A weak first-quarter performance in its Early Development business, with operating income plunging 46% year on year, has driven US-based contract research organisation (CRO) Covance to lower its expectations for revenue growth and earnings in 2009.

For all that, Covance’s first-quarter results were ahead of the consensus forecast from financial analysts. Net revenues, which excluded reimbursable out-of-pocket expenses, grew by 7.0% to US$441.2 million – an increase that would have been 13.8% without the impact of currency translation. Analysts polled by Thomson Reuters had been expecting revenues of US$429.40 million for the quarter.

Covance’s operating income fell by 10.8% year-on-year to US$55.9 million, while diluted earnings per share (EPS) were down 17.4% to US0.63. The analyst consensus was for EPS of US$0.61 in the first quarter. The decline in recorded EPS was 14.1% without taking into account a net gain of US$1.9 per share in the first quarter of 2008 from the sale of Covance’s centralised electrocardiogram business.

Net revenues from Early Development activities dropped by 4.7% to US$192.5 million in the first quarter. Operating income was US$27.2 million, 46.3% lower than in the same period of 2008, and the operating margin was 14.1% compared with 25.0% in Q1 2008. Covance cited lower demand for most of its Early Development offerings and the effect of currency translation, which shaved around 670 basis points off quarterly revenue growth.

First-quarter operating margins in Early Development were squeezed by a lower level of study activity and by costs related to the staffing and validation of Covance’s new US preclinical development facility in Chandler, Arizona and to the consolidation of two small clinical pharmacology sites, the CRO reported. In addition, Covance has maintained staffing levels in the segment “to support expected increases in revenue generation in the second half of the year”.

Late-Stage Development revenues jumped 18.2% year on year in the first quarter to US$248.7 million and were 10.8% ahead of the fourth quarter of 2008, led by gains from both central laboratory and clinical development services. Foreign exchange constrained Q1 revenue growth by around 680 basis points. Excluding the impact of foreign exchange, revenue growth in Late-Stage Development for the rest of the year is expected to be around 20%.

Operating income in the segment was 44.9% higher at US$56.3 million, with “exceptional” profitability in central laboratory services and preclinical development generating an operating margin of 22.6% against 18.5% in the first quarter and 19.6% in the final quarter of 2008 respectively, Covance said. The operating margin in Late-Stage Development “is expected to trend toward approximately 20% in the back half of the year”, it added.

Book to bill

Adjusted net orders in the first quarter came to US$589 million, giving an adjusted book-to-bill ratio of 1.34 to 1. “Central laboratory and clinical development services each delivered record adjusted net orders in the quarter, leading to a trailing 12-month book-to-bill for Late-Stage Development greater than 1.5 to 1,” Covance noted.

In December the CRO released initial financial guidance for 2009 that projected revenue growth of 5-10% year on year and EPS in the range of US$3.00 to US$3.20.

“As previously outlined, these targets assumed foreign exchange rates would remain at budgeted levels throughout the year, Late-Stage backlog would continue to convert to revenue at historical rates, and demand for Early Development services would remain flat coming into the year and would begin to pick up between the second and third quarters of 2009,” pointed out Covance’s chairman and chief executive officer, Joe Herring.

“Relative to these assumptions, the dollar has remained close to our budget assumption and first-quarter Late-Stage Development performance exceeded our expectations,” he commented. “However, first-quarter results in Early Development were well below our expectations and, while we believe a bottoming of demand is underway, we expect growth to return later and slower than originally projected and from a lower base of revenue.”

In view of these factors, Covance has lowered its expectations for revenue growth in 2009 to “the single-digit range” and its earnings-per-share target to US$2.50 to US$2.70.