Plans for a sharp increase in IT expenditure and further efforts to expand its commercial footprint during 2012 dampened Covance’s profit forecast for the year ahead, as fourth-quarter revenues came in below the analyst consensus but earnings per share (EPS) met expectations once restructuring and other charges were stripped out.

The US-based drug development services company is projecting diluted earnings per share in the range of US$2.50 to US$2.80 for 2012, compared with a consensus estimate of US$2.94 from analysts polled by Thomson Reuters.

Along with significantly higher operating expenses, Covance’s figure includes an estimated boost of US$0.15 to US$0.20 per share from anticipated share buybacks but excludes potential new strategic alliances with clients. It also assumes foreign exchange rates will remain at year-end 2011 levels.

The Covance board has just authorised the repurchase of up to US$300 million in outstanding common stock. Representing around 10% of the common stock overall, this tranche is in addition to the 800,000 or so shares remaining under a previously approved buyback.   

Covance is forecasting that revenue growth during 2012 will be in the “mid-single” digits, including the impact of a stronger US dollar. This is more in line with the analyst consensus, which sees full-year revenues reaching US$2.20 billion – around 5% higher than the net revenues of US$2,096 million recorded in 2011.

Strategic investments

The company said it was making strategic investments in its information technology infrastructure and applications to increase the productivity of its drug development services, drive operating efficiencies and “arrest the long-term rate of growth of our information technology spending”.  

As well as implementing Covance’s central laboratory system, which was previously disclosed as a US$10 million incremental spend, the company is funding three strategic projects to help achieve these objectives.

Together, the four projects will push capital expenditure on IT up to around US$90 million in 2012, compared with about US$60 million in 2011, and will “lead to a significant increase in operating expense over the next two years”, Covance warned.  

It also aims to “continue expanding our commercial footprint in order to capture an increasing share of the opportunities available in the CRO [contract research organisation] industry and position us for longer-term growth”.  

In aggregate, Covance expects spending in these areas to be “above the growth rate in revenue by approximately US$25 million, or US$0.32 per diluted share, in 2012”.

Charges impact

Diluted EPS for the fourth quarter of 2011 were 23.6% lower year on year at US$0.35. That included a number of special items, however, amounting to roughly US$0.41 per diluted share in charges, offset by a gain of around US$0.03 from favorable income tax developments.

Of the charges, about US$0.10 per share was for completing previously announced restructuring measures, US$0.11 for terminating a research products inventory supply agreement and inventory write-down, and US$0.20 for the impairment of an associated equity investment.

Covance recorded charges of US$10.3 million in its Early Development segment, reflecting lower demand for its research products, which “caused us to reassess inventory levels and the fair value of an equity investment in a supplier”.

Without the accumulated charges, diluted EPS for the fourth quarter of 2011 were US$0.73, which was what analysts were expecting on average.

Operating income for the latest quarter was up by 35.0% over Q4 2010 at US$39.0 million. Without the charges mentioned above (and those recorded in the year-before quarter), operating income was 22.6% higher at US$57.9 million.

Revenue gains

Net revenues for the final quarter of 2011 were 8.3% ahead year on year, at US$532.5 million, with gains of 6.3% in Early Development and 10.0% in Late-Stage Development.

Quarter by quarter, though, Early Development revenues were down by US$5.7 million, with Covance blaming lower demand for research products and European toxicology services, as well as a US$2.3 million foreign-exchange headwind.

The pro forma operating margin in Early Development grew by 190 basis points year-on-year to 13.9% but did not expand sequentially, as Covance had forecasted, due mainly to the operating losses incurred in research products.

Sequential revenues in Late-Stage Development were also down, by $US5.0 million, which Covance attributed to a US$10.1 million foreign-exchange headwind, more than offsetting growth across the segment’s service offerings at constant exchange rates.

The pro forma operating margin for Late-Stage Development was 20.0% in Q4 2011, compared with 19.3% in the previous quarter and 20.2% in the final quarter of 2010.

Book to bill

Adjusted net orders for the fourth quarter of 2011 came to US$759 million, giving an adjusted book-to-bill ratio of 1.42 to 1.  

“We were particularly pleased to see continued strong orders in clinical development and a further increase in orders in our central laboratory for the second consecutive quarter,” Covance commented.