Covance's CEO Discusses Q2 2011 Results - Earnings Call Transcript

| About: Covance Inc. (CVD)

Covance (NYSE:CVD)

Q2 2011 Earnings Call

July 28, 2011 9:00 am ET

Executives

Joseph Herring - Chairman and Chief Executive Officer

William Klitgaard - Chief Financial Officer, Principal Accounting Officer, Corporate Senior Vice President and Treasurer

Paul Surdez - VP of IR

Analysts

Ricky Goldwasser - Morgan Stanley

Robert Jones - UBS

Ross Muken - Deutsche Bank AG

Douglas Tsao - Barclays Capital

Stephen Unger - Lazard Capital Markets LLC

Tycho Peterson - JP Morgan Chase & Co

James Kumpel - BB&T Capital Markets

David Windley - Jefferies & Company, Inc.

Eric Coldwell - Robert W. Baird & Co. Incorporated

John Kreger - William Blair & Company L.L.C.

Todd Van Fleet - First Analysis Securities Corporation

Operator

Good day, and welcome to the Covance Second Quarter 2011 Earnings Conference Call. This call is being recorded. And at this time, for opening remarks, I would like to turn the call over to Vice President of Investor Relations, Mr. Paul Surdez. Please go ahead, sir.

Paul Surdez

Thank you, operator. Good morning, and thank you for joining us for Covance's Second Quarter 2011 Earnings Teleconference and Webcast. Today, Joe Herring, Covance's Chairman and Chief Executive Officer; and Bill Klitgaard, Covance's Chief Financial Officer, will be presenting our second quarter financial results. Following our opening comments, we will host a Q&A session.

In addition to the press release, 16 slides corresponding to the commentary you are about to hear are available on our website at www.covance.com.

Before we begin the commentary, 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 outside of our normal operations, such as items associated with our restructuring. 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, which we issued last night.

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

William Klitgaard

Thank you, Paul, and good morning, everyone. Net revenue for the second quarter was $518 million, an increase of 9.1% over the second quarter of last year. Growth was 3.7% on a constant dollar basis.

Sequentially, net revenues increased $16 million. Operating income on a GAAP basis in the second quarter was $48.8 million and on a pro forma basis was $53.3 million or 10.3% of net revenue.

EPS on a GAAP basis was $0.61 a share and on a pro forma basis was $0.66 per share. Sequentially, pro forma EPS increased $0.06 due to increased earnings from higher revenue levels.

The pro forma effective tax rate for the quarter was 22.2%, and we expect an effective tax rate in the mid-22% range as we look ahead for the rest of 2011.

Now please turn to Slide 5. In the second quarter, Early Development contributed 45% of net revenue, and Late-Stage contributed 55%. In terms of the revenue distribution, 53% of our revenue came from the U.S., 14% from Switzerland, 12% from the U.K., 9% from countries in the eurozone and the remaining 12% from the rest of the world.

Now please turn to Slide 6 to discuss segment results. In Early Development in the second quarter, net revenue was $232 million, an 11.4% year-on-year increase, driven by the results from our Alnwick and Porcheville sites, foreign exchange tailwind of 230 basis points and stronger results in Clinical Pharmacology. This more than offsets a net decline of revenue from the wind down and transition of work from our Vienna Toxicology facility.

Sequentially, revenues increased to $7.8 million on a broad basis. Second quarter operating income on a GAAP basis was $30.9 million and on a pro forma basis was $32.9 million or 14.2% of net revenue. OM increased 240 basis points sequentially, again on a broad basis.

Turning to Late-Stage Development. Net revenues in the second quarter were $286 million, which is up $8 million from the first quarter and up 7.3% from the second quarter of last year. Growth in both periods was primarily driven by the continued strong performance in Clinical Development, coupled with the weakening of the U.S. dollar, which offset ongoing softness in Central Labs caused by continued higher-than-normal level of cancellations and generally slower rate of conversion of backlog.

Late-Stage operating income on a GAAP basis was $56.5 million and on a pro forma basis, plus $57.3 million or 20% of revenue.

Now please turn to Slide 7 to recap orders and backlog. Adjusted net orders in the second quarter were $614 million, which represents an adjusted net book-to-bill of 1.18:1. Backlog at June 30 grew 29% year-on-year to $6.25 billion. Sequentially, the weakening of the U.S. dollar increased the value of our backlog by approximately $100 million during the quarter, which was offset by the removal of $141 million of CMV commitment, which is contract minimum volume commitment. The CMV contract was replaced by a broader non-CMV arrangement, under which the underlying studies will be included in future orders as individual project study documentation is prepared.

Please turn to Page 8 for review of cash flow earnings. We ended the quarter with DSO at 38 days, and that compares to 37 days at the end of last quarter and 47 days a year ago. We continue to target year-end DSOs of approximately 40 days. Cash and equivalents were $406 million at the end of the quarter, that's $38 million more than the end of last quarter. At the end of the quarter, our debt level was $93 million, which was down $37 million for March 31 levels.

Free cash flow for the second quarter was $59 million, consisting of operating cash flow of $89 million and capital expenditures of $30 million. Year-to-date, free cash flow was $38 million, consisting of operating cash flow of $89 million and CapEx of $51 million. Full-year CapEx is now forecasted to be approximately $110 million in 2011.

Corporate expenses were $38.7 million in the quarter on a GAAP basis and on a pro forma basis, corporate expense was $36.9 million or 7.1% of revenue. The sequential increase in corporate expense was due to higher incentive compensation costs and certain non-recurring professional fees. We expect corporate expense as a percent of revenue on a pro forma basis to trend lower during 2011 as more savings are realized from the restructuring actions. And finally, we ended the quarter with 10,811 employees.

So now I would like to turn the call over to Joe for his comments.

Joseph Herring

Thank you, Bill, and good morning, everyone. Covance delivered improved financial performance again in the second quarter. Both net revenues and pro forma earnings per share increased sequentially for the fourth consecutive quarter.

Looking forward, we expect ongoing improvement in demand for our Early Development service offerings, flat sequential performance from Central Lab and continued strong performance in our Clinical business. In the total company perspective, we expect sequential revenue growth and further margin expansions in Q3 and Q4.

Orders and proposed volumes are gaining momentum, and to capitalize on these market opportunities, we've added several dozen new sales and marketing professionals across the company. And we continue to have interesting discussions with large pharmaceutical companies who are looking to make their fixed R&D cost structures lower and more variable. In this environment, we remain very well positioned given our broad service portfolio and our track record of striking R&D alliances, which create genuine value both for us and for our clients.

In our Early Development segment, revenues grew sequentially by $7.8 million with growth in all major service areas, including Toxicology, Analytical Chemistry, Clinical Pharmacology and Discovery Support. We delivered very strong drop-through on this incremental revenue as pro forma operating margin increased 240 basis points to 14.2% in the second quarter.

Keep in mind that our Q2 pro forma operating margin includes operating losses we're absorbing as we wind down our Vienna site, as well as startup losses relating to the opening of our new specialty Toxicology services in Greenfield and the launch of our preclinical facility in China.

In Toxicology, the improvement we are seeing in North America is due to a combination of factors, including lower capacity levels across the industry, improved biotech funding and more consistent study placement by some of our large pharma clients. European Toxicology, however, is not yet experiencing the recovery we are seeing in North America.

We believe we are taking market share in Toxicology. Covance is the only provider with state-of-the-art Tox facilities in North America, the U.K., Continental Europe and China. We are effectively combining these facilities with superior scientific and operational talent and a robust program management offering that integrates our IND-enabling capabilities to substantially improve the time and cost of drug development for our clients.

Revenue at our Alnwick and Porcheville sites is running ahead of plan, as the contracted revenue commitment from Sanofi are being supplemented by small but increasing amounts of revenue awarded by clients other than Sanofi. More specifically, these new clients have placed work at these sites for regular label Chemistry, DMC, formulation, Pharmacokinetic and Toxicology services. We've now appointed the projects for 45 different global clients of these new sites, and we've already been awarded work from 22 of those clients.

Projects awarded are primarily in support of IND-enabling programs being conducted at other Covance sites, as well as competitor labs. We are especially pleased with the quality of the formulation capabilities of these sites and the positive impact these services are having on our clients' programs. Drug formulation problems are a major reason for preclinical program delays, but these capabilities further enhance our market-leading Early Development service portfolio.

During the second quarter, our Bioanalytical Chemistry team secured a multiyear contract from a top 10 pharmaceutical company. Historically, this client utilized multiple bioanalytical providers under a tactical delivery model. This client has committed to place all future clinical, bioanalytical projects with Covance in order to drive efficiencies and improve timing and delivery.

In Clinical Pharmacology, our revenue and operating income grew nicely both year-on-year and sequentially, driven largely by volume from our R&D alliance partners. Quarterly results in Clinical Pharmacology have been quite choppy over the last few years, but our outlook is improving. We differentiate our Clinical Pharmacology capabilities by linking services between preclinical and clinical under our program management offering, as well as integrating Phase I with biomarkers, early clinical and translational medicine studies.

On the business development front, we were able to leverage our broad service portfolio to create a win-win solution for Covance and a long-time Early Development client who have seen a shift in their service needs. Client had 4.5 years and approximately $140 million remaining on its CMV commitment for Toxicology and Chemistry services flipped between Chandler and other facilities.

Our Chandler facility is now roughly breakeven and performing an increasing amount of work for over 30 other clients, and these other clients made up approximately half of Chandler's Q2 revenues.

Under a new non-CMV arrangement, the client confirmed that they plan to continue to use Chandler, as well as play studies across a broader range of Covance services in excess of the remaining value of the CMV.

Consistent with how we treat similar arrangements, such as the sole source arrangements we have with a number of clients in our Central Lab, we will include these new projects in orders and backlog as the individual projects study documentation is prepared.

Revenue from this new arrangement is expected to be at least $170 million over the next 4 years.

I'd now like to comment on our Late-Stage Development, where revenue growth accelerated to 7.3% year-on-year and increased $8 million sequentially. Continued momentum in clinical and foreign exchange tailwinds more than offset volume in our Central Lab. Pro forma operating margins were 20%.

On the commercial front, Late-Stage orders were solid with Clinical net orders again stronger than in Central Lab. Cancellations in Clinical remained in the normal range, while Central Labs experienced the continued elevated levels of cancellations that have seen over the past year. Looking forward, our new proposal volume in Clinical Development is robust and improving in Central Lab.

Central Lab's inbound kit volumes continue to be impacted by the slower conversion of backlog to revenue. As a reminder, the factors impacting the conversion rate include: an overall lengthening in the duration of Clinical trials; continued high proportion of backlog consisting of complex global studies, which take longer to initiate; and projects, co-productions and cancellations due to pipeline rationalization decisions by our clients.

We expect Central Laboratory revenue to be relatively flat sequentially through 2011, as somewhat lower volumes are largely offset by FX translation upside, assuming that the Swiss franc remains near its June 30 levels.

Turning now to Phase II-IV Clinical Development. Our Clinical team delivered another quarter of stellar results, with revenue growing in excess of 20% year-on-year and a $6 million jump sequentially. We entered the third quarter with a robust list of pending proposals.

Our close whole success is underpinned by the strategic investments we've made, such as our Xcellerate informatics, use of Six Sigma to narrow service variation and improve efficiency, new project management tools and elevated levels of employee training. These programmatic capabilities have allowed us to improve Clinical trial design and Xcellerate patient enrollment. We enjoy very high levels of client satisfaction and repeat business across our Clinical Development businesses.

Now I'd like to review our full-year outlook. On a segment basis, we expect sequential Early Development revenue growth in the back half of the year. We also project pro forma operating margins to expand further in both the third and fourth quarters driven by higher volume, increased savings from our restructuring program and completing the transition of Specialty Toxicology from Vienna to Greenfield.

In Late-Stage Development, we expect revenues to be relatively flat over the next 2 quarters as continued growth in Clinical development and foreign exchange tailwinds are offset by seasonal trends, including the impact of summer vacations in Q3 and the unusual holiday disruptions in November and December, as well as lower volume in Central Labs. We believe this will translate into slightly lower Late-Stage pro forma operating margin in the back half of this year.

On a consolidated basis, we forecast sequential growth in Covance revenues throughout the remainder of the year, as well as total company margin expansion on a pro forma basis. We expect this to translate into full-year pro forma earnings per share of $2.60 to $2.80. Looking forward to Q3, we are targeting pro forma earnings per share of approximately $0.70.

In closing, reducing high fixed cost infrastructure and improving R&D productivity are strategic mandates for our clients. To meet these pressing client needs, Covance brings an unparalleled combination of talent and service portfolio to be a strong R&D partner. We effectively integrate our services to help our clients take time and cost out of drug development, and we also have a demonstrated track record of creating novel R&D alliances which allow our clients to make their fixed costs lower and more flexible. We are going to continue innovating new outsourcing models which are good for our clients and good for us. Because in the process, we are creating new market opportunities where Covance is best positioned to win.

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

Question-and-Answer Session

Operator

[Operator Instructions] And our first question will come from John Krieger with William Blair.

John Kreger - William Blair & Company L.L.C.

Joe, can you just sort of give us your broad perspective on where we are with the whole strategic partnering trend? What are the lessons you've learned over the last several years? And given that, what sort of deal structure and relationships are you guys most interested in going forward?

Joseph Herring

Well, John, I think we're in an interesting time where clients, as I call the strategic mandate to lower their fixed cost infrastructure and make the cost more variable. And each client has a different approach as to how they want to do it. Some of these initiatives are being driven by procurement, some are being driven by executive management and so there's lots of different flavors. I think we've tried to be very clear on the types of arrangements where we think we can add the most value for clients. And it's in multi-year agreements where there's -- to both sides, appropriate government structure. We think in certain aspects where there's a transfer of assets and that asset fits our portfolio, we can market that on the outside. Certainly, those are good. Once we don't involve asset transfers, it really requires a senior executive commitment and engagement, and we have several partnerships that I guess you could consider us 1 of 1 or 1 of 2 preferred providers, where we are holding hands with the clients and utilizing our informatics and our platform to deliver a lower total cost of ownership. So certain transactions that we've looked at don't fit our model, others fit our model because we create value for clients and for us. So we turned down far more than we've accepted, and we'll continue to be very choosy. I guess the most precious asset we have at Covance is our talent. And tying them up and dedicating them to work that doesn't create value for us and for shareholders is not a good decision, applying them where they create value for clients and shareholders is where we're going to apply them, and there's nothing to funnel that. I think we can pick the ones that are mutually beneficial.

John Kreger - William Blair & Company L.L.C.

Great. My follow-up to that, as you watch some of these deals get awarded, how comfortable are you with the competitive pricing dynamic that's out there? I would imagine there's a temptation to cut price to win some of these deals.

Joseph Herring

Well, I think both buy side and sell side analysts have triangulated in the marketplace and figured out ones that met sort of the crushing pricing category, and we understand our cost structure very well and we unfortunately as a company, from time to time historically have had to live with the long-term detriment of taking prices that really aren't fair, that really aren't commercial terms that are reasonable. I mean, if I'm a big pharma client, I want to get good pricing, but I want business continuity, I want my provider to put the best teams on, I want that provider to invest in our relationship. And I think over time, the contracts that generate the most true value for clients will be obvious. So some have been very, very competitive but again, I think there's enough information in the marketplace for people to know where that is.

Operator

And moving on, we'll go to James Kumpel with BB&T Capital Markets.

James Kumpel - BB&T Capital Markets

Joe, can you comment a little bit about the transition of that minimum committed value contract to a more variable one? How confident are you that the aggregate future volumes are going to be at $170 million or above? And do you see that as an emerging trend in the marketplace?

Joseph Herring

Well, let me take the last question first. I don't necessarily see it as an emerging trend. This is a client that has had a change in their portfolio and their service needs. They're happy with the work, they're trending towards the commitment that they had for this year. But in the next several years, that commitment goes up in an area where they don't feel like they need as much service. And so much -- it's sort of like a mirror image of what we did with the very visible Lilly and Sanofi contracts. The client had an issue and an asset they needed to move that on face value wasn't sure was a good deal. But because of our broad service portfolio, said we can do that if can we become a substantial -- have a substantial increase in our Central Lab business and become a primary clinical provider. It's the same situation here where the client had a well-defined need, and they've made that commitment larger than the commitment that they had made before. And we're very confident. We have the project numbers. We know where the work is going to come and it's just a matter of finalizing those and dropping them in orders as their pipeline progresses probably over the next couple of years. We also had additional flexibility here in that Chandler has more than 30 clients. With the Vienna campus closing, we're able to plug in even more into Chandler, and things are looking better there. So it's a matter again of flexing our portfolio to create something that's good for the clients and good for us. And what we said is at least $170 million in revenue; I think it's going to be more than that. And I think if things play out the way the discussions went, that revenue will actually come a little faster than the CMV revenue would have come. So I think it's a matter of just leveraging our portfolio to create a win-win and help a strategic client.

James Kumpel - BB&T Capital Markets

Okay. On the Late-Stage Development, obviously kind of a study in contrast here, but your Phase II-IV business is growing outstandingly, and Central Lab seems to be stuck a little bit in neutral. Can you offer up kind of a view of what you think is going to basically break for Central Labs to improve on some of those fundamentals? And maybe help us understand kind of the divergence between the really strong growth on Phase II-IV and what seems to be plugging up the pipes on Central Lab.

Joseph Herring

Well, since you're contracting the 2, let me refer you back to how the Clinical businesses performed over the last 3 or 4 years. Remember that a couple of years ago, it was growing 15% to 20% and everything was great, and then we announced that there were 3 large projects that will be in cancellation -- canceled and delayed. And our Clinical business went from 15% to 20% growth to 0% growth, and we tried to explain we haven't lost any clients, it isn't a service issue, it's just changes in the portfolio where projects are being delayed and canceled. And it slowed the growth of the company down. Those projects eventually plugged in and we kept winning business. We didn't lose any clients, and now it's growing 20% again. And I think Central Lab is the same way. There are project delays and cancellations that are rippling across the industry. Keep in mind, Jim, that 70% to 80% of the work that we do in our Central Lab are not for trials that are outsourced at all. And so a lot of this is happening on studies that you may or may not even know about that are being done by the internal CRO at the pharma company. And just keep referring to the headlines coming out of the pharma industry: patent cliffs, pricing pressure to end users, needing to reduce costs, needing to be more efficient. And they're looking at their pipelines and delaying and canceling projects. What leads us out of this I think is when pharma companies have gone through that purging process and they get back to really the business at hand, which is we have got to bring innovative new medicines to the market that drive revenue and earnings growth. And we can only focus on purging the pipelines so long. We've got to get new products to the market. They are working on in licensing and doing all sorts of other things to try to bolster that pipeline. And as those projects plug in and takeoff, our Central Lab will be humming again. Keep in mind, gross orders continue to be good at our Central Lab, our win rate still in the 70% range. We have clients, they've chosen us as sole source, and we have several years of that where they're delighted with the quality. There's nothing fundamentally wrong with our Central Lab. We have in front of us new IT system going in that's going to improve efficiency, other automation investments that we're just realizing. It's a very powerful business. It's just right now delays and cancellations and for the past 4 to 6 quarters have been at elevated rates. And at some point in time, that moderates and when Central Lab comes back, incremental margins are powerful.

Operator

Moving on, we'll go to Ross Muken with Deutsche Bank.

Ross Muken - Deutsche Bank AG

So as we think about the cost actions that were taken last year and sort of the margin profile of the business going forward and how you sort of executed on that plan, particularly in early stage where I think the margin result seemed certainly better than what we were looking for, do you think kind of the level of action taken was sort of appropriate relative to the market that we're seeing? And are you encouraged by at least some of the, I guess, stability we're seeing in the markets, although certainly parts like labs aren't quite up to the level where you'd like them to be in terms of performance?

Joseph Herring

Well, I guess in Early Development, Ross, I think we look back retrospectively and say that we took the cost actions probably a little later than we could have. And remember, we had a couple of false positives and increased orders and study starts that at that time made us feel like, "Boy, I'm glad we didn't move sooner." But it turns out we were bouncing along the bottom. I think when we did make the moves, I guess I look back and say it was about right. And we transitioned already almost 70% of the revenue that was Indiana successfully to Madison and Chandler and Greenfield, which is pretty impressive. And once we finish the specialty capabilities in Greenfield, that number is going to go higher because clients have made it clear that when you're ready, we're going to plug in the balance of that work. As you look at our Toxicology footprint globally now, we closed the oldest facility that was least efficient, and what we have is largely either brand new or totally renovated base in Madison, Chandler, Münster, Germany, Harrogate and now China. We had the most modern IT infrastructure in terms of pathology, toxicology data collection and reporting. We have a new version of study tracker that's allowing us to report that information to clients on a real-time basis. And with the new volume, the drop through was, call it roughly 80%. I like exactly where we are. And if we see continued small incremental gains in Early Development revenue and in Toxicology revenue, I think it's going to be good for our company. But keep in mind, Toxicology is a small part of our Early Development. I think we did some early moves in Clinpharm, which I think got our cost structure in line. And as we've seen competitors quickly take out capacity, we're getting upside there because we have the ability on a global basis to do Clinpharm and early clinical studies again, in very modern facilities. And there are things happening in the Chemistry market, both on the competitive and client standpoint, that encourage us. So I feel like we took the right actions maybe a little slow, but once we got going, I think we hit it just about right.

Ross Muken - Deutsche Bank AG

And maybe turning to the level of activity from an M&A perspective, we've seen particularly amongst the private players across the CRO space, there still is a ton of small to mid-size competitors. One, as you think about the activity that you've seen, how would you sort of characterize, not specifically to any of the deals, but broadly kind of what we're seeing and sort of the need on that size level competitor to kind of get bigger? And what do you think the implications are for industry? And two, do you feel like your strategy of having sort of breadth of services relative to what you're seeing these players try to replicate, this sort of validates kind of your belief in sort of the assets you've assembled?

Joseph Herring

Well, first of all, in terms of the M&A activity, I would say one word: expected. We've been saying for the last several years that as pharma became more strategic in working with CROs that it was going to favor the sort of the top 5 players. And that if you were a small niche provider and it was defensible and it was powerful, you'd probably be okay. But anything in between was going to be very, very difficult and difficult to compete and difficult longer terms in terms of sustained revenue growth. So seeing players come together, I think, is totally expected. It doesn't change our view of the world. I will say that earlier in my career, I had a chance to see what roll-ups look like and in a highly regulated business where quality matters and where clients are watching every move because potentially billion-dollar drugs, having 3 different operating systems, 3 different IT strategies, 3 different leadership and culture, 3 different facilities in a given region need to be rationalized is a very, very difficult way to compete. And I think we've seen clients take time out when they see those sort of things happen. And so I think it's going to take a while for roll-up companies to get their feet under them and compete. And in the meantime, we're really focused on being an R&D partner. I mean, if you're looking at the CRO industry from a client perspective and you say, "We have got to dramatically reduce our fixed cost infrastructure, make it more variable, but this work is critical and has to be done properly." And you look at Covance and say, "They have the biggest preclinical footprint in the world. They integrate services and could show you tangibly they can take 30% to 50% of the cost out of our infrastructure and do the work 30% to 50% faster. And oh, by the way, they generate more drug safety data sent to the EMEA and FDA than anybody in the world. And they've already taken several companies and have literally become their entire R&D engine in preclinical." That seems like a pretty safe bet rather than some stitched-together company or rounding up 3 or 4, 5 different companies and try to get a lower price. And in Late-Stage Development, I look at the informatics coming out of Covance's Central Lab and go, "Boy, I want that." And frankly, we could take 3 or 4 more sole-source providers and not have to add any capacity on our side. And we compete very effectively in that market. And our clinical team continues to wow clients with early enrollment, early contract startup, early study closeout and informatics that help them get better and more usable data out of their clinical trials. So we're building a company that's going to be a true R&D partner, and we're not trying to necessarily be the biggest in everything. Our goal is to be the best and the fastest and the department that creates the most value for clients. So all of that is interesting, but it doesn't deter us. If we do what we're capable of as a company, we'll be fine and then some.

Operator

Tycho Peterson of JPMorgan has the next question.

Tycho Peterson - JP Morgan Chase & Co

Joe, I'm wondering if you could just help us parse out the growth you're seeing in early stage and the sequential growth here. How much of that came from the ramping of strategic deals versus market share shift and maybe overall market growth?

Joseph Herring

Yes, Tycho, a huge percentage of the Early Development growth was in the Sanofi sites, a little bit of FX, but mostly year-on-year at the Sanofi site. Sequentially, it's new revenue. But keep in mind, we are -- we have a big headwind, which is closing, winding down a facility and transitioning. And that's still a headwind for us. So to grow even on top of that, we feel pretty good about where we are. Looking into sort of the demand picture, Biotech funding has been better. I think there's some debate as to how much better it was most recently but over the last year, it's been better. And some of the improvements in Biotech spending, 6, 9, 12 months ago, are now flowing into sort of preclinical studies, and we're seeing some benefit there. And we're also seeing some of these big pharma mergers where clients are getting back to work. I think I've characterized it before. Two years ago, even a year ago, the client would show up in the place of study, and they were sort of nervous about their job. And on the way out of the door, they would slip you their resume. Now, they're showing up saying, "We've made our pipeline decisions, we're behind, we need to get this study started. When can you get the study lined up and going?" So it feels very different. And to the extent that, that continues and we see a slow but steady march up in Early Development, that would be a good thing.

Tycho Peterson - JP Morgan Chase & Co

And maybe with regards to Sanofi, can you talk a little bit about your ability to kind of leverage the additional capabilities you brought on board and just how you're feeling about bringing additional customers on to those sites?

Joseph Herring

Well, first of all, Tycho, the scientific staff that came with those 2 sites are really terrific. I mean, they're skilled in Toxicology, Bioanalytical Chemistry formulation. CMC are just terrific. I guess the Toxicology and Bioanalytical Chemistry, we haven't competed all that well in France because we didn't have a footprint there. And there are many clients in France who saw Sanofi and their facility capabilities as the gold standard, and now they're actually using those capabilities. And if we stay on track with that, that's a good thing. As far as the CMC and formulation capabilities, that was a gap in our Service portfolio. So if you look at what it takes to get a drug through late discovery and into IND, formulation is a big issue. If the drug is not soluble, if you can't formulate it in a way that the dose release is proper, it doesn't get to the target, then you really don't have a drug. And we either didn't provide that service or try to sort of refer it to someone. Now, we have what we think are some of the best people in the world doing that. We have 3 or 4 client situations that are pretty stunning where the whole project was delayed. They were working with another small formulations company that was trying to figure it out, couldn't figure it out. We called in the experts at Alnwick and literally, they worked over a weekend, fixed it and got the whole preclinical project off the shelf and going again. One of those -- unfortunately, it was at a competitor, but a couple of those have been in Covance. So if you think about the sort of market-leading position we have in Early Development, to say the biggest gap that we had is now filled with high-quality capabilities and facilities, it's a good thing. I said in my prepared comments that small but growing revenue, we don't want to overcall it right now. But we've got more clients in faster than we thought, we've got more studies placed than we would have thought and faster than we did at Lilly. It doesn't mean that that's going to continue, but it's off to a good start. And if we stay on that track, it's a wonderful capability to add to our portfolio, as well as having a competitive preclinical capability there in France.

Tycho Peterson - JP Morgan Chase & Co

Great. And then just last one. Can you provide us an update on China, how you're thinking about kind of the ramp at GLP services there and maybe what the pipeline looks like? And are you looking to bring on additional capabilities over there?

Joseph Herring

Well, we have a couple of large clients that we're talking to. I mean, as the only Western company with a facility there, it puts us in an admirable position. We're also are working carefully with China-based companies who are looking for both China as well as global reach for their products. It's still early days. The first couple of small studies are filtering in, but I would say that the conversations with clients is relatively encouraging, and the support that we've had from the Chinese government there in terms of support and tech support has all been good. So it's still a drag on earnings at this point and probably will be most of next year, but we're glad we're there.

Tycho Peterson - JP Morgan Chase & Co

Maybe just one quick follow-up. Can you give us a sense of what percentage of your preclinical client base or work overall is open to location? Is it 20%, 30%? I mean, how do you think about customers' willingness to kind of move products around the different geographies?

Joseph Herring

Tycho, I have to parse that by segment. In Toxicology, I'd say it's largely regional. In Bioanalytical Chemistry, it's increasingly global. What essentially is a go-forward sole source that we signed in Bioanalytical Chemistry this year, the #1 reason why we emerged ahead of the pact was that of our global capabilities. So I'd say that's important. Clinpharm, not so much. So I guess it's really by segment. But if you weighted it all, I would say it's -- 20% may be a good number. It's more regional than global, at least right now.

Operator

And next we'll go with Eric Coldwell with Robert W. Baird.

Eric Coldwell - Robert W. Baird & Co. Incorporated

Joe, I'm surprised when you commented that in clinical, I believe you said you could take on 3 or 4 sole-source deals without adding infrastructure or capacity. Can you talk a little bit about that? Or is this a comment underutilization or a comment on efficiency or both?

Joseph Herring

Well, Eric, if I said that and I misspoke, well, I was talking about Central Lab.

Eric Coldwell - Robert W. Baird & Co. Incorporated

Oh, okay, I misheard you then. So that makes much more sense. We can shift gears. I guess the next question, I think it's probably a nonevent, but we've seen in the life science tool space some pretty weak trends here in June and some disappointing reports related to government and academic work in particular. I was hoping we could get a quick update on what your exposure is there and if you've seen any shift in that very small market for you.

Joseph Herring

It's negligible, 1% or less.

Eric Coldwell - Robert W. Baird & Co. Incorporated

So absolutely no exposure to worry about. And then final question, and I mentioned this yesterday on a call. There's a bioanalytical shop that's had a very serious FDA issue, and their clients are going to have to rework studies that have been done over the last 5 years. We saw this experience in the past with MDS, and it drove a lot of incremental volume to a couple of the leading CROs for an extended period of time. I'm curious what your thoughts are on opportunities like that today. And are quality issues among the smaller companies another reason that work is shifting to the bigger CROs and why you're seeing some of these sole-source arrangements pop up?

Joseph Herring

Yes, well, it's got to be incredibly discouraging for clients who find themselves in that situation. But I think it's just further evidence that R&D and many of the services we provide are not commodities. And there are certain levels in a pharma company where it all feels like it's all the same, and that's great as long as things go well. But when you talk about having to redo a program, resubmit data and you lose 1 month, 3 months, 6 months or a year in revenue under the patent protection, you destroy tremendous, tremendous value. So I would say it's disappointing for the industry, but hopefully it just shows you get what you pay for. And I think as with history, it will benefit players who have the systems and the quality oversight and a proven track record, and we'll see how that plays out.

Operator

.

We'll move to Steve Unger with Lazard Capital Markets.

Stephen Unger - Lazard Capital Markets LLC

Just a couple of quick questions. As far as the Central Lab cancellations are concerned, are new orders exceeding cancellations at this point?

Joseph Herring

Absolutely.

Stephen Unger - Lazard Capital Markets LLC

Good. Okay. So as far as the net book-to-bill in Central Lab, that is now on the upswing.

Joseph Herring

Well, what we said is proposals are on the upswing. Right?

Stephen Unger - Lazard Capital Markets LLC

Proposals.

Joseph Herring

Yes.

Stephen Unger - Lazard Capital Markets LLC

As far as hard orders, are you seeing greater order flow?

Joseph Herring

I would say it's sort of been up and down over the last several quarters. I wouldn't say it's headed down a big way or headed up in a big way, but what we're saying is that cancellations has been the issue. But most recently, the proposal volume is pretty encouraging.

Stephen Unger - Lazard Capital Markets LLC

Good. Okay. And then as far as -- you said that the second quarter in Early Development included losses from both Vienna, the startup at Greenfield in China. Is there a way to frame sort of what that impact was on the second quarter? And how quickly...

Joseph Herring

Yes, I think it's a couple of hundred basis points. So we would have had a margin, pro forma margin, I guess, of about 16%. And so a nice climb back from where we were. And as you see in the P&L, the drop-through was pretty robust.

Stephen Unger - Lazard Capital Markets LLC

Yes, it's excellent. Okay. And then my last question is, you mentioned that Europe Tox is not seeing a recovery like we are seeing in North America, and I was under the impression that at least the Münster facility was doing quite well. Could you comment on European Toxicology and what dynamics are happening there?

Joseph Herring

Well, we're not saying that they're not doing well. I mean, they're profitable, but it's not seeing a recovery. It's more still bouncing along the bottom as we saw in North America, and it's related to some of the same issues that we've seen in North America in terms of project delays and cancellations and clients not, I guess, showing up to start work.

William Klitgaard

Also, I think another factor is we've added more salespeople recently, that we noted that. I think that will help turn the situation around for us in Europe as well.

Operator

And next we'll go to Bob Jones of Goldman Sachs.

Robert Jones - UBS

Joe, I just wanted to go back to the Tox comments on you taking market share. Maybe could you talk a little bit about what you think clients are making their decisions based on today, maybe why they're choosing Covance? Has it moved away from a more price-based discussion?

Joseph Herring

Well, I mean, this market has always been competitive and certainly been hypercompetitive over the last couple of years. But I think if you're a client, you've seen Tox companies go up for sale. I think you've seen some close. I think you've seen a lot of pressure to get things done more quickly. I think our program management offering continues to resonate with more and more clients where yes, you can chop this up into 15 pieces and get a little lower purchase price on something, but the net-net is to have one scientific leader over all the DMPK Tox work and having to go right into the clinic and into early patients. That speed advantage is pretty compelling. I think compared to most competitors, Covance has been the most stable in terms of hanging onto our senior scientific staff and quality assurance staff. And through the downturn, they had the same friendly voice, the same knowledgeable, thoughtful person that they've had and when the work comes back, that person is still there. I think that's a good thing. So I wouldn't say there's any one overwhelming. It's just Covance is stable, predicable, financially viable, global and looks for ways to create value for clients. And being price competitive is a part of that, but adding value to their drug development efforts really is the most important thing.

Robert Jones - UBS

That's helpful. And then moving over to the Central Lab and the outlook, is there anything -- I know you have touched on this a little bit in the past. Is there anything, as you look at the backlog for Central Lab, that gives you comfort that things will in fact improve beyond this year? Obviously, it seems like we're in a little bit of a rough patch right now. But I guess maybe as you look out beyond '11, are there things you guys are tracking that give you comfort there?

Joseph Herring

Well, as delays and cancellations moderate, that is the single driver. That is it. Beyond that, the list of reasons why kits come and the value of those kits, the density of those kits is multi-factorial. And if some of the emerging markets ramp back up in terms of enrollment, I think they're better prepared to get kits back faster. The therapeutic areas bounce around a little bit more. There's a lot of factors there, but the single biggest factor is delays and cancellations moderating, and we think they will.

Robert Jones - UBS

No, that's helpful. And then just one last one, Bill, I might have missed this. But it looks like corporate expense in the quarter was a bit higher than expected. Can you discuss maybe what was in there? And then how should we think about the corporate expense in the back half?

William Klitgaard

Yes, we talked about that a little bit, but essentially it's higher incentive compensation and then some non-recurring professional fees. We do expect to trend lower in the back half of the year.

Operator

And next we'll go to Todd Van Fleet of First Analysis.

Todd Van Fleet - First Analysis Securities Corporation

I apologize if I missed this in your prepared remarks, but the comments in the release about the several dozen incremental sales and marketing folks, I know you had said that you have -- there's some focus going on in Europe to help fill out the new facilities. But what other areas of opportunities do you see that would necessitate the increase in headcount in those areas?

Joseph Herring

John Watson, our Chief Commercial Officer, has really conducted a comprehensive evaluation of our go-to-market over the last 12 to 18 months. And we just sat down and looked at the fact and said, "In some of our business, we're outdone on the commercial front." It's amazing how much we win when a competitor has twice or 3x as many salespeople as we do. We looked at some geographic regions, and we felt like we didn't have the coverage. We look at fielding the ongoing requests we have for strategic discussions. And one thing we don't like to do is overcommit to too many clients and promise the same resource over and over again. When you're winning, that's a difficult thing. So on a strategic partnering front we've added some resources, and we continue to introduce new product and service offerings. Xcellerate is a great example. We have had that in data testing with key clients for the last couple of years. Launching that required some marketing muscle, and we're going to continue to push that. But it's really a comprehensive evaluation of our go-to-market, and we feel like that we were undermanned and that with our service offering and our offering, if more clients heard it with more region frequency, we'd probably win more business.

Todd Van Fleet - First Analysis Securities Corporation

So is this kind of banging down the doors or more doors in existing customers? Or is this new group of folks intended to maybe pursue a customer base and maybe feel like you're under-penetrated, I guess, in the way you referred to the process of you're kind of outgunned in certain RP processes? I guess it would suggest that maybe you feel like you want to support what's going on for large pharma and those sales and marketing initiatives. But are you breaking -- are you trying to cover new territory with these folks? Or is it just shoring up the existing effort?

Joseph Herring

Well, it's a comprehensive evaluation, so it's a little bit of all of that. But frankly if you just look at the strategic relationships we have in Central Labs, clinical and preclinical, just the ones that we already have where there is a committed volume or where the clients picked us as 1 or 1 of 2. Frankly, growing preferentially with those is a fantastic outcome for our company. So I think growing where we are strong and respected and trusted and deal terms are all set aside is a good return on the investment. And again, looking beyond them, there are certain regions and there are certain businesses where we have a very strong offering and just feel like a couple extra salespeople here and there could easily pay for themselves. If you're suggesting are we out on the bleeding edge and chasing stuff that is speculative, the answer is absolutely not. I think expanding existing clients where there's a trust-base relationship in getting repeat work is way more profitable and way more time valuable than something that's way out there.

Todd Van Fleet - First Analysis Securities Corporation

Okay, great. Could I squeeze one on Central Labs real quick? We understand the impact of the delays and the cancellations and so forth and I think the shifting geography mix as well. But on kind of a per-kit basis as it works its way into the lab, can you comment on what the -- if there's a general trend in pricing characteristics or the complexity of the kits that are running through the labs, are you doing more work per kit as it actually gets to the lab that would either help or hurt margin or help or hurt kind of the general dollar amount attached to that given kit, if you understand what I mean?

Joseph Herring

Yes, well, let me try to parse it in half year. I would say there's nothing remarkable in our backlog in terms of the pricing, either low-price or high-price work coming. So I wouldn't characterize it that way. But in terms of the therapeutic mix, density of the kit, whether it's biomarker or automated, honestly, Todd, is very, very difficult for us to forecast. There may be a cardiovascular study with very rich and dense kits that sort of catches fire on enrollment, and we just proportionally get those. That gives you more tests per kit and more price per test, and it's all good. On the other hand, if a couple of big CNS study come on board and ramp up quickly, it's sort of the exact opposite, and how those roll in when you're sort of rolling up almost 40% of all clinical trials in the world, it is very difficult to predict.

Operator

[Operator Instructions] Next, we'll go to Ricky Goldwasser of Morgan Stanley.

Ricky Goldwasser - Morgan Stanley

I have follow-up questions. I know you mentioned that the growth in Early Stage in the quarter was really mostly due to Sanofi. So when you look ahead to the second half of the year, does your guidance factor in only that known benefit from Sanofi? Or did you also budget for growth from non-committed deals?

Joseph Herring

I think Sanofi growth is the year-on-year piece, but sequentially, we're growing with other clients. And -- so what's factored into the budget? I think we largely call most of our revenue growth in Sanofi. If the other clients did better, then we would do better. That's what we saw in the second quarter, and that's what we expect to see in the third and the fourth quarter.

Ricky Goldwasser - Morgan Stanley

Okay. So to get to kind of like that higher end of the guidance, we just kind of like -- started to see just kind of like that growth from other customers. Is that fair?

Joseph Herring

Yes, that's fair. And the growth right now in Early Development care is lower margin than in Late-Stage, and so that's sort of reflected in there as well.

Ricky Goldwasser - Morgan Stanley

Okay. And then just to clarify, to make sure that I understood it right, the $170 million in commitment, is that kind of like a guarantee, kind of like a pay or play type of agreement?

Joseph Herring

No.

Ricky Goldwasser - Morgan Stanley

That's why you didn't include it in the backlog?

Joseph Herring

But we took it out of the CMV, yes.

Operator

And next we'll go to Douglas Tsao of Barclays Capital.

Douglas Tsao - Barclays Capital

I was just wondering if you could provide an update where you are in terms of the transition out of the Vienna site. Are there still analyzed studies ongoing there? Or will you be out completely -- or will you be completely out during the third quarter?

Joseph Herring

We are winding down the last studies there and we'll be completely out in the fourth quarter.

Douglas Tsao - Barclays Capital

Okay. And then, Bill, I think you provided last quarter some sense of what the margin would have been if we took out the losses in Vienna. Could you provide a sense of where they would have been on sort of a more normalized basis this quarter?

William Klitgaard

Again, I think the way we want to characterize that, as you say, let's adjust for Vienna, let's adjust for Greenville and China all together, and that's about 200 basis points of operating margin for Early Development.

Douglas Tsao - Barclays Capital

Okay. And then in terms of the business development staff being added, are they going to focus on one -- any particular area? Or is it going to be across the entire portfolio?

Joseph Herring

It's across-the-board, Doug.

Operator

And moving on, we'll go to Dave Windley of Jefferies & Company.

David Windley - Jefferies & Company, Inc.

Joe, I'm curious on the swap of the CMV contract for the broader arrangement. Will the projects be bid as they come up? I'm wondering how the pricing works on those new projects.

Joseph Herring

The projects are not going to be bid. They've already been earmarked, and the pricing is already within a service line where we have pricing arrangement.

David Windley - Jefferies & Company, Inc.

Okay. So based on a preexisting MSA?

Joseph Herring

Well, some sort of an agreement between us and the client, yes.

David Windley - Jefferies & Company, Inc.

Okay, okay. In Early Development, more broadly, as you've pointed out on the call, the incremental margin was very high. Were there costs, perhaps related to the restructuring actions that came out, discreet costs that came out? Or should I really view that as 7 and change million dollars in incremental revenue that really only had 20% variable cost attached to it?

William Klitgaard

Dave, it's Bill. I think the way to look at this is not really related to the one-time cost being substantially different between Q1 and Q2. It's kind of incremental drop-through, and then it's a bit of a mix of service lines that go in here as well. So there's 2 factors, it's not just one factor that can explain entirely the drop-through.

David Windley - Jefferies & Company, Inc.

Okay. So mix, that certainly makes sense. The last question I had was in terms of cancellation on Central Lab. I believe in some of your presentations recently, you've talked about kind of an aging or maturation of the backlog of Central Lab, and as it gets toward 3 or 4 years in age, the revenue generation of those projects gets more attractive. I'm wondering kind of where you see yourself standing against that measure. And are the cancellations versus new orders creating a situation where the aging of the Central Lab backlog is getting younger? Older studies getting canceled, newer studies going in?

Joseph Herring

Yes, Dave, I think the #1 issue is delays and cancellations. And so the age of the backlog was one part of the answer, but as we've had repeated quarters of delays and cancellations, I think it swamps anything else.

Operator

And there are no further questions. Gentlemen, I'd like to turn the conference back to you for any additional or closing comments.

William Klitgaard

Thanks, operator, and thank you, everybody, for taking the time this morning to listen to our call. If you have any follow-up questions, I'll be available and in the office throughout the remainder of the day. Have a fantastic day. Thank you.

Operator

And that concludes today's conference. We'd like to thank you all for your participation.

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