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Covance Inc. (CVD - Analyst Report) reported adjusted earnings per share of 78 cents in the second quarter of 2013. The results beat the year-ago figure by 19.9% and was ahead of the Zacks Consensus Estimate by a penny.  The upside was driven by higher top line and margin.

Including the impact of certain one-time items (losses from restructuring costs and other charges, and gain on sale of an equity investment), reported earnings in the quarter came in at 72 cents, a huge beat compared to the year-ago loss of 23 cents a share.

Revenue

Revenues in the second quarter increased 10% from the year-ago adjusted revenues and reached $542.8 million. However, it missed the Zacks Consensus Estimate of $585 million. Covance primarily derives its revenues from two segments, Early Development and Late-Stage Development. Solid sales performance in Late Stage Development backed by accelerated revenues in central laboratories more than offset the decline in Early Development during the quarter.

Early Development Stage

Net revenue from Early Development declined 2.3% year over year to $214.6 million in the quarter. Growth in nutritional chemistry and clinical pharmacology was offset by pharmaceutical chemistry services and discovery support services.

In the reported quarter, Early Development pro forma operating margin was 8.7%, up 260 basis points (bps) year over year. Restructuring activities, which took place in 2012, are largely responsible for the expansion in the operating margin.

Late Stage Development

Net revenue from Late-Stage Development surged 16.9% year over year to $377.7 million. Despite increased spending on strategic IT projects, the segment witnessed growth on the back of better-than-expected kit volumes in central laboratories and Clinical development. Unfavorable foreign exchange also impacted revenues by 20 bps.

Pro forma operating margin expanded 30 bps on a year-over-year basis to 21.4%. Year-over- year increase in profitability in central laboratories offset the increase in strategic IT spending.

Consolidated Margins

For the second quarter, gross margin expanded 468.9 bps to 34.9%. Operating margin of the company increased about 537 bps to 12.9%. Reimbursable out-of-pocket expenses increased 22.3% year over year to $51.7 million, while selling, general and administrative expenses declined 0.5% year over year to $90.2 million.

Balance Sheet

Covance exited second quarter 2013 with cash and cash equivalents of $446 million, down 3.7% year over year. Operating cash flow of $51 million and capital expenditure of $38 million in second quarter 2013 resulted in free cash flow of $13 million.

Guidance

Covance expects 2013 revenues to grow in the high single-digit range. However, the company narrowed its adjusted earnings expectation to the range of $3.10−$3.20, from previously guided range of $3.00−$3.20 per share. Currently, the Zacks Consensus Estimate for 2013 is pegged at $3.13.

Out Take

The Early Development segment continues to decline gradually. On the other hand, Late-stage Development continues to drive single handedly. Based on its expectation of accelerated growth for the rest of 2013, Covance increased the lower end of its earnings per share guidance for the fiscal. Another reason behind this optimistic approach might be the expiration of several patents in the pharmaceutical industry, which will likely improve the market conditions for Covance.  With the ongoing ‘patent cliff’, the company expects higher demand from its customers in the pharmaceutical and biotechnology industries as they develop their pipeline.

With positive industry trends, estimates continue to move higher for Covance. Accordingly, the stock carries a Zacks Rank #2 (Buy). Other Zacks Rank #2 medical stocks are China Cord Blood Corporation (CO - Snapshot Report), WellPoint Inc. (WLP - Analyst Report) and Hospira Inc. (HSP - Analyst Report), which also warrant a look.

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