Covance Management Discusses Q3 2012 Results - Earnings Call Transcript

Nov. 6.12 | About: Covance Inc. (CVD)

Covance (NYSE:CVD)

Q3 2012 Earnings Call

November 06, 2012 9:00 am ET

Executives

Paul Surdez

Alison Cornell - Chief Financial Officer and Corporate Vice President

Joseph L. Herring - Chairman and Chief Executive Officer

Analysts

John Kreger - William Blair & Company L.L.C., Research Division

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

David H. Windley - Jefferies & Company, Inc., Research Division

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Krishna Chaitanya Arikatla - Goldman Sachs Group Inc., Research Division

Stephen S. Unger - Lazard Capital Markets LLC, Research Division

Garen Sarafian - Citigroup Inc, Research Division

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

Vijay Kumar - ISI Group Inc., Research Division

Andrew Schenker - Morgan Stanley, Research Division

Operator

Good day, everyone, and welcome to the Covance Third Quarter 2012 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. Good morning, and thank you for joining us for Covance's Third Quarter 2012 Earnings Call Conference and Webcast. Today, Joe Herring, Covance's Chairman and Chief Executive Officer; and Alison Cornell, Covance's Chief Financial Officer, will be presenting our third quarter financial results. Following our opening comments, we will host a Q&A session. In addition to the press release, 20 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 effects 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 and slide deck issued last night.

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 Cornell

Thank you, Paul, and good morning, everyone. Let me begin by talking about the special items included in our GAAP results that we have excluded in arriving at our pro forma results this quarter. First, we've excluded revenue of $3 million and operating losses of $2.6 million from 3 facilities we're in the process of closing: The Chandler Arizona preclinical facility and our Phase I clinics in Honolulu, Hawaii and Basel, Switzerland. The second special item is the $18.1 million in cost associated with our ongoing restructuring action. Third, a $1.5 million gain on the sale of our ownership in an equity investment. And finally, an $11.5 million gain related to the favorable resolution of certain tax matters. The vast majority of this gain relates to the completion of several income tax audits. My commentary which follows will focus on our pro forma results, which exclude the impact of these items. You may find the GAAP to pro forma reconciliations in the release we issued last night and the presentation we are reviewing today.

Now to the results. Pro forma net revenues for the third quarter were $542 million, down 0.3% on a reported basis from the third quarter of last year. On a constant exchange rate basis, year-on-year growth was 3.6%. Keep in mind that year-on-year growth in comparability was also affected by the wind down of the 3 facilities in 2012, as well as the 2012 sale of our environmental services business, which were included in 2011 results. On a comparable basis, revenue growth was 5% as detailed in the appendix of the slide deck.

Sequentially, revenues increased $3.4 million. And this was despite a $4.4 million foreign exchange translation headwind from the stronger U.S. dollar in the third quarter. Pro forma operating income in the third quarter was $51.3 million, resulting in a pro forma operating margin of 9.5%. This is a 50 basis point sequential increase, although down 90 basis points year-on-year. Pro forma diluted earnings per share were $0.72, up $0.07 from last quarter driven by significantly stronger profitability in our North American toxicology operations, as well as higher kit volumes in our central laboratories. The pro forma effective tax rate for the quarter was 20.9%. We expect an effective tax rate around 21.3% next quarter.

Please turn to Slide 5 of the presentation. In the third quarter, Early Development contributed 40% of net revenues and Late-Stage contributed 60%. 52% of our revenue came from the U.S., 14% from Switzerland, 11% from the U.K., 8% from countries in the Eurozone and the remaining 15% from the rest of the world.

Now to Slides 6 and 7, where we'll review segment results for the quarter. In early development, net revenue was $218 million. This represents a $2.4 million sequential increase driven by significant improvement in performance in our North American toxicology services, which more than offset a decline in clinical pharmacology. This is a 9.3% reduction year-on-year or an 8.4% reduction on a constant currency basis, driven by declining revenues in toxicology, research products in clinical pharmacology, as well as the exclusion of revenues from the 3 facilities in closure and the sale of the environmental services business in 2012.

Pro forma operating income was $26.9 million in the quarter, up $8.2 million from last quarter and down $8.1 million from the third quarter of 2011. Pro forma operating margin was 12.4%, increasing 370 basis points from last quarter and down 220 basis points from the third quarter of 2011. Sequentially, pro forma operating income increased primarily from a large improvement in profitability in North America toxicology and the return to profitability in research products, which more than offset a decline in clinical pharmacology.

Turning to Late-Stage Development. Net revenues were $324 million, up $1 million from the second quarter level in reported dollars despite a $3.8 million foreign exchange sequential headwind from the stronger U.S. dollar. Revenues increased 6.9% in reported dollars versus 2011 or 13.1% excluding the impact of changes in the foreign exchange rates between both periods. Year-on-year revenue growth was again driven by continued strong performance in clinical development, where revenue grew 18% in reported dollars and an excess of 20% on a constant exchange rate basis and continued growth in central laboratories, which more than offset a decline in market access services revenue.

Central laboratories delivered a sequential revenue increase of approximately $3 million in reported dollars, while year-on-year revenue growth was 2% in reported dollars, and 11% on a constant currency basis. Pro forma operating margins were 20% compared to pro forma operating margins of 21.1% last quarter and 19.3% in the third quarter of last year. The year-on-year increase in profitability was driven by both clinical development and central laboratories. While the sequential decrease was primarily driven by increased hiring and staffing costs in clinical development, spending on strategic IT projects and lower profitability in market access services.

Moving to Slide 8, I will recap the order and backlog information for the quarter. Adjusted net orders were $701 million, which represents an adjusted net book-to-bill of 1.29:1. Backlog at September 30 was $6.37 billion versus $6.23 billion at the end of last quarter. Foreign exchange aided backlog by $69 million sequentially.

Please turn to Page 9 for a review of cash flow information. Cash and equivalents were $441 million at the end of the quarter, a $43 million increase in cash flow at the end of the second quarter. At September 30, our debt balance stood at $340 million. We repurchased approximately 415,000 shares of our common stock at a cost of $20 million in the quarter. Approximately $20 million of share repurchase authorization remains which we plan to complete by year end. Free cash flow for the third quarter was $35 million consisting of operating cash flow of $71 million with capital expenditures of $36 million. Our operating cash flow in the third quarter was impacted by 3-day increase in DSO to 38 days from last quarter, which impacted operating cash flows by approximately $18 million as each day of DSO represents approximately $6 million of cash flow. We continue to target year-end DSOs of approximately 40 days. For 2012, we're slightly reducing our forecasted full year CapEx to approximately $160 million.

Corporate expenses on a pro forma basis were $40.5 million or 7.5% of net revenue in the quarter. We expect corporate expenses as a percentage of revenue excluding restructuring costs to increase in the fourth quarter as spending ramps up on a corporate data center consolidation component of our strategic IT spending. And finally, we ended the quarter with 11,582 employees as continued hiring in Late-Stage development more than offset headcount reductions in early development.

Now I'd like to turn that call over to Joe for his comments.

Joseph L. Herring

Thank you, Alison, and good morning, everyone. Covance's results improved substantially in the third quarter. We have taken 2 definitive courses of action since our slow start to the year in Early Development. We intensified our sales focus and we accelerated and expanded our cost-reduction actions. These actions made a positive impact this year and helped set up a stronger 2013 for Covance. We're encouraged by the improvement in our toxicology businesses, as well as our continued momentum in clinical development in central labs.

Let me summarize our key third quarter results. First, Early Development performance improved for the second consecutive quarter. We are capturing our cost savings faster than expected, which led to a nice step up in profitability. Second, Late-Stage Development continued to deliver strong results and proposals for new clinical trial and central labs studies remain at very high levels. Third, our intensified sales focus helped us deliver a 20% increase in year-to-date adjusted net orders for the company. Fourth, we are taking additional cost actions which will reduce our corporate and functional support spending. And finally, the strategic IT projects we announced earlier in the year continue to run on time and on budget.

I'd now like to comment in more detail on our segment results. In Early Development, revenue increased sequentially due to a combination of higher volume and favorable study mix. By capturing some of our cost savings earlier than expected, Early Development operating margin jumped 370 basis points sequentially. This increase is in addition to the 340 basis point improvement we realized last quarter and a nice recovery from the disappointing start to the year. I would characterize the sequential increase in profitability as roughly half related to increased volume and favorable steady mix, and the other half related to cost and capacity reduction actions.

The largest driver of Early Development profit improvement came from our toxicology services, where both revenue and operating income increased sharply from levels in the second quarter. This improved toxicology performance was driven by several factors, including lower delay and cancellations, favorable steady mix and accelerated cost savings. While delays and cancellations were lower than we had expected, it is too early to call a change in trend line based upon one quarter's results. Toxicology orders improved from the second to the third quarters, with more work coming from transactional clients than large pharma clients. Even though we are making solid progress in toxicology, we remain somewhat guarded given the macro environment, and we will soon head into the historically soft first quarter.

In discovery support services, results were relatively flat last quarter's level and expected to remain at a similar level again in Q4. In clinical pharmacology, results were down sequentially. At this point, we expect Q4 performance to be roughly flat with those results.

Rounding out Early Development, research products demand continues to be choppy. After losing money in the second quarter, revenue grew modestly in the third quarter and we return to profitability due to mix, as well as savings from our cost actions. Finally, our chemistry businesses are tracking slightly above the expectations we set for the year.

Now let's turn to Late-Stage development, where performance continues to be powerful. First, clinical development delivered another tremendous quarter with constant currency revenue growth in excess of 20% for the sixth consecutive quarter. Operating income grew strongly year-on-year, but declined sequentially due to normal summer seasonality, incremental hiring and an increase in spending related to the clinical portion of our strategic IT projects.

On the commercial front, clinical orders were again very strong, with the first 9 months net orders already exceeding the entire order total for 2011. This performance leads us to expect at least mid-teen revenue growth for our clinical development services going forward. High client satisfaction continues to lead to high levels of work from our clients, which has been key to our growth in clinical development over the last several years. Recent independent surveys of clients rank Covance as the best position CRO to win late stage work.

In our central laboratory, kit volumes increased sequentially for the fourth consecutive quarter. This generated constant currency sequential revenue growth of $5 million and drove year-on-year constant currency revenue growth rate of 11%. New orders remained strong in central labs and we are confident we continue to take market share. Cancellations are still higher than we would like for them to be. However, they are below the very high levels we experience in the back half of last year. Assuming cancellations remain at 2012 levels, we expect central labs to continue its growth trajectory into 2013.

If you would please turn to Slide 10, where I would like to discuss incremental cost actions we are taking to help drive the longer-term earnings growth of Covance. During the third quarter, we identified opportunities to reduce costs and improve efficiency in our corporate and functional support groups. We expect to recognize savings of $2 million from these actions in the fourth quarter and an incremental $8 million of savings next year. A portion of these savings will be recognized within corporate spending with the remainder recognized in the business units, where these functional support spending reside.

When combining these new cost actions with our previously announced initiatives, and after accounting for approximately $3 million of accelerated savings this year, we now expect an additional $5 million in savings in each of 2012 and 2013. The new savings total is approximately $17 million for 2012 and $28 million for 2013, resulting in total annualized savings of $45 million. While this comprehensive list of cost actions provide a nice tailwind for 2013, remember that we previously announced a $20 million to $25 million headwind for IT spending above the rate of revenue growth next year.

While on the subject of IT, I'd like to comment on our 3 strategic IT initiatives. The first initiative, which is an upgrade of our clinical trial systems, will bring a world-class standard in terms of supporting trial execution, data analysis, reporting and client connectivity. The first phase of the clinical trial management system and the electronic master file portion of this program was implemented during the third quarter. Smaller studies are being started on the new system now and larger studies are scheduled to come on stream next year. Once these systems are fully implemented, we expect to see increases in employee productivity, faster study conduct and greater savings in terms of efficiency and software maintenance costs.

The second initiative, our investment in data center consolidation, is running a little ahead of plan. The European data center went live in August and we have completed the migration of our largest European data center. The remaining European data centers are expected to be converted over the next year, which is consistent with our plan. Our North American data center is largely complete and will be commissioned before year end. Migration will begin early in the new year. We expect to see the savings of this more efficient footprint beginning in 2014, eventually achieving a 20% or greater cost improvement relative to our current environment.

The third initiative is our investment in a new laboratory information management system for central lab, and it continues to be carefully and cautiously implemented as we replace our legacy system with an improved single-instance database. Once in place, the new system will provide a more efficient means to capture, analyze and report clinical safety and efficacy data, and demonstrate the power of our informatics capability to our clients.

Based on our progress with these 3 projects, we are coming to believe that IT can deliver more savings than we initially projected. Over time, we aspire for our IT service costs to stay flat or possibly go down for a sustained period once these projects are complete. Separately and distinctly, we will grow our informatics and accelerate capabilities, which could become a meaningful revenue generator and a source of competitive advantage over time for Covance.

Now I'd like to comment on the outlook for Covance. Our performance this quarter demonstrates the operating leverage of our scalable business model by combining commercial success with our lower cost infrastructure. And once our strategic IT initiatives are fully implemented, we expect to see even greater benefit. However, as we develop our budgets and forecast for 2013, we intend to maintain a cautious look based on the volatility we have experienced in our business over the last few years.

Looking specifically at the fourth quarter, we expect Early Development results to be similar to the third quarter level, as we model delays and cancellations more in line with the average levels we have experienced over the past year. This delay and cancellation assumption would largely offset slightly increased volume and the upside from our cost actions. In Late-Stage Development, revenues are expected to increase sequentially and operating margins are expected to be roughly in line with the third quarter level due to increased IT spending and the normal fourth quarter holiday impact in clinical development. This assumption would offset the incremental earnings we expect from increased central lab volumes. Corporate expenses are expected to increase in the fourth quarter due to spending increases on the corporate-wide components of our strategic IT initiatives.

On a consolidated basis, these assumptions translate into a slight sequential pro forma revenue increase with pro forma EPS at approximately $0.70. When combining our fourth quarter projection with our better-than-expected third quarter results, we continue to forecast full year revenue growth of low- to mid-single digits and we are raising the bottom end of our previous pro forma EPS range by $0.15 resulting in a revised forecast of $2.65 to $2.70.

Let me close by saying that we believe our continued commercial success is a direct reflection of our primary strategy, which is to deliver operational and service excellence for our clients and superior performance on the drug development projects. All of the Covance strategies lever off of this core service quality strategy.

I would like to thank Covance employees around the world, who take great care of our clients and help them bring their important new innovations to patients around the world. Operator, you may now open the call up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And we will hear first from John Kreger with William Blair.

John Kreger - William Blair & Company L.L.C., Research Division

Joe, as you look across your portfolio of businesses kind of discovery the whole way through to Late Stage, what are your current thoughts on your clients' pipeline? And put another way, how concerned are you that the slower volumes in clinical pharmacology could eventually work its way into a Late Stage?

Joseph L. Herring

John, as we look at Late Stage molecules, we actually have completed a comprehensive analysis of where those molecules are today, which is slightly growing and what that's going to translate to over the next 3 to 5 years because, obviously, that could potentially have a big impact on our business. And we're actually quite bullish. We think that that's where pharma companies are focusing their efforts most keenly. We do see an improvement in molecule success going into Phase III. And if that continues, then we believe there will continue to be a robust Late Stage margin. Obviously, in Early Development, it's a little bit choppier and sort of the customer mix we see changing over time. But it does feel like we bottomed out and people are starting to get back in and get to work to replenish the pipeline. Not in a big way, but we've seen some encouraging signs.

John Kreger - William Blair & Company L.L.C., Research Division

That's great. And then a follow-up actually just -- this follows right along that line. As you talked to your clients about their sort of initial thoughts in '13, are we far enough into that budgeting process as we kind of move through the biggest generic erosion period? Does it feel like we could be back in a growth mode in terms of client spending patterns or do you feel like they're still going to be in a cost cutting mode in '13?

Joseph L. Herring

Well, John, it's difficult to answer speaking sort of all clients on a consolidated basis. Some are in very, very difficult situations, others are very optimistic. But I they had to sort of draw a line between it, I mean, pharma stocks are up 15%, 20% this year. You see new therapeutic categories like PCSK9 inhibitors, CETP inhibitors, some exciting new things in deep vein thrombosis and diabetes, and of course an ongoing role of new cancer products. So I don't think our clients are done with their budgets. They tend to really not roll out the budgets until mid to late February of every year, so I'm not sure where they are. But I know that they are all anxious to launch new products and we think that they will preferentially spend in Late-Stage Development and obviously, that's why we're making so many investments in our clinical business ongoing automation, our central lab which continues to pay great dividends, as well as informatics capabilities to help us -- help our clients pick the right molecules, pick the right investigator sites and get the trials done as quickly as possible.

Operator

And we will hear next from Greg Bolan with Sterne Agee.

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

Joe, as it relates to dedicated nonclinical capacity deals, can you possibly talk about any change in mentality you are seeing among those large pharma companies that have been hoarding work internally?

Joseph L. Herring

Dedicated -- Greg, I'm sorry, I'm not quite sure on...

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

So call it, GOP talks deals essentially where large pharma companies are transferring their internal work to you to 0[ph].

Joseph L. Herring

Well, obviously, there's a lot of pressure for all pharmaceutical companies to make their fixed cost infrastructure lower and more flexible. So I would just say it's an ongoing rolling sort of process. Clients who have outsourced maybe 1/3 or looking to get to a 1/2 or more. There have been a couple of opportunities that have come into the marketplace, new capacity being outsourced. We picked up a couple of those. We've missed a couple of those. So I would say it just continues to roll on sort of a predictable pass, sort of once it's hot. It's not a landslide of additional outsourcing. But I just -- I struggle to see how large pharma client can justify having that fixed cost infrastructure when it's been proven over and over again that this type of work can be done faster, more cheaply and just as accurately if not better by the large CROs.

Gregory T. Bolan - Sterne Agee & Leach Inc., Research Division

That's fair. And then just -- I'm kind of thinking about this from a stepping off point, Joe, Alison. How should we think about Early Development margins from here? I mean, I understand the volatility of some of the parts of this business, that is Early Development segment, but should we look at 12-ish percent as a stepping off point or any color would be helpful there.

Joseph L. Herring

Well, I guess, Greg, we're not going to stick our neck too far. We were delighted with the progress 2 quarters in a row. We have more cost actions that'll be rolling in. But generally, December, January, February are slow times for this business and so we'll probably remain cautious until we see how that goes. We did have very good orders in October, which was very encouraging. But some of those studies so far into next year but continued momentum there. But we would probably be flattish to more cautious as we look out. And hopefully, we beat that. But we're not going to be counting on, at least, at this point in time.

Operator

And we will hear next from Tycho Peterson with JPMorgan.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

I wanted to just hear from you how your discussions with customers may have changed since you announced the changes in Chandler. And in terms of any dynamics around pricing, locking up additional work, can you just talk to whether the dialogue with pharmas changed post the Chandler announcement?

Joseph L. Herring

100% of the work from Chandler has transferred to Madison. That's the reason when we try to cobble together what is the underlying growth rate of the business, we assume that 100% of that transferred and it did. Largely, these are clients that worked with Madison before. We have very low turnover, particularly in our senior scientific levels there, our study directors, principal investigators. And they were happy to have the work done maybe a little closer on a geographic basis, but they flip back using the same people and the same SOPs and the same pumps and pulls and study designs, and it's just done in Madison, Wisconsin. So I don't think it really changed anything in the market. I think most of the preclinical competitors are talking about increased capacity utilization. We don't see it at the 2005 to 2007 levels yet, so I don't think it's having a big impact other than for us. We reduced our overall infrastructure cost and footprint and rooftops, which is allowing us to improve our margin outlook for the business.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

So no change in discussion around pricing. Obviously, as capacity comes out, pricing has the potential to creep back up, but you're not -- you're saying there's been no change there?

Joseph L. Herring

Well, Tycho, I mean, I would say that there are a couple places where prices have clicked up. There's a couple where it's gotten more competitive and about the same. So I would say sort of flattish.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then just a quick follow-up on the cost actions. I understand these things are always kind of hard to estimate in terms of the timing. But how much of this was pulling forward cost action that we would have otherwise been taking? And then what's your ability to kind of halt these actions if things start to really improve on the top line?

Alison Cornell

Tycho, it's Alison, from a cost action perspective, if you refer to Slide 10, the accelerated benefit in the second half, we pulled forward about $3 million worth of cost action largely in the Early Development segment, and the actions that were announced today, the $2 million, we expect to see reflected in Q4. As we mentioned on the earlier call, we believe we need to -- we needed to rightsize our cost structure as we had built an infrastructure for 2x growth in that part of the business, which we didn't think that we were going to experience go forward. And so don't really see us halting that cost action. We think it's necessary and plan on moving forward with that with the resulting improved profitability in that segment.

Joseph L. Herring

Also, Tycho, I wouldn't think of it so much as accelerating this cost savings for any other reason, we just -- we were somewhat conservative as we projected that. We thought we could do better, but we want to give ourselves a little bit of breathing room. And in fact, everything happens on time or a little bit faster. But we are in good shape from a capacity standpoint. If there was a roar back in the market in Early Development, we would participate aggressively in that. And certainly, our central lab, we built a lot of scalability with automation. We barely touch kits or kit components anymore, so we could take a lot more of volume there. And in clinical development, our recruiting, training, on-boarding engine and our geographic footprint is such that we continue to maintain 20-plus percent revenue growth in that business. So we're open and ready for business, I can tell you that.

Tycho W. Peterson - JP Morgan Chase & Co, Research Division

Okay. And then one last quick one. Are you doing anything with the genetic service business that's different? We are hearing a little bit more from pharma about sequencing? Can you just talk to how that business is trending?

Joseph L. Herring

It's growing. Strong new orders. We're very well positioned from a competitive standpoint. We're very well positioned from a technology platform standpoint with deep sequencing, and we have converted the majority of that capacity from preclinical to clinical genomics testing, which is bigger studies, more important studies, they have to look at longer revenue conversion, but a longer time frame in terms of revenue. So almost everything about that business is better for us than at the time we acquired it and we're very happy with how things are going.

Operator

And we will hear next from Dave Windley with Jefferies.

David H. Windley - Jefferies & Company, Inc., Research Division

Joe, I wanted to focus on the cost actions a little bit. On the last call, you had alluded to looking at corporate and on this quarter, you're coming through with some additional cost actions there. I guess I wondered if you could give us a sense for if you're still combing through the business to look for additional cost-saving opportunities. Or if you think from a formal action standpoint this pretty much takes care of it.

Joseph L. Herring

Well, Dave, we, I guess, have several different things that we're looking at. Some of the cost actions we're able to capture pretty quickly. But as we continue to make these IT investments, we're finding ways to automate. We're finding ways to outsource some capabilities and I think that we will have ongoing reviews of this as we go forward. So -- but the biggest bite of the apple, we've already taken and it's going to take some technology investments and automation, I think, to capture things down the road, and we'll comment as we crystallize some of those actions. Let me just see if Alison wants to add to that.

Alison Cornell

Sure. Just to give a bit more color in terms of the cost -- the corporate actions, so those are mostly focused on HR, finance, sourcing and procurement as well as some separate[ph] grant rationalization that hits the corporate line. What you should expect to see just from a cycling perspective is about, again, referring back to Slide 10, half of the $17 million actually happened in the fourth quarter. So as you -- as we go through next year, you'd expect to see the sequential increase of about $1 million more per quarter through the first few quarters in terms of incremental savings with about 50% of that hitting in at the corporate line and about 50% of that hitting in the business units.

David H. Windley - Jefferies & Company, Inc., Research Division

Okay. And then following up on, Joe, on segment questions. I think in both central lab, it sounds like, and in preclinical, you had some positive favorable mix in your volumes and I wondered if you could drill into that a little bit or at least give us a sense for what you see in your new orders and whether that positive mix is sustainable going forward.

Joseph L. Herring

Well, Dave, mix in preclinical bounces around, and I don't think it's going to be all that helpful for me to comment on what happened or to try to bank on that going forward. But, as you know, there's different species, there's dose rangefinding studies versus a carc study, and all of those are really out of our control, depends on what comes through the door and we burn that backlog about every 40 days. So I would just say it was a little better than we thought and some shorter burning smaller studies but necessarily count on that going forward. As it relates to central labs, the sort of sign wave of that business is whatever's happening, tends to happen for quite a while and if it starts going in another direction, that takes a while and right now, we're benefiting from price per test, test per kit, richness of test and volume sort of all at the same time and we expect that to continue for at least the foreseeable future.

Operator

And we will go next to Eric Coldwell with Robert W. Baird.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

First question is on the CMV contracts. I'm just curious if you can give us a sense of where you are year-to-date with those and whether you'd see any trough activity or just incremental workflow from CMV clients as we go into the fourth quarter.

Joseph L. Herring

I think we're tracking more or less on the CMV agreement. A couple are ahead, a couple are right on, a couple are a little bit short but we're working with the clients to try to true that up so I would say, no big change either year-to-date or as we look into the fourth quarter. So about where we want to be, Eric.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Got it. Shifting gears. The CapEx number, you brought down by $20 million roughly. Is that delayed spending? Or is that a permanent revision to your outlook in terms of what will be required?

Alison Cornell

Well we've gone down from $180 million to $160 million, and that's consistent with our planned spend. So that level of spend will allow us to execute our strategic IT initiatives as planned, as well as support the normal projects, process projects, maintenance projects within the business unit. So we think the revised guidance is really just where it needs to be. So it's more of a refinement than a reduction.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Okay. I didn't say it was $20 million reduction. I'm just trying to figure out if it at was pushed out to 2013. I think when we started the year, you said $90 million in IT, $35 million in growth projects and $55 million in maintenance, and I'm curious where you got the -- where the lower output came from.

Joseph L. Herring

Yes. I would say, Eric, if you look back over the years, we tend to revise our CapEx guidance down as the year goes because people are trying to get a lot of things done. They know don't necessarily have the bandwidth to do all those projects. They have to be justified in great detail and so as the year goes along, we tend to revise that down but there's no real change in IT. We're not really delaying anything and so I don't really see this as anything out of the ordinary at all. Certainly not a conscious action or a conscious decision on behalf of management relating to the business in any way.

Eric W. Coldwell - Robert W. Baird & Co. Incorporated, Research Division

Okay, got it. And then on the corporate expense commentary, a lot of puts and takes in that number. You normally give us a percent of revenue outlook for that number. Should we be thinking about this as north of the 7.5% in the third quarter, but is it 8% in the fourth quarter? What are you thinking? And then maybe also just looking at 2013 with the incremental $20 million to $25 million in IT above the rate of revenue growth. I know you mentioned that -- I think you mentioned that half of that is allocated to corporate and half to the units, if I'm not mistaken, but I'm just trying to get a sense on where corporate's going to be as a percent of revenue both for the fourth quarter and then, hopefully, for next year as well.

Alison Cornell

So, Eric, for the fourth quarter, while some corporate savings will begin to reflect themselves in the incremental $2 million, again, on Slide 10, we expect incremental IT spend to tick up associated with the corporate data center consolidation and our corporate as a percentage of revenue get to increase from 7.5% to 7.8% in Q4. In terms of corporate expense next year, at this point, we're not really talking about 2013 and we would expect to share that early next year as we talk about our overall guidance. But that will include, when all the studies are done, savings that we're announcing here today.

Operator

And moving on, we have a question from Todd Van Fleet with First Analysis.

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Alison, I'm sorry if I missed this earlier, did you cite the incremental IT investment in 2013 relative to 2012?

Alison Cornell

In 2013, we expect it to increase $20 million to $25 million.

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Okay. So we're thinking about that as kind of -- as the offset to maybe the $28 million in incremental expense savings, is it fair to think of it that way?

Alison Cornell

Yes, and it's actually over the run rate of revenue, the $25 million -- $20 million to $25 million increase.

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Okay. And then, Joe, I wanted to ask you. It's a small part of the business but market access services, I mean the performance there recently, I guess one's counter to what I would've perhaps expected. How are you thinking about that business to you, Dave, in terms of the opportunity and does Covance need to reposition itself in some way to take advantage of any kind of missed market opportunity?

Joseph L. Herring

Actually, we're very happy with the business, Todd. It's about 3% of revenue for the company. There are 2 very large projects that have run for years that sort of reached their natural wind down, and we've had several quarters where we're trying to replace that with new work and so that makes the P&L look tough in the short term but we have a very strong team. We've made some incredible new hires for the business that really will bolster our health economics and outcome research business, as well as a couple of new business lines that we are launching that will help our clients in market access. So we're bullish on the longer term. It's an important space. We just have a little bit of a lull while we try to fill in some large projects that went away.

Todd Van Fleet - First Analysis Securities Corporation, Research Division

Any idea, Joe, when you think the year-over-year comparisons will start to look better for that business?

Joseph L. Herring

Well, I would say our early look at budget for next year is encouraging, but we've still got some work to do. I'd say probably midyear of next year.

Operator

[Operator Instructions] And we will go next to Robert Jones with Goldman Sachs.

Krishna Chaitanya Arikatla - Goldman Sachs Group Inc., Research Division

This is Krishna on behalf of Bob Jones. I had a question on the early stage. How should we think about the margin trajectory into first half of next year? Does less CMV deals in the first half of the year impact margins? Or should we think of first half '13 margin expansion early-stage with second half '12 as a good starting point?

Joseph L. Herring

Stephan, it was really hard to hear that question. Would you mind maybe briefly repeating it louder and if we can hear, we'll answer.

Krishna Chaitanya Arikatla - Goldman Sachs Group Inc., Research Division

Sure. So I was asking if the margin trajectory -- how the margin trajectory in the early stage would be in first half of next year? And does less CMV deals in the first half impact margins? And should we think of first half '13 margin expansion in early stage with second half '12 as a good starting point?

Alison Cornell

Well, Stephan, I think -- I mean, we have a historically seasonal slow starts at the beginning of the year. So I would expect the first quarter to be sequentially down but what you will see go throughout the year is the impact of the cost savings. So the first quarter sequential decrease would be just more of a function of a slow start to volume with that picking up throughout the year.

Krishna Chaitanya Arikatla - Goldman Sachs Group Inc., Research Division

Okay. And a quick follow-up-on the late-stage margins, they were a little lower than we were looking for most of the projects win by the IT investments but given the incremental IT investments in 2013, should we think about margin -- more margin pressure on the late stage in 2013 and any order of magnitude would be helpful.

Joseph L. Herring

Well, we had called out the third quarter late-stage margin would be down. We were having to hire quite a large number of new people in our clinical business. Our investigators have summer holidays, which slows down kit flow in central labs, as well as patient visits and we had incremental IT spending. So we called that out. It was really only down slightly and we see margins there continuing to be strong.

Operator

And next, we will hear from Steve Unger with Lazard Capital Markets.

Stephen S. Unger - Lazard Capital Markets LLC, Research Division

Joe, I would say, well, let me ask you this question. As far as the year is concerned, is the biggest surprise for you the performance of the central lab? And currency aside, it looks like the comps are going to get easier rather than harder going forward. Is double-digit growth then, in your mind, for just the central lab, sustainable over the next 4 quarters?

Joseph L. Herring

Well, let me start with the first part of the question. The biggest upside for us this year definitely was central labs. Combination of volumes, richness of kit, test per kit, tubes per kit, so that has been a good guy and our new order performance remains very, very strong. As it relates to next year, we are in the middle of our budget process. We're not done yet so it's a little bit early to comment on exactly what that will look like. But suffice it to say, a good strong order performance in the fourth quarter and it feels like we're set up for that. It will help bolster the back half of next year. So a little early for us to comment on that at this point.

Stephen S. Unger - Lazard Capital Markets LLC, Research Division

Got it. But as far as if the mix stays the same and, in general, cancellation levels stay the same based upon the order book that we've had now over, what, maybe 8 quarters of elevated central lab orders that you're at least on a growth trajectory that's sustainable?

Joseph L. Herring

Yes. And it's in the transcript. That's almost exactly what we said.

Stephen S. Unger - Lazard Capital Markets LLC, Research Division

Got it. Okay. And then as far as European toxicology, could you make some comments there? I don't believe that you've made any on this quarter anyway.

Joseph L. Herring

Yes. Actually, European toxicology is picking up a bit. We're not going to get carried away with it but they were a big contributor in the third quarter and the orders so far in the fourth quarter are strong in the European bit or so.

Operator

And moving on, we have a question from Garen Sarafian with Citi.

Garen Sarafian - Citigroup Inc, Research Division

But first question on Early Development, if I understood correctly, I think you stated flat sales in 4Q is what you're anticipating, which seems to be a little lighter than your prior comment last quarter which was sequential increases for the back half of the year. So I'm just wondering, can you just shed a little bit more color on that? Some others have said that there's softening of demand to meet year-end budgets and financial constraints, but if you could just elaborate on that.

Joseph L. Herring

Yes. Well, Garen, like you can probably see, results in the third quarter were stronger. So we have a higher jumping off point and we said that was because delays and cancellations were lower than we expected. We, for the fourth quarter, are assuming that delays and cancellations are more on sort of the full year range and which gives a little bit lower output for the fourth quarter if they continue at the level that we had in the third quarter, then it will pick up again. But keep in mind, Q3 was quite a bit stronger. So we got there a little faster.

Garen Sarafian - Citigroup Inc, Research Division

Got it. So your outlook for 4Q hasn't really changed? It's just that relative to a stronger 3Q, it's now flat?

Joseph L. Herring

Yes.

Garen Sarafian - Citigroup Inc, Research Division

Okay, great. And then the second question is a bit bigger picture and I realize it's a sensitive topic, you're through the budgeting process right now but last year yielded some surprising results. So while I know that you can't really discuss specific guidance for 2013 now. How should we think about some of the potential larger investment opportunities that naturally arise in a corporation? Are there as many projects of similar scale in discussions last year? If there's any other color you can add as to what we should expect in either direction would be appreciated.

Joseph L. Herring

Well, in terms of are there any other larger new projects, the answer is absolutely not. But we have previously announced that will be in the second year of our strategic IT spend and that it would be $20 million to $25 million above a normal run rate in revenue in terms of IT growth. We expect to start completing those projects and the good news is I think it's going to help drive down our IT cost to flat or potentially down over a sustained period of time. We have accounted in any of our financials the productivity impact that will have for our employees, or the client satisfaction, improvement in quality, our ability to drive further Six Sigma projects with new automation, capitalized on the informatics capability and predictability -- prediction and forecasting capabilities that we're building as new products and new offerings for clients. So all of that will start showing up in 2014 and we're very excited to get there. But no, I think we bit off just as much as we can chew with these strategic IT initiatives. We're not looking for any other new projects, don't see any new surprises coming and hopefully, we will stay on track to having them finish on time or faster and deliver more savings than we thought. So -- but no new ideas.

Operator

And we will go next to Tim Evans with Wells Fargo Securities.

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

I was just hoping to get maybe little bit of directional color on the clinical business, the performance there. What -- how much of this -- of the bookings in that business are coming from existing partners versus new partners that you're winning? And I would also be curious as to how the tone of the discussion around partnerships, in general, is shifting understanding that you have a pretty formal definition of what constitutes a strategic partnership.

Joseph L. Herring

Well, Tim, we actually have 2 definitions. The definitions of the partnerships that we have announced in public, Lily and Sanofi, we have a commitment, long-term commitment to the company. They're performing well. I would still say they're in the earlier ramping up phase than anything anywhere close to the third or fourth inning. And then the second category would be strategic partnerships that we haven't announced because I think they're misunderstood in the marketplace and we have more of those than people know and we're not overly reliant on any one client. Our clinical business is very diversified but we have 8 or 9 clients that are stacking in quite a bit of work. We did share with you the Bayer press release where they announced our partnership. It hasn't contributed meaningfully from a revenue and margin standpoint yet, but the new order flow for them has been very exciting and faster than we thought. So I would characterize it as broad-based, more broad-based than you know and client satisfaction across our -- all of our major clients is just drilling, to be honest with you. When you're finishing enrollment 6 and 9 months ahead of schedule, you're helping them forecast resource needs, they're increasingly comfortable transferring their staff to us and just to support the work but also to help build our company with knowledgeable people who know their pipelines. I'll tell you, it's just a lot to feel good about. I'm so proud of this clinical team and what they had done and what they continue to do to really do clinical development in a different way than we have in the past and that we think our major competitors are doing.

Timothy C. Evans - Wells Fargo Securities, LLC, Research Division

That's actually very helpful. Would you be willing to put any quantitative metrics around the client concentration in that business in particular?

Joseph L. Herring

I don't have it in my fingertip. But suffice it to say, we're not overly reliant on any one client in clinical development.

Operator

And moving on, we have a question from Ross Muken from ISI.

Vijay Kumar - ISI Group Inc., Research Division

This is Vijay Kumar for Ross Muken. I just had one question on the restructuring, Joe, and could you maybe just give us some context in the philosophy or how you guys thought about this new cost action, whether it signals anything on future expectations either in earlier or maybe other parts of the business?

Joseph L. Herring

We're looking at each other. We're not quite sure how to answer your question. Could you rephrase it slightly?

Vijay Kumar - ISI Group Inc., Research Division

I guess what was the thinking behind the new cost action rate and does it sort of imply or signal anything on future expectations for growth in early-stage, I guess? What was the moderation for the new cost action, I guess, that was my question.

Joseph L. Herring

Let me give you -- thank you for that clarification. I'm sorry we missed [indiscernible]. Let me give you a short answer and then I'm going to hand it over to Alison. I mean, we've been sort of an interesting company as you look at our business model over the last several years. I mean, what's disguised -- well, first of all, earnings have been relatively flat for 4 years and what that disguise is that 60% of our company has been growing faster than the market, improving margins and performing extraordinarily well while 40% of the company or half of that 40% has gone through a cataclysmic decline in market demand and we've been trying to get our cost structure right. So we're determined as a company to return to earnings growth. And so the cost actions have all been to get that Early Development cost structure right and once you reduce that cost structure in footprint, then you naturally look at corporate spending and say, "Do we need corporate to be as big?" And in order to support earnings growth for the company, we sort of threw everything in the pot and said for years, we were kind of a 2x company, growing low to mid-teens in revenue and we haven't been growing that fast because of Early Development and we need be more competitive and we need to be leaner and meaner and we have been getting after it. And I'm going to turn it over to the commander-in-chief of a lot of these actions, Alison, for her comments.

Alison Cornell

So just to build on what Joe said, this has been part of our evolution in terms of cost reduction. We announced last quarter that we were going to analyze and reduce our corporate costs. But just to backup a bit, we started with late stage several years ago in terms of rightsizing that cost structure. Most recently, I'll say rightsized our Early Development cost structure and then corporate for us is the next natural progression. And so we're looking at any and all costs across the business because we think it's necessary and it demonstrates our commitment to -- it will return earnings growth. And so again, this was something that was planned. We thought that we needed to look at the business units first followed by corporate to make sure that those cost structures were complementary as well as necessary for the business.

Vijay Kumar - ISI Group Inc., Research Division

Great. If I can just squeeze one last in. Joe, how our customers responding to the strategic IT investment? What are you hearing? And can you comment on pacing of IT implementation next year, one half -- first half versus second half?

Joseph L. Herring

Most of what we're doing in IT is not as visible to the client right now, and so I don't have a whole lot of client feedbacks. There are a couple of strategic clients, however, who are looking at a new clinical trial management system or an electronic trial master file or a clinical portal. And because we work so closely with them, they say, "Before we spend the money, let's see what you're doing." And they look at our projects and go, "Holy cow, maybe we don't need to spend that money. We can just use yours." Those are early conversations but they're very exciting. The part that they have had visibility to is Xcellerate and I would say the Xcellerate tool has been a huge differentiator for us and a way for us to create value for clients by starting clinical trials faster, enrolling them faster and completing them faster. Ultimately, I think the CROs that are going to win the majority of the work in the future are the ones that can help clients transform drug development faster, more evidence in data for the drug that is ultimately approved and to improve success rates. And we are using our capability, which, if you don't know, we generate more safety and efficacy data for the approval of new medicines than any organization in the world. And use that data to help our clients make better decisions is what we're determined to do and a lot of this infrastructure that work that we're doing on virtualized data centers and some of the middleware that goes with that will make us an informatics powerhouse, we think. And so more to come there. It's all part of the investment that we're making and I think clients will see it initially and continue the improvement and productivity in their clinical trials, but later for helping them create value for their important medicines.

Vijay Kumar - ISI Group Inc., Research Division

And on the pacing of IT investments? One half versus second half?

Alison Cornell

From an IT investment perspective, we, I'd say, increased slightly in Q3, with a bigger increase in Q4 of about, say, $5 million.

Joseph L. Herring

Of 2012.

Alison Cornell

This is in 2012, so this is first half, second half in 2012.

Operator

And our final question comes from Ricky Goldwasser from Morgan Stanley.

Andrew Schenker - Morgan Stanley, Research Division

This is Andrew Schenker in for Ricky. just real quick, I was wondering if you can give a little more color on cancellations and delays in late stage. For central lab, you said there was an improvement over last year, but how had that trended from the beginning of this year and also, if could you give a little color on how cancellations and delays are trending in the clinical side of the business?

Joseph L. Herring

Well, clinical delays and cancellations are towards the low end of historical range. So that's not a concern. Central labs was very high last year and it sort of moderated down all year this year. I think picked up slightly in the third quarter but still within an acceptable range. That's not in our control. These are projects that had a safety signal or lack of efficacy or it was pulled because maybe the client thought the molecule would not be competitive in this market or on a comparative effective basis, and we can't predict those. But, overall, I would say for the year so far and in the third quarter, a better picture. Hopefully, clients sort of finish the purging of their pipelines and it goes to the low end of the range. But that remains to be seen.

Andrew Schenker - Morgan Stanley, Research Division

Okay. And your just for your fourth quarter you're assuming these trends kind of continue on as is?

Joseph L. Herring

Well, in the fourth quarter, we're assuming that it has the sort of the full year delay and cancellation rate. As we said in Early Development, it was lower than we expected but we're going to assume that it's going to go back to sort of the yearly average.

Andrew Schenker - Morgan Stanley, Research Division

But for clinical, they've been kind of in line. Okay, that helps. And then just real quick, if you could remind us on your thoughts on capital deployment and maybe debt levels, including share repurchases and acquisitions? Where do you guys stand on that today?

Alison Cornell

Just for me, share repurchase perspective, we have $20 million left in terms of our share repurchase authorization which we plan to complete by the end of the year. Once we complete that, then we'll revisit what we plan to do for 2013.

Andrew Schenker - Morgan Stanley, Research Division

Okay. And has there -- I assume the answer is no, but has there been any changes in your thoughts on acquisitions outlook?

Alison Cornell

Well, I mean, we look at acquisition opportunities on a regular basis and just continue to assess the fit and we tend to be conservative by nature and so, as and when one makes sense, we'll pursue it, but nothing out there in the short term.

Operator

That does conclude the question-and-answer session. I'd now like to turn the call back over to Paul Surdez for any additional or closing remarks.

Paul Surdez

Well, thank you, everyone, for your time and questions today. Enjoy your election day, and I will be around all day if you'd like to follow up with any questions. Thanks.

Operator

And again, that does conclude the call. We thank everyone for participating today.

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