The global economic downturn is producing “some signs of delayed decision-making that may impact our business in the coming months”, Covance has warned.
Speaking during the conference call for the US-based contract research organisation’s (CR) third-quarter results, chairman and chief executive officer Joe Herring specifically mentioned Covance’s Early Development segment, where some project starts are being pushed back to next year. However, the CRO is not seeing any increase in cancellations of late-stage clinical trials, Herring added.
Covance also noted that the continued strength of the US dollar “is creating headwind”, given that around 40% of the company’s revenue now comes from overseas operations. Based on current foreign exchange rates, the CRO expects revenue growth for 2008 to be “in the low-teens”, although Covance its holding to its previous guidance of 20% annual growth in full year earnings per share (EPS) to US$3.18 per diluted share.
These factors, together with comments about pharmaceutical companies paring back their drug pipelines in a more constrained economy, were blamed by Forbes magazine for pushing Covance’s share price down by 21.1% on the back of the third-quarter results. The impact spread across the CRO sector, with Parexel’s shares falling by 18.0%, ICON’s by 8.3% and Kendle’s by 18.0%, Forbes said.
In fact, Covance delivered a very respectable set of figures for Q3, with net revenues (excluding reimbursable out-of-pocket expenses) up by 11.1% year on year to US$440.1 million and operating income 16.4% higher at US$70.0 million.
Moreover, Herring noted, there are upsides to the current economic climate. While the substantial drop in financing for biotechnology companies (which make up around 10% of Covance’s client base) is worrying, there has also been strong growth in biotech partnering.
According to the conference call transcript supplied by Seeking Alpha, Herring described the partnering trend as “equally good news for our space. Through partnering, novel new compounds survive and move through development with a well-funded owner, while inspiring more biotech innovation, as the pay-off is often quicker and more tangible through a pharma partnering exit”.
In addition, he said, Covance “continues to see the payoff of delivering high-value solutions and services to smaller biotech companies which are later acquired by large pharmaceutical companies. These biotechs often comment on the speed and quality advantages of Covance’s programme management service to their new owners, which has recently led to new programme management work being awarded from large pharma clients who would previously not consider programme management”.
The clinical pharmacology studies susceptible to delayed starts are projects that are “not on the critical path”, Herring commented. But early-stage is still the fastest-growing segment of drug development, he stressed. “We really like our position, and we are going to continue to invest and grow that business. We also note that the business can turn around as quickly as it goes down. So I see it as a very strategic asset, and we look for a rebound in that service segment.”
Early Development
Net revenues from Covance’s Early Development services grew by 8.0% to US$215.4 million in the third quarter, while operating income in the segment improved by 5.9% to US$54.8 million and the operating margin slipped a little to 25.5% from 26.0% in Q3 2007. Strong year-on-year growth from preclinical laboratories in North America was offset by softness in clinical pharmacology and slower growth from European preclinical laboratories, aggravated by the decline of UK sterling against the dollar, the CRO reported.
The contraction in operating margins reflected start-up costs related to the preclinical campus in Greenfield, US that Covance acquired as part of its recently announced 10-year strategic collaboration with Eli Lilly, as well as the CRO’s entry into the Chinese preclinical market, it added. A “sequential jump” in Early Development revenues and operating income is expected in the fourth quarter as the Greenfield, Indiana campus starts to make a contribution.
The Late-Stage Development segment generated net revenues of US$224.7 million for the third quarter, a year-on-year increase of 14.4% that would have been 18.8% without Covance’s centralised electrocardiogram (ECG) business, which was sold in November 2007 but remained in the comparison year. Operating income from the segment was 28.6% ahead at US$44.3 million and the operating margin widened from 17.5% to 19.7%.
Revenue growth in Late-Stage Development was led by a strong performance from central laboratories (up by more than 20% on a year-on-year increase in kit volumes and a stronger Swiss franc) and “continued accelerating results” in clinical development, Covance said.
The CRO’s order backlog received a substantial boost from the Lilly collaboration, which brought in US$1.27 million worth of dedicated incremental net orders from Covance’s partner. Without this contribution, net orders for the third quarter were US$506 million. In all, Covance’s backlog at 30 September 2008 was US$4.25 billion, up by 62.1% year on year and giving a book-to-bill ratio of 4.04 to 1.
