UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 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 November 14, 2000, the Registrant had 57,798,666 shares of Common Stock
outstanding.
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COVANCE INC.
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
INDEX
Page
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Consolidated Balance Sheets--September 30, 2000 and
December 31, 1999................................................. 3
Consolidated Statements of Income--Three and Nine months
ended September 30, 2000 and 1999................................. 4
Consolidated Statements of Cash Flows--Nine months ended
September 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 6. Exhibits and Reports on Form 8-K............................. 16
SIGNATURE PAGE........................................................ 17
2
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<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2000 AND DECEMBER 31, 1999
(DOLLARS IN THOUSANDS) September 30, December 31,
2000 1999
------------ ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents .................................. $ 18,835 $ 25,444
Accounts receivable, net ................................... 169,067 139,680
Unbilled services .......................................... 57,996 52,647
Inventory .................................................. 29,661 26,474
Deferred income taxes ...................................... 24,574 17,292
Prepaid expenses and other current assets .................. 43,371 40,587
------------ ------------
Total Current Assets ..................................... 343,504 302,124
Property and equipment, net .................................... 322,051 296,943
Goodwill, net .................................................. 82,231 84,575
Other assets ................................................... 25,682 16,672
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Total Assets ............................................. $ 773,468 $ 700,314
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable ........................................... $ 27,194 $ 25,715
Accrued payroll and benefits ............................... 37,911 34,138
Accrued expenses and other liabilities ..................... 39,578 36,172
Accrued restructuring ...................................... 10,282 4,146
Unearned revenue ........................................... 83,360 75,531
Short-term debt ............................................ 18,918 19,787
Income taxes payable ....................................... 844 4,388
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Total Current Liabilities ............................... 218,087 199,877
Long-term debt ................................................. 252,804 208,724
Deferred income taxes .......................................... 14,461 14,982
Other liabilities .............................................. 14,670 14,079
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Total Liabilities ....................................... 500,022 437,662
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Commitments and Contingent Liabilities
Stockholders' Equity:
Common Stock - Par value $0.01 per share; 140,000,000
shares authorized 59,706,140 and 59,024,976 shares
issued and outstanding, including those held in
treasury, at September 30, 2000 and December 31, 1999,
respectively ......................................... 597 590
Paid-in capital ............................................ 110,184 95,954
Retained earnings .......................................... 201,295 192,190
Accumulated other comprehensive income--
Cumulative translation adjustment .................... (18,723) (6,504)
Treasury Stock at cost (2,025,589 and 1,995,000 shares at
September 30, 2000 and December 31, 1999,
respectively) ........................................ (19,907) (19,578)
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Total Stockholders' Equity ........................... 273,446 262,652
------------ ------------
Total Liabilities and Stockholders' Equity ........... $ 773,468 $ 700,314
============ ============
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30 September 30
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(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 2000 1999 2000 1999
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues ................................ $ 214,946 $ 198,920 $ 636,691 $ 624,612
Cost and expenses:
Cost of revenue ........................... 160,149 134,643 458,607 416,979
Selling, general and administrative ....... 33,192 28,912 97,490 97,106
Depreciation and amortization ............. 13,744 12,243 40,598 35,035
Restructuring charge ...................... (876) 7,719 13,789 7,719
Merger-related costs ...................... -- -- -- 5,249
------------ ------------ ------------ ------------
Total ................................... 206,209 183,517 610,484 562,088
------------ ------------ ------------ ------------
Income from operations ...................... 8,737 15,403 26,207 62,524
------------ ------------ ------------ ------------
Other expense, net:
Interest expense, net ..................... 4,947 2,682 11,315 7,087
Other (income) expense, net ............... 174 (22) 38 59
------------ ------------ ------------ ------------
Other expense, net ...................... 5,121 2,660 11,353 7,146
------------ ------------ ------------ ------------
Income before taxes ......................... 3,616 12,743 14,854 55,378
Taxes on income ............................. 1,406 5,037 5,749 22,317
------------ ------------ ------------ ------------
Net income .................................. $ 2,210 $ 7,706 $ 9,105 $ 33,061
============ ============ ============ ============
Basic earnings per share .................... $ 0.04 $ 0.13 $ 0.16 $ 0.56
Weighted average shares
outstanding - basic ....................... 57,582,175 58,946,003 57,303,043 58,753,481
Diluted earnings per share .................. $ 0.04 $ 0.13 $ 0.16 $ 0.56
Weighted average shares
outstanding - diluted ..................... 57,649,229 59,033,962 57,353,347 59,332,078
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
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<TABLE>
<CAPTION>
COVANCE INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000 AND 1999
(UNAUDITED)
Nine Months Ended September 30
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(DOLLARS IN THOUSANDS) 2000 1999
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<S> <C> <C>
Cash flows from operating activities:
Net income ............................................. $ 9,105 $ 33,061
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ...................... 40,598 35,035
Restructuring charge, net of cash paid ............. 9,325 7,282
Stock issued under employee benefit and stock
compensation plans ............................... 3,194 6,501
Deferred income tax provision ...................... (7,803) 1,524
Other .............................................. 651 94
Changes in operating assets and liabilities:
Accounts receivable .............................. (29,387) (5,121)
Unbilled services ................................ (5,349) (23,217)
Inventory ........................................ (3,187) 886
Accounts payable ................................. 1,479 (6,659)
Accrued liabilities .............................. 3,990 (643)
Unearned revenue ................................. 7,829 (2,669)
Income taxes payable ............................. (3,544) (3,197)
Other assets and liabilities, net ................ (4,984) (9,230)
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Net cash provided by operating activities .............. 21,917 33,647
------------ ------------
Cash flows from investing activities:
Capital expenditures ............................... (75,004) (90,091)
Contingent purchase price paid in connection with
prior acquisitions ............................... (909) (16,830)
Other, net ......................................... 539 635
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Net cash used in investing activities .................. (75,374) (106,286)
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Cash flows from financing activities:
Net borrowings under revolving credit facility ..... 45,000 60,000
Repayments of long-term debt ....................... (920) --
Stock issued under employee stock purchase and
option plans ..................................... 3,097 5,774
Purchase of treasury stock ......................... (329) --
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Net cash provided by financing activities .............. 46,848 65,774
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Net change in cash and cash equivalents ................ (6,609) (6,865)
Cash and cash equivalents, beginning of period ......... 25,444 19,263
------------ ------------
Cash and cash equivalents, end of period ............... $ 18,835 $ 12,398
============ ============
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)
SEPTEMBER 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 and Covance's
quarterly filings on Form 10-Q during 2000. Operating results for the nine
months ended September 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 $27.1
million and $27.3 million at September 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 September 30,
2000 and 1999, the denominator was increased by 67,054 shares and 87,959 shares,
respectively, and for the nine months ended September 30, 2000 and 1999, the
denominator was increased by 50,304 shares and 578,597 shares, respectively,
representing the dilution of stock options outstanding at September 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 $(3.8 million) and $10.0 million for the three
months ended September 30, 2000 and 1999, respectively, and $(3.1 million) and
$27.0 million for the nine months ended September 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.
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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
(UNAUDITED)
SEPTEMBER 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 5 for segment disclosure.
3. SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest for the nine months ended September 30, 2000 and
1999 totaled $10.7 million and $4.8 million, respectively. Cash paid for income
taxes for the nine months ended September 30, 2000 and 1999 totaled $18.0
million and $22.0 million, respectively.
4. RESTRUCTURING
In the second quarter of 2000, in order to restructure its Phase III
clinical trials unit to align its cost base with revenue projections, 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 a result of favorable lease terminations completed in the third quarter of
2000, Covance reversed $0.9 million of the second quarter 2000 restructuring
charge. As of September 30, 2000, approximately $4.5 million has been paid,
while the remaining $9.3 million has been accrued. Also included in Accrued
Restructuring in the Consolidated Balance Sheet is $1.0 million in remaining
obligations associated with Covance's 1999 restructuring plan.
5. SEGMENT INFORMATION
Covance has two reportable segments: early development and late-stage
development. Early development services, which includes 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 product launch 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.
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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONT'D)
(UNAUDITED)
SEPTEMBER 30, 2000 AND 1999
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
nine months ended September 30, 2000 and 1999 are as follows:
<TABLE>
<CAPTION>
EARLY LATE-STAGE
DEVELOPMENT DEVELOPMENT TOTAL
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(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
THREE MONTHS ENDED SEPTEMBER 30, 2000
Net revenues from external customers $ 71,414 $143,532 $214,946
Operating income 9,039 (1,178)(d) 7,861 (d)
THREE MONTHS ENDED SEPTEMBER 30, 1999
Net revenues from external customers 67,971 130,949 198,920
Operating income 12,068 (c) 11,054 (c) 23,122 (c)
NINE MONTHS ENDED SEPTEMBER 30, 2000
Net revenues from external customers 214,763 421,928 636,691
Operating income 30,096 9,900 (a),(d) 39,996 (a),(d)
NINE MONTHS ENDED SEPTEMBER 30, 1999
Net revenues from external customers 202,863 421,749 624,612
Operating income 31,355 (b) 44,137 (b) 75,492 (b)
</TABLE>
----------------
(a) Excludes restructuring charge incurred in the second quarter of 2000
totaling $14,665 ($8,946 after tax).
(b) Excludes special charges recorded during the three and nine months
ended September 30, 1999, as follows: (1) Third quarter restructuring
charge totaling $7,719 ($4,631 after tax); (2) Second quarter 1999
merger related charge totaling $5,249 ($3,150 after tax).
(c) Excludes restructuring charge recorded in the third quarter of 1999
totaling $7,719 ($4,631 after tax).
(d) Excludes third quarter 2000 reversal of restructuring charge totaling
$876 ($534 after tax).
6. NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission 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 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 September 30, 2000.
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. 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 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, 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 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.
9
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RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED WITH THREE MONTHS ENDED SEPTEMBER
30, 1999. Net revenues increased 8.1% to $214.9 million for the three months
ended September 30, 2000 from $198.9 million for the corresponding 1999 period.
Excluding the impact of foreign exchange rate variances between both periods,
net revenues increased 11.8%. Net revenues from Covance's late-stage development
services increased 9.6%, or 13.3% excluding the impact of foreign exchange rate
variances between both periods. The year over year growth in late-stage
development net revenues is primarily affected by continuing softness in our
clinical development services, resulting from weak new order generation. Net
revenues from Covance's more mature early development services grew 5.1%, or
8.8% excluding the impact of foreign exchange rate variances between both
periods. The reduction in growth in early development is primarily a result of
temporary softness in certain of our chemistry service offerings during the 2000
period. Covance's toxicology business, which accounts for approximately half of
all early development revenues, continued to deliver solid results and
experience strong demand during the third quarter of 2000.
Cost of revenue increased 18.9% to $160.1 million or 74.5% of net revenues
for the three months ended September 30, 2000 from $134.6 million or 67.7% of
net revenues for the corresponding 1999 period. Gross margins declined to 25.5%
for the three months ended September 30, 2000 from 32.3% for the corresponding
1999 period. The reduction in gross margins is attributable primarily to our
clinical development services, which continues to experience weak new business
generation (as mentioned above) and increasing price competition; direct costs
in our biomanufacturing services; and increased investment spending on internet
initiatives and bioanalytical services increased at a faster rate than net
revenues from such services. We also experienced an increased mix of lower
margin studies in our central laboratory services during the third quarter of
2000.
Overall, selling, general and administrative expenses increased 14.8% to
$33.2 million for the three months ended September 30, 2000 from $28.9 million
for the corresponding 1999 period. As a percentage of net revenues, selling,
general and administrative expenses increased to 15.4% for the three months
ended September 30, 2000 from 14.5% for the corresponding 1999 period.
Depreciation and amortization increased 12.3% to $13.7 million or 6.4% of
net revenues for the three months ended September 30, 2000 from $12.2 million or
6.2% of net revenues for the corresponding 1999 period, due to increased
depreciation expense associated with capital spending.
As discussed further below, as a result of favorable lease terminations
completed in the third quarter of 2000, Covance reversed $0.9 million of
restructuring charges taken during the second quarter of 2000.
Income from operations decreased to $8.7 million for the three months ended
September 30, 2000 from $15.4 million for the corresponding 1999 period,
inclusive of the $0.9 million restructuring charge reversal in the third quarter
of 2000 and a $7.7 million restructuring charge recorded in the third quarter of
1999. Excluding the impact of these restructuring charges, income from
operations decreased 66.0% as compared to $23.1 million for the corresponding
1999 period; as a percentage of net revenues, income from operations decreased
to 3.7% for the three months ended September 30, 2000 from 11.6% for the
corresponding 1999 period, primarily as a result of the reduction in gross
margins discussed above. Excluding the impact of these restructuring charges,
income from operations from Covance's early and late-stage development segments
totaled $9.0 million and a loss of $1.2 million, respectively, for the three
months ended September 30, 2000, and $12.1 million and $11.1 million,
respectively, for the three months ended September 30, 1999. The reduction in
late-stage development operating income is due primarily to the issues in
clinical development and biomanufacturing services, a shift in central
laboratories business mix and increased investment spending on internet
initiatives as discussed above. The reduction in early development operating
income is primarily due to temporary softness experienced in certain of our
chemistry service offerings, increased investment spending on our bioanalytical
service offering as discussed above, and comparison to very strong margins in
the third quarter of 1999.
Other expense increased $2.5 million to $5.1 million for the three months
ended September 30, 2000 from $2.7 million for the corresponding 1999 period,
primarily due to an increase in the weighted average cost of our long-term
revolving credit facilities and an increase in net interest expense resulting
from higher average borrowings and as compared to the corresponding 1999 period.
Covance's effective tax rate for the three months ended September 30, 2000
decreased to 38.9% from 39.5% 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.
10
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Net income decreased to $2.2 million for the three months ended September
30, 2000 from $7.7 million for the corresponding 1999 period, inclusive of the
after tax impact of the restructuring charges recorded in each period. Excluding
the after tax impact of these restructuring charges, net income decreased $10.7
million for the three months ended September 30, 2000 compared to $12.3 million
for the corresponding 1999 period.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED WITH NINE MONTHS ENDED SEPTEMBER
30, 1999. Net revenues increased 1.9% to $636.7 million for the nine months
ended September 30, 2000 from $624.6 million for the corresponding 1999 period.
Excluding the impact of foreign exchange rate variances between both periods,
net revenues increased 4.6%. Net revenues from Covance's late-stage development
services were flat compared to the corresponding 1999 period and increased 3.0%
excluding the impact of foreign exchange rate variances. As discussed above, the
weakness 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 5.9%, or 8.1% excluding the impact of foreign exchange rate variances
between both periods. As discussed above, the reduction in growth in early
development is primarily a result of temporary softness in certain of our
chemistry service offerings during the 2000 period. Covance's toxicology
business, which accounts for approximately half of all early development
revenues, delivered solid results and experienced strong demand during the nine
months ended September 30, 2000.
Cost of revenue increased 10.0% to $458.6 million or 72.0% of net revenues
for the nine months ended September 30, 2000 from $417.0 million or 66.8% of net
revenues for the corresponding 1999 period. Gross margins declined to 28.0% for
the nine months ended September 30, 2000 from 33.2% for the corresponding 1999
period. As discussed above, the reduction in gross margins is attributable
primarily to our clinical development services, which continues to experience
weak new business generation (as mentioned above) and increasing price
competition. In addition, direct costs in our biomanufacturing services and
increased investment spending on internet initiatives and bioanalytical services
increased at a faster rate than net revenues from such services. We also
experienced an increased mix of lower margin studies in our central laboratory
services during the third quarter of 2000. While the increase in
biomanufacturing 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
lower utilization of equipment and people in revenue generating activities).
Overall, selling, general and administrative expenses increased 0.4% to
$97.5 million for the nine months ended September 30, 2000 from $97.1 million
for the corresponding 1999 period. As a percentage of net revenues, selling,
general and administrative expenses decreased 0.2% to 15.3% for the nine months
ended September 30, 2000 from 15.5% for the corresponding 1999 period.
Depreciation and amortization increased 15.9% to $40.6 million or 6.4% of
net revenues for the nine months ended September 30, 2000 from $35.0 million or
5.6% of net revenues for the corresponding 1999 period, due primarily to
increased depreciation expense associated with capital spending.
In the second quarter of 2000, in order to restructure its Phase III
clinical trials unit to align its cost base with revenue projections, 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
of approximately $7 million in the second half of 2000 and approximately $16
million annually beginning in 2001. Actual cost savings realized during the
third quarter of 2000 totaled approximately $3.0 million. Severance payments
began in June 2000 and will continue through 2001. As a result of favorable
lease terminations completed in the third quarter of 2000, Covance reversed $0.9
million of restructuring charges taken during the second quarter of 2000. As of
September 30, 2000, approximately $4.5 million has been paid, while the
remaining $9.3 million has been accrued.
Inclusive of the $13.8 million restructuring charge recorded in the second
quarter of 2000, 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 International Corporation, and a $7.7 million restructuring charge
recorded in the third quarter of 1999, income from operations decreased 58.1% to
$26.2 million for the nine months ended September 30, 2000 from $62.5 million
for the corresponding 1999 period. Excluding the impact of these special
charges, income from operations decreased 47.0% to $40.0
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million, from $75.5 million, for the corresponding 1999 period; as a percentage
of net revenues, income from operations decreased to 6.3% for the nine months
ended September 30, 2000 from 12.1% for the corresponding 1999 period, primarily
as a result of the reduction in gross margins discussed above. Excluding the
impact of these special charges, income from operations from Covance's early and
late-stage development segments totaled $30.1 million and $9.9 million,
respectively, for the nine months ended September 30, 2000, and $31.4 million
and $44.1 million, respectively, for the nine months ended September 30, 1999.
The reduction in late-stage development operating income is due primarily to the
issues in clinical development and biomanufacturing services, a shift in central
laboratories business mix and increased investment spending on internet
initiatives. The reduction in early development is primarily due to temporary
softness experienced in certain of our chemistry service offerings, and
increased investment spending on our bioanalytical service offering. Another
factor is a comparison to very strong margins in the second and third quarters
of 1999.
Other expense increased $4.2 million to $11.3 million for the nine months
ended September 30, 2000 from $7.1 million for the corresponding 1999 period,
primarily due to an increase in the weighted average cost of our long-term
revolving credit facilities and an increase in net interest expense resulting
from higher average borrowings as compared to the corresponding 1999 period.
Covance's effective tax rate excluding the impact of special charges for
the nine months ended September 30, 2000 decreased to 38.7% from 40.3% 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 $8.4 million after tax impact of the second quarter 2000
restructuring charge, the $3.1 million after tax impact of the one-time
merger-related charge recorded in the second quarter of 1999, and the $4.6
million after tax impact of the restructuring charge recorded in the third
quarter of 1999, net income decreased 72.5% to $9.1 million for the nine months
ended September 30, 2000 from $33.1 million for the corresponding 1999 period.
Excluding the after tax impact of these special charges, net income decreased
$23.3 million to $17.5 million for the nine months ended September 30, 2000 from
$40.8 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.
Covance has senior revolving credit facilities totaling $300 million
(collectively the "Credit Facility"). Covance has amended its Credit Facility.
Material changes to the Credit Facility include an increase in the cost of funds
and other changes in terms, including an agreement to apply all proceeds from
sales of assets or subsidiaries, which divestiture processes are well underway,
toward the payment of amounts outstanding under the Credit Facility, with a
corresponding reduction in the aggregate facility size. Management believes that
Covance has sufficient access to capital to meet its operating cash
requirements. At September 30, 2000 and December 31, 1999, respectively, there
was $235.0 million and $190.0 million of outstanding borrowings and $0.8 million
and $11.3 million of outstanding letters of credit under the Credit Facility.
Interest on substantially all outstanding borrowings during the nine months
ended September 30, 2000 and 1999 was based on the London Interbank Offered Rate
("LIBOR") plus a margin and approximated 7.23% and 5.35% 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 September 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 carried interest at a fixed rate of 2.9% per
annum and was paid in full upon maturity in October 2000.
During the nine months ended September 30, 2000, Covance's operations
provided net cash of $21.9 million, a decrease of $11.7 million from the
corresponding 1999 period. Cash flows from net earnings adjusted for non-cash
activity provided $55.1 million for the nine months ended September 30, 2000,
down $28.4 million or 34.0% from the corresponding 1999
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period. The change in net operating assets used $33.2 million and $49.8
million in cash during the nine months ended September 30, 2000 and 1999,
respectively, primarily due to an increase in accounts receivable and unbilled
services during both periods.
Working capital was $125.4 million at September 30, 2000, an increase of
$23.2 million from December 31, 1999. Aggregate accounts receivable and unbilled
services, net of unearned revenue, at September 30, 2000 of $143.7 million were
up $26.9 million or 23.0% from the December 31, 1999 level of $116.8 million.
Net days sales outstanding ("DSOs") increased from 52 days at December 31, 1999
to 61 days at September 30, 2000. DSOs are customarily at their lowest levels at
year end and generally increase during the first six to nine months of the year,
before returning to their seasonally lower levels at year end. For comparison,
DSOs at December 31, 1998 were 55 days and increased to 69 days at September 30,
1999. Covance's ratio of current assets to current liabilities was 1.58 at
September 30, 2000 and 1.51 at December 31, 1999.
Investing activities for the nine months ended September 30, 2000 used
$75.4 million compared to $106.3 million for the corresponding 1999 period.
Capital spending for the first nine months of 2000 totaled $75.0 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 $90.1 million for the corresponding 1999 period.
Investing activities for the nine months ended September 30, 2000 and 1999
included cash payments of contingent purchase price totaling approximately $0.9
million and $16.8 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
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stockholders' equity account, referred to as the cumulative translation
adjustment account. This account exists only in the foreign subsidiary's U.S.
dollar balance sheet and is necessary to keep the foreign balance sheet stated
in U.S. dollars in balance. To date such cumulative translation adjustments have
not been material to Covance's consolidated financial position.
TAXES
Since Covance conducts operations on a global basis, Covance's effective
tax rate has and will continue to depend upon the geographic distribution of its
pretax earnings among locations with varying tax rates. Covance's profits are
further impacted by changes in the tax rates of the various 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 $8.5
million through September 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 $6.4 million
through September 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 divest businesses at a satisfactory price, resumption of
demand for certain of Covance's chemistry service offerings, 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.
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NEW ACCOUNTING PRONOUNCEMENTS
In December 1999, the Securities and Exchange Commission 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See Management's Discussion and Analysis of Financial Condition and Results of
Operations
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PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
(1) Exhibit 10.A - Amended and Restated Employment Agreement Between
Covance Inc. and Charles Harwood, Jr.
(2) Exhibit 10.B - Resignation Agreement Between Covance Inc. and
Jeffrey S. Hurwitz
(3) Exhibit 27 - Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K
During the three month period ended September 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: November 14, 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 November 14, 2000
and Chief Executive Officer
(Principal Executive Officer)
/s/ WILLIAM E. KLITGAARD
----------------------------
William E. Klitgaard Corporate Senior Vice President, November 14, 2000
Chief Financial Officer and Treasurer
(Principal Financial Officer)
/s/ MICHAEL GIANNETTO
----------------------------
Michael Giannetto Corporate Vice President and Controller November 14, 2000
(Principal Accounting Officer)
</TABLE>
17
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EXHIBIT INDEX
EXHIBIT DESCRIPTION
10.A Amended and Restated Employment Letter Agreement Between Covance Inc.
and Charles Harwood, Jr.
10.B Resignation Agreement Between Covance Inc. and Jeffrey S. Hurwitz
27 Financial Data Schedule (for SEC use only)
18
