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Covance Inc. (CVD - Analyst Report) reported earnings per share (EPS) of 61 cents in the fourth quarter of 2012, higher than the year-ago quarter EPS of 35 cents. The year-over-year increase in earnings was primarily due to a healthy top-line growth and a reduction in share count by 9.6%.

Excluding the impact of the one-time items (losses from facilities in wind-down, restructuring costs and other charges), adjusted EPS in the reported quarter came in at 73 cents, beating the Zacks Consensus Estimate of 71 cents as well as the company’s expectation of about 70 cents. However, adjusted EPS was relatively flat compared with the year-ago quarter.

For full year 2012, adjusted EPS of $2.70 was similar to the prior year and edged past the corresponding Zacks Consensus Estimate of $2.68.

Quarter in Detail

Revenues in the fourth quarter increased 4.6% to $609.1 million, sailing past the Zacks Consensus Estimate of $551 million. For 2012, revenues were $2,365.7 million, up 5.8% year over year and considerably higher than the Zacks Consensus Estimate of $2,161 million.

Covance primarily derives its revenues from two segments, Early Development and Late-Stage Development. Pro forma revenues from Early Development declined 7.9% year over year to $215.9 million in the quarter, mainly due to a decline in toxicology, research products and clinical pharmacology, sale of environmental services (which contributed $2.0 million in quarterly revenue) and the inclusion of the Chandler, Honolulu and Basel sites in the year-ago results. However, currency movement had a positive impact of 20 basis points (bps) on year-over-year sales comparisons.

In the reported quarter, Early Development pro forma operating margin was 12.0%, down from 13.9% in the year-ago quarter and down 40 bps sequentially. The fall in profitability from discovery support services was responsible for the sequential decline.

Net revenues from the Late-Stage Development surged 15.7% year over year to $344.8 million although unfavorable foreign exchange headwinds impacted year-over-year growth by 130 bps. The growth in this segment was attributable to persistent strong performance in clinical development and a robust contribution from clinical labs, offsetting a decline in market access services revenue.

Despite the higher spending on strategic IT projects, pro forma operating margin expanded 130 bps on a year-over-year basis as well as sequentially to 21.3%. The increase in operating margin was attributable to improved results from clinical development and central laboratories.

At year-end 2012, Covance’s backlog was $6.64 billion, up 8.1% year over year. Sequentially, backlog increased 4.2% as foreign exchange favorably impacted sequential backlog growth by $44 million. Adjusted net orders (net orders adjusted for dedicated capacity contracts) were $769 million in the quarter, representing an adjusted book-to-bill ratio of 1.37.

Covance exited 2012 with cash and cash equivalents of $492.8 million, up 26.7% year over year. Operating cash flow of $260 million and capital expenditure of $152 million in 2012 resulted in annual free cash flow of $108 million.

Guidance

Covance envisages mid- to high-single digit growth for 2013. Based on current foreign exchange rates, the company expects adjusted EPS to be in the range of $2.85 to $3.15. Currently, the Zacks Consensus Estimate for 2013 is pegged at $2.98.

For the first quarter of 2013, Covance expects nominal sequential improvement in revenues. The company believes that periodically-lower Early Development revenues will offset the growth in Late-Stage Development revenues. Accordingly, the forecast for adjusted EPS lies in the band of 71-73 cents for the first quarter. The current Zacks Consensus Estimate of 68 cents is lower than the guidance.

Recommendation

With the ongoing softness in the Early Development franchise, Late-Stage Development continues to single-handedly drive growth. However, the company looks forward to 2013 with optimism and expects to accelerate growth in the future. This is primarily due to several patent expiries in the pharmaceutical industry which might improve 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 short-term Zacks Rank #2 (Buy). Other Zacks Rank #2 medical stocks are PAREXEL (PRXL - Snapshot Report) and Cepheid (CPHD - Analyst Report). ResMed (RMD - Analyst Report), which reported a positive quarter last week, carries a Zacks Rank #1 (Strong Buy) and also warrants a look.

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