UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 1998
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from __________________ to ____________________
Commission File Number: 1-12213
COVANCE INC.
(Exact name of Registrant as specified in its Charter)
Delaware 22-3265977
(State of Incorporation) (I.R.S. Employer Identification No.)
210 Carnegie Center, Princeton, New Jersey 08540
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (609) 452-4440
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 _X_ NO ___
APPLICABLE ONLY TO CORPORATE ISSUERS:
As of October 26, 1998, the Registrant had 58,237,076 shares of Common Stock
outstanding.
<PAGE>
Covance Inc.
Form 10-Q For the Quarterly Period Ended September 30, 1998
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets--September 30, 1998
and December 31, 1997 .................................................... 3
Consolidated Statements of Income--Three and
Nine Months ended September 30, 1998 and 1997 ............................ 4
Consolidated Statements of Cash Flows--
Nine Months ended September 30, 1998 and 1997 ............................ 5
Notes to Consolidated Financial Statements ............................... 6
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations ................... 7
Item 3. Quantitative and Qualitative Disclosure
About Market Risk .................................................. 14
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K ................................... 15
Signature Page .............................................................. 16
<PAGE>
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 1998 AND DECEMBER 31, 1997
(UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in thousands) September 30, December 31,
1998 1997
-------- --------
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents ....................... $ 11,475 $ 28,027
Accounts receivable, net ........................ 130,285 104,789
Unbilled services ............................... 57,609 40,980
Inventory ....................................... 23,766 18,088
Deferred income taxes ........................... 12,373 10,474
Prepaid expenses and other assets ............... 37,519 28,120
-------- --------
Total Current Assets ......................... 273,027 230,478
Property and equipment, net ......................... 217,112 193,129
Goodwill, net ....................................... 49,259 50,979
Other assets ........................................ 9,004 9,428
-------- --------
Total Assets ................................. $548,402 $484,014
======== ========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable ................................ $ 29,989 $ 24,344
Accrued payroll and benefits .................... 38,818 39,647
Accrued expenses and other liabilities .......... 32,051 30,702
Unearned revenue ................................ 60,831 62,099
Short-term debt ................................. 10,000 10,000
Income taxes payable ............................ 13,732 4,198
-------- --------
Total Current Liabilities .................... 185,421 170,990
Long-term debt ...................................... 127,761 132,423
Deferred income taxes ............................... 13,802 10,758
Other liabilities ................................... 12,631 12,786
-------- --------
Total Liabilities ............................ 339,615 326,957
-------- --------
Commitments and Contingent Liabilities
Stockholders' Equity:
Common Stock - Par value $0.01 per share;
140,000,000 shares authorized; 58,191,429
and 57,678,977 shares issued and outstanding
at September 30, 1998 and December 31, 1997,
respectively .................................... 582 577
Paid-in capital ................................. 70,928 58,276
Retained earnings ............................... 134,147 97,764
Cumulative translation adjustment ............... 3,130 440
-------- --------
Total Stockholders' Equity ................... 208,787 157,057
-------- --------
Total Liabilities and Stockholders' Equity ... $548,402 $484,014
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
3
<PAGE>
<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
--------------------------- ----------------------------
(Dollars in thousands, except per share data) 1998 1997 1998 1997
----------- ----------- ----------- ------------
<S> <C> <C> <C> <C>
Net revenues ...................................... $ 182,187 $ 151,464 $ 532,785 $ 432,579
Cost and expenses:
Cost of revenue ............................... 119,366 99,120 351,433 285,099
Selling, general and administrative expense ... 29,058 23,452 85,395 66,698
Depreciation and amortization ................. 9,488 7,990 27,066 22,519
----------- ----------- ----------- ------------
Total ..................................... 157,912 130,562 463,894 374,316
----------- ----------- ----------- ------------
Income from operations ............................ 24,275 20,902 68,891 58,263
----------- ----------- ----------- ------------
Other expense, net:
Interest expense, net ......................... 1,787 2,187 5,290 6,375
Other expense (income) ........................ 16 (60) 203 (111)
----------- ----------- ----------- ------------
Other expense, net ........................ 1,803 2,127 5,493 6,264
----------- ----------- ----------- ------------
Income before taxes and equity investee results ... 22,472 18,775 63,398 51,999
Taxes on income ................................... 9,329 8,058 26,577 22,151
Equity investee loss (gain) ....................... 80 (142) 438 (157)
----------- ----------- ----------- ------------
Net income ........................................ $ 13,063 $ 10,859 $ 36,383 $ 30,005
=========== =========== =========== ============
Basic earnings per share .......................... $ 0.22 $ 0.19 $ 0.63 $ 0.52
Weighted average shares outstanding - basic ....... 58,154,402 57,342,130 57,961,092 57,177,192
Diluted earnings per share ........................ $ 0.22 $ 0.19 $ 0.62 $ 0.52
Weighted average shares outstanding - diluted ..... 59,010,297 57,690,814 58,539,706 57,371,085
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
4
<PAGE>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30
--------------------
(Dollars in thousands) 1998 1997
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................. $ 36,383 $ 30,005
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ...................... 27,066 22,519
Stock issued under employee benefit and stock
compensation plans ............................... 5,843 2,942
Deferred income tax provision ...................... 1,145 2,453
Other .............................................. 454 117
Changes in operating assets and liabilities:
Accounts receivable .............................. (25,496) (8,729)
Unbilled services ................................ (16,629) (5,076)
Inventory ........................................ (5,678) (1,137)
Accounts payable ................................. 5,645 (6,546)
Accrued liabilities .............................. 520 4,376
Unearned revenue ................................. (1,268) (1,633)
Income taxes payable ............................. 9,534 6,232
Other assets and liabilities, net ................ (8,209) (6,299)
-------- --------
Net cash provided by operating activities .............. 29,310 39,224
-------- --------
Cash flows from investing activities:
Capital expenditures ............................... (46,037) (34,883)
Other, net ......................................... 122 99
-------- --------
Net cash used in investing activities .................. (45,915) (34,784)
-------- --------
Cash flows from financing activities:
Repayments of long-term debt ....................... (5,000) (25,000)
Proceeds from short-term debt ...................... -- 10,000
Stock issued under employee stock purchase and
stock option plans ............................... 5,053 2,216
-------- --------
Net cash provided by (used in) financing activities .... 53 (12,784)
-------- --------
Net change in cash and cash equivalents ................ (16,552) (8,344)
Cash and cash equivalents, beginning of period ......... 28,027 25,416
-------- --------
Cash and cash equivalents, end of period ............... $ 11,475 $ 17,072
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
5
<PAGE>
COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 1998
1. Basis of Presentation
The accompanying unaudited consolidated financial statements reflect all
adjustments of a normal recurring nature, which are, in the opinion of
management, necessary for a fair statement of the results of operations for the
interim periods presented. The consolidated financial statements have been
compiled without audit and are subject to such year-end adjustments as may be
considered appropriate and should be read in conjunction with the historical
consolidated financial statements of Covance Inc. and subsidiaries ("Covance")
for the years ended December 31, 1997, 1996 and 1995 included in the Annual
Report on Form 10-K for the fiscal year ended December 31, 1997. Operating
results for the nine months ended September 30, 1998 are not necessarily
indicative of the results that may be reported for the year ending December 31,
1998.
2. Summary of Significant Accounting Policies
Use of Estimates
The preparation of these unaudited consolidated financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.
Earnings Per Share
Earnings per share has been calculated in accordance with Financial
Accounting Standards Board Statement No. 128, Earnings Per Share. In computing
diluted earnings per share for the three months ended September 30, 1998 and
1997, the denominator was increased by 855,895 shares and 348,684 shares,
respectively, and for the nine months ended September 30, 1998 and 1997, the
denominator was increased by 578,614 and 193,893 shares, respectively;
representing the dilution of stock options outstanding at September 30, 1998 and
1997 with exercise prices less than the average market price of Covance's Common
Stock during each respective period.
Comprehensive Income
In June 1997, the Financial Accounting Standards Board (the "FASB") issued
Statement No. 130, Reporting Comprehensive Income ("SFAS 130"). This Statement
establishes standards for reporting and display of comprehensive income and its
components in the financial statements. Initial application of this Statement is
required for interim periods of fiscal years beginning after December 15, 1997;
however, interim period disclosure is limited to reporting a total for
comprehensive income. In accordance with SFAS 130, Covance has determined total
comprehensive income, net of tax, to be $15.9 million and $9.8 million for the
three months ended September 30, 1998 and 1997, respectively; and $38.0 million
and $27.2 million for the nine months ended September 30, 1998 and 1997,
respectively. Covance's total comprehensive income represents net income plus
the after-tax effect of the change in the cumulative translation adjustment
equity account for the periods presented.
3. Supplemental Cash Flow Information
Cash paid for interest for the nine months ended September 30, 1998 and
1997, totaled $5.8 million and $6.8 million, respectively. Cash paid for income
taxes for the nine months ended September 30, 1998 and 1997, totaled $18.1
million and $12.3 million, respectively.
6
<PAGE>
Part I. Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion should be read in conjunction with the unaudited
Consolidated Financial Statements and related Notes thereto of Covance included
herein, and the Consolidated Financial Statements and related Notes thereto
included in Covance's Annual Report on Form 10-K for the fiscal year ended
December 31, 1997.
Overview
Covance is a leading contract research organization ("CRO") providing a
wide range of integrated product development services on a worldwide basis to
the pharmaceutical, biotechnology and medical device industries. In addition,
and to a lesser extent, Covance also provides services such as health economics
and outcomes for managed care organizations, hospitals and other health care
providers and laboratory testing services to the chemical, agrochemical and food
industries. The foregoing services can be broadly classified into two lines of
business: early development services (preclinical, early clinical and
biomanufacturing) and late-stage development services (clinical, central
laboratory, pharmaceutical packaging, periapproval and health economics and
outcomes). Covance believes it is one of the largest biopharmaceutical CROs,
based on 1997 annual net revenues, and one of a few that is capable of providing
comprehensive global product development services. Covance offers its clients
high quality services designed to reduce product development time, enabling them
to introduce their products into the marketplace faster and, thus, maximize the
period of market exclusivity and monetary return on their research and
development investments. Additionally, Covance's comprehensive services and
broad experience provides clients with a variable cost alternative to fixed cost
internal development capabilities.
Historically, a majority of Covance's net revenues have been earned under
contracts which generally range in duration from a few months to two years.
Revenue from these contracts is generally recognized under either the percentage
of completion method of accounting or as services are rendered or products are
delivered. The contracts may contain provisions for renegotiation for cost
overruns arising from changes in the scope of work. Renegotiated amounts are
included in net revenues when earned and realization is assured. In some cases,
for multi-year contracts a portion of the contract fee is paid at the time the
trial is initiated, with performance-based installments payable over the
contract duration as milestones are achieved. Covance routinely subcontracts
with independent physician investigators in connection with either single or
multi-site clinical trials. Investigator fees are not reflected in net revenues
or expenses since such fees are granted by customers on a "pass-through basis"
without risk or reward to Covance. While most contracts are terminable either
immediately or upon notice by the client, they typically require payment of
expenses to wind down a study, payment of fees earned to date, and, in some
cases, a termination fee or a payment of some portion of the fees or profit that
could have been earned under the contract if it had not been terminated early.
Covance's cost of revenue includes appropriate amounts necessary to
complete the revenue and earnings process, and includes direct labor and related
benefit charges, other direct costs and allocable expenses (including indirect
labor, facility charges and information technology costs). These costs, as a
percentage of net revenues, tend and are expected to fluctuate from one period
to another (generally within a range of up to 200 basis points in either
direction) principally as a result of changes in labor utilization and the mix
of service offerings involving hundreds of studies conducted during any period
of time.
Quarterly Results
Covance's quarterly operating results are subject to variation, and are
expected to continue to be subject to variation, as a result of factors such as
delays in initiating or completing significant drug development trials,
termination of drug development trials, acquisitions and exchange rate
fluctuations. Delays and terminations of studies or trials are often the result
of actions taken by clients or regulatory authorities and are not typically
controllable by Covance. Since a large amount of Covance's operating costs are
relatively fixed while revenues are subject to fluctuation, minor variations in
the commencement, progress or completion of drug development trials may cause
significant variations in quarterly operating results.
7
<PAGE>
Results of Operations
Three Months Ended September 30, 1998 Compared with Three Months Ended September
30, 1997.
Net revenues increased 20.3% to $182.2 million for the three months ended
September 30, 1998 from $151.5 million for the corresponding 1997 period. Net
revenues from Covance's late-stage development services grew 24.0%, benefiting
from the continuing trend in outsourcing of clinical development activities,
while net revenues from Covance's early development services grew 14.6%.
Cost of revenue increased 20.4% to $119.4 million for the three months
ended September 30, 1998 from $99.1 million for the corresponding 1997 period,
as a result of the increase in net revenues. Cost of revenue, as a percentage of
net revenues, increased slightly to 65.5% for the three months ended September
30, 1998 from 65.4% for the corresponding 1997 period.
Selling, general and administrative expense, which consists primarily of
administrative payroll and related benefit charges, advertising and promotional
expenses, administrative travel and allocable expenses (facility charges and
information technology costs), increased 23.9% to $29.1 million for the three
months ended September 30, 1998 from $23.5 million for the corresponding 1997
period. As a percentage of net revenues, selling, general and administrative
expense increased to 15.9% for the three months ended September 30, 1998 from
15.5% for the corresponding 1997 period. The increase in selling, general and
administrative expense of 23.9% is attributable to a number of factors,
including higher sales and marketing expenses and higher recruitment expenses
during the 1998 three month period compared to the corresponding 1997 period.
Depreciation and amortization increased 18.7% to $9.5 million or 5.2% of
net revenues for the three months ended September 30, 1998 from $8.0 million or
5.3% of net revenues for the corresponding 1997 period, as the growth in net
revenues slightly outpaced the increase in these non-cash charges.
Income from operations increased $3.4 million or 16.1% to $24.3 million for
the three months ended September 30, 1998 from $20.9 million for the
corresponding 1997 period. As a percentage of net revenues, income from
operations decreased to 13.3% for the three months ended September 30, 1998 from
13.8% for the corresponding 1997 period, primarily as a result of the increase
in selling, general and administrative expense.
Other expense, net, decreased $0.3 million or 15.2% to $1.8 million for the
three months ended September 30, 1998, from $2.1 million for the corresponding
1997 period, primarily as a result of a reduction in interest expense, relating
to Covance's lower level of debt for the three months ended September 30, 1998
as compared to the corresponding 1997 period.
Covance's effective tax rate for the three months ended September 30, 1998
decreased to 41.5% from 42.9% for the corresponding 1997 period. Since Covance
operates on a global basis, its effective tax rate is subject to variation from
period to period as the geographic distribution of its pre-tax earnings changes.
Net income increased $2.2 million or 20.3% to $13.1 million for the three
months ended September 30, 1998 from $10.9 million for the corresponding 1997
period.
Nine Months Ended September 30, 1998 Compared with Nine Months Ended
September 30, 1997.
Net revenues increased 23.2% to $532.8 million for the nine months ended
September 30, 1998 from $432.6 million for the corresponding 1997 period. Net
revenues from Covance's late-stage development services grew 27.1%, benefiting
from the continuing trend in outsourcing of clinical development activities,
while net revenues from Covance's early development services grew 17.8%.
Cost of revenue increased 23.3% to $351.4 million for the nine months ended
September 30, 1998 from $285.1 million for the corresponding 1997 period, as a
result of the increase in net revenues. Cost of revenue, as a percentage of net
revenues, increased slightly to 66.0% for the nine months ended September 30,
1998 from 65.9% for the corresponding 1997 period.
Selling, general and administrative expense increased 28.0% to $85.4
million for the nine months ended September 30, 1998 from $66.7 million for the
corresponding 1997 period. As a percentage of net revenues, selling, general and
administrative expense increased to 16.0% for the nine months ended September
30, 1998 from 15.4% for the corresponding
8
<PAGE>
1997 period. The increase in selling, general and administrative expense of
28.0% is attributable to a number of factors, including higher sales and
marketing expenses and higher recruitment expenses during the 1998 nine month
period compared to the corresponding 1997 period.
Depreciation and amortization increased 20.2% to $27.1 million or 5.1% of
net revenues for the nine months ended September 30, 1998 from $22.5 million or
5.2% of net revenues for the corresponding 1997 period, as the growth in net
revenues outpaced the increase in these non-cash charges.
Income from operations increased $10.6 million or 18.2% to $68.9 million
for the nine months ended September 30, 1998 from $58.3 million for the
corresponding 1997 period. As a percentage of net revenues, income from
operations decreased to 12.9% for the nine months ended September 30, 1998 from
13.5% for the corresponding 1997 period, primarily as a result of the increase
in selling, general and administrative expense.
Other expense, net, decreased $0.7 million or 12.3% to $5.5 million for the
nine months ended September 30, 1998 from $6.2 million for the corresponding
1997 period. This decrease is a result of a reduction in interest expense of
$1.0 million, partially offset by foreign exchange transaction losses of $0.2
million reported during the nine months ended September 30, 1998, as compared to
foreign exchange transaction gains of $0.1 million during the corresponding 1997
period.
Covance's effective tax rate for the nine months ended September 30, 1998
decreased to 41.9% from 42.6% for the corresponding 1997 period. Since Covance
operates on a global basis, its effective tax rate is subject to variation from
period to period as the geographic distribution of its pre-tax earnings changes.
Net income increased $6.4 million or 21.3% to $36.4 million for the nine
months ended September 30, 1998 from $30.0 million for the corresponding 1997
period.
Liquidity and Capital Resources
Covance's primary cash needs on both a short and long-term basis are for
capital expenditures, expansion of services, possible future acquisitions,
geographic expansion, working capital and other general corporate purposes.
Management believes that its long-term revolving credit facility will provide
Covance with sufficient financial flexibility and ready access to cash on both a
short-term and a long-term basis to fund, as required, capital expenditures,
potential future acquisitions and other longer-term growth opportunities. At
September 30, 1998, there was $115.0 million of outstanding borrowings and $11.6
million of outstanding letters of credit, with a remaining availability of
$123.4 million under Covance's long-term $250 million revolving credit facility.
At September 30, 1998, Covance Biotechnology Services Inc. had $3.0 million
in long-term debt outstanding with the North Carolina Biotechnology Center. This
debt matures in December 1999 and is guaranteed by Covance. In addition, Covance
Biotechnology Services Inc. has a $10.0 million short-term revolving credit
facility with a bank, of which $10.0 million of borrowings were outstanding as
of September 30, 1998. This short-term revolving credit facility carries
interest at a rate substantially equivalent to the rate in effect on Covance's
borrowings under its long-term credit facility and is also guaranteed by
Covance.
In October 1997, a foreign subsidiary of Covance borrowed 13.5 million
Swiss Francs from a bank. This loan bears interest at a fixed rate of 2.9% per
annum and matures in three years. In connection with the loan, Covance provided
a letter of credit in favor of the lender which may be drawn upon in event of
default.
During the nine months ended September 30, 1998, Covance's operations
provided net cash of $29.3 million compared to $39.2 million provided by
operations for the corresponding 1997 period. Cash flows from net earnings
adjusted for non-cash activity provided $70.9 million for the nine months ended
September 30, 1998, up $12.9 million or 22.2% from the corresponding 1997
period. The change in net operating assets used $41.6 million in cash during the
nine months ended September 30, 1998, primarily as a result of an increase in
accounts receivable and unbilled services, while this net change used $18.8
million during the first nine months of 1997, also primarily as a result of an
increase in accounts receivable and unbilled services.
Working capital was $87.6 million at September 30, 1998, an increase of
$28.1 million from December 31, 1997. Aggregate accounts receivable and unbilled
services at September 30, 1998 of $187.9 million were up $42.1 million or 28.9%
from the December 31, 1997 level of $145.8 million. Covance has increased
collection and contract management efforts to
9
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reduce the percentage increase in aggregate accounts receivable and unbilled
services to a level consistent with the increase in net revenues. Covance's
ratio of current assets to current liabilities was 1.47 at September 30, 1998
and 1.35 at December 31, 1997.
Investing activities for the nine months ended September 30, 1998 used
$45.9 million compared to $34.8 million for the corresponding 1997 period.
Capital spending for the first nine months of 1998 totaled $46.0 million,
primarily for outfitting of new facilities, purchase of new equipment,
maintenance and upgrade of existing equipment and computer equipment and
software for newly hired employees, compared to $34.9 million for the
corresponding 1997 period.
Foreign Currency
Since Covance operates on a global basis, it is exposed to various foreign
currency risks. Two specific risks arise from the nature of the contracts
Covance executes with its customers since from time to time contracts are
denominated in a currency different than the particular Covance subsidiary's
local currency. This contract currency denomination issue is generally
applicable only to a portion of the contracts executed by Covance's foreign
subsidiaries providing clinical and periapproval services. The first risk occurs
as revenue recognized for services rendered is denominated in a currency
different from the currency in which the subsidiary's expenses are incurred. As
a result, the subsidiary's net revenues and resultant earnings can be affected
by fluctuations in exchange rates. While some contracts provide either that
currency fluctuations from the rates in effect at the time the contract is
executed are the responsibility of the customer and others provide that currency
fluctuations from the rates in effect at the time the contract is executed up to
a specified threshold (generally plus or minus a few percentage points) are
absorbed by Covance while fluctuations in excess of the threshold are the
customer's responsibility, most contracts do not specifically address
responsibility for currency fluctuations. Historically, fluctuations in exchange
rates from those in effect at the time contracts were executed have not had a
material effect upon Covance's consolidated financial results.
The second risk results from the passage of time between the invoicing of
customers under these contracts and the ultimate collection of customer payments
against such invoices. Because the contract is denominated in a currency other
than the subsidiary's local currency, Covance recognizes a receivable at the
time of invoicing for the local currency equivalent of the foreign currency
invoice amount. Changes in exchange rates from the time the invoice is prepared
and payment from the customer is received will result in Covance receiving
either more or less in local currency than the local currency equivalent of the
invoice amount at the time the invoice was prepared and the receivable
established. This difference is recognized by Covance as a foreign currency
transaction gain or loss, as applicable, and is reported in other expense
(income) in Covance's Consolidated Statements of Income.
Finally, Covance's consolidated financial statements are denominated in
U.S. dollars. Accordingly, changes in exchange rates between the applicable
foreign currency and the U.S. dollar will affect the translation of each foreign
subsidiary's financial results into U.S. dollars for purposes of reporting
Covance's consolidated financial results. The process by which each foreign
subsidiary's financial results are translated into U.S. dollars is as follows:
income statement accounts are translated at average exchange rates for the
period; balance sheet asset and liability accounts are translated using end of
period exchange rates; and equity accounts are translated at historical rates.
Translation of the balance sheet in this manner affects the stockholders' equity
account, referred to as the cumulative translation adjustment account. This
account exists only in the foreign subsidiary's U.S. dollar balance sheet and is
necessary to keep the foreign balance sheet stated in U.S. dollars in balance.
To date such cumulative translation adjustments have not been material to
Covance's consolidated financial position.
Taxes
Since Covance conducts operations on a global basis, Covance's effective
tax rate has and will continue to depend upon the geographic distribution of its
pretax earnings among locations with varying tax rates. Covance's profits are
further impacted by changes in the tax rates of the various jurisdictions. In
particular, as the geographic mix of Covance's pre-tax earnings among various
tax jurisdictions changes, Covance's effective tax rate may vary from period to
period.
Inflation
While most of Covance's net revenues are earned under contracts, the
long-term contracts (those in excess of one year) generally include an inflation
or cost of living adjustment for the portion of the services to be performed
beyond one year from the contract date. As a result, Covance believes that the
effects of inflation generally do not have a material adverse effect on its
operations or financial condition.
10
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Year 2000 Issues
Information systems are an integral part of the services and products
Covance provides. Covance has formed a group, led by its Year 2000 Project
Director working in conjunction with a steering committee of executives from
Covance, to implement Covance's Year 2000 assessment and remediation plan (the
"Plan") from an internal, supplier and customer perspective. Presently, there
are approximately 32 full-time employee equivalents who are dedicated to the
Year 2000 project. This Plan is being executed under the guidance of Covance's
senior management, including the Chief Executive Officer and the Board of
Directors. Specifically, the Plan is managed at the operational level by the
General Manager and Group President of the applicable business. In addition,
each business location undergoes periodic comprehensive management reviews with
other executives of Covance, including the Chief Executive Officer, the Chief
Financial Officer and the General Counsel concerning the Year 2000 readiness of
such location. The Board of Directors also periodically reviews with Covance's
management the progress under the Plan.
State of Readiness. The Plan is intended to provide a comprehensive and
rigorous methodology for identifying and addressing the risks of Year 2000
problems to Covance. Its goal is to minimize the number and seriousness of any
defects and related disruptions or problems stemming from Year 2000 issues and
to quickly repair any that do occur. Covance's Plan has been divided into six
phases: inventory, risk assessment, evaluation, remediation, validation and
implementation.
The inventory is intended to cover all of Covance's systems and processes
that involve the use of dates irrespective of whether or not the system is
deemed Year 2000 compliant, including computer related hardware, computer
related software, internally developed systems, devices, equipment, scientific
instrumentation, outsourced services, outsourced products and client systems
that with which Covance interacts. The inventory phase also involves assessing
systems interrelationships to minimize the adverse effects non-compliant data or
systems could have on remediated systems. Risk assessment involves determining
the potential impact to Covance's operations because of Year 2000
non-compliance. Specifically, the most business critical systems are prioritized
and potential material liabilities identified. Evaluation involves determining
whether a system is Year 2000 compliant. The inventory, risk assessment and
evaluation phases of the Plan commenced in October 1997 and were substantially
completed for internal systems in May 1998.
In conjunction with the inventory, risk assessment and evaluations phases,
Covance has undertaken a company-wide Year 2000 awareness campaign for purposes
of employee awareness and involvement. Covance believes that employee awareness
will serve to maximize the completeness of its Year 2000 inventory and enhance
the effectiveness of the Plan generally.
Also as part of the inventory, assessment and evaluation phases, Covance is
conducting an assessment of material third-party relationships for Year 2000
compliance. These third parties include investigational sites, utility
companies, telecommunications companies, business specific product suppliers,
such as software, animal feed and reagent suppliers or providers, transportation
companies, and payroll and benefit services companies. Important vendors,
suppliers and service providers are being requested to supply Covance with
certification that their systems are Year 2000 compliant. Generally, where
certification cannot be obtained, or even when certification is obtained but the
risk of disruption to Covance's business is considered so potentially severe,
Covance is investigating alternative sources and considering stockpiling
supplies to guard against potential shortages. However, there can be no
assurances that Covance's suppliers, vendors and service providers will attain
Year 2000 compliance or that suitable alternative suppliers, vendors and service
providers can be engaged. It is possible that delays, increased costs or
supplier, vendor or service provider failures could have a material adverse
impact on Covance's business, financial condition, results of operations or cash
flows, by, for example, negatively effecting Covance's ability to meet its
contractual or regulatory obligations or service its customers.
While Covance is taking steps to raise awareness of the Year 2000 issue
among its customers, Covance does not believe it is appropriate to require
clients to certify their Year 2000 readiness and compliance. For the fiscal year
ended December 31, 1997, Covance had no single customer which accounted for
greater than 10% of its net revenues and only one customer which accounted for
more than 5% of its net revenues. However, in the event a significant customer
or group of customers were adversely effected by Year 2000 related problems,
Covance could experience a reduction of business and revenue and a consequent
material adverse effect on its business, financial condition, results of
operations or cash flows.
Remediation is defined as the phase of the Plan where systems are fixed to
maximize Year 2000 compliance so that they are able to properly calculate dates
without interfering with the proper operation of other components of the system.
Remediation includes, without limitation, the repair, replacement or removal of
non-compliant systems. Covance is presently in the process of remediating its
systems and will continue to do so, as necessary, for the duration of the Plan.
11
<PAGE>
In the validation phase of the Plan, remediated systems are required to be
tested and the testing to be documented. In addition, systems deemed compliant
in the evaluation phase are required to be documented as are vendor and supplier
systems. The validation phase is scheduled to be substantially completed for
business critical systems by March 1999.
The final phase of the Plan is the implementation phase where remediated
systems, which have undergone and completed validation, are put into operational
use and observed for interaction with other aspects and components of systems
that may or may not be related to the Year 2000 issue to ensure non-disruption
of essential functions. This phase is scheduled to be 95% completed for internal
business critical systems by August 1999 and completed for business critical
systems by December 1999.
Costs of Year 2000 Project. Covance has, beginning in early 1998, and
expects to continue, through the end of the year 2000, to incur costs and make
expenditures relating to the Year 2000 project. These costs and expenditures can
be broadly classified into two categories: amounts that will be expensed as
incurred (internal payroll relating to employees newly hired or redeployed to
work on the Year 2000 project, external consultants and the net book value of
non-Year 2000 compliant equipment to be replaced); and amounts that will be
capitalized and depreciated over the useful lives of the associated assets (the
purchase price of new hardware, software and other equipment acquired to replace
existing hardware, software and other equipment that is not Year 2000
compliant).
Covance currently estimates that the costs of internal payroll, external
consultants and the net book value of equipment to be replaced (amounts that
have and will be expensed as incurred) will total between $7.0 million and $8.0
million over the three year period ending December 31, 2000. Of these amounts, a
total of $1.2 million has been incurred and expensed during the nine months
ended September 30, 1998. Covance currently estimates that the cost of new
hardware, software and other equipment to be acquired in replacement of existing
non-Year 2000 compliant hardware, software and other equipment (amounts that
will be capitalized and depreciated over the useful lives of the related assets)
will total between $7.0 million and $9.0 million and will primarily be incurred
over the two year period ending December 31, 1999. Of these amounts,
capitalizable expenditures totaling $0.8 million have been made during the nine
month period ended September 30, 1998. The primary source of funds for all costs
to be incurred and expenditures to be made is expected to be provided by
Covance's operating cash flows.
Risks of Year 2000 Problems. Worst-case scenarios resulting from Year 2000
problems deemed by Covance to be most reasonably likely include the following:
loss of power and other utility services which could result in disruption to
existing and future studies generally, harm to specimens and test samples used
in studies and an adverse impact on the health and well being of the animals;
inability to obtain timely and sufficient supplies of reagents, lab ware or
animal feed, which could result in the inability to perform existing and future
laboratory and central laboratory studies and an adverse impact on the health
and well being of the animals; computer hardware, software and embedded
technology failure which could disrupt Covance's equipment, systems and networks
resulting in an inability to perform existing and future studies and/or an
adverse impact on the health and well being of patients; the loss of
telecommunications capabilities (both voice and data), which could result in an
inability for Covance to internally communicate or to communicate with, among
others, its clients and investigational sites; and the inability of Covance's
third party investigational sites to become Year 2000 compliant, which could
result in the loss to Covance of their services. Any one or more of these or
other events could result in business slowdowns or suspensions, subject Covance
to liability for breach of contract or personal injury and have a material
adverse effect on Covance's business, financial condition, results of operations
or cash flows.
While deferrals of scheduled information technology projects as a result of
the need to remediate Year 2000 problems are not presently expected to have a
material adverse effect on Covance's business, financial condition, results of
operations or cash flows, in the event the implementation of the Plan requires
greater expenditures or more qualified employees than presently estimated or
qualified information technology workers become more difficult or expensive to
attract and retain, certain significant projects may be subject to deferral. If
such deferrals occur, they may have a material adverse effect on Covance's
business, financial condition, results of operations or cash flows.
Contingency Plans. Covance has developed and is continuing to develop
contingency plans for handling these critical areas in the event remediation is
unsuccessful. Contingency plans include the utilization of back-up generators
for power supply; identifying alternative suppliers for reagents, animal feed
and other supplies as well as stockpiling significant quantities of such
supplies in advance of the year 2000; porting from one long distance carrier to
another and utilizing cell phones and call access cards when available; and
manning interactive voice response system phones with staff and manually
randomizing systems on
12
<PAGE>
paper to ensure the continued validity of studies. Contingency plans not yet
developed will be developed on a case by case basis and are scheduled to be in
place by September 1999. Contingency plans themselves; however, are subject to
variables and uncertainties and therefore there can be no assurance that Covance
will correctly anticipate the level, impact or duration of non-compliance of
computer hardware, software, systems or suppliers, vendors or service providers
(which may supply inaccurate information to Covance or otherwise be unable to
provide their service or product free of defect or disruption arising from Year
2000 problems) or that its contingency plans will be sufficient to mitigate the
impact of non-compliance. Thus, there can be no assurance that the Year 2000
problem, even after giving effect to the implementation of applicable
contingency plans, will not materialize and such occurrence could have a
material adverse impact on Covance's business, financial condition, results of
operations or cash flows.
Forward Looking Statements. Statements in this Management's Discussion and
Analysis of Financial Condition and Results of Operations, as well as in certain
other parts of this quarterly report on Form 10-Q that look forward in time, are
forward looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Forward looking statements
include statements concerning plans, objectives, goals, strategies, future
events or performance, expectations, predictions, and assumptions and other
statements which are other than statements of historical facts. All such forward
looking statements are based on the current expectations of management and are
subject to, and are qualified by, risks and uncertainties that could cause
actual results to differ materially from those expressed or implied by those
statements. These risks and uncertainties include, but are not limited to,
Covance's ability to identify and correct all relevant computer codes and
embedded chips, Covance's ability to attract and retain qualified information
technology personnel to address and remediate Year 2000 problems, the
availability or affordability of alternative sources for critical supplies and
services, the effect of the Year 2000 problem on Covance's suppliers, customers
and other third parties, Covance's ability to estimate costs of Year 2000
remediation and predict problems and costs that might arise with respect to Year
2000 issues, Covance's ability to address other Year 2000 issues, and risks and
uncertainties set forth in Covance's filings with the Securities and Exchange
Commission including without limitation its Annual Report on Form 10-K.
New Accounting Pronouncements
In June 1997, the FASB issued Statement No. 131, Disclosures about Segments
of an Enterprise and Related Information ("SFAS 131"). SFAS 131 establishes
standards for the way that public business enterprises report information about
operating segments in annual and interim financial statements. It also
establishes standards for related disclosures about products and services,
geographic areas and major customers. SFAS 131 shall be effective for financial
statements for fiscal years beginning after December 15, 1997 (calendar year
1998 for Covance). Financial statement disclosures for prior periods are
required to be restated. Covance is in the process of evaluating the disclosure
requirements. SFAS 131, by its nature, will not impact Covance's consolidated
results of operations, financial position or cash flows.
In March 1998, the Accounting Standards Executive Committee ("AcSEC") of
the American Institute of Certified Public Accountants issued Statement of
Position 98-1, Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use ("SOP 98-1"). SOP 98-1 provides guidance for the
accounting treatment of various costs typically incurred during the development
or purchase of computer software for internal use. SOP 98-1 shall be effective
for fiscal periods beginning after December 15, 1998 (calendar year 1999 for
Covance). Historically, Covance's policy has been to expense internal costs
associated with software developed for internal use. Upon adoption of SOP 98-1
in 1999, Covance may capitalize certain internal software development costs,
which under Covance's current policy would have been expensed. Had Covance
accounted for internal software development costs in 1998 in accordance with SOP
98-1, results of operations, financial position and cash flows would not have
been materially different.
In April 1998, the AcSEC issued Statement of Position 98-5, Reporting on
the Costs of Start-Up Activities ("SOP 98-5"). SOP 98-5 provides guidance on the
financial reporting of start-up and organization costs; requiring such costs be
expensed as incurred. SOP 98-5 shall be effective for fiscal periods beginning
after December 15, 1998 (calendar year 1999 for Covance). Application of SOP
98-5 is not expected to have a material impact on Covance's consolidated results
of operations, financial position or cash flows.
In June 1998, the FASB issued Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities ("SFAS 133"). SFAS 133 provides a
comprehensive and consistent standard for the recognition and measurement of
derivatives and hedging activities and requires all derivatives to be recorded
on the balance sheet at fair value. SFAS 133 is effective for years beginning
after September 15, 1999 (calendar year 2000 for Covance). Adoption of SFAS 133
is not expected to have a material impact on Covance's consolidated results of
operations, financial position or cash flows.
13
<PAGE>
Part I. Financial Information
Item 3. Quantitative and Qualitative Disclosure About Market Risk
not applicable
14
<PAGE>
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(1) Exhibit 27 - Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K
none
15
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
COVANCE INC.
Dated: November 11, 1998 By: /s/ Christopher A. Kuebler
--------------------------------
Christopher A. Kuebler
Chairman of the Board, President
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
Signature Title Date
/s/ Christopher A. Kuebler
------------------------
Christopher A. Kuebler Chairman of the Board, November 11, 1998
President and Chief
Executive Officer
(Principal Executive Officer)
/s/ Charles C. Harwood, Jr.
------------------------
Charles C. Harwood, Jr. Corporate Senior Vice President November 11, 1998
and Chief Financial Officer
(Principal Financial Officer)
/s/ Michael Giannetto
------------------------
Michael Giannetto Corporate Vice President November 11, 1998
and Controller
(Principal Accounting Officer)
16
<PAGE>
EXHIBIT INDEX
Exhibit Description
27 Financial Data Schedule (for SEC use only)
17
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial
information extracted from the Covance
consolidated financial statements for the nine
months ended September 30, 1998 and is qualified
in its entirety by reference to such financial
statements.
</LEGEND>
<CIK> 0001023131
<NAME> Covance Inc.
<MULTIPLIER> 1
<CURRENCY> US$
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1
<CASH> 11,475,000
<SECURITIES> 0
<RECEIVABLES> 187,894,000
<ALLOWANCES> 0
<INVENTORY> 23,766,000
<CURRENT-ASSETS> 273,027,000
<PP&E> 242,163,000
<DEPRECIATION> 25,051,000
<TOTAL-ASSETS> 548,402,000
<CURRENT-LIABILITIES> 185,421,000
<BONDS> 0
0
0
<COMMON> 582,000
<OTHER-SE> 70,928,000
<TOTAL-LIABILITY-AND-EQUITY> 548,402,000
<SALES> 0
<TOTAL-REVENUES> 532,785,000
<CGS> 351,433,000
<TOTAL-COSTS> 463,894,000
<OTHER-EXPENSES> 203,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,290,000
<INCOME-PRETAX> 63,398,000
<INCOME-TAX> 26,577,000
<INCOME-CONTINUING> 36,383,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 36,383,000
<EPS-PRIMARY> 0.63
<EPS-DILUTED> 0.62
</TABLE>
