Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Start Time: 09:00

End Time: 09:47

Covance Inc. (NYSE:CVD)

Q1 2014 Earnings Conference Call

May 02, 2014, 09:00 AM ET

Executives

Joseph Herring - Chairman and CEO

Alison A. Cornell - Corporate VP and CFO

Paul Surdez - VP, IR

Analysts

Jeffrey Bailin - Credit Suisse

Ross Muken - ISI Group

John Kreger - William Blair

Greg Bolan - Sterne Agee

Robert Jones - Goldman Sachs

Rafael Tejada - Bank of America-Merrill Lynch

Tejas Savant - JPMorgan

Steven Valiquette - UBS Securities

Dave Windley - Jefferies

Donald Hooker - KeyBanc Capital Markets

Garen Sarafian - Citi Investment Research

Douglas Tsao - Barclays Capital

Operator

Good day, and welcome to the Covance First Quarter 2014 Investor Conference Call. This call is being recorded.

At this time, for opening remarks, I would like to turn the conference over to the Vice President of Investor Relations, Mr. Paul Surdez. Please go ahead, sir.

Paul Surdez

Good morning, and thank you for joining us for Covance's first quarter 2014 earnings teleconference and webcast. Today, Joe Herring, Covance's Chairman and CEO; and Alison Cornell, Covance's Chief Financial Officer, will be presenting our first quarter financial results. Following our opening comments, we will host a Q&A session.

In addition to the press release, 21 slides corresponding to our prepared comments are available on our website at www.covance.com.

Before we begin the discussion, I would like to remind you that statements made during today's conference call and webcast, which are not historical facts, might be considered forward-looking statements. Such statements may include comments regarding future financial results and are subject to a number of risks and uncertainties, certain of which are beyond Covance's control.

Actual results could differ materially from such statements due to a variety of facts including the ones outlined in our SEC filings. Certain of the financial measures we will discuss on this call are non-GAAP measures, which exclude the effect of events we consider to be outside of our normal operations. We believe that providing these measures helps investors gain a more complete understanding of our results and is consistent with how management views our financial results.

For a reconciliation of GAAP to pro forma results, please refer to the supplemental schedules included in our press release issued last night. Note that our pro forma results this quarter exclude 4.1 million in cost associated with our ongoing restructuring and other cost reduction actions as well as a 1.6 million gain on sale from the divestiture of the Seattle genomics laboratory.

Now, I will turn it over to Alison for a review of our financial performance, which begins on Page 4 of the slide show.

Alison A. Cornell

Thank you, Paul, and good morning, everyone. Consolidated net revenue to the first quarter was 620 million, up 6.9% year-on-year. Foreign exchange contributed 170 basis points to this growth rate. Sequentially, revenues decreased $3 million due to the sale of the Seattle genomics lab coupled with the seasonally weak start of the year in early development which more than offset the sequential growth in late-stage development.

Pro forma consolidated operating income in the first quarter was 71 million and our operating margin was 11.5%. This is a 210 basis point year-over-year increase and 110 basis point sequential increase.

Pro forma diluted earnings per share in the first quarter were $0.90, up $0.15 or 20.1% from the first quarter of 2013. Sequentially, EPS was up $0.03, as operational strength in late stage and lower corporate spending more than offset early development seasonality.

The following items are included in the first quarter. Higher than forecasted stock option exercises, which drove significant payroll-related tax expense such as FICA and Medicare in the United States and equivalent social cost outside of the United States and a higher than expected weighted average share count resulting from these exercises as well as a higher average stock price.

These equity-related items were roughly offset by a tax credit which drove capability in our Q1 effective tax rate. The pro forma effective tax rate in the first quarter was 23.2% and it is expected to be approximately 24% for the full year from '14.

Please turn to Slide 5 of the presentation. In the first quarter, late-stage development contributed 65% of net revenues while early development contributed 35%. Revenues from our international operations continue to exceed our U.S. operations coming in at 54% ex-U.S. versus 46% U.S.

Turning now to slides 6 and 7 where I review our segment results for the quarter. In early development net revenue was 218 million in the first quarter, up 5.3% in the first quarter of last year, as growth in clinical pharmacology and toxicology more than offset a decline in discovery support and the impact of the sale of the Seattle genomics laboratory.

Foreign exchange contributed 180 basis points of its growth. Sequentially, revenue declined by $10 million as growth in clinical pharmacology and research products were more than offset by the impact of the sale of the Seattle genomics laboratory and seasonal declines in toxicology and discovery support.

Pro forma operating income in the first quarter was 21.1 million, up 5% year-on-year with an operating margin in line with the first quarter of last year at 9.7%. Segue to the first quarter margins included lower results in discovery support services, the impact of extreme weather in the United States which drove record high facility heating and maintenance costs, increased spending associated with the European expansion of our nutritional chemistry services, the mix of services within early development segments and higher payroll-related fringe costs associated with stock option exercises.

A sequential decline in pro forma operating income resulted from the seasonally lower level of revenue in both toxicology and discovery support coupled with the same items I just mentioned, which more than offset increases in our chemistry services. Looking ahead to the second quarter, we expect a considerable sequential increase in revenue and income in the early development segment.

Turning to late-stage development. Net revenues in the first quarter were 402 million, an increase of 7.8% versus the first quarter of 2013. Foreign exchange contributed 160 basis points of growth. Year-over-year was driven by 10.9% growth in central laboratories and 5.7% growth in clinical development, which more than offset a modest decline in our market access services.

Sequentially, revenue in the segment increased $7 million including a $3.3 million foreign exchange tailwind. Clinical development drove the sequential increase. Pro forma operating income in the first quarter grew 10% year-over-year to 93 million. This represents an operating margin of 23.2% which is up 40 basis points year-on-year and 50 basis points sequentially.

Turning now to corporate expenses. On a pro forma basis, corporate expenses were 43.4 million or 7% of net revenue in the quarter. This is a decrease of approximately $9 million sequentially and $7 million year-over-year. Those comparisons reflect a lower level of IT operating expense related to project timing, the shift of our informatics expenses to the late-stage segment, continued incremental savings in the corporate and functional support cost reduction actions, incentive compensation reset to budget levels and lower stock-based compensation expense resulting from the timing benefit from the change in vesting of stock grants from three to four years.

Please turn to Slide 8 where I will now review the order and backlog information for the quarter. Adjusted net orders in the first quarter were 710 million or adjusted net book-to-bill of 1.15 to 1. Backlog at March 31 was 6.9 billion versus 6.92 billion at the end of last quarter. Changes in foreign exchange rates positively impacted backlog by 37 million sequentially which was more than offset by the negative impact on backlog due to the sale of the Seattle genomics laboratory.

Please turn to Page 9 for a review of cash flow information. Cash and cash equivalents and short-term investments at March 31, 2014 was 660 million, down 69 million from year end and up 230 million from a year ago. Debt outstanding remains at 250 million. Free cash flow for the first quarter was negative 106 million, consisting of negative operating cash flow of 71 million, less CapEx of 35 million.

The negative operating cash flow reflects the payment of 2013 annual bonuses, the remittance in Q1 to the tax authorities of a client back payment received in the fourth quarter of 2013 and a four-day increase in DSO. We continue to project 2014 full year CapEx of approximately 160 million and free cash flow of approximately 130 million. (Indiscernible) which reflects our normalized cash flow can be found in the Appendix of the slide deck.

Finally, we ended the quarter with 12,630 employees, an increase of 129 from last quarter and inclusive of the transfer of nearly 50 staff as a result of the divestiture of the Seattle genomics lab.

Now, I will turn the call over to Joe for his comments.

Joseph Herring

Thank you, Alison. Good morning, everyone. Before discussing the quarter, along with our Q1 results we released last night, we also announced our new Covance brand and tagline, Solutions Made Real. As our clients' world continues to evolve, especially their critical needs to innovate, reduce the timely cost of drug development and improve success rates, they are looking to outsource more and are increasingly looking for their CRO partner to provide even more proactive, insightful and resourceful solutions.

The old paradigm of outsourced drug development as simply auxiliary arms and legs is giving way to a more comprehensive approach. In our proprietary market research we heard clients asking for a new model in a collaboration, one that generates high impact solutions. Our new brand, Solutions Made Real, recognizes these needs in the market and captures the essence of our industry leadership.

Covance generates more drug development than any other company in the world. Our ability to combine this competitive advantage with precision delivery and unique insights that help shape new solutions for our clients differentiates us in the marketplace. These solutions have enabled our clients to get to market sooner resulting in longer patent protection, improved NPVs and a deeper relationship with Covance. For Covance consistently delivering Solutions Made Real is a win-win for all of our stakeholders. It's how we will be known in the marketplace.

Now to the financial results. Covance started the year with Q1 pro forma EPS growing 20% year-on-year and $0.03 sequentially to $0.90. 7% revenue growth was coupled with strong operating margins in clinical and central laboratories and lower corporate spending as a result of our IT infrastructure transformation, timing of IT project spending and other previously announced cost savings initiatives.

On the commercial front, strong orders in early development in central laboratories offset lower than expected net orders and clinical development which again experienced elevated installations. In total, adjusted net orders were a healthy 710 million representing adjusted net book-to-bill of 1.15 to 1.

Now I'll comment on our segment results. In early development revenue grew 5.3% year-on-year and operating income grew 5%. Growth in clinical pharmacology, toxicology and nutritional analysis was more than offset by a large decline in discovery support resulting from the sale of the Seattle genomics laboratory and lower volume in the remaining discovery services.

Sequentially, both revenue and income were down as forecasted due to typical first quarter seasonality and weather factors. Based on already scheduled studies we expect both early development segment revenue and income to increase sharply in the second quarter from these levels and continue to increase throughout the remainder of the year assuming our current business momentum continues.

Orders in this segment were higher than we have seen in years, driven by higher demand in both toxicology and clinical pharmacology. We are now booking studies out several months even into August for certain types of toxicology and clinical pharm work. Orders continue to run above our expectations in April. This is an ongoing sign of market stabilization following several years of low demand and oversupply in the industry.

Many of the analysts on the call today were recently in Phoenix for the annual Society of Toxicology conference. The theme coming out of the meeting was that demand has been steadily growing for about a year. Capacity, especially North America, is filling and prices stabilizing and in some cases increasing.

With that backdrop we thought it would be useful to share an illustration of what toxicology volume has been in the past, where we see it today and where can it go in the future. Slide 11 provides the illustration of what we believed happened to toxicology volume over the last two decades.

First, the blue area represents what we believe is a steady growing volume of high quality preclinical compounds. We believe the 5,000 or so preclinical molecules in the 2013 pipeline are the new normal level. Big pharma and private equity can no longer afford to base their capital on low probability molecules. We believe the level of high quality molecules is growing and will continue to grow at roughly a 2% compound annual growth rate and form a growing high quality base of work for preclinical companies.

Next, the green shaded area represents the biotech boom of 2000 to 2008. This was a time of excess R&D spending by private equity and venture capital which added a bonus of low probability molecules into the pipeline. This drove demand for preclinical services up to a level that in hindsight were unsustainably high. While biotech funding has experienced a renaissance over the past 18 months, we believe this spending today is more thoughtful and calculated and is now part of the longer term high probability compounds represented in the blue. As our level of contribution varies over time, we believe biotech will be a contributor of the blue area's continued growth.

The red shaded area represents Big pharma's shots-on-goal approach in preclinical development over the past decade. This was a strategy that we've seen in quantity of the compounds over quality and it simply did not work as advertised. We believe this focus on quality is resulting in at least as many successful compounds exiting toxicology today as during periods when they focused on quantity and higher volumes.

Finally, the purple shaded area represents client buying behavior resulting from a constraining supply during that period of high demand. This [fear-driven] (ph) buying lead sponsors to pay up for dedicated space, conduct full package of studies on compounds that (indiscernible) into a long-term safety work forward in order to avoid delays in clinical regulatory submission. Their client behavior is much closer to adjusting time approach which could change if capacity continues to fall.

In total, we believe the biotech boom, shots-on-goal and favorable buying behavior drove levels of volume 20% higher than we are seeing today with prices 20% higher than last year's levels. But based on this, the question is, where have we reached today and where are we headed? We see current volumes closer to 2004 levels with capacity probably near 2004 or 2005 levels as well.

For Covance a year ago, we were around 60% capacity on a global basis and now we're little over 70% on a global basis with North America even higher. We believe an underlying 2% growth rate in molecules coupled with increased outsourcing preclinical tox, heightened capacity and Covance market share gains can fuel nice revenue growth and margin expansion for our toxicology business.

Another way to help characterize this market is when you consider the longer term revenue growth of Covance toxicology services which has grown at a 5% compound in annual rate over the past 50 years. This period includes both the spike and the decline in the tox market depicted on this chart. We believe this is a reasonable predictor of a longer term future growth rate for this business.

For this year, our improving outlook for toxicology is supported by several quarters of much stronger new orders as well as the mid-single-digit revenue growth we have experienced in the last two quarters and expect for the remainder of the year.

Turning to our late-stage results. Central laboratory revenue was up 11% year-on-year but flat sequentially due primarily to the impact of weather in the first quarter. Operating margins were down slightly sequentially. This reflected our need to increase staff to process an expected higher level of future kit volumes as net orders for central lab continue to be very strong.

In clinical development, first quarter revenues were in line with our projections to grow 6% year-on-year against the tough first quarter comparison and up 6 million in revenues sequentially with strong operating margins. While we won a record level of gross orders in the second half of 2013, we also experienced higher than expected project cancelations in that timeframe, and cancelations were elevated again in the first quarter. This dampens our 2014 clinical revenue growth rate forecast with our higher single digit range.

Ultimately, the mix of second quarter orders is to be faster burning versus slower burning as well as cancelation levels in the coming quarters will ultimately determine our clinical revenue growth for the year. Having said that, we believe our clinical development services just had the fastest revenue growth of the top five clinical CROs over the past five years continues to be positioned as a market share taker as evidenced by its trailing four quarter book-to-bill of 1.4 to 1.

In the second quarter, we are working a healthy list of clinical proposals and we believe we are well positioned to win many of them. In terms of our information technology operating expense in 2014, we are forecasting full year spending roughly in line with the 2013 level. This provides evidence that our strategic initiatives are delivering on the initial goal we set and that was to invest the growth rate of our IT spending.

Flat IT spending is a stark contract from the double-digit growth rate we experienced before our infrastructure implementation projects began. The remaining strategic IT projects continue to run on time and on budget and we continue to make excellent progress with the development of our expanded informatics capabilities. Covance IT is delivering significant value for our clients, our employees and our shareholders.

Let's now turn to our forward outlook for Covance. For 2014 we now forecast revenue growth of 69%. The midpoint of this range assumes high single digit growth in late-stage development and mid single digit growth in early development. Revenue growth expectations include a headwind from the sale of the Seattle genomics laboratory.

We're also narrowing our full year pro forma diluted earnings per share to a range of $3.70 to $3.95. In terms of deciphering the 2014 earnings, we expect sequential growth of a few cents in earnings each quarter as we progress throughout the year, which would deliver earnings at the midpoint of our guidance range.

Looking further ahead, we continue to build a stronger Covance for the future utilizing both the depth and breadth of our portfolio and enormous talent in our global drug development teams to create solutions made real for our clients. In closing, I'd like to thank Covance employees around the world for delivering exceptional service to our clients and helping bring their important new medicines to patients.

Operator, you now may open up the call for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll go to Jeff Bailin with Credit Suisse.

Jeffrey Bailin - Credit Suisse

Good morning, and thanks for the questions. Maybe just to start, Joe, given all of the recent news amongst the client base around some potential significant merger activity and perceptions around the disruption of that can cause, can you maybe offer your view of this trend and maybe how things could be different today than in some of the past cycles?

Joseph Herring

Yes, Jeff, based on the transactions we've heard so far, we don't really see any downside just to Covance. If anything there's opportunity based on how a couple of our largest services are positioned with those two companies.

Jeffrey Bailin - Credit Suisse

Okay, great. And moving on just on the book-to-bill performance and commentary in the quarter, it sounds as though the clinical development orders were perhaps a little lighter this quarter than internal expectations along with higher cancellations. Is there any color you can add around whether you think this was a timing issue with some signatures that slipped, issues related to customer mix or a win rate that shook out lower than expected in the quarter?

Joseph Herring

Well, the win rate was just fine. It's really the matter of cancelations. Obviously the cancelations had nothing to do with Covance, it's just changing the priority position of a pipeline or a safety and efficacy issue that caused a client to pull back. Again, if you look over the last four quarters, a trailing book-to-bill of 1.4 is very healthy and as I said in my prepared comments, we have a healthy list of proposals we're working on and we do expect to win at least our fair share.

Jeffrey Bailin - Credit Suisse

Great. Thanks for the questions.

Operator

We'll go next to Ross Muken with ISI Group.

Ross Muken - ISI Group

Good morning, guys. So just sticking with sort of the M&A topic, I mean it seems like there's been a fair amount of concern of disruption. I mean do you see it as a sort of near-term risk more to one function of the business than the other just in terms of historical precedents or do you feel like in general based on what you've seen in your client mix, there's really kind of a fairly minimal exposure across the whole platform?

Joseph Herring

Ross, if you look back over the history of Covance, we've never really been impacted in a major way by pharma M&A. The last slide in the deck shows our late-stage business and how it has performed over the last seven or eight years. And what you see is extraordinary growth and margin expansion through a bunch of pharma M&A. Second of all is our client diversity is a real positive. We have – the top three clients represent approximately 25% of our revenues. That one is just a hair over 10% of revenue and everything else is sort of 8% or less. So, I guess there are a couple of examples where a small company has super high concentration with a particular client and when they lost it, it was pretty much headline news. But again, we have seen impacts in the past and again the ones that are lining up right now, if anything, is outside potential for us.

Ross Muken - ISI Group

That's helpful. Maybe just as sort of a follow-up, you guys did some unique rebranding of services that you announced yesterday also. Just in the context, do you feel like in general whether it's in the M&A case or as others are kind of contemplating larger scale decisions, your ability given your breadth to kind of bring a very different suite of services, whether it's the case of M&A to help somebody execute against a synergy target or is someone who's just trying to improve efficiency or tied in the market in the business, do you feel like now you're getting that message and that's kind of behind sort of this new marketing campaign and some of how you're coupling the services? I'm just trying to get a sense for the timing and the thought behind it.

Joseph Herring

Well, thanks for the question, Ross. First of all, we've been working on our brand new project for a year. It just happened to line up – to come out the same time as our Q1 earnings here. Just a couple of things and you touched on one of them. First of all, when the client is looking for a big solution there's no better company to talk to than Covance. We had made several proposals over the last 18 months where we could help a client take $2 billion, $3 billion, $4 billion, $5 billion, $6 billion, $7 billion out of their R&D infrastructure. And so how would you do that? Well, they have these huge fixed cost infrastructures and now large CROs like Covance can allow them to close those big facilities and buy on the variable cost bases a faster, more cost effective service than they're getting internally. And there is zero doubt in my mind that that is going to happen. And whether it happens for a slowly yield return or not that's the question. There are several companies right now that are thinking about making very big changes in their business model. You've seen a few announcements just over the last couple of weeks. The same kind of questions are being asked about R&D infrastructure and as you get new leaders, new orders of the business, people with a different set of eyes that go you've got to be kidding me. We have 1.5 million square feet of toxicology space, where we could buy a more effective service on the outside, why wouldn't they do that. I think the other element of the brand is really aspirational for us where we're making investments in IT with our informatics to help our clients make better drug development decisions faster and help them get product to market sooner. We've talked a little bit over the last quarter or so about a major clinical trial mission-critical for our company and we enrolled it 13 months faster than they asked us to, and just imagine the net present value difference for that company getting to market. It has been competitive and we own the patent curve. So I think it's a really interesting time for the CRO industry where the top companies, including Covance, are moving from sort of arms and legs to actually having bigger scale, bigger capability, more investments in automation global scale than even the biggest pharmaceutical companies. And to me that is very exciting and with our portfolio we are well positioned to make solutions real for our clients.

Ross Muken - ISI Group

Thanks, Joe.

Joseph Herring

Thank you, Ross.

Operator

Due to the high volume of questions, we ask that you please limit yourself to one question. If you have a follow-up, please re-queue. We'll go next to John Kreger with William Blair.

John Kreger - William Blair

Hi. Thanks very much. Joe, could you just clarify a little bit; it's interesting, it sounds like you're getting a much significant uptick in order flow in clinical pharm and tox, but perhaps the lower flow in clinical, are we hearing that right? Or is the clinical issue strictly one of cancellations? Just curious if you're seeing a sign that maybe some of your clients are starting to tilt demand back towards early stage.

Joseph Herring

No, this is all about cancelations that have flowed through over the last several quarters. Proposals are strong. And like I said, we're well positioned.

John Kreger - William Blair

All right, great. Thanks.

Operator

We'll go next to Greg Bolan with Sterne Agee.

Greg Bolan - Sterne Agee

Thanks, Joe, and you've kind of alluded to this but I was hoping maybe you could expand a bit. I mean there's been obviously in the news lots of transfers of assets. It appears that large biopharma is kind of going towards the Jack Welch approach if you're not number one or two, then get out of the market. So kind of sticking to what they're good at. In that same sense, as they look to narrow their pipelines, to me it would almost lead to the idea that they would be looking to narrow the number of CROs that they're using which obviously we've been seeing that for years but I'm talking about narrowing to maybe an alliance with one zero in the case – in your case obviously Lilly, [Otsukas] (ph), sanofi's of the world. Is that something that you see as an opportunity for you just from the standpoint of these large multi-year, minimum take-or-pay type of alliances?

Joseph Herring

Greg, I think we got a long way to go before a client goes that far. First of all, there's no one single decision maker in a large pharma company and they tend to spread it around. I mean even – for years with our earlier deal, we were in the largest CRO that they worked with. It took us a long time to get to that place. I don't see one company going with just one CRO. I think the primary, secondary or primary Pfizer brand, we've seeing that. As you saw Bayer announced that it's primary Covance but we have to fight and compete every day. They're an exciting company and we have to service their needs. So I don't know, I think that would be an extreme situation.

Greg Bolan - Sterne Agee

Okay. Thanks, Joe.

Operator

We'll go next to Robert Jones with Goldman Sachs.

Robert Jones - Goldman Sachs

Thanks for the question. As it relates to the operating profit in early development, you're highlighting a number of impacts in the quarter that had a negative impact. On the surface, Joe, a lot of these seem pretty transient. Just wondering any sense you can give us on what you think the underlying margin was or could be excluding some of these things like stock comp or spending in Europe? Maybe some more simplistically, is there any way we should be thinking about the drop through today in early development?

Joseph Herring

Well, some of the things that happened in first quarter we really look and foresee some of the stock-based comp, incredible weather, it takes a lot of electricity to keep facilities going in such extreme temperatures, but we see margins – we see early development and particularly toxicology rebounding sharply in the second quarter and getting that to something like the fourth quarter levels or higher, something in the mid teens range pretty quickly.

Robert Jones - Goldman Sachs

Okay. Thanks.

Operator

We'll go next to Rafael Tejada with Bank of America-Merrill Lynch.

Rafael Tejada - Bank of America-Merrill Lynch

Good morning and thank you…

Joseph Herring

Hi, Rafael. Are you there? We'll try to take you in a little bit. It sounds like you were disconnected.

Operator

Rafael's line is now open.

Rafael Tejada - Bank of America-Merrill Lynch

Not sure what happened there.

Joseph Herring

You're on Rafael.

Rafael Tejada - Bank of America-Merrill Lynch

There we are. Okay. Sorry about that, apologies for that. So basically if I'm looking at the way in which Covance performed over, let's call it the last down cycle in 2008 to 2011. Top line growth – overall top line growth was in the mid high single digits. During that time, operating margins did come in a bit but mainly driven by early development pressures. So, where I'm getting at is if we do see some of these pharma mergers come through and potential project delays as there is some asset transfers, I'm just wondering how do you see – what opportunities, what levers the company has to mitigate any potential headwinds in the operating margin side. How do you control that and what's different in this environment versus last environment? Thanks.

Joseph Herring

Well, thanks for your question. Watching the news right now we don't see downside just to Covance. And as I said earlier, if anything, there is an opportunity based on how a couple of our services are positioned with those companies, it provides upside opportunities. So that's not in our thinking right now but I think we've shown an ability to take a lot of cost out of business units as well as corporate overhead when the time comes.

Operator

We'll go next to Tycho Peterson with JPMorgan. Your line is open.

Tejas Savant - JPMorgan

Hi, guys. It's Tejas in for Tycho. Just a couple of quick ones within late stage. I wanted to delve a little bit into your weakness in market access. Last quarter you had said that orders were picking up a little bit and things were getting better sequentially. So, can you just talk about what's changed and linearity sort of exiting the quarter within that business?

Joseph Herring

I think it was a bit of breather for the quarter. They continue to have nice orders. It's about 2% or 3% of revenues, so it's not really a driver of our total results in the quarter, but we expect it to improve as the year progresses.

Tejas Savant - JPMorgan

Thanks.

Operator

We'll go next to Steven Valiquette with UBS.

Steven Valiquette - UBS Securities

Hi. Thanks. Good morning. Actually one question we keep getting from investors is if we continue to see pharma customer consolidation, does it make sense for CROs to continue to consolidate? There seems to be some mixed views on this, I'm just curious to get your quick thoughts. Thanks.

Joseph Herring

It's kind of an apples and an orange question. You're talking about manufacturing, R&D driven company versus a service company, I guess from my perspective over the last 10 years, there really haven't been any consuming kind of M&A activity amongst the top five players and I don't foresee that changing any time soon.

Steven Valiquette - UBS Securities

Okay. Thanks.

Operator

We'll go next to Dave Windley with Jefferies.

Dave Windley - Jefferies

Hi. Good morning. Thanks for taking the questions. Joe, I want to ensure that I'm taking away what you want us to hear on your preclinical thoughts as it relates to the compound growth over a long period of time, vis-à-vis your fairly enthusiastic comments about near-term order flow improving. I guess the one sounds like something that would ramp up to at least a recent history – a much more attractive level vis-à-vis with history, but the 2% compound growth is something that I think is kind of putting back on the range relative to where investors might get enthusiastic?

Joseph Herring

Dave, I'm having a little bit of hard time understanding you, but I think I got enough. So we're saying that the underlying growth rate in compounds is about 2% and we would add to that that outsourcing will continue to increase as well as market share gains by Covance. And we sort of do that math to get to something like 5% growth rate or better. For us this year if you take out the headwind of the sale of the Seattle genomics business, we're running 8-ish. And then I gave a sort of second build up which is if you look over the last 15 years our compound annual growth rate has been 5% even with the run up and the run down. So just to trying to bracket it, Dave, and say somewhere between 5% or 8% (indiscernible), it might even be better than that. That's not what we're calling for but that's what we're fighting for. And that's just a barometer. Some years it maybe a little faster, some years it maybe a little bit slower, but I think when you come through the down cycle that you know very well, Dave, starting in 2008 we wonder what's really the underlying foundation of this market and that's what we're trying to do today which I'm trying to give you an idea if normalized for all of that what does it look like. And so our outlook will be something in the 5% to 8% range and we'll be pushing harder to be even better.

Dave Windley - Jefferies

Very good. Thank you. I appreciate the color.

Joseph Herring

Sure, Dave.

Operator

(Operator Instructions). We'll go next to Donald Hooker with KeyBanc.

Donald Hooker - KeyBanc Capital Markets

Great. Thank you. So on the topic sort of the drop through of higher tox revenue to margin, I was curious. You kept referencing weather in the first quarter in terms of expenses that I guess I hadn't contemplated, but can you quantify that in terms of the margin impact in Q1?

Joseph Herring

Just heating costs alone were more than $1 million extraordinary, but again I think as an investor I'd be looking more to Q2 than the rest of the year. And what we're saying is with some extraordinary things sort of happened in the first quarter plus the seasonality; we had mentioned that ahead of time, we had forecasted what of course would happen. It shouldn't have been a surprise. But what we're saying is the sharp increase going forward and based on a fair amount of evidence. We've said over the last couple of years we don't want to get too far ahead of ourselves in forecasting toxicology. We'd rather show P in the P&L and the business performance. And we think now we've got enough quarters of show and see in the P&L and show and see in new orders that we feel good about to build forward.

Alison A. Cornell

I think another thing to think about, Donald, is mix of studies. And so when we think about mix of studies, margins are lower at study start when animals are released into the study, if you will. And so the good news is we had a lot of study starts in tox in the first quarter that you should see manifest itself in higher revenue growth as we move through the second quarter.

Donald Hooker - KeyBanc Capital Markets

Thank you.

Operator

We'll go next to Ricky Goldwasser with Morgan Stanley. Your line is open. Please check your mute function.

Unidentified Analyst

Hi. This is (indiscernible) in for Ricky Goldwasser. I just wanted to follow-up a little bit on the margins for early development. I mean there are still up here somewhat challenged, so how should we square that up with the improved comments about the environment?

Joseph Herring

Well, we've answered several questions like that. I guess what we would say is looking to the second quarter we're looking sort of in the low teens and then going higher from there. There were a number of items in the first quarter that I think were all characterized between our press release and our prepared comments.

Unidentified Analyst

Thank you.

Operator

We'll go next to Garen Sarafian with Citi.

Garen Sarafian - Citi Investment Research

Good morning, Joe. Good morning, Alison.

Joseph Herring

Hi, Garen.

Alison A. Cornell

Hi.

Garen Sarafian - Citi Investment Research

Good morning. I'd like to focus on early development. Earlier this week from just news that there might be some expansion in capacity by one of your competitors and also news that two of the private companies in early development, preclinical are now merging. So I'm just wondering how are you guys thinking through your plans or have you anticipated this before or how does it sort of impact it? And just the competitive landscape with two private companies now integrated together with some more of a full function CRO?

Joseph Herring

I don't really think one of those bits of news impact our business all that much. In comparison, you're talking about a very small add. We have no plans to add capacity. And as it relates to a couple of other competitors coming together, really no comment. It's not going to enhance capacity and my guess is they'll be pretty busy with integration activities for a while. So really not impact on us.

Garen Sarafian - Citi Investment Research

Not even positive though, I mean it could also just be that they could take capacity out of the market or if there's any sort of disruptive pricing then that could become more rationale or anything else. So neither positive nor negative?

Joseph Herring

I mean it's just hard for me to speculate about what they might do. If I were them I'd be taking some capacity out to try to get the cost saving synergies. But that's not my call. But again, I just look in the scheme of things. The amount of work that we've won and the studies we're starting and the business flow, we need to stay focused on what we're doing.

Garen Sarafian - Citi Investment Research

Got it, great. Thank you.

Operator

We'll go next to Douglas Tsao with Barclays.

Douglas Tsao - Barclays Capital

Hi. Good morning. Just sort of maybe shifting gears a little bit, but sort of maybe sticking along the lines of sort of customer issues. I know with the sanofi contract that you signed at the end of 2010, there is the five-year fixed portion for the early development piece. So I think my expectation would be, correct me if I'm wrong, that would sort of end the end of next year. At what point or have you engaged with sanofi in terms of renewal of that deal and sort of your perspectives on sort of how that might progress and certainly would it continue on a fixed basis or do you think given the strength of the relationship, it could sort of just keep going on a steady-by-steady basis?

Joseph Herring

Well, Doug, those agreements run I'd say about another 18 months to the end of next year is premature for us to speculate exactly what our plans would be at that time. In the meantime we continue to drive incremental business into those sites to make them competitive. Keep in mind there are two portions in the agreement, the larger and the ramping part of the agreement is a ten-year agreement and the five-year agreement we're starting to engage a little bit now, but we will. I don't know what their plans are at this point in time.

Douglas Tsao - Barclays Capital

Okay, great. Thank you.

Operator

At this time, there are no further questions.

Joseph Herring

Great. Thank you, operator, and thank you everyone for your participation on today's call. I'll be available all day if you should have any follow-ups; email or phone works for me and I hope you have a great day and a great weekend. Thank you.

Operator

Thank you. This does conclude today's conference. We appreciate your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Covance's CEO Discusses Q1 2014 Results - Earnings Call Transcript
This Transcript
All Transcripts