Covance (CVD) reported an EPS of 35 cents in the fourth quarter of 2011 compared with 45 cents in the year-ago quarter. During the quarter, Covance incurred $31 million or 41 cents per share in charges, out of which roughly 10 cents were related to the completion of restructuring actions, 11 cents in the termination of a research products inventory supply agreement and inventory write down and 20 cents for the impairment of a related equity investment, partially offset by a gain of approximately 3 cents from favorable income tax developments. After considering these adjustments, EPS increased 30.3% year over year to 73 cents.

For fiscal 2011, adjusting for charges of 58 cents and gain of 4 cents, EPS stood at $2.70, up 25.6%.

Net revenue in the fourth quarter rose 8.3% (7.3% on a constant currency basis) year over year to $532 million. However, net revenue witnessed an 8.1% sequential decline on the back of a strong US dollar leading to a $12.4 million headwind in foreign exchange. For the full year, net revenue was up 8.8% (5.4% on a constant currency basis) to $2.1 billion.

The company primarily derives its revenues from two segments, namely Early Development and Late-Stage Development. Revenues from the Early Development segment increased 6.3% year over year to $234.5 million, on the back of improved results from the company’s two facilities (Alnwick in UK and Porcheville in France). However, revenues declined 2.3% sequentially due to lower demand in research products and European toxicology services, as well as a $2.3 million foreign exchange headwind.

In the reported quarter, Early Development pro forma operating margin increased 190 basis points (bps) year over year to 13.9%. However, sequentially, it contracted 70 basis points due to operating losses in research products.

Revenues from the Late-Stage Development segment jumped 10.0% year over year to $298 million attributable to strong performance of clinical development services and domestic currency depreciation (a benefit of 190 bps). However, adjusted operating margin contracted 20 bps year over year but expanded 70 bps sequentially to 20.0%. The sequential increase in operating margin was due to an increase in profitability arising from stronger central laboratory performance.

At the end of the reported quarter, Covance’s backlog inched up 1.0% to $6.14 billion. Foreign exchange negatively impacted sequential backlog growth by roughly $75 million. Adjusted net orders (net orders adjusted for dedicated capacity contracts) were $759 million in the quarter, representing an adjusted book-to-bill ratio of 1.42.

Covance exited the quarter with cash and cash equivalents of $389 million compared with $377 million at the end of fiscal 2010. The company repaid $60.0 million in debt during the quarter and currently has $30.0 million in debt outstanding associated with borrowings under the accelerated share repurchase program since the fourth quarter of 2010.

Free cash flow for the fourth quarter of 2011 was $54 million, with capital expenditures of $48 million. In a separate release, Covance announced that its Board has authorized an additional $300 million in share repurchase. Adding to its remaining 800,000 shares under the previously announced repurchase authorization, this will represent about 10% of the company’s total market value.

Outlook

Covance provided soft outlook for first quarter and fiscal 2012.For the first quarter, the company expects modest sequential increase in net revenue as it forecasted a further sequential decline in Early Development net revenue, offset somewhat by an increase in Late-Stage net revenue. The company also expects Early Stage Development EPS to drop leading to the quarter’s EPS in the low-60 cents range (the Zacks Consensus Estimate is 67 cents).

For fiscal 2012, the company expects mid-single digit revenue growth, which includes approximate 200 bps headwind pertaining to stronger US dollar. EPS for the year is expected to be in the range of $2.50-$2.80, well below the Zacks Consensus Estimate of $2.87. For fiscal 2012, Covance expects capital spending to be around $180 million.

Presently, Covance retains a short-term Zacks #3 Rank (Hold rating). Based on the company’s strong market leadership position, broad service offering, increasing geographical footprint, economies of scale and growing biotechnology and pharmaceutical customer base, we have a long-term ‘Neutral’ recommendation on the stock.

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