Covance Earnings Call Insights: Organic Margin Assumption and Central Lab Levels

Covance, Inc. (NYSE:CVD) recently reported its fourth quarter earnings and discussed the following topics in its earnings conference call.

Organic Margin Assumption

Robert Jones – Goldman Sachs: Just want to dig into the operating margin assumptions for the segments relative to guidance. On the Late-Stage specifically if we start with that 21.3% you did in the fourth quarter, could you just remind us how much of the IT spend hits Late-Stage expense versus corporate? Then outside of that incremental IT spend how are you thinking about the organic margin assumption for 2013.

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Alison A. Cornell – Corporate VP and CFO: Bob, this is Alison. Before we go the question, I wanted to clarify a number that I reported as I was going through. For full year revenue growth on a constant exchange rate basis, our growth was 5.4%, not 4.5% as I had indicated. So, let me just talk a bit about the guidance, starting in at Late-Stage. So, with Late-Stage roughly we would come in at 21% due to the increase of IT spend in 2013 as well as Q4 favorable mix in central labs returning to more normal levels. So that’s how I would think about Late-Stage. We ended the year at 21.3% and (actually hit a) full year of 21.3% but would look at roughly 21% again due to the increase of IT spend in 2013 and then the favorable mix in central labs returning to the more normal levels. From an Early Development perspective, we’d look to come and stay above the 2012 result of 9.6%, but below the fourth quarter level of 12%. So, it’s something in the 11% range due to Q1 seasonality. Again, I’m speaking to the midpoint here. So, there’s several ways to get to the midpoint, this is just one way. Then from a corporate perspective, due to IT spend we see corporate moving closer to 8% of revenue in 2013 versus the 7.5% that we saw in 2012. As Joe had mentioned, keep in mind that these assumptions are at the midpoint of the range only. To get to the higher end of range, we might see a mix of tests in central labs more in line with the second half of 2012 for example, or some growth in Early Development. The lower end of the range would likely be characterized by decline in Early, and perhaps unusually large cancellations in Late-Stage.

Robert Jones – Goldman Sachs: Then if I could just ask a follow-up, longer-term big picture question around free cash flow. As we think about the CapEx spending beyond 2013, could you maybe just share your thoughts on your view of the Company’s ability to generate free cash flow?

Alison A. Cornell – Corporate VP and CFO: So, we see our earnings in 2013 and beyond improving and our capital spend roughly staying the same. So, we would expect that our free cash flow would improve over time.

Central Lab Levels

Tim Evans – Wells Fargo: Joe could you maybe comment on your longer term view for the central lab, would you expect the growth at some point to kind of moderate back to the same levels as R&D spending growth, and if so how long would you expect it to take to normalize to that level?

Joseph Herring – Chairman and CEO: Well, Tim first of all I would say there is no such thing as a normal central lab levels. We really have had four plus years of very good order performance and at a fairly similar level and one year it spit out 30% revenue growth, one time in constant dollar it was a shrink of about 12% and this past year in reported dollars up a little less than 10%. So, it’s multi-factorial in terms of where the kits are coming from which drives transportation revenue, market share gains, the (which specific) gets in and all of that cobble together. So, again, I think if we sort of stay on the trajectory that we saw this past year, we called 2013 as 10% revenue growth, I can give you some scenarios where it could be better than that. But if we got cancellations it would be smaller than that. So, I guess maybe my answer would be as we continue to market share a couple of bps a year, we certainly did that in 2013. So, if you say, hey, R&D spending growth is going to be about 4%, everything is already outsourced, maybe Covance would grow 6% and maybe add a little bit for biomarkers and richness of test and global expansion and get to 8%. I mean, that would be a way to model it. But to be honest with you, it’s bounced around quite a bit. Last quarter, it was up substantially more than anything in the last five years. So, hard to model that.