US-based contract research organisation (CRO) Covance disappointed investors last week when it lowered earnings guidance for 2010 that was already below analysts’ expectations.

Covance also narrowed its forecast for full-year revenue growth, despite reporting a more than 9% increase in net revenues for the first quarter ended 31 March. Study delays are clouding the outlook for the rest of the year, and the CRO announced the closure of two “underperforming” sites as well as cost rationalisations elsewhere in the business that will reduce its staff count by around 200.

Net revenues for the first quarter were US$481.9 million, 9.2% more than in the same period last year. Analysts polled by Thomson Reuters had been expecting revenues of US$493.2 million. Operating profit was 5.5% down at US$52.9 million and diluted earnings per share (EPS) dropped by 4.3% to US$0.60, which was in line with the analyst consensus.

Early Development revenues improved for the second quarter running, lifting by 6.5% over the first quarter of 2009 to US$205.0 million. The year-on-year growth was led by clinical pharmacology and research products, and was offset to some extent by revenue declines in toxicology and chemistry.

Operating income in the segment, however, fell by 15.7% year on year to US$22.9 million, while the operating margin shrank from 14.1% to 11.2%.

Gradual improvement

According to Covance, the commercial outlook for the company’s Early Development services “continues to see gradual improvement”. Segment revenues are expected to grow sequentially throughout the year, as is the operating margin – excluding facility rationalisation costs that will be charged in the second quarter.

In the Late-Stage Development segment, first-quarter revenues rose by 11.3% year on year to US$276.9 million. They were US$5.0 million lower than in the fourth quarter of 2009, though, due to a shortfall in central laboratory revenues that reflected sluggish trial start-ups and the negative impact of the strengthening US dollar, Covance noted.

In the second quarter, it added, expected sequential growth in central laboratory revenues is unlikely to offset lower revenues from clinical development services, which have been hit by the delayed start of three large Phase III trials. As such, Covance is now projecting full-year revenue growth “in the mid-single-digit range” for its Late-Stage Development arm.

The segment delivered operating income of US$66.2 million for the first quarter, up by 17.6% year on year. The operating margin expanded from 22.6% to 23.9%, thanks to stronger than expected profitability in central laboratory services and clinical development.

Over the next two quarters, Covance said, operating margin is projected to be “approximately 300 basis points lower than the first quarter level … as headcount in clinical development will be under-utilised due primarily to the delay of three large trials”.

Backlog up 8%

Covance’s backlog was US$4.79 million as of 31 March 2010, 8.4% higher than a year previously. Adjusted net orders for the first quarter were worth US$490 million, representing an adjusted book-to-bill ratio of 1.02 to 1.

The Early Development segment managed an adjusted book-to-bill of more than 1.0 to 1 for the third quarter in a row, Covance noted. But the net book-to-bill for Late-Stage Development was below 1.0 to 1, due to the delayed client decision-making already mentioned.

However, the trailing 12-month adjusted book-to-bill ratio for the Late-Stage Development segment was around 1.25 to 1, and outstanding proposals are at record levels, Covance pointed out.

“With regard to building new strategic relationships, we continue to advance discussions with several large clients,” commented chairman and chief executive officer Joe Herring. In early March, Covance and Eli Lilly expanded their long-term strategic alliance with a three-year biotechnology services agreement.

The CRO has already started closing its two underperforming sites in the US – a Phase I clinic in Austin, Texas and a research products facility in Kalamazoo, Michigan – and is “consolidating the volume into more efficient locations”.

These closures, and smaller cost rationalisations elsewhere, will mean a hit of around US$0.09 per share in the second quarter, Covance said. It expects these actions to generate “savings ramping to at least US$0.12 per share on an annualised basis by year-end”.

Revised guidance

In the light of these initiatives, “coupled with the headwinds created by a stronger US dollar, and delays in the commencement of Late-Stage studies”, Covance is adjusting its guidance for revenue growth in 2010 to the 5%-8% range, while earnings per share are now expected to be US$2.40 to US$2.65.

These projections include the impact of the second-quarter cost initiatives but not the benefits of any potential strategic transactions”, the CRO noted.

Reporting its fourth-quarter results in February, Covance forecast revenue growth of around 10% for 2010 and earnings per share in the range of US$2.50 to US$2.75.
The analyst consensus at the time was for full-year revenues of US$2.04 billion – which would have been an increase of 4.1% over 2009 – but for EPS of US$2.90. That was subsequently revised to earnings per share of US$2.70 on revenues of $2.05 billion.