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 March 31, 1999
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 April 16, 1999, the Registrant had 58,609,289 shares of Common Stock
outstanding.
<PAGE>
Covance Inc.
Form 10-Q For the Quarterly Period Ended March 31, 1999
INDEX
<TABLE>
<CAPTION>
Page
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<S> <C>
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets--March 31, 1999 and December 31, 1998.......................... 3
Consolidated Statements of Income--Three Months ended March 31, 1999 and 1998.............. 4
Consolidated Statements of Cash Flows--Three Months ended March 31, 1999 and 1998.......... 5
Notes to Consolidated Financial Statements................................................. 6
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations................................................................................ 8
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
</TABLE>
2
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COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
MARCH 31, 1999 AND DECEMBER 31, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
(Dollars in thousands) March 31, December 31,
1999 1998
----- ----
<S> <C> <C>
Assets
Current Assets:
Cash and cash equivalents................................. $ 20,073 $ 19,263
Accounts receivable, net................................... 136,643 139,145
Unbilled services.......................................... 58,298 41,589
Inventory.................................................. 25,264 26,726
Deferred income taxes...................................... 9,800 9,671
Prepaid expenses and other assets.......................... 37,172 38,095
-------- --------
Total Current Assets.................................... 287,250 274,489
Property and equipment, net.................................... 242,755 237,587
Goodwill, net.................................................. 86,205 71,999
Other assets................................................... 11,279 9,340
-------- --------
Total Assets............................................ $627,489 $593,415
======== ========
Liabilities and Stockholders' Equity
Current Liabilities:
Accounts payable........................................... $ 32,185 $ 33,381
Accrued payroll and benefits............................... 37,137 41,505
Accrued expenses and other liabilities..................... 41,525 39,117
Unearned revenue........................................... 55,943 60,226
Short-term debt............................................ 13,000 13,000
Income taxes payable....................................... 12,190 5,772
-------- --------
Total Current Liabilities............................... 191,980 193,001
Long-term debt................................................. 169,167 149,909
Deferred income taxes.......................................... 11,607 12,416
Other liabilities.............................................. 15,242 13,074
-------- --------
Total Liabilities....................................... 387,996 368,400
-------- --------
Commitments and Contingent Liabilities
Stockholders' Equity:
Common Stock - Par value $0.01 per share; 140,000,000
shares authorized; 58,609,289 and 58,417,536 shares issued
and outstanding at March 31, 1999 and December 31, 1998,
respectively............................................... 586 584
Paid-in capital............................................ 82,343 75,853
Retained earnings.......................................... 159,520 146,372
Accumulated other comprehensive income--
Cumulative translation adjustment....................... (2,956) 2,206
-------- --------
Total Stockholders' Equity.............................. 239,493 225,015
-------- --------
Total Liabilities and Stockholders' Equity.............. $627,489 $593,415
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
3
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COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31
---------------------------
(Dollars in thousands, except per share data) 1999 1998
----------- -----------
<S> <C> <C>
Net revenues ..................................... $210,632 $168,509
Cost and expenses:
Cost of revenue .............................. 141,430 112,729
Selling, general and administrative expenses . 33,811 26,911
Depreciation and amortization ................ 11,225 8,555
-------- --------
Total ................................... 186,466 148,195
-------- --------
Income from operations ........................... 24,166 20,314
-------- --------
Other expense, net:
Interest expense, net ........................ 1,986 1,695
Other (income) expense ....................... (80) 113
-------- --------
Other expense, net ...................... 1,906 1,808
-------- --------
Income before taxes and equity investee results .. 22,260 18,506
Taxes on income .................................. 9,112 7,860
Equity investee loss ............................. -- 194
-------- --------
Net income ....................................... $ 13,148 $ 10,452
======== ========
Basic earnings per share ......................... $0.22 $0.18
Weighted average shares outstanding - basic ...... 58,562,963 57,775,312
Diluted earnings per share ....................... $0.22 $0.18
Weighted average shares outstanding - diluted .... 59,827,159 58,241,983
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
4
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COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE THREE MONTHS ENDED MARCH 31, 1999 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31
-----------------------------
(Dollars in thousands) 1999 1998
------------ -----------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................. $ 13,148 $ 10,452
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ...................... 11,225 8,555
Stock issued under employee benefit and stock
compensation plans ............................... 2,178 1,352
Deferred income tax provision ...................... (938) 89
Other .............................................. 26 219
Changes in operating assets and liabilities:
Accounts receivable .............................. 2,502 1,227
Unbilled services ................................ (16,709) (8,290)
Inventory ........................................ 1,462 (1,668)
Accounts payable ................................. (1,196) (1,724)
Accrued liabilities .............................. (1,960) (7,847)
Unearned revenue ................................. (4,283) 1,390
Income taxes payable ............................. 6,418 7,614
Other assets and liabilities, net ................ 1,306 (3,110)
-------- --------
Net cash provided by operating activities .............. 13,179 8,259
-------- --------
Cash flows from investing activities:
Capital expenditures ............................... (20,196) (9,957)
Acquisition of businesses .......................... (15,133) --
Other, net ......................................... 301 10
-------- --------
Net cash used in investing activities .................. (35,028) (9,947)
-------- --------
Cash flows from financing activities:
Proceeds from long-term debt ....................... 20,000 --
Repayments of long-term debt ....................... -- (10,000)
Stock issued under employee stock purchase and
stock option plans ............................... 2,659 1,391
-------- --------
Net cash provided by (used in) financing activities .... 22,659 (8,609)
-------- --------
Net change in cash and cash equivalents ................ 810 (10,297)
Cash and cash equivalents, beginning of period ......... 19,263 28,027
-------- --------
Cash and cash equivalents, end of period ............... $ 20,073 $ 17,730
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
5
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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
March 31, 1999 and 1998
1. Basis of Presentation
The accompanying unaudited consolidated financial statements reflect all
normal recurring adjustments 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 not been audited and are
subject to such year-end adjustments as may be considered appropriate. You
should read these consolidated financial statements together with the historical
consolidated financial statements of Covance Inc. and subsidiaries ("Covance")
for the years ended December 31, 1998, 1997 and 1996 included in the Annual
Report on Form 10-K for the fiscal year ended December 31, 1998. Operating
results for the three months ended March 31, 1999 are not necessarily indicative
of the results that may be expected for the year ending December 31, 1999.
2. Summary of Significant Accounting Policies
Use of Estimates
These unaudited consolidated financial statements have been prepared in
conformity with generally accepted accounting principles. Generally accepted
accounting principles require 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 ("FASB") Statement No. 128, Earnings Per Share. In
computing diluted earnings per share for the three months ended March 31, 1999
and 1998, the denominator was increased by 1,264,196 shares and 466,671 shares,
respectively, representing the dilution of stock options outstanding at March
31, 1999 and 1998 with exercise prices less than the average market price of
Covance's Common Stock during each respective period.
Comprehensive Income
Comprehensive income has been calculated in accordance with FASB Statement
No. 130, Reporting Comprehensive Income. Covance has determined total
comprehensive income to be $8.0 million and $9.2 million for the three months
ended March 31, 1999 and 1998, respectively. Covance's total comprehensive
income represents net income plus the change in the cumulative translation
adjustment equity account for the periods presented.
Segment Reporting
Covance reports information about its operating segments and related
disclosures about products, services, geographic areas and major customers in
accordance with FASB Statement No. 131, Disclosures About Segments of an
Enterprise and Related Information. See Note 5 for segment disclosure.
3. Supplemental Cash Flow Information
Cash paid for interest for the three months ended March 31, 1999 and 1998
totaled $2.3 million and $1.7 million, respectively. Cash paid for income taxes
for the three months ended March 31, 1999 and 1998 totaled $2.5 million and $0.7
million, respectively.
4. Acquisition
In March 1999, Covance paid $15.1 million in contingent purchase price in
connection with its 1996 purchase of Health Technology Associates, Inc. The
goodwill associated with this acquisition aggregated $28.8 million.
6
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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (cont'd)
(UNAUDITED)
March 31, 1999 and 1998
5. Segment Information
Covance has two reportable segments: early development and late-stage
development. Early development services, which consist of Covance's preclinical
and Phase I clinical service capabilities, involve evaluating a new compound for
safety and early effectiveness as well as evaluating the absorption,
distribution, metabolism and excretion of the compound in the human body. It is
at this stage that a pharmaceutical company, based on available data, will
generally decide whether to continue further development of a drug. Late-stage
development services, which consist of Covance's clinical and clinical support
service capabilities, are geared toward demonstrating the clinical effectiveness
of a compound in treating certain diseases or conditions, obtaining regulatory
approval and maximizing the drug's commercial potential.
The accounting policies of the reportable segments are the same as those
described in Note 2. Segment net revenues and operating income for the three
months ended March 31, 1999 and 1998 are as follows:
<TABLE>
<CAPTION>
Early Late-Stage
Development Development Total
----------- ----------- -----
<S> <C> <C> <C>
Three months ended March 31, 1999
Net revenues from external customers $ 65,583 $ 145,049 $ 210,632
Operating income $ 7,990 $ 16,176 $ 24,166
Three months ended March 31, 1998
Net revenues from external customers $ 56,948 $ 111,561 $ 168,509
Operating income $ 8,301 $ 12,013 $ 20,314
</TABLE>
6. Subsequent Event
On April 28, 1999, Covance and PAREXEL International Corporation
("PAREXEL") entered into an Agreement and Plan of Merger whereby PAREXEL will
become a wholly-owned subsidiary of Covance. Under the terms of the agreement,
PAREXEL shareholders will receive 1.184 shares of Covance common stock for each
share of PAREXEL stock they hold. The tax-free merger, to be structured as a
pooling-of-interests, is contingent upon the approval of both regulators and
shareholders of both companies.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
You should read the following discussion together with the unaudited
Covance consolidated financial statements and the accompanying notes included in
this Quarterly Report on Form 10-Q for the quarter ended March 31, 1999.
Overview
Covance is a leading contract research organization 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 provides services such as health economics and outcomes
for managed care organizations, hospitals and other health care providers and
laboratory testing to the chemical, agrochemical and food industries. The
foregoing services comprise two segments for financial reporting purposes: early
development services (preclinical and Phase I clinical); and late-stage
development services (clinical and clinical support services). Covance believes
it is one of the largest biopharmaceutical contract research organizations,
based on 1998 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. This enables
Covance's customers to introduce their products into the marketplace faster and
as a result, maximize the period of market exclusivity and monetary return on
their research and development investments. Additionally, Covance's
comprehensive services and broad experience provide its customers with a
variable cost alternative to fixed cost internal development capabilities.
Historically, a majority of Covance's net revenues have been earned under
contracts. These contracts 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. Additional payments are made based upon the
achievement of performance based milestones over the contract duration. 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 these investigator fees are paid by
the customers to Covance on a "pass-through basis" (i.e., without risk or reward
to Covance). Most contracts are terminable either immediately or upon notice by
the client. These contracts typically require payment to Covance of expenses to
wind down a study, payment to Covance of fees earned to date, and, in some
cases, a termination fee or a payment to Covance of some portion of the fees or
profit that could have been earned by Covance under the contract if it had not
been terminated early.
Covance segregates its recurring operating expenses among three categories:
cost of revenue; selling, general and administrative expenses; and depreciation
and amortization. Cost of revenue consists of appropriate amounts necessary to
complete the revenue and earnings process, and includes direct labor and related
benefit charges, other direct costs, and an allocation of facility charges and
information technology costs. Cost of revenue, as a percentage of net revenues,
tends and is expected to fluctuate from one period to another, generally within
a range of up to 200 basis points in either direction. This variability is
principally a result of changes in labor utilization and the mix of service
offerings involving hundreds of studies conducted during any period of time.
Selling, general and administrative expenses consist primarily of administrative
payroll and related benefit charges, advertising and promotional expenses,
administrative travel and an allocation of facility charges and information
technology costs.
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
(1) delays in initiating or completing significant drug development trials, (2)
termination of drug development trials, (3) acquisitions and (4) exchange rate
fluctuations. Delays and terminations of trials are often the result of actions
taken by Covance's customers or regulatory authorities and are not typically
controllable by Covance. Since a large amount of Covance's operating costs are
relatively fixed while revenue is subject to fluctuation, minor variations in
the commencement, progress or completion of drug development trials may cause
significant variations in quarterly operating results.
8
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Results of Operations
Three Months Ended March 31, 1999 Compared with Three Months Ended March 31,
1998. Net revenues increased 25.0% to $210.6 million for the three months ended
March 31, 1999 from $168.5 million for the corresponding 1998 period. Excluding
the impact of acquisitions, net revenues increased 22.3%. Net revenues from
Covance's late-stage development services grew 30.0%, or 27.9% excluding the
impact of acquisitions, benefiting from the continuing trend in outsourcing of
clinical development activities. Net revenues from Covance's more mature early
development services grew 15.2%, or 11.4% excluding the impact of acquisitions.
Cost of revenue increased 25.5% to $141.4 million for the three months
ended March 31, 1999 from $112.7 million for the corresponding 1998 period as a
result of the increase in net revenues. Cost of revenue, as a percentage of net
revenues, was 67.1% and 66.9% for the three months ended March 31, 1999 and
1998, respectively.
Overall, selling, general and administrative expenses increased 25.6% to
$33.8 million for the three months ended March 31, 1999 from $26.9 million for
the corresponding 1998 period. As a percentage of net revenues, selling, general
and administrative expenses increased 10 basis points to 16.1% for the three
months ended March 31, 1999 from 16.0% for the corresponding 1998 period.
Depreciation and amortization increased 31.2% to $11.2 million or 5.3% of
net revenues for the three months ended March 31, 1999 from $8.6 million or 5.1%
of net revenues for the corresponding 1998 period due primarily to the goodwill
amortization resulting from the November 1998 acquisitions.
Income from operations increased 19.0% to $24.2 million for the three
months ended March 31, 1999 from $20.3 million for the corresponding 1998
period. As a percentage of net revenues, income from operations decreased to
11.5% for the three months ended March 31, 1999 from 12.1% for the corresponding
1998 period. This decrease is a result of the increases in cost of revenue,
selling, general and administrative expenses and depreciation and amortization.
Contributing to part of the increased cost of revenue and selling, general and
administrative expenses was approximately $1.4 million in additional Y2K
expenses in the 1999 three-month period as compared to the corresponding 1998
three-month period. Income from operations from Covance's late-stage and early
development segments totaled $16.2 million and $8.0 million, respectively, at
March 31, 1999 and $12.0 million and $8.3 million, respectively, at March 31,
1998.
Other expense increased $0.1 million to $1.9 million for the three
months ended March 31, 1999 from $1.8 million for the corresponding 1998 period.
Covance's effective tax rate for the three months ended March 31, 1999
decreased to 40.9% from 42.5% for the corresponding 1998 period. Since Covance
operates on a global basis, its effective tax rate is subject to variation from
period to period due to the changes in the geographic distribution of its
pre-tax earnings.
Net income increased 25.8% to $13.1 million for the three months ended
March 31, 1999 from $10.5 million for the corresponding 1998 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 a combination of borrowing under its long-term
revolving credit facility, cash generated from operations and possible future
capital market financings 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 March 31, 1999, there was $160.0
million of outstanding borrowings and $11.3 million of outstanding letters of
credit, with a remaining availability of $78.7 million under Covance's long-term
revolving credit facility.
At March 31, 1999, Covance Biotechnology Services Inc. ("Covance
Biotechnology") had $3.0 million in short-term debt outstanding with the North
Carolina Biotechnology Center. This debt matures in December 1999 and is
guaranteed by Covance. In addition, Covance Biotechnology has a $10.0 million
short-term revolving credit facility with a bank, of which $10.0 million of
borrowings were outstanding as of March 31, 1999. 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
guaranteed by Covance.
9
<PAGE>
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 October 2000. 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 three months ended March 31, 1999, Covance's operations provided
net cash of $13.2 million, an increase of $4.7 million from the corresponding
1998 period. Cash flows from net earnings adjusted for non-cash activity
provided $25.6 million for the three months ended March 31, 1999, up $5.0
million or 24.1% from the corresponding 1998 period. The change in net operating
assets used $12.5 million and $12.4 million in cash during the three months
ended March 31, 1999 and 1998, respectively.
Working capital was $95.3 million at March 31, 1999, an increase of $13.8
million from December 31, 1998. Aggregate accounts receivable and unbilled
services at March 31, 1999 of $194.9 million were up $14.2 million or 7.9% from
the December 31, 1998 level of $180.7 million. Covance's ratio of current assets
to current liabilities was 1.50 at March 31, 1999 and 1.42 at December 31, 1998.
Investing activities for the three months ended March 31, 1999 used $35.0
million compared to $9.9 million for the corresponding 1998 period. Capital
spending for the first three months of 1999 totaled $20.2 million, primarily for
outfitting of new facilities, purchase of new equipment, upgrade of existing
equipment and computer equipment and software for newly hired employees,
compared to $10.0 million for the corresponding 1998 period. Investing
activities for the three months ended March 31, 1999 also included a cash
payment of contingent purchase price totaling approximately $15.1 million in
connection with Covance's 1996 purchase of Health Technology Associates, Inc.
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 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. Some contracts provide that currency fluctuations from the
rates in effect at the time the contract is executed are the responsibility of
the customer. Other contracts 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 at end of
period exchange rates; and equity accounts are translated at historical exchange
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.
10
<PAGE>
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 taxing
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.
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 with a steering committee of executives from Covance, to
implement Covance's Year 2000 assessment and remediation plan. This plan
approached the Year 2000 problem from an internal, supplier and customer
perspective. Presently, there are approximately 66 full-time employee
equivalents who are dedicated to the Year 2000 project. This Year 2000 plan is
being executed under the guidance of Covance's senior management, including the
Chief Executive Officer and the Board of Directors. Specifically, the General
Manager and Group President of each applicable business location manage the Year
2000 plan at an operational level. In addition, other executives of Covance,
including the Chief Executive Officer, the Chief Financial Officer and the
General Counsel periodically review each business location concerning the Year
2000 readiness of the location. The Board of Directors also periodically reviews
with Covance's management the progress under the Year 2000 plan.
State of Readiness. The Year 2000 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 Year 2000
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, whether or not the system is deemed Year 2000
compliant, including:
o computer related hardware;
o computer related software;
o internally developed systems;
o devices, equipment and scientific instrumentation;
o outsourced services;
o outsourced products; and
o client systems that Covance interacts with
We also assess systems interrelationships to minimize the adverse effects
non-compliant data or systems could have on remediated systems. During the risk
assessment we determine 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 Year 2000 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 and operation specific Year 2000 awareness
campaign for purposes of employee awareness and involvement. Covance believes
that employee awareness will maximize the completeness of its Year 2000
inventory and enhance the effectiveness of the Year 2000 plan generally.
11
<PAGE>
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, or to tell us that
they are not. 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, we cannot assure you 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 and 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, 1998, 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, if a significant customer or group of
customers were adversely effected by Year 2000 related problems, Covance's
business and revenue could be reduced and a material adverse effect on our
business, financial condition, results of operations and cash flows could
result.
Remediation is defined as the phase of the Year 2000 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 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 Year 2000 plan.
In the validation phase of the Year 2000 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 has been substantially
completed for internal business critical systems, and is scheduled to be
completed for all other business critical systems by August 31, 1999.
The final phase of the Year 2000 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 that
they function as intended. 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. Beginning in early 1998, Covance began to incur
costs and make expenditures related to the Year 2000 project. Covance expects to
continue to incur costs and make expenditures relating to the Year 2000 project
through the end of the year 2000. These costs and expenditures can be broadly
classified into two categories:
(1) amounts that will be expensed as incurred. These amounts consist of
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
(2) amounts that will be capitalized and depreciated over the useful lives
of the associated assets. These amounts consist of 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 $7.9 million and $9.0
million over the three year period ending December 31, 2000. Of these amounts, a
total of $1.5 million has been incurred and expensed during the three month
period ended March 31, 1999 and a total of $2.3 million was incurred and
expensed during 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, will total between $8.0
million and $9.2 million. These amounts will be capitalized and depreciated over
the useful lives of the related assets and will primarily be incurred over the
two year period ending December 31, 1999. Of these amounts, capitalizable
expenditures totaling $2.0 million have been
12
<PAGE>
made during the three month period ended March 31, 1999 and $1.7 million have
been made during the year ended December 31, 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:
o loss of power and other utility services which could result in
disruption to existing and future studies generally;
o harm to specimens and test samples used in studies and an adverse
impact on the health and well being of the animals;
o 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;
o 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;
o the loss of voice and data telecommunications capabilities, which
could result in an inability for Covance to internally communicate or
to communicate with, among others, its clients and investigational
sites; and
o 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 a material adverse effect on our business, financial condition,
results of operations and cash flows could result.
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 and cash flows. However, in the event the implementation of the Year
2000 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
and cash flows.
Contingency Year 2000 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:
o the utilization of back-up generators for power supply;
o 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;
o porting from one long distance carrier to another and utilizing cell
phones and call access cards when available; and
o manning interactive voice response system phones with staff and
manually randomizing systems on 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. However, contingency
plans themselves are subject to variables and uncertainties. Therefore, we
cannot assure you that Covance will correctly anticipate the level, impact or
duration of non-compliance of computer hardware, software, systems or suppliers.
We also cannot assure you that we will correctly anticipate the 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. We also cannot assure you that our
contingency plans will be adequate. Thus, there can be no assurance that the
Year 2000 problem, even after giving effect to the implementation of applicable
contingency plans, will not happen and this occurrence could have a material
adverse impact on Covance's business, financial condition, results of operations
and 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 contain statements that look
forward in time. These statements are forward looking statements made under the
safe harbor provisions of the Private
13
<PAGE>
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 not statements of historical facts. All our forward looking statements
are based on our current expectations and may be effected 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:
o Covance's ability to identify and correct all relevant computer codes
and embedded chips;
o Covance's ability to attract and retain qualified information
technology personnel to address and remediate Year 2000 problems;
o the availability or affordability of alternative sources for critical
supplies and services;
o the effect of the Year 2000 problem on Covance's suppliers, customers
and other third parties;
o Covance's ability to estimate costs of Year 2000 remediation and
predict problems and costs that might arise with respect to Year 2000
issues; and
o 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.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
See Management's Discussion and Analysis of Financial Condition and Results of
Operations
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
During the three month period ended March 31, 1999, no reports on Form
8-K were filed. Subsequently, Covance filed one report on Form 8-K dated May 4,
1999, reporting its announcement on April 29, 1999 of an Agreement and Plan of
Merger between Covance and PAREXEL International Corporation.
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: May 7, 1999 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.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Christopher A. Kuebler
- --------------------------
Christopher A. Kuebler Chairman of the Board, President May 7, 1999
and Chief Executive Officer
(Principal Executive Officer)
/s/ Charles C. Harwood, Jr.
- --------------------------
Charles C. Harwood, Jr. Corporate Senior Vice President May 7, 1999
and Chief Financial Officer
(Principal Financial Officer)
/s/ Michael Giannetto
- --------------------------
Michael Giannetto Corporate Vice President May 7, 1999
and Controller
(Principal Accounting Officer)
</TABLE>
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 quarter ended March 31, 1999
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> YEAR
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> MAR-31-1999
<EXCHANGE-RATE> 1
<CASH> 20,073,000
<SECURITIES> 0
<RECEIVABLES> 194,941,000
<ALLOWANCES> 0
<INVENTORY> 25,264,000
<CURRENT-ASSETS> 287,250,000
<PP&E> 446,376,000
<DEPRECIATION> 203,621,000
<TOTAL-ASSETS> 627,489,000
<CURRENT-LIABILITIES> 191,980,000
<BONDS> 0
0
0
<COMMON> 586,000
<OTHER-SE> 238,907,000
<TOTAL-LIABILITY-AND-EQUITY> 627,489,000
<SALES> 0
<TOTAL-REVENUES> 210,632,000
<CGS> 141,430,000
<TOTAL-COSTS> 186,466,000
<OTHER-EXPENSES> (80,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,986,000
<INCOME-PRETAX> 22,260,000
<INCOME-TAX> 9,112,000
<INCOME-CONTINUING> 13,148,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 13,148,000
<EPS-PRIMARY> 0.22
<EPS-DILUTED> 0.22
</TABLE>
