable impact from foreign exchange in the quarter.
Adjusted operating margin in this segment contracted 30 bps on a year-over-year basis to 22.3%.
Consolidated Margins
Gross margin expanded 150 bps to 35.8%, on the back of positive top-line growth. Adjusted operating margin improved about 120 bps to 14.3% with a 16.4% rise in adjusted operating income to $33.5 million.
Balance Sheet
Covance exited the quarter with cash and cash equivalents and short-term investments of $704.8 million, down from $729 million as of Dec 31, 2013. Operating cash flow of $132.6 million and capital expenditure of $105.4 million in third-quarter 2014 resulted in free cash flow of $27.2 million.
Guidance Narrowed
Covance revised its guidance for 2014. The company lowered its earnings per share expectations from a range of $3.78−$3.92 to $3.78−$3.81 to reflect currency headwinds. The adjusted earnings guidance excludes gains on sale, costs associated with our restructuring activities, and asset impairment charges. Currently, the Zacks Consensus Estimate for 2014 EPS is pegged at $3.85, which lies above the company's guided range.
However, the company has not provided any revenue guidance for 2014.
As per Sep 30 exchange rates, Covance expect fourth-quarter revenues to be in the range of $625 million to $635 million and EPS in the band of $0.95–$0.98.
Our Take
Covance reported mixed third-quarter 2014 financial results, with the bottom line exceeding the Zacks Consensus Estimate and the top line missing the same. Overall, the Early Development segment delivered impressive performance on both sequential and year-over-year bases. However, revenues declined in the Late Stage Development segment sequentially due to slower-than-expected revenue conversion and the impact of cancellations in clinical development, summer seasonality in central lab and clinical development, and the strengthening of the US dollar, which negatively impacted sequential revenue growth by 100 bps. However, given the past positive trends observed in this segment, we believe Covance will soon overcome these negatives and deliver healthy performance in the near future.
During the quarter, Covance incurred a lower level of corporate expense which reflects the continued impact of management's cost reduction actions, lower IT operating expense due to project timing, and lower incentive compensation expense.
Zacks Rank
Covance currently carries a Zacks Rank #3 (Hold). Some better-ranked stocks that warrant a look in the medical services industry are BioTelemetry, Inc. (BEAT) and ICON Public Limited Company (ICLR). Both these stocks sport a Zacks Rank #1 (Strong Buy).
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