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 June 30, 2000
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.
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(Exact name of Registrant as specified in its Charter)
Delaware 22-3265977
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(State of Incorporation) (I.R.S. Employer Identification No.)
210 Carnegie Center, Princeton, New Jersey 08540
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(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 July 14, 2000, the Registrant had 57,303,310 shares of Common Stock
outstanding.
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COVANCE INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets--June 30, 2000 and
December 31, 1999............................................. 3
Consolidated Statements of Operations--Three and Six Months
ended June 30, 2000 and 1999.................................. 4
Consolidated Statements of Cash Flows--Six Months ended
June 30, 2000 and 1999........................................ 5
Notes to Consolidated Financial Statements....................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 9
Item 3. Quantitative and Qualitative Disclosure About Market Risk. 15
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders....... 16
Item 6. Exhibits and Reports on Form 8-K.......................... 17
SIGNATURE PAGE..................................................... 18
2
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<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
JUNE 30, 2000 AND DECEMBER 31, 1999
(DOLLARS IN THOUSANDS) June 30, December 31,
2000 1999
--------- ---------
(UNAUDITED)
ASSETS
Current Assets:
<S> <C> <C>
Cash and cash equivalents ................................... $ 14,217 $ 25,444
Accounts receivable, net .................................... 173,523 139,680
Unbilled services ........................................... 57,232 52,647
Inventory ................................................... 27,575 26,474
Deferred income taxes ....................................... 22,129 17,292
Prepaid expenses and other current assets ................... 49,511 40,587
--------- ---------
Total Current Assets ..................................... 344,187 302,124
Property and equipment, net ..................................... 309,718 296,943
Goodwill, net ................................................... 83,292 84,575
Other assets .................................................... 22,250 16,672
--------- ---------
Total Assets ............................................. $ 759,447 $ 700,314
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ............................................ $ 34,136 $ 25,715
Accrued payroll and benefits ................................ 33,033 34,138
Accrued expenses and other liabilities ...................... 34,817 36,172
Accrued restructuring ....................................... 15,665 4,146
Unearned revenue ............................................ 79,483 75,531
Short-term debt ............................................. 19,512 19,787
Income taxes payable ........................................ 326 4,388
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Total Current Liabilities ................................ 216,972 199,877
Long-term debt .................................................. 243,142 208,724
Deferred income taxes ........................................... 13,773 14,982
Other liabilities ............................................... 14,708 14,079
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Total Liabilities ........................................ 488,595 437,662
--------- ---------
Commitments and Contingent Liabilities
Stockholders' Equity:
Common Stock - Par value $0.01 per share; 140,000,000 shares
authorized 59,328,899 and 59,024,976 shares issued and
outstanding, including those held in treasury,
at June 30, 2000 and December 31, 1999, respectively . 593 590
Paid-in capital ............................................. 103,773 95,954
Retained earnings ........................................... 199,085 192,190
Accumulated other comprehensive income--
Cumulative translation adjustment ..................... (12,692) (6,504)
Treasury stock at cost (2,025,589 and 1,995,000 shares at
June 30, 2000 and December 31, 1999, respectively) .... (19,907) (19,578)
--------- ---------
Total Stockholders' Equity ............................... 270,852 262,652
--------- ---------
Total Liabilities and Stockholders' Equity ............... $ 759,447 $ 700,314
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
3
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<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2000 AND 1999
(UNAUDITED)
Three Months Ended Six Months Ended
June 30 June 30
---------------------------- ----------------------------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues ........................... $ 212,118 $ 215,060 $ 421,745 $ 425,692
Cost and expenses:
Cost of revenue ...................... 152,533 140,906 298,458 282,336
Selling, general and administrative .. 33,875 34,383 64,298 68,194
Depreciation and amortization ........ 13,498 11,567 26,854 22,792
Restructuring charge ................. 14,665 -- 14,665 --
Merger-related costs ................. -- 5,249 -- 5,249
------------ ------------ ------------ ------------
Total .............................. 214,571 192,105 404,275 378,571
------------ ------------ ------------ ------------
Income (loss) from operations .......... (2,453) 22,955 17,470 47,121
------------ ------------ ------------ ------------
Other expense, net:
Interest expense, net ................ 3,476 2,419 6,368 4,405
Other (income) expense ............... 245 161 (136) 81
------------ ------------ ------------ ------------
Other expense, net ................. 3,721 2,580 6,232 4,486
------------ ------------ ------------ ------------
Income (loss) before taxes ............. (6,174) 20,375 11,238 42,635
Taxes on income ........................ (2,431) 8,168 4,343 17,280
------------ ------------ ------------ ------------
Net income (loss) ...................... $ (3,743) $ 12,207 $ 6,895 $ 25,355
============ ============ ============ ============
Basic earnings (loss) per share ........ $ (0.07) $ 0.21 $ 0.12 $ 0.43
Weighted average shares
outstanding - basic .................. 57,289,753 58,751,478 57,163,477 58,657,220
Diluted earnings (loss) per share ...... $ (0.07) $ 0.21 $ 0.12 $ 0.43
Weighted average shares
outstanding - diluted ................ 57,312,310 59,348,559 57,204,265 59,600,313
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
4
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<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2000 AND 1999
(UNAUDITED)
Six Months Ended June 30
--------------------------
(DOLLARS IN THOUSANDS) 2000 1999
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................. $ 6,895 $ 25,355
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ...................... 26,854 22,792
Restructuring charge, net of cash paid ............. 14,317 --
Stock issued under employee benefit and stock
compensation plans ............................... 697 4,479
Deferred income tax provision ...................... (6,046) (451)
Other .............................................. 96 149
Changes in operating assets and liabilities:
Accounts receivable .............................. (33,843) (19,174)
Unbilled services ................................ (4,585) (11,883)
Inventory ........................................ (1,101) 1,676
Accounts payable ................................. 8,421 (3,292)
Accrued liabilities .............................. (5,258) 2,296
Unearned revenue ................................. 3,952 (7,712)
Income taxes payable ............................. (4,062) (174)
Other assets and liabilities, net ................ (9,029) 656
---------- ----------
Net cash (used in) provided by operating activities .... (2,692) 14,717
---------- ----------
Cash flows from investing activities:
Capital expenditures ............................... (44,040) (48,349)
Contingent purchase price paid in connection with
prior acquisitions ............................... (909) (16,128)
Other, net ......................................... 56 564
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Net cash used in investing activities .................. (44,893) (63,913)
---------- ----------
Cash flows from financing activities:
Net borrowings under revolving credit facility ..... 35,000 50,000
Repayments of long-term debt ....................... (582) --
Stock issued under employee stock purchase and
option plans ..................................... 2,269 5,014
Purchase of treasury stock ......................... (329) --
---------- ----------
Net cash provided by financing activities .............. 36,358 55,014
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Net change in cash and cash equivalents ................ (11,227) 5,818
Cash and cash equivalents, beginning of period ......... 25,444 19,263
---------- ----------
Cash and cash equivalents, end of period ............... $ 14,217 $ 25,081
========== ==========
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)
JUNE 30, 2000 AND 1999
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, 1999, 1998 and 1997 included in our Annual
Report on Form 10-K for the fiscal year ended December 31, 1999. Operating
results for the six months ended June 30, 2000 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2000.
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.
PREPAID EXPENSES AND OTHER CURRENT ASSETS
Covance routinely subcontracts with independent physician investigators in
connection with 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. Amounts receivable from
customers in connection with billed and unbilled investigator fees and
out-of-pocket pass-through costs are included in prepaid expenses and other
current assets in the accompanying Consolidated Balance Sheets and totaled $30.6
million and $27.3 million at June 30, 2000 and December 31, 1999, respectively.
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 June 30, 2000
and 1999, the denominator was increased by 22,557 shares and 597,081 shares,
respectively, and for the six months ended June 30, 2000 and 1999, the
denominator was increased by 40,788 shares and 943,093 shares, respectively,
representing the dilution of stock options outstanding at June 30, 2000 and 1999
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 (loss) to be $(7.4)million and $9.0 million for the three
months ended June 30, 2000 and 1999, respectively, and $0.7 million and $17.0
million for the six months ended June 30, 2000 and 1999, respectively. Covance's
total comprehensive income represents net income plus the change in the
cumulative translation adjustment equity account for the periods presented.
6
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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
(UNAUDITED)
JUNE 30, 2000 AND 1999
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 6 for segment disclosure.
3. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest for the six months ended June 30, 2000 and 1999
totaled $7.5 million and $2.5 million, respectively. Cash paid for income taxes
for the six months ended June 30, 2000 and 1999 totaled $15.7 million and $16.1
million, respectively.
4. RESTRUCTURING
In order to restructure its Phase III clinical trials unit to align its
cost base with current revenue projections, in the second quarter of 2000
Covance announced a plan to close certain satellite offices, consolidate other
facilities and eliminate approximately 200 positions globally. In connection
with these actions, Covance recorded a pre-tax restructuring charge of
approximately $14.7 million ($8.9 million net of tax) in the second quarter of
2000, consisting primarily of approximately $7.6 million in lease termination
and other facility related costs and $6.3 million for severance and related
benefits. Severance payments began in June 2000 and will continue through 2001.
As of June 30, 2000, approximately $0.4 million has been paid, while the
remaining $14.3 million has been accrued. Also included in Accrued Restructuring
in the Consolidated Balance Sheet is $1.4 million in remaining obligations
associated with Covance's 1999 restructuring plan.
5. DEBT
In June 2000, Covance amended its $250 million senior revolving credit
facility and entered into a new facility to add an additional $50 million in
available funding (collectively the "Amended Credit Facility"). In connection
with this amendment, Covance paid fees totaling $1.3 million which will be
amortized over the remaining 17-month term of the Amended Credit Facility.
Material changes in the terms under the Amended Credit Facility include an
increase in the cost of borrowed funds of 100 basis points, and a 12.5 basis
point increase in the facility fee.
6. 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 include Covance's clinical development, clinical
support, biomanufacturing and commercialization 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 and
six months ended June 30, 2000 and 1999 are as follows:
7
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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
(UNAUDITED)
JUNE 30, 2000 AND 1999
<TABLE>
<CAPTION>
EARLY LATE-STAGE
DEVELOPMENT DEVELOPMENT TOTAL
----------- ----------- -----
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
THREE MONTHS ENDED JUNE 30, 2000
Net revenues from external customers $ 71,180 $140,938 $212,118
Operating income 10,050 2,162 (a) 12,212 (a)
THREE MONTHS ENDED JUNE 30, 1999
Net revenues from external customers 69,309 145,751 215,060
Operating income 11,297 (b) 16,907 (b) 28,204 (b)
SIX MONTHS ENDED JUNE 30, 2000
Net revenues from external customers 143,349 278,396 421,745
Operating income 21,058 11,078 (a) 32,136 (a)
SIX MONTHS ENDED JUNE 30, 1999
Net revenues from external customers 134,892 290,800 425,692
Operating income 19,287 (b) 33,083 (b) 52,370 (b)
</TABLE>
-------------------
(a) Excludes restructuring charge incurred in the second quarter of 2000
totaling $14,665 ($8,946 after tax).
(b) Excludes one-time charge incurred in the second quarter of 1999 in
connection with the termination of the Proposed Merger totaling $5,249
($3,150 after tax).
7. NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Committee issued Staff
Accounting Bulletin 101, Revenue Recognition ("SAB 101"). SAB 101 summarizes
certain of the SEC staff's views in applying generally accepted accounting
principles to selected revenue recognition issues in financial statements.
Implementation of SAB 101, which was delayed by the issuance of SAB 101A on
March 27, 2000 and SAB 101B on June 26, 2000, is required by the fourth quarter
of 2000. Covance is currently in the process of evaluating the impact, if any,
SAB 101 will have on its consolidated financial position or results of
operations.
8
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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 June 30, 2000.
OVERVIEW
Covance is a leading contract research organization providing a wide range
of product development services on a worldwide basis to the pharmaceutical,
biotechnology and medical device industries. Covance also 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 (includes preclinical and Phase I
clinical); and late-stage development services (includes clinical development,
clinical support, biomanufacturing and commercialization). Covance believes it
is one of the largest biopharmaceutical contract research organizations, based
on 1999 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 a
few 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; 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 and
information technology costs. Cost of revenue, as a percentage of net revenues,
tends and is expected to fluctuate from one period to another, as 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 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.
9
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RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2000 COMPARED WITH THREE MONTHS ENDED JUNE 30, 1999.
Net revenues decreased 1.4% to $212.1 million for the three months ended June
30, 2000 from $215.1 million for the corresponding 1999 period. Excluding the
impact of foreign exchange rate variances between both periods, net revenues
increased 0.9%. Net revenues from Covance's late-stage development services
decreased 3.3%, or 0.8% excluding the impact of foreign exchange rate variances
between both periods. The year over year reduction in late-stage development net
revenues is primarily attributable to continuing softness in our clinical
development services, resulting from weak new order generation. Net revenues
from Covance's early development services grew 2.7%, or 4.6% excluding the
impact of foreign exchange rate variances between both periods. The year over
year reduction in early development growth is primarily a result of softness in
our European Phase I clinic and our chemistry service offerings.
Cost of revenue increased 8.3% to $152.5 million or 71.9% of net revenues
for the three months ended June 30, 2000 from $140.9 million or 65.5% of net
revenues for the corresponding 1999 period. Gross margins declined to 28.1% for
the three months ended June 30, 2000 from 34.5% for the corresponding 1999
period. The reduction in gross margins is attributable primarily to our clinical
development services, which experienced weak new business generation (as
mentioned above) and increasing price competition. In addition, direct costs in
our biomanufacturing services increased at a faster rate than net revenues from
such services. While this increase in direct costs was planned to meet demand,
net revenues fell short of plan due to a combination of factors, most
significant among them were efforts directed toward preparing the facility for
commercial scale production which resulted in the lower utilization of equipment
and people in revenue generating activities.
Overall, selling, general and administrative expenses decreased 1.5% to
$33.9 million for the three months ended June 30, 2000 from $34.4 million for
the corresponding 1999 period. As a percentage of net revenues, selling, general
and administrative expenses were 16.0% for both the three months ended June 30,
2000 and 1999.
Depreciation and amortization increased 16.7% to $13.5 million or 6.4% of
net revenues for the three months ended June 30, 2000 from $11.6 million or 5.4%
of net revenues for the corresponding 1999 period, due to increased depreciation
expense associated with capital spending.
In order to restructure its Phase III clinical trials unit to align its
cost base with current revenue projections, in the second quarter of 2000
Covance announced a plan to close certain satellite offices, consolidate other
facilities and eliminate approximately 200 positions globally. In connection
with these actions, Covance recorded a pre-tax restructuring charge of
approximately $14.7 million ($8.9 million net of tax) in the second quarter of
2000, consisting primarily of approximately $7.6 million in lease termination
and other facility related costs and $6.3 million for severance and related
benefits. This restructuring initiative is expected to deliver pre-tax savings
between $7 million and $8 million in the second half of 2000 and approximately
$16 million annually beginning in 2001. Severance payments began in June 2000
and will continue through 2001. As of June 30, 2000, approximately $0.4 million
has been paid, while the remaining $14.3 million has been accrued.
Inclusive of the $14.7 million restructuring charge recorded in the second
quarter of 2000 and a $5.2 million one-time merger-related charge incurred in
the second quarter of 1999 in connection with the termination of the proposed
merger with Parexel, income from operations decreased to a loss of $2.5 million
for the three months ended June 30, 2000 from $23.0 million for the
corresponding 1999 period. Excluding the impact of these special charges, income
from operations decreased 56.7% to $12.2 million, from $28.2 million, for the
corresponding 1999 period; as a percentage of net revenues, income from
operations decreased to 5.8% for the three months ended June 30, 2000 from 13.1%
for the corresponding 1999 period, primarily as a result of the reduction in
gross margins discussed above. Income from operations from Covance's late-stage
and early development segments for the three months ended June 30, 2000 totaled
$2.2 million and $10.0 million, respectively, and $16.9 million and $11.3
million, respectively, for the three months ended June 30, 1999. The reduction
in late-stage development operating income was due primarily to the issues in
clinical development and biomanufacturing services as discussed above. The
reduction in early development operating income was primarily the result of
softness in our European Phase I clinic and chemistry service offerings, as
discussed above, and a comparison to very strong margins in the second quarter
of 1999.
Other expense increased $1.1 million to $3.7 million for the three months
ended June 30, 2000 from $2.6 million for the corresponding 1999 period,
primarily due to an increase in net interest expense resulting from higher
average borrowings and an increase in the weighted average borrowing rate under
our long-term revolving credit facilities as compared to the corresponding 1999
period.
10
<PAGE>
Covance's effective tax rate excluding the impact of special charges for
the three months ended June 30, 2000 decreased to 38.7% from 40.1% for the
corresponding 1999 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.
Inclusive of the $8.9 million after tax impact of the second quarter 2000
restructuring charge and the $3.1 million after tax impact of the one-time
merger-related charge recorded in the second quarter of 1999, net income
decreased to a loss of $3.7 million for the three months ended June 30, 2000
from $12.2 million for the corresponding 1999 period. Excluding the after tax
impact of these special charges, net income decreased 66.1% or $10.2 million to
$5.2 million for the three months ended June 30, 2000 compared to $15.4 million
for the corresponding 1999 period.
SIX MONTHS ENDED JUNE 30, 2000 COMPARED WITH SIX MONTHS ENDED JUNE 30, 1999. Net
revenues decreased 0.9% to $421.7 million for the six months ended June 30, 2000
from $425.7 million for the corresponding 1999 period. Excluding the impact of
foreign exchange rate variances, net revenues increased 1.3%. Net revenues from
Covance's late-stage development services decreased 4.3%, or 1.7% excluding the
impact of foreign exchange rate variances. As discussed above, the year over
year reduction in late-stage development net revenues is primarily attributable
to softness in our clinical development services, resulting from weak new order
generation. Net revenues from Covance's more mature early development services
grew 6.3%, or 7.8% excluding the impact of foreign exchange rate variances
between both periods. As discussed above, early development growth was
negatively impacted by the softness experienced during the second quarter of
2000 in our European Phase I clinic and our chemistry service offerings.
Cost of revenue increased 5.7% to $298.5 million or 70.8% of net revenues
for the six months ended June 30, 2000 from $282.3 million or 66.3% of net
revenues for the corresponding 1999 period. Gross margins declined to 29.2% for
the six months ended June 30, 2000 from 33.7% for the corresponding 1999 period.
As discussed above, the reduction in gross margins is attributable primarily to
our clinical development services, which experienced weak new business
generation (as mentioned above) and increasing price competition. In addition,
direct costs in our biomanufacturing services increased at a faster rate than
net revenues from such services. While this increase in direct costs was planned
to meet demand, net revenues, although increasing considerably over the
corresponding 1999 period, fell short of plan due to a combination of factors,
including facility shutdowns in the first quarter of 2000, subsequent production
complications, and efforts directed toward preparing the facility for commercial
scale production (resulting in a lower utilization of equipment and people in
revenue generating activities).
Overall, selling, general and administrative expenses decreased 5.7% to
$64.3 million for the six months ended June 30, 2000 from $68.2 million for the
corresponding 1999 period. As a percentage of net revenues, selling, general and
administrative expenses decreased 0.8% to 15.2% for the six months ended June
30, 2000 from 16.0% for the corresponding 1999 period.
Depreciation and amortization increased 17.8% to $26.9 million or 6.4% of
net revenues for the six months ended June 30, 2000 from $22.8 million or 5.4%
of net revenues for the corresponding 1999 period, due primarily to increased
depreciation expense associated with capital spending.
In order to restructure its Phase III clinical trials unit to align its
cost base with current revenue projections, in the second quarter of 2000
Covance announced a plan to close certain satellite offices, consolidate other
facilities and eliminate approximately 200 positions globally. In connection
with these actions, Covance recorded a pre-tax restructuring charge of
approximately $14.7 million ($8.9 million net of tax) in the second quarter of
2000, consisting primarily of approximately $7.6 million in lease termination
and other facility related costs and $6.3 million for severance and related
benefits. This restructuring initiative is expected to deliver pre-tax savings
between $7 million and $8 million in the second half of 2000 and approximately
$16 million annually beginning in 2001. Severance payments began in June 2000
and will continue through 2001. As of June 30, 2000, approximately $0.4 million
has been paid, while the remaining $14.3 million has been accrued.
Inclusive of the $14.7 million restructuring charge recorded in the second
quarter of 2000 and a $5.2 million one-time merger-related charge incurred in
the second quarter of 1999 in connection with the termination of the proposed
merger with Parexel, income from operations decreased 62.9% to $17.5 million for
the six months ended June 30, 2000 from $47.1 million for the corresponding 1999
period. Excluding the impact of these special charges, income from operations
decreased 38.6% to $32.1 million, from $52.4 million, for the corresponding 1999
period; as a percentage of net revenues, income from operations decreased to
7.6% for the six months ended June 30, 2000 from 12.3% for the corresponding
1999 period, primarily as a result of the reduction in gross margins discussed
above. Income from operations from Covance's late-stage and early
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development segments for the six months ended June 30, 2000 totaled $11.1
million and $21.0 million, respectively, and $33.1 million and $19.3 million,
respectively, for the six months ended June 30, 1999. The reduction in
late-stage development operating income was due primarily to the issues in
clinical development and biomanufacturing services as discussed above.
Other expense increased $1.7 million to $6.2 million for the six months
ended June 30, 2000 from $4.5 million for the corresponding 1999 period,
primarily due to an increase in net interest expense resulting from higher
average borrowings and an increase in the weighted average borrowing rate under
our long-term revolving credit facilities as compared to the corresponding 1999
period.
Covance's effective tax rate excluding the impact of special charges for
the six months ended June 30, 2000 decreased to 38.9% from 40.5% for the
corresponding 1999 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.
Inclusive of the $8.9 million after tax impact of the second quarter 2000
restructuring charge and the $3.1 million after tax impact of the one-time
merger-related charge recorded in the second quarter of 1999, net income
decreased 72.8% to $6.9 million for the six months ended June 30, 2000 from
$25.4 million for the corresponding 1999 period. Excluding the after tax impact
of these special charges, net income decreased 44.4% or $12.7 million to $15.8
million for the six months ended June 30, 2000 from $28.5 million for the
corresponding 1999 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 through a combination of borrowing under its long-term
revolving credit facility, cash generated from operations and capital that
Covance expects to be made available to it from other sources if required,
Covance will have 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. In June 2000, Covance amended its $250 million senior revolving
credit facility and entered into a new facility to add an additional $50 million
in available funding (collectively the "Amended Credit Facility"). In connection
with this amendment, Covance paid fees totaling $1.3 million which will be
amortized over the remaining 17-month term of the Amended Credit Facility.
Material changes in terms under the Amended Credit Facility include an increase
in the cost of borrowed funds of 100 basis points, and a 12.5 basis point
increase in the facility fee. At June 30, 2000 and December 31, 1999,
respectively, there was $225.0 million and $190.0 million of outstanding
borrowings and $0.8 million and $11.3 million in outstanding letters of credit,
with a remaining availability of $74.2 million and $48.7 million, respectively,
under the Amended Credit Facility. Interest on substantially all outstanding
borrowings during the six months ended June 30, 2000 and 1999 was based on the
London Interbank Offered Rate ("LIBOR") plus a margin and approximated 6.49% and
5.30% per annum, respectively.
Covance Biotechnology Services Inc. ("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 June 30, 2000. 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 facilities and is
guaranteed by Covance.
In December 1999, Covance financed its newly constructed North American
packaging facility through a five year, $20 million mortgage which bears
interest at a rate of 7.72% per annum.
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 six months ended June 30, 2000, Covance's operations used net
cash of $2.7 million, a decrease of $17.4 million from the corresponding 1999
period. Cash flows from net earnings adjusted for non-cash activity provided
$42.8 million for the six months ended June 30, 2000, down $9.5 million or 18.2%
from the corresponding 1999 period. The change in net operating assets used
$45.5 million and $37.6 million in cash during the six months ended June 30,
2000 and 1999, respectively, primarily due to an increase in accounts receivable
during the six months ended June 30, 2000, and an increase in accounts
receivable and unbilled services coupled with a reduction in unearned revenue
during the six months ended June 30, 1999.
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Working capital was $127.2 million at June 30, 2000, an increase of $25.0
million from December 31, 1999. Aggregate accounts receivable and unbilled
services, net of unearned revenue, at June 30, 2000 of $151.3 million were up
$34.5 million or 29.5% from the December 31, 1999 level of $116.8 million. Net
days sales outstanding ("DSOs") increased from 52 days at December 31, 1999 to
65 days at June 30, 2000. DSOs are customarily at their lowest levels at year
end and generally increase during the first, second and third quarters, before
returning to their seasonally lower levels at year end. For comparison, DSOs at
December 31, 1998 were 55 days and increased to 67 days at June 30, 1999.
Covance's ratio of current assets to current liabilities was 1.59 at June 30,
2000 and 1.51 at December 31, 1999.
Investing activities for the six months ended June 30, 2000 used $44.9
million compared to $63.9 million for the corresponding 1999 period. Capital
spending for the first half of 2000 totaled $44.0 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 $48.3 million for the corresponding 1999 period. Investing
activities for the six months ended June 30, 2000 and 1999 included cash
payments of contingent purchase price totaling approximately $0.9 million and
$16.1 million, respectively, in connection with prior acquisitions.
COMPETITION
Covance's Clinical Development Services participates in a competitive
industry. Covance believes that this industry is experiencing an increase in
price competition which is having a material adverse effect on both Covance's
late-stage development and consolidated net revenues and net income. Covance has
taken actions, as discussed above, to mitigate the effects of this price
competition; however, if this trend continues, it could continue to have a
material adverse effect on Covance's late-stage development and consolidated net
revenues and net income, and additional actions may be required in the future.
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.
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<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
Commencing in 1997, Covance planned and implemented a Year 2000 assessment
and remediation plan. The plan approached the Year 2000 problem from an
internal, supplier and customer perspective. As a result of this plan, Covance's
information systems have been successfully transitioned into the Year 2000 and
Covance's operations have not been adversely affected by Year 2000 computer
issues.
Beginning in early 1998, Covance began to incur costs and make expenditures
related to the Year 2000 project. Covance has continued to incur costs and make
expenditures relating to the Year 2000 project into 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's Year 2000 project is now substantially complete. The cost of
internal payroll, external consultants and the net book value of equipment to be
replaced, amounts that were expensed as incurred, totaled approximately $8.4
million through June 30, 2000. 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 totaled approximately $6.3 million
through June 30, 2000.
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 estimate costs of Year 2000 remediation, price competition
in the clinical development services industry, Covance's ability to obtain
credit on terms satisfactory to it, 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 December 1999, the Securities and Exchange Committee issued Staff
Accounting Bulletin 101, Revenue Recognition ("SAB 101"). SAB 101 summarizes
certain of the SEC staff's views in applying generally accepted accounting
principles to selected revenue recognition issues in financial statements.
Implementation of SAB 101, which was delayed by the issuance of SAB 101A on
March 27, 2000 and SAB 101B on June 26, 2000, is required by the fourth quarter
of 2000. Covance is currently in the process of evaluating the impact, if any,
SAB 101 will have on its consolidated financial position or results of
operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See Management's Discussion and Analysis of Financial Condition and Results of
Operations
15
<PAGE>
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of Covance was held on April 25,
2000, pursuant to notice.
The following table sets forth the number of votes cast for, against or
withheld, as well as the number of abstentions and broker non-votes, as to each
matter voted on at the meeting:
NUMBER OF NUMBER OF
PROPOSAL VOTES FOR VOTES WITHHELD
-------- --------- --------------
To elect three members to the
Covance Class III Board of Directors:
Van C. Campbell 48,343,129 869,469
Christopher A. Kuebler 42,416,170 6,796,427
Nigel W. Morris 48,348,588 864,010
<TABLE>
<CAPTION>
NUMBER OF NUMBER OF NUMBER OF NUMBER OF BROKER
PROPOSAL VOTES FOR VOTES AGAINST ABSTENTIONS NON-VOTES
-------- --------- ------------- ----------- ----------------
<S> <C> <C> <C> <C>
To approve the 2000 Employee 35,217,453 4,962,697 726,753 8,305,694
Equity Participation Plan.
To ratify the appointment of
PricewaterhouseCoopers as independent 48,939,209 13,252,800 2,257,837
auditors of Covance for the fiscal
year ending December 31, 2000.
</TABLE>
16
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(1) Exhibit 10.A - Credit Agreement Among Covance Inc., Lenders Named
Therein, and Bank of America, N.A., dated June 28, 2000
(2) Exhibit 10.B - Third Amendment to Credit Agreement dated November
26, 1996 Among Covance Inc., Nationsbank, N.A., Wachovia Bank of
Georgia, N.A., and Lenders Named Therein (amended June 28, 2000)
(3) Exhibit 10.C - Amendment No. 1 to Executive Employment Letter
Between Covance Inc. and Joseph L. Herring
(4) Exhibit 27 - Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K
During the three month period ended June 30, 2000, no reports on Form
8-K were filed.
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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: July 28, 2000 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 July 28, 2000
and Chief Executive Officer
(Principal Executive Officer)
/s/ MICHAEL GIANNETTO
----------------------------
Michael Giannetto Corporate Vice President and Controller July 28, 2000
(Principal Accounting Officer and
Co-Principal Financial Officer)
/s/ WILLIAM E. KLITGAARD
----------------------------
William E. Klitgaard Corporate Vice President and Treasurer July 28, 2000
(Co-Principal Financial Officer)
</TABLE>
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EXHIBIT INDEX
EXHIBIT DESCRIPTION
10.A Credit Agreement Among Covance Inc., Lenders Named Therein,
and Bank of America, N.A., dated June 28, 2000
10.B Third Amendment to Credit Agreement dated November 26, 1996
Among Covance Inc., Nationsbank, N.A., Wachovia Bank of
Georgia, N.A., and Lenders Named Therein (amended June 28,
2000)
10.C Amendment No. 1 to Executive Employment Letter Between Covance
Inc. and Joseph L. Herring
27 Financial Data Schedule (for SEC use only)
19
