UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549

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FORM 10-Q

ý

Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934For the quarterly period ended September 30, 2004oro

Transition Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934For the transition period from  toCommission File Number: 1-12213


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COVANCE INC.(Exact name of Registrant as specified in its Charter)

Delaware(State of Incorporation)

22-3265977(I.R.S. Employer Identification No.)210 Carnegie Center, Princeton, New Jersey(Address of Principal Executive Offices)

08540(Zip Code)


Registrant's telephone number, including area code: (609) 452-4440

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Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES ý    NO o

Indicate by check mark whether the Registrant is an accelerated filer (as described in Rule 12b-2 of the Exchange
Act). YES ý    NO o

APPLICABLE ONLY TO CORPORATE ISSUERS:

As of October 14, 2004, the Registrant had 62,439,943 shares of Common Stock outstanding.



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Covance Inc.  Form 10-Q For the Quarterly Period Ended September 30, 2004        INDEX

PagePart I. Financial InformationItem 1. Financial Statements (Unaudited)Consolidated Balance SheetsSeptember 30, 2004 and December 31, 2003

2Consolidated Statements of IncomeThree and Nine Months ended September 30, 2004 and 2003

3Consolidated Statements of Cash FlowsNine Months ended September 30, 2004 and 2003

4Notes to Consolidated Financial Statements

5Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

12Item 3. Quantitative and Qualitative Disclosure About Market Risk

23Item 4. Controls and Procedures

23Part II. Other InformationItem 2. Unregistered Sales of Equity Securities and Use of Proceeds

24Item 6. Exhibits and Reports on Form 8-K

24Signatures

25


1

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COVANCE INC. AND SUBSIDIARIES  CONSOLIDATED BALANCE SHEETS  SEPTEMBER 30, 2004 AND DECEMBER 31, 2003

(Dollars in thousands)

September 30,
2004

December 31,
2003(UNAUDITED)AssetsCurrent Assets:Cash and cash equivalents

$
161,087

$
171,600Accounts receivable


161,537


156,799Unbilled services


64,120


44,053Inventory


37,437


39,926Deferred income taxes


8,232


6,230Prepaid expenses and other current assets


47,409


31,246Total Current Assets


479,822


449,854Property and equipment, net


287,653


284,413Goodwill, net


56,876


56,876Other assets


37,924


16,482Total Assets

$
862,275

$
807,625Liabilities and Stockholders' EquityCurrent Liabilities:Accounts payable

$
21,050

$
20,129Accrued payroll and benefits


59,106


50,433Accrued expenses and other current liabilities


36,744


37,035Unearned revenue


68,759


82,227Income taxes payable


11,724


Total Current Liabilities


197,383


189,824Deferred income taxes


36,415


36,776Other liabilities


19,863


17,044Total Liabilities


253,661


243,644Commitments and Contingent LiabilitiesStockholders' Equity:Preferred StockPar value $1.00 per share; 10,000,000 shares
    authorized; no shares issued and outstanding at September 30, 2004
    and December 31, 2003, respectively





Common StockPar value $0.01 per share; 140,000,000 shares
    authorized; 69,076,729 and 66,345,070 shares issued, including
    those held in treasury, at September 30, 2004
    and December 31, 2003, respectively


691


663Paid-in capital


268,076


199,534Retained earnings


465,882


395,245Accumulated other comprehensive income
    Cumulative translation adjustment


22,673


21,960Treasury stock at cost (6,702,117 and 3,820,531 shares at September 30,
    2004 and December 31, 2003, respectively)


(148,708
)

(53,421
)Total Stockholders' Equity


608,614


563,981Total Liabilities and Stockholders' Equity

$
862,275

$
807,625


The
accompanying notes are an integral part of these consolidated financial statements.

2

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COVANCE INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF INCOME  FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003  (UNAUDITED)

Three Months Ended
September 30

Nine Months Ended
September 30(Dollars in thousands, except per share data)

2004

2003

2004

2003Net revenues

$
256,334

$
231,954

$
751,572

$
699,188Reimbursable out-of-pockets


7,602


7,897


22,481


26,057Total revenues


263,936


239,851


774,053


725,245Cost and expenses:Cost of revenue


169,254


154,789


497,950


473,517Reimbursed out-of-pocket expenses


7,602


7,897


22,481


26,057Selling, general and administrative


39,746


36,109


116,993


106,251Depreciation and amortization


11,220


11,263


34,411


33,874Total


227,822


210,058


671,835


639,699Income from operations


36,114


29,793


102,218


85,546Other (income) expense, net:Interest expense


77


399


819


1,211Interest income


(758
)

(372
)

(2,244
)

(1,000
)Foreign exchange transaction loss, net


296


313


714


334Other (income) expense, net


(385
)

340


(711
)

545Income before taxes and equity investee earnings


36,499


29,453


102,929


85,001Taxes on Income


11,667


10,035


33,068


29,658Equity investee earnings


341


92


776


339Net income

$
25,173

$
19,510

$
70,637

$
55,682Basic earnings per share

$
0.40

$
0.32

$
1.13

$
0.90Weighted average shares outstandingbasic


62,407,776


61,679,462


62,505,003


61,569,954Diluted earnings per share

$
0.39

$
0.31

$
1.09

$
0.89Weighted average shares outstandingdiluted


64,570,014


62,674,600


64,697,286


62,734,837


The
accompanying notes are an integral part of these consolidated financial statements.

3

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COVANCE INC. AND SUBSIDIARIES  CONSOLIDATED STATEMENTS OF CASH FLOWS  FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004 AND 2003  (UNAUDITED)

Nine Months Ended
September 30(Dollars in thousands)

2004

2003Cash flows from operating activities:Net income

$
70,637

$
55,682Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization


34,411


33,874Stock issued under employee benefit and stock compensation plans


8,984


9,886Deferred income tax (benefit) provision


(2,363
)

4,692Other


(422
)

255Changes in operating assets and liabilities:Accounts receivable


(4,738
)

16,628Unbilled services


(20,067
)

(10,917
)Inventory


2,489


1,859Accounts payable


921


(4,950
)Accrued liabilities


8,382


(10,649
)Unearned revenue


(13,468
)

(23,851
)Income taxes payable


22,176


5,516Other assets and liabilities, net


(13,155
)

(917
)Net cash provided by operating activities


93,787


77,108Cash flows from investing activities:Equity method investment


(20,741
)

Capital expenditures


(37,623
)

(48,726
)Other, net


109


(18
)Net cash used in investing activities


(58,255
)

(48,744
)Cash flows from financing activities:Stock issued under employee stock purchase and option plans


49,134


17,420Purchase of treasury stock


(95,287
)

(13,931
)Net cash (used in) provided by financing activities


(46,153
)

3,489Effect of exchange rate changes on cash


108


3,150Net change in cash and cash equivalents


(10,513
)

35,003Cash and cash equivalents, beginning of period


171,600


75,913Cash and cash equivalents, end of period

$
161,087

$
110,916


The
accompanying notes are an integral part of these consolidated financial statements.

4

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

1.    Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for
interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending
December 31, 2004. The balance sheet at December 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes
required by GAAP for complete financial statements. You should read these
consolidated financial statements together with the historical consolidated financial statements of Covance Inc. and subsidiaries ("Covance") for the years ended December 31, 2003, 2002,
and 2001 included in our Annual Report on Form 10-K for the year ended December 31, 2003.

2.    Summary of Significant Accounting Policies



These unaudited consolidated financial statements include the accounts of all entities controlled by Covance. All significant intercompany accounts and
transactions are eliminated. The equity method of accounting is used for investments in affiliates in which Covance owns between 20 and 50 percent and does not have the ability to exercise
control. See Note 4.



These unaudited consolidated financial statements have been prepared in conformity with GAAP, which requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from these estimates.



In connection with the management of multi-site clinical trials, Covance pays on behalf of its customers fees to investigators, volunteers and other
out-of-pocket costs (such as travel, printing, meetings, couriers, etc.), for which we are reimbursed at cost, without mark-up or profit. Amounts receivable from
customers in connection with billed and unbilled investigator fees, volunteer payments and other out-of-pocket pass-through costs are included in prepaid expenses
and other current assets in the accompanying Consolidated Balance Sheets and totaled
$28.1 million and $14.5 million at September 30, 2004 and December 31, 2003, respectively. See Note 2 "Reimbursable Out-of-Pocket Expenses".



Inventories, which consist principally of finished goods and supplies, are valued at the lower of cost (first-in, first-out method) or
market.



Goodwill represents investment costs in excess of the fair value of net tangible and identifiable net intangible assets acquired. In accordance with Financial
Accounting Standards Board ("FASB") Statement No. 142,Goodwill and Other Intangible Assets, Covance performs an annual test for impairment of
goodwill. The most recent annual test performed for 2003 did not identify any instances of impairment and there were no events through September 30, 2004 that warranted a reconsideration of our
impairment test results.

5

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

2.    Summary of Significant Accounting Policies (Continued)



Covance uses the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the expected
future tax consequences of differences between the carrying amount of assets and liabilities and their respective tax bases using tax rates in effect for the year in which the temporary differences
are expected to reverse. The effect on deferred taxes of a change in enacted tax rates is recognized in income in the period when the change is effective.

Covance
has established, and periodically reviews and reevaluates, an estimated income tax reserve, which is included in accrued expenses and other current liabilities on the
accompanying Consolidated Balance Sheets. This income tax reserve is for exposures related to various Federal, state and foreign income tax matters. The purpose of this income tax reserve is to
provide for the possibility of adverse outcomes in income tax proceedings across these various tax jurisdictions in which Covance operates. An accrual is established at the time an exposure is
identified. The amount of the accrual for each item for which an exposure exists is adjusted when either (a) matters are settled at amounts which are different than the amount included in the reserve
or (b) when facts indicate a significant change in either the probability or estimated amount of the potential exposure.



Covance's total comprehensive income, which represents net income plus the change in the cumulative translation adjustment equity account for the periods
presented, was $23.3 million and $20.8 million for the three months ended September 30, 2004 and 2003, respectively, and $71.4 million and $63.6 million for the nine
months ended September 30, 2004 and 2003, respectively.



Basic EPS is computed by dividing net income available to common stockholders by the weighted average number of shares outstanding during the period. The
computation of diluted EPS is similar to the computation of basic EPS, except that the denominator is increased to include the number of additional common shares that would have been outstanding if
the dilutive potential common shares had been issued; computed under the treasury stock method in accordance with the requirements of SFAS No. 128,Earnings Per
Share. In computing diluted earnings per share for the three months ended September 30, 2004 and 2003, the denominator was increased by 2,162,238 shares and 995,138
shares, respectively, and for the nine months ended September 30, 2004 and 2003, the denominator was increased by 2,192,283 shares and 1,164,883 shares, respectively, representing the number of
additional common shares that would have been outstanding if the dilutive potential common shares had been issued for stock options outstanding at September 30, 2004 and 2003 with exercise
prices less than the average market price of Covance's Common Stock during each respective period.



As discussed in Note 2 "Prepaid Expenses and Other Current Assets", Covance pays on behalf of its customers fees to investigators, volunteers and other
out-of-pocket costs for which we are reimbursed at cost, without mark-up or profit. In connection with the requirements of Financial Accounting Standards Board
Emerging Issues Task Force Rule No. 01-14 ("EITF 01-14"),Income Statement Characterization of Reimbursements Received for
"Out-of-Pocket" Expenses Incurred, amounts paid to volunteers and other out-of-pocket costs are reflected in operating expenses,
while the reimbursements received are reflected in revenues in the Consolidated Statements of Income. Covance will continue to exclude from revenue and expense in the Consolidated Statements of Income
fees paid to investigators and the associated reimbursement since Covance acts as an agent on behalf of the pharmaceutical company sponsors with regard to investigator payments.

6

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

2.    Summary of Significant Accounting Policies (Continued)



Covance has several stock-based compensation plans, which are described more fully in Note 10 to our audited consolidated financial statements included in
our Annual Report on Form 10-K for the year ended December 31, 2003. Effective January 1, 2003, Covance adopted FASB Statement No. 148, Accounting for Stock-Based CompensationTransition and
Disclosure.Statement No. 148 amends FASB Statement No. 123,Accounting for Stock-Based Compensation, to provide, among other things, prominent disclosure of the effects of an entity's accounting policy with
respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. Covance intends to continue to follow the
disclosure-only provisions of FASB Statement No. 123 and, accordingly, will continue to account for these plans under the recognition and measurement principles of APB Opinion
No. 25,Accounting for Stock Issued to Employees, and related interpretations. Under APB 25, when stock options are issued with an exercise price
equal to the market price of the underlying stock price on the date of grant, no compensation expense is recognized.

While
Covance does record compensation expense related to awards of stock, no compensation cost is recorded for option grants under Covance's stock option plans as all options granted
under these plans are issued with an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings
per share for the three and nine months ended September 30, 2004 and 2003 had Covance applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to all of its stock-based employee compensation plans.

Three Months Ended
September 30

Nine Months Ended
September 302004

2003

2004

2003Net Income, as reported

$
25,173

$
19,510

$
70,637

$
55,682Add: Stock award-based employee compensation included in reported net income, net of related tax effects

$
746

$
794

$
2,135

$
2,402Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

$
(3,694
)
$
(3,441
)
$
(10,140
)
$
(9,645
)Pro forma net income

$
22,225

$
16,863

$
62,632

$
48,439Earnings per share:Basicas reported

$
0.40

$
0.32

$
1.13

$
0.90Basicpro forma

$
0.36

$
0.27

$
1.00

$
0.79Dilutedas reported

$
0.39

$
0.31

$
1.09

$
0.89Dilutedpro forma

$
0.34

$
0.27

$
0.97

$
0.77




Cash paid for interest for the nine months ended September 30, 2004 and 2003 totaled $0.8 million and $1.3 million, respectively. Cash paid
for income taxes for the nine months ended September 30, 2004 and 2003 totaled $13.9 million and $13.3 million, respectively.

7

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

3.    Treasury Stock

In February 2003, the Covance Board of Directors authorized the repurchase of 3.0 million shares under Covance's stock repurchase program. In
June 2004, the Covance Board of Directors authorized the repurchase of an additional 3.0 million shares under this program. For the nine months ended September 30, 2004 and 2003,
Covance repurchased 2.7 million shares and 0.6 million shares, respectively, under these two authorizations. At September 30, 2004, there were 2.7 million shares remaining
for purchase under the 2004 authorization. Covance also reacquires shares of its common stock in connection with certain employee benefit plans when employees tender shares upon choosing the reload
option for stock option exercises and when employees tender shares to satisfy income tax withholdings associated with the vesting of stock awards. The following table sets forth the treasury stock
activity during the nine month periods ended September 30, 2004 and 2003.

Nine Months Ended September 302004

2003(amounts in thousands)

$

# shares

$

# sharesShares repurchased in connection with:Board approved buyback programs

$
86,929


2,655.3

$
13,515


640.3Employee benefit plans


8,358


226.3


416


9.4Total

$
95,287


2,881.6

$
13,931


649.7


4.    Equity Method Investees

In March 2004, Covance acquired a 47% minority equity position in Noveprim Limited, an existing supplier of research products, for a total cost of
$20.7 million. The excess of the purchase price over the underlying equity in Noveprim's net assets is approximately $13.8 million. This investment is reflected in Other Assets on the
Consolidated Balance Sheet. During the three and nine month periods ended September 30, 2004, Covance recognized $0.2 million and $0.3 million, respectively, representing its
share of Noveprim's earnings, less an elimination of profit on inventory purchased from Noveprim Limited and still on hand at Covance at September 30, 2004.

Covance
has a minority equity position (approximately 22% at September 30, 2004) in Bio-Imaging Technologies, Inc. ("BITI"). BITI uses proprietary medical
imaging technologies to process and analyze medical images, and also provides other services, including the data-basing and regulatory submission of medical images, quantitative data and
text. During the three and nine month periods ended September 30, 2004, Covance recognized $0.1 million and $0.4 million, respectively, representing its share of BITI's earnings.
During the three and nine month periods ended September 30, 2003, Covance recognized $0.1 million and $0.3 million, respectively, representing its share of BITI's earnings. The
carrying value of Covance's investment in BITI as of September 30, 2004 was $0.9 million while the fair market value was $11.5 million.

5.    Defined Benefit Plans

Covance sponsors various pension and other post-retirement benefit plans. During the first quarter of 2004, Covance adopted the interim disclosure
provisions of SFAS No. 132 (revised 2003),Employers' Disclosure About Pensions and Other Post-Retirement Benefits.This statement
requires the interim disclosures as shown below.

8

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

5.    Defined Benefit Plans (Continued)



Covance sponsors two defined benefit pension plans for the benefit of its employees at two United Kingdom subsidiaries and one defined benefit pension plan for
the benefit of its employees at a German subsidiary, all of which are legacy plans of previously acquired companies. Benefit amounts for all three plans are based upon years of service and
compensation. The German plan is unfunded while the UK plans are funded. Covance's funding policy has been to contribute annually a fixed percentage of the eligible employee's salary at least equal to
the local statutory funding requirements. Pension plan assets are administered by the plans' trustees and are principally invested in equity and fixed income securities. The components of net periodic
pension expense for these plans for the three and nine month periods ended September 30, 2004 and 2003 are as follows:

United Kingdom Plans

German PlanThree Months Ended
September 30

Three Months Ended
September 302004

2003

2004

2003Components of Net Periodic Pension Cost:Service cost

$
1,151

$
1,050

$
72

$
63Interest cost


1,199


943


60


52Expected return on plan assets


(1,073
)

(806
)




Amortization of net actuarial loss


277


296


1


2Participant contributions


(500
)

(463
)




Net periodic pension cost

$
1,054

$
1,020

$
133

$
117Assumptions Used to Determine Net Periodic Pension Cost:Discount rate


6.00
%

6.00
%

5.75
%

5.75
%Expected rate of return on assets


6.00
%

6.00
%

n/a


n/aSalary increases


3.50
%

3.50
%

3.00
%

3.00
%


United Kingdom Plans

German PlanNine Months Ended
September 30

Nine Months Ended
September 302004

2003

2004

2003Components of Net Periodic Pension Cost:Service cost

$
3,490

$
3,150

$
217

$
189Interest cost


3,638


2,829


181


156Expected return on plan assets


(3,256
)

(2,418
)




Amortization of net actuarial loss


840


888


4


5Participant contributions


(1,517
)

(1,389
)




Net periodic pension cost

$
3,195

$
3,060

$
402

$
350Assumptions Used to Determine Net Periodic Pension Cost:Discount rate


6.00
%

6.00
%

5.75
%

5.75
%Expected rate of return on assets


6.00
%

6.00
%

n/a


n/aSalary increases


3.50
%

3.50
%

3.00
%

3.00
%


9

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

5.    Defined Benefit Plans (Continued)



In addition to these foreign defined benefit pension plans, Covance also has a non-qualified Supplemental Executive Retirement Plan ("SERP"). The
SERP, which is not funded, is intended to provide retirement benefits for certain executive officers of Covance. Benefit amounts are based upon years of service and compensation of the participating
employees. The components of net periodic pension cost for the three and nine month periods ended September 30, 2004 and 2003 are as follows:

Three Months Ended
September 30

Nine Months Ended
September 302004

2003

2004

2003Components of Net Periodic Pension Cost:Service cost

$
236

$
141

$
710

$
423Interest cost


131


98


393


294Amortization of prior service cost


19





57


Amortization of net actuarial loss


6


2


16


6Net periodic pension cost

$
392

$
241

$
1,176

$
723Assumptions Used to Determine Net Periodic Pension Cost:Discount rate


6.25
%

6.75
%

6.25
%

6.75
%Salary increases


4.00
%

4.50
%

4.00
%

4.50
%




Covance also sponsors a post-employment retiree health and welfare plan for the benefit of eligible employees at certain U.S. subsidiaries who retire
after satisfying service and age requirements. This plan is funded on a pay-as-you-go basis and the cost of providing these benefits is shared with the retirees.
The components of net periodic post-retirement benefits cost for the three and nine month periods ended September 30, 2004 and 2003 are as follows:

Three Months Ended
September 30

Nine Months Ended
September 302004

2003

2004

2003Components of Net Periodic Post-retirement Benefits Cost:Service cost

$
59

$
56

$
179

$
168Interest cost


98


96


294


288Amortization of prior service cost (benefit)


(97
)

(99
)

(293
)

(297
)Amortization of net actuarial loss


50


46


150


136Net periodic post-retirement benefits cost

$
110

$
99

$
330

$
295Assumptions Used:Discount rate


6.25
%

6.75
%

6.25
%

6.75
%Health care cost trend rate


9.00
%(a)

9.90
%(a)

9.00
%(a)

9.90
%(a)


---

10

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COVANCE INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
(UNAUDITED)
September 30, 2004 and 2003
(dollars in thousands, unless otherwise indicated)

6.    Segment Information

Covance has two reportable segments: early development and late-stage development. Early development services, which includes Covance's preclinical
and Phase I clinical service capabilities, involve evaluating a new compound for safety and early effectiveness as well as evaluating the absorption, distribution, metabolism and excretion of the
compound in the human body. It is at this stage that a pharmaceutical company, based on available data, will generally decide whether to continue further development of a drug. Late-stage
development services, which include Covance's central laboratory, clinical development, periapproval, central ECG diagnostic services, and healthcare economic and reimbursement services, are geared
toward demonstrating the clinical effectiveness of a compound in treating certain diseases or conditions, obtaining regulatory approval and maximizing the drug's commercial potential.

The
accounting policies of the reportable segments are the same as those described in Note 2. Segment net revenues, operating income and total assets for the three and nine months
ended September 30, 2004 and 2003 are as follows:

Early
Development

Late-Stage
Development

Other
Reconciling Items

TotalThree months ended September 30, 2004Total revenues from external customers

$
121,086

$
135,248

$
7,602
(a)
$
263,936Operating income

$
28,936

$
21,669

$
(14,491
) (b)
$
36,114Total assets

$
435,272

$
362,584

$
64,419
(c)
$
862,275Three months ended September 30, 2003Total revenues from external customers

$
104,653

$
127,301

$
7,897
(a)
$
239,851Operating income

$
23,051

$
18,823

$
(12,081
) (b)
$
29,793Total assets

$
356,919

$
324,412

$
51,749
(c)
$
733,080Nine months ended September 30, 2004Total revenues from external customers

$
357,088

$
394,484

$
22,481
(a)
$
774,053Operating income

$
83,767

$
59,629

$
(41,178
) (b)
$
102,218Total assets

$
435,272

$
362,584

$
64,419
(c)
$
862,275Nine months ended September 30, 2003Total revenues from external customers

$
303,341

$
395,847

$
26,057
(a)
$
725,245Operating income

$
61,339

$
58,913

$
(34,706
) (b)
$
85,546Total assets

$
356,919

$
324,412

$
51,749
(c)
$
733,080


---

11

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion together with the unaudited Covance consolidated financial statements and the accompanying notes included in this
Quarterly Report on Form 10-Q for the quarter ended September 30, 2004.

Overview

Covance is a leading drug development services company providing a wide range of early stage and late-stage product development services on a
worldwide basis primarily to the pharmaceutical, biotechnology and medical device industries. Covance also provides services such as laboratory testing to the chemical, agrochemical and food
industries. The foregoing services comprise two reportable segments for financial reporting purposes: early development services, which includes preclinical and Phase I clinical; and
late-stage development services, which includes central laboratory, clinical development, periapproval, central ECG diagnostic services, and healthcare economic and reimbursement services.
Although each segment has separate services within it, they can be combined in joint service offerings and we believe clients increasingly are interested in opportunities for such combined services.
Covance believes it is one of the largest drug development services companies, based on annual net revenues, and one of a few that is capable of providing comprehensive global product development
services. Covance offers its clients high quality services designed to provide data to clients as rapidly as possible and reduce product development time. We believe this enables Covance's customers
to introduce their products into the marketplace faster and as a result, maximize the period of market exclusivity and monetary return on their research and development investments. Additionally,
Covance's comprehensive services and broad experience provide its customers with a variable cost alternative to fixed cost internal development capabilities.

Critical Accounting Policies

Covance's consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles, which require management to make
estimates and assumptions about future events that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from these
estimates. The following discussion highlights what we believe to be the critical accounting policies and judgments made in the preparation of these consolidated financial statements.

Revenue Recognition.Covance recognizes revenue either as services are performed or products are
delivered, depending upon the nature of the work contracted. Historically, a majority of Covance's net revenues have been earned under contracts which range in duration from a few months to two years,
but can extend in duration up to five years or longer. Service contracts generally take the form of fee-for-service or fixed-price arrangements. In the case of
fee-for-service contracts, revenue is recognized as services are performed, based upon, for example, hours worked or samples tested. For long-term fixed-price
service contracts, revenue is recognized as services are performed, with performance generally assessed using output measures, such as units-of-work performed to date as
compared to the total units-of-work contracted. Changes in the scope of work generally result in a renegotiation of contract pricing terms. Renegotiated amounts are not
included in net revenues until earned and realization is assured. Estimates of costs to complete are made to provide, where appropriate, for losses expected on contracts. Costs are not deferred in
anticipation of contracts being awarded, but instead are expensed as incurred. In some cases, for multi-year contracts, a portion of the contract fee is paid at the time the trial is
initiated. These advances are deferred and recognized as revenue as services are performed, as discussed above. Additional payments may be made based upon the achievement of performance-based
milestones over the contract duration. Most contracts are terminable by the client either immediately or upon notice. These contracts typically require payment to Covance of expenses to wind down the
study, fees earned to date and, in some cases, a termination fee or a payment to Covance of some portion of the fees or profits that could have been earned by Covance under the contract if it had not
been terminated early. Termination fees are included in net revenues when realization is assured.

Bad Debts.Covance endeavors to assess and monitor the creditworthiness of its customers to which it
grants credit terms in the ordinary course of business. Covance maintains a provision for doubtful accounts to provide for the possibility that amounts due Covance may not be collected. This bad debt
provision is monitored on a monthly basis and adjusted as circumstances warrant. Since the recorded bad debt provision is based upon management's judgment, actual bad debt write-offs may
be greater or less than the amount recorded. Historically bad debt write-offs have not been material.

12

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Taxes on Income.Since Covance conducts operations on a global basis, its effective tax rate has and
will continue to depend upon the geographic distribution of its pre-tax earnings among locations with varying tax rates. Covance's profits are further impacted by changes in the tax rates
of the various jurisdictions. In particular, as the geographic mix of Covance's pre-tax earnings among various tax jurisdictions changes, Covance's effective tax rate may vary from period
to period. Covance has established, and periodically reviews and reevaluates, an estimated income tax reserve which is included in accrued expenses and other current liabilities on its consolidated
balance sheet. This income tax reserve is for exposures related to various Federal, state and foreign income tax matters. The purpose of this income tax reserve is to provide for the possibility of
adverse outcomes in income tax proceedings across these various tax jurisdictions in which Covance operates. An accrual is established at the time an exposure is identified. The amount of the accrual
for each item for which an exposure exists is adjusted when either (a) matters are settled at amounts which are different than the amount included in the reserve or (b) when facts
indicate a significant change in either the probability or estimated amount of the potential exposure. While Covance believes that it has identified all reasonably identifiable exposures and that the
reserve it has established for identifiable exposures is appropriate under the circumstances, it is possible that additional exposures exist and that exposures will be settled at amounts different
than the amounts reserved. It is
possible that changes in estimates in the future could cause Covance to either materially increase or reduce the carrying amount of its income tax reserve. In addition, Covance's policy is to provide
income taxes on earnings of foreign subsidiaries to the extent those earnings are taxable or are expected to be remitted. Taxes have not been provided on accumulated foreign unremitted earnings
totaling $127.0 million as of December 31, 2003 because Covance currently intends to leave these earnings invested in those countries. If Covance were to repatriate these earnings, or a
portion of these earnings, Covance might incur a significant income tax liability.

Stock Based Compensation.Covance grants stock options to its employees at an exercise price equal to
the fair value of the shares at the date of grant and accounts for these stock option grants in accordance with APB Opinion No. 25,Accounting for Stock Issued to
Employees("APB 25") and related interpretations. Under APB 25, when stock options are issued with an exercise price equal to the market price of the underlying stock on the
date of grant, no compensation expense is recognized in the income statement.

Impairment of Assets.Covance reviews its long-lived assets for impairment, when events
or changes in circumstances occur that indicate that the carrying value of the asset may not be recoverable. The assessment of possible impairment is based upon Covance's judgment of its ability to
recover the asset from the expected future undiscounted cash flows of the related operations. Actual future cash flows may be greater or less than estimated.

Covance
performs an annual test for impairment of goodwill. This test is performed by comparing, at the reporting unit level, the carrying value of goodwill to its fair value. Covance
assesses fair value based upon its best estimate of the present value of the future cash flows that it expects to be generated by the reporting unit. The test performed for 2003 did not identify any
instances of impairment. However, changes in expectations as to the present value of the reporting unit's future cash flows might impact subsequent years' assessments of impairment.

Defined Benefit Pension Plans.Covance sponsors defined benefit pension plans for the benefit of its
employees at three foreign subsidiaries. The measurement of the related pension benefit obligation and the expense recorded in each year is based upon actuarial computations which require judgment as
to (a) the appropriate discount rate to use in computing the present value of the benefit obligation, (b) the expected return on plan assets and (c) the expected future rate of
salary increases. Actual results will likely differ, in some periods materially, from the assumptions used in the actuarial valuation.

Foreign Currency Risks

Since Covance operates on a global basis, it is exposed to various foreign currency risks. Two specific risks arise from the nature of the contracts Covance
executes with its customers since from time to time contracts are denominated in a currency different than the particular Covance subsidiary's local currency. These risks are generally applicable only
to a portion of the contracts executed by Covance's foreign subsidiaries providing clinical services. The first risk occurs as revenue recognized for services rendered is denominated in a currency
different from the currency in which the subsidiary's expenses are incurred. As a result, the subsidiary's net revenues and resultant earnings can be affected by fluctuations in exchange rates.
Historically, fluctuations in exchange rates from those in effect at the time contracts were executed have not had a material effect upon Covance's consolidated financial results. See "Risk Factors".

The
second risk results from the passage of time between the invoicing of customers under these contracts and the ultimate collection of customer payments against such invoices. Because
the contract is denominated in a currency other than the subsidiary's local currency, Covance recognizes a receivable at the time of invoicing for the local currency equivalent of the foreign currency
invoice amount. Changes in exchange rates from the time the invoice is prepared and payment from the customer is received will result in Covance receiving either more or less in local currency than
the local currency equivalent of

13

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the
invoice amount at the time the invoice was prepared and the receivable established. This difference is recognized by Covance as a foreign currency transaction gain or loss, as applicable, and is
reported in other expense (income) in Covance's Consolidated Statements of Income.

Finally,
Covance's consolidated financial statements are denominated in U.S. dollars. Accordingly, changes in exchange rates between the applicable foreign currency and the U.S. dollar
will affect the translation of each foreign subsidiary's financial results into U.S. dollars for purposes of reporting Covance's consolidated financial results. The process by which each foreign
subsidiary's financial results are translated into U.S. dollars is as follows: income statement accounts are translated at average exchange rates for the period; balance sheet asset and liability
accounts are translated at end of period exchange rates; and equity accounts are translated at historical exchange rates. Translation of the balance sheet in this manner affects the stockholders'
equity account, referred to as the cumulative translation adjustment account. This account exists only in the foreign subsidiary's U.S. dollar balance sheet and is necessary to keep the foreign
balance sheet stated in U.S. dollars in balance.

Operating Expenses and Reimbursable Out-of-Pockets

Covance segregates its recurring operating expenses among four categories: cost of revenue; reimbursed out-of-pocket expenses; selling,
general and administrative expenses; and depreciation and amortization. Cost of revenue includes direct labor and related benefits, other direct costs, shipping and handling fees, and an allocation of
facility charges and information technology costs, and excludes depreciation and amortization. Cost of revenue, as a percentage of net revenues, tends and is expected to fluctuate from one period to
another, as a result of changes in labor utilization and the mix of service offerings involving hundreds of studies conducted during any period of time. Selling, general and administrative expenses
consist primarily of administrative payroll and related benefit charges, advertising and promotional expenses, administrative travel and an allocation of facility charges and information technology
costs, and excludes depreciation and amortization.

In
connection with the management of multi-site clinical trials, Covance pays on behalf of its customers fees to investigators, volunteers and other
out-of-pocket costs (such as for travel, printing, meetings, couriers, etc.), for which it is reimbursed at cost, without mark-up or profit. Investigator fees are
not reflected in total revenues or expenses where Covance acts in the capacity of an agent on behalf of the pharmaceutical company sponsor, passing through these costs without risk or reward to
Covance. All other out-of-pocket costs are included in total revenues and expenses.

Quarterly Results

Covance's quarterly operating results are subject to variation, and are expected to continue to be subject to variation, as a result of factors such as
(1) delays in initiating or completing significant drug development trials, (2) termination or reduction in size of drug development trials, (3) acquisitions and divestitures, and
(4) exchange rate fluctuations. Delays and terminations of trials are often the result of actions taken by Covance's customers or regulatory authorities and are not typically controllable by
Covance. Since a large amount of Covance's operating costs are relatively fixed while revenue is subject to fluctuation, moderate variations in the commencement, progress or completion of drug
development trials may cause significant variations in quarterly results.

Results of Operations

Three Months Ended September 30, 2004 Compared with Three Months Ended September 30,
2003.Net revenues increased 10.5% to $256.3 million for the three months ended September 30, 2004 from $232.0 million for the corresponding
2003 period. Excluding the impact of foreign exchange rate variances between both periods net revenues increased 7.5% as compared to the corresponding 2003 period. Net revenues from Covance's early
development segment grew 15.7%, or 12.0% excluding the impact of foreign exchange rate variances between both periods, primarily on continuing strong performance in our global toxicology, chemistry
and North American Phase I services. Net revenues from Covance's late-stage development segment grew 6.2%, or 3.8% excluding the impact of foreign exchange rate variances between both
periods, primarily on strong performance in our central diagnostics and health economics services. Late-stage development net revenues from clinical development services also benefited
from gains earned upon the conclusion of a few large fixed price contracts.

Cost
of revenue increased 9.3% to $169.3 million or 66.0% of net revenues for the three months ended September 30, 2004 as compared to $154.8 million or 66.7% of net
revenues for the corresponding 2003 period. Gross margins improved 70 basis

14

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points
to 34.0% for the three months ended September 30, 2004 from 33.3% for the corresponding 2003 period on process improvements and cost controls.

Overall,
selling, general and administrative expenses increased 10.1% to $39.7 million for the three months ended September 30, 2004 from $36.1 million for the
corresponding 2003 period. As a percentage of net revenues, selling, general and administrative expenses decreased 10 basis points to 15.5% for the three month period ended September 30, 2004
from 15.6% for the corresponding 2003 period.

Depreciation
and amortization decreased 0.4% to $11.2 million or 4.4% of net revenues for the three months ended September 30, 2004 from $11.3 million or 4.9% of net
revenues for the corresponding 2003 period.

Income
from operations increased 21.2% to $36.1 million or 14.1% of net revenues for the three months ended September 30, 2004 from $29.8 million or 12.8% of net
revenues for the corresponding 2003 period. Income from operations from Covance's early development segment increased $5.8 million or 25.5% to $28.9 million or 23.9% of net revenues for
the three months ended September 30, 2004 from $23.1 million or 22.0% of net revenues for the corresponding 2003 period, primarily driven by strong performance in our global toxicology,
chemistry and North American Phase I services. Income from operations from Covance's late-stage development segment increased $2.9 million or 15.1% to $21.7 million or 16.0%
of net revenues for the three months ended September 30, 2004 from $18.8 million or 14.8% of net revenues for the corresponding 2003 period, primarily driven by strong performance in our
central diagnostics and health economics services. Corporate expenses increased $2.4 million to $14.5 million or 5.7% of net revenues for the three months ended September 30, 2004
from $12.1 million or 5.2% of net revenues for the three months ended September 30, 2003. The increase is primarily attributable to increased centralized information technology costs.

Other
income, net of $0.4 million for the three months ended September 30, 2004 increased $0.7 million compared to net expense of $0.3 million for the
corresponding 2003 period. This increase is the result of a $0.4 million increase in interest income due primarily to higher invested cash balances, combined with a decrease in interest expense
of $0.3 million due to lower fees associated with our new revolving credit facility.

Covance's
effective tax rate for the three months ended September 30, 2004 was 32.0% compared to 34.1% for the corresponding 2003 period. The year over year 210 basis point
reduction in Covance's effective tax rate is attributable to a number of factors, including the mix of our pre-tax earnings across various tax jurisdictions, recently enacted research and
development tax credits in the United Kingdom, and other planning measures.

Covance
has a minority equity position (approximately 22% at September 30, 2004) in Bio-Imaging Technologies, Inc. ("BITI"). BITI uses proprietary medical
imaging technologies to process and analyze medical images, and also provides other services, including the data-basing and regulatory submission of medical images, quantitative data and
text. During both of the three month periods ended September 30, 2004 and 2003, Covance recognized $0.1 million, representing its share of BITI's earnings.

In
March 2004, Covance acquired a 47% minority equity position in Noveprim Limited, an existing supplier of research products. Covance began recognizing earnings from this
investment in the second quarter of 2004. For the three month period ended September 30, 2004, Covance recognized $0.2 million, representing its share of Noveprim's earnings, less an
elimination of profit on inventory purchased from Noveprim Limited and still on hand at Covance at September 30, 2004.

Net
income of $25.2 million for the three months ended September 30, 2004 increased $5.7 million or 29.0% as compared to $19.5 million for the corresponding
2003 period.

Nine Months Ended September 30, 2004 Compared with Nine Months Ended September 30, 2003.Net revenues increased
7.5% to $751.6 million for the nine months ended September 30, 2004 from $699.2 million for the corresponding 2003 period. Excluding the impact of foreign exchange rate variances
between both periods, net revenues increased 4.4% as compared to the corresponding 2003 period. Net revenues from Covance's early development segment grew 17.7%, or 13.4% excluding the impact of
foreign exchange rate variances between both periods, primarily on strong performance in our global toxicology, chemistry and North American Phase I services. Net
revenues from Covance's late-stage development segment decreased 0.3%, or 2.5% excluding the impact of foreign exchange rate variances between both periods. While we experienced a return
to growth in the third quarter of 2004, on a year-to-date basis, growth in our late-stage development segment was

15

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negatively
impacted by reduced testing volumes in our central laboratory service offering due to low order volume in the first half of 2003.

Cost
of revenue increased 5.2% to $497.9 million or 66.3% of net revenues for the nine months ended September 30, 2004 as compared to $473.5 million or 67.7% of net
revenues for the corresponding 2003 period. Gross margins improved 140 basis points to 33.7% for the nine months ended September 30, 2004 from 32.3% for the corresponding 2003 period primarily,
on process improvements and cost controls.

Overall,
selling, general and administrative expenses increased 10.1% to $117.0 million for the nine months ended September 30, 2004 from $106.3 million for the
corresponding 2003 period. As a percentage of net revenues, selling, general and administrative expenses increased 40 basis points to 15.6% for the nine months ended September 30, 2004 from
15.2% for the corresponding 2003 period.

Depreciation
and amortization increased 1.6% to $34.4 million or 4.6% of net revenues for the nine months ended September 30, 2004 from $33.9 million or 4.8% of net
revenues for the corresponding 2003 period.

Income
from operations increased 19.5% to $102.2 million or 13.6% of net revenues for the nine months ended September 30, 2004 from $85.5 million or 12.2% of net
revenues for the corresponding 2003 period. Income from operations from Covance's early development segment increased $22.5 million or 36.6% to $83.8 million or 23.5% of net revenues for
the nine months ended September 30, 2004 from $61.3 million or 20.2% of net revenues for the corresponding 2003 period, primarily driven by strong performance in our global toxicology,
chemistry and North American Phase I services. Income from operations from Covance's late-stage development segment increased $0.7 million or 1.2% to $59.6 million or 15.1%
of net revenues for the nine months ended September 30, 2004 from $58.9 million or 14.9% of net revenues for the corresponding 2003 period. While we experienced a return to growth in the
third quarter of 2004, on a year-to-date basis, income from operations from our late-stage development segment continued to be negatively impacted by reduced
testing volumes in our central laboratory service offering resulting from low order volume in the first half of 2003. Corporate expenses increased $6.5 million to $41.2 million or 5.5%
of net revenues for the nine months ended September 30, 2004 from $34.7 million or 5.0% of net revenues for the nine months ended September 30, 2003. The increase is primarily
attributable to increased centralized information technology and human resources costs and increased spending in sales and marketing, finance, legal and resource management.

Other
income, net of $0.7 million for the nine months ended September 30, 2004 increased $1.2 million compared to net expense of $0.5 million for the
corresponding 2003 period. This increase is the result of a $1.6 million increase in net interest income due primarily to higher invested cash balances.

Covance's
effective tax rate for the nine months ended September 30, 2004 was 32.1% compared to 34.9% for the corresponding 2003 period. The 280 basis point reduction in Covance's
effective tax rate year over year is attributable to a number of factors, including the mix of our pre-tax earnings across various tax jurisdictions, recently enacted research and
development tax credits in the United Kingdom, and other initiatives.

Covance
has a minority equity position (approximately 22% at September 30, 2004) in Bio-Imaging Technologies, Inc. ("BITI"). BITI uses proprietary medical
imaging technologies to process and analyze medical images, and also provides other services, including the data-basing and regulatory submission of medical images, quantitative data and
text. During the nine month period ended September 30, 2004, Covance recognized $0.4 million, representing its share of BITI's earnings, as compared to $0.3 million for the
corresponding 2003 period.

In
March 2004, Covance acquired a 47% minority equity position in Noveprim Limited, an existing supplier of research products. Covance began recognizing earnings from this
investment in the second quarter of 2004. For the nine month period ended September 30, 2004, Covance recognized $0.3 million, representing its share of Noveprim's earnings, less an
elimination of profit on inventory purchased from Noveprim Limited and still on hand at Covance at September 30, 2004.

Net
income of $70.6 million for the nine months ended September 30, 2004 increased $15.0 million or 26.9% as compared to $55.7 million for the corresponding
2003 period.

16

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Liquidity and Capital Resources

Covance's expected primary cash needs on both a short and long-term basis are for capital expenditures, expansion of services, possible future
acquisitions, geographic expansion, working capital and other general corporate purposes, including possible share repurchases. On June 30, 2004, Covance entered into a new $75.0 million
revolving credit facility which expires in June 2009. Covance believes cash from operations and available borrowings under its new credit facility will provide sufficient liquidity for the
foreseeable future. At September 30, 2004, there were no outstanding borrowings and $0.8 million in outstanding letters of credit under the new credit facility. Interest on all
outstanding borrowings under the new credit facility is based upon the London Interbank Offered Rate ("LIBOR") plus a 75 basis point margin. Costs associated with the new credit facility consisted
primarily of bank and legal fees totaling $0.4 million which are being amortized over the five year facility term. The new credit facility contains various financial and other covenants. The
new credit facility is collateralized by guarantees of certain of Covance's domestic subsidiaries and a pledge of 65 percent of the capital stock of certain of Covance's foreign subsidiaries. A
commitment fee of 15 basis points on the undrawn balance of the new credit facility will be payable in arrears on the first day of each July, October, January and April, beginning in
October 2004.

During
the nine months ended September 30, 2004, Covance's operations provided net cash of $93.8 million, an increase of $16.7 million from the corresponding 2003
period. The change in net operating assets used $17.5 million in cash during the nine months ended September 30, 2004, primarily due to a reduction in unearned revenue and an increase in
unbilled services, offset by an increase in income taxes payable, while this net change used $27.3 million in cash during the nine months ended September 30, 2003, primarily due to a
reduction in accrued liabilities and unearned revenue and an increase in unbilled services. Covance's ratio of current assets to current liabilities was 2.43 at September 30, 2004 and 2.37 at
December 31, 2003.

Investing
activities for the nine months ended September 30, 2004 used $58.3 million, compared to using $48.7 million for the corresponding 2003 period. Capital
spending for the first nine months of 2004 totaled $37.6 million, and was primarily for the outfitting of new facilities, purchase of new equipment, upgrade of existing equipment and computer
equipment and software for newly hired employees. Investment activities for the nine months ended September 30, 2004 also include a 47% equity investment in Noveprim Limited, an existing
supplier of research products, totaling $20.7 million. Capital spending for the corresponding 2003 period totaled $48.7 million, and was primarily for the purchase of our previously
leased Geneva facility in September 2003 for $18.8 million, expansion and enhancement of our Harrogate, England facility, outfitting of new facilities, purchase of new equipment, upgrade
of existing equipment and computer equipment and software for newly hired employees.

Financing
activities for the nine months ended September 30, 2004 used $46.2 million and consisted primarily of the purchase of 2,881,586 shares of Covance common stock for
an aggregate cost of $95.3 million, primarily in connection with two separate 3.0 million share buyback programs authorized by Covance's Board of Directors in February 2003 and
June 2004, partially offset by $49.1 million received from stock option exercises and employee contributions to Covance's noncompensatory employee stock purchase plan. Financing
activities for the nine months ended September 30, 2003 provided $3.5 million, and consisted primarily of $17.4 million received from stock option exercises and employee
contributions to Covance's noncompensatory employee stock purchase plan, partially offset by the purchase of 649,700 shares of Covance common stock for an aggregate cost of $13.9 million,
primarily in connection with a 3.0 million share buyback program authorized by Covance's Board of Directors in February 2003.

In
June 2004, Covance's Board of Directors authorized the repurchase of up to 3.0 million additional shares of Covance common stock. At September 30, 2004, there are
2.7 million shares remaining for repurchase under this program and no shares remaining for repurchase under the 2003 Board approved repurchase program.

Inflation

While most of Covance's net revenues are earned under contracts, the long-term contracts (those in excess of one year) generally include an inflation
or cost of living adjustment for the portion of the services to be performed beyond one year from the contract date. As a result, Covance believes that the effects of inflation generally do not have a
material adverse effect on its operations or financial condition.

17

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Forward Looking Statements.Statements in this Management's Discussion and Analysis of Financial Condition and Results of Operations, as
well as in certain other parts of this Quarterly Report on Form 10-Q that look forward in time, are forward looking statements made pursuant to the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. Forward looking statements include statements concerning plans, objectives, goals, strategies, future events or performance, expectations,
predictions, and assumptions and other statements which are other than statements of historical facts. All such forward looking statements are based on the current expectations of management and are
subject to, and are qualified by, risks and uncertainties that could cause actual results to differ materially from those expressed or implied by those statements. These risks and uncertainties
include, without limitation, competitive factors, outsourcing trends in the pharmaceutical industry, levels of industry research and development spending, the Company's ability to continue to attract
and retain qualified personnel, the fixed price nature of contracts or the loss of large contracts, risks associated with acquisitions and investments, the Company's ability to increase order volume,
the pace of translation of orders into revenue in late-state development services, and other factors described in Covance's filings with the Securities and Exchange Commission, including,
its Annual Report on Form 10-K.

18

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Risk Factors

This section discusses various risk factors that are attendant with our business and the provision of our services. If the events outlined below were to occur
individually or in the aggregate, our business, results of operations, financial condition, and cash flows could be materially adversely affected.

Changes in government regulation or in practices relating to the pharmaceutical industry could decrease the need for the services we provide.

Governmental
agencies throughout the world, but particularly in the United States, strictly regulate the drug development process. Our business involves helping pharmaceutical and
biotechnology companies navigate the regulatory drug approval process. Changes in regulation, such as a relaxation in regulatory requirements or the introduction of simplified drug approval procedures
or an increase in regulatory requirements that we have difficulty satisfying, could eliminate or substantially reduce the need for our services. Also, if government efforts to contain drug costs and
pharmaceutical and biotechnology company profits from new drugs, our customers may spend less, or reduce their growth in spending, on research and development. If health insurers were to change their
practices with respect to reimbursements for pharmaceutical products, our customers may spend less, or reduce their growth in spending on research and development.

Failure to comply with existing regulations could result in a loss of revenue or earnings or in increased costs.

Any
failure on our part to comply with applicable regulations could result in the termination of on-going research, the disqualification of data for submission to regulatory
authorities, the loss of on-going studies, or damage to the reputation of Covance. For example, if we were to fail to verify that patient participants were fully informed and have fully
consented to a particular clinical trial, the data collected from that trial could be disqualified. If this were to happen, we could be contractually required to repeat the trial at no further cost to
our customer, but at substantial cost to us.

We may bear financial losses because most of our contracts are of a fixed price nature and may be delayed or terminated or reduced in scope for reasons beyond our
control.

Many
of our contracts provide for services on a fixed price or fee-for-service with a cap basis and they may be terminated or reduced in scope either immediately
or upon notice. Cancellations may occur for a variety of reasons, including:



The
loss, reduction in scope or delay of a large contract or the loss or delay of multiple contracts could materially adversely affect our business, although our contracts frequently
entitle us to receive the costs of winding down the terminated projects, as well as all fees earned by us up to the time of termination. Some contracts also entitle us to a termination fee.

We may bear financial risk if we under price our contracts or overrun cost estimates.

Since
our contracts are often structured as fixed price or fee-for-service with a cap, we bear the financial risk if we initially under price our contracts or
otherwise overrun our cost estimates. Such under pricing or significant cost overruns could have a material adverse effect on our business, results of operations, financial condition, and cash flows.

We may not be able to successfully develop and market new services.

We may seek to develop and market new services that complement or expand our existing business or expand our service offerings through acquisition. If we are
unable to develop new services and/or create demand for those newly developed services, or expand our service offerings through acquisition, our future business, results of operations, financial
condition, and cash flows could be adversely affected.

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Our quarterly operating results may vary.

Our operating results may vary significantly from quarter to quarter and are influenced by such factors over which we have little control such as:



We
believe that operating results for any particular quarter are not necessarily a meaningful indication of future results. While fluctuations in our quarterly operating results could
negatively or positively affect the market price of our common stock, these fluctuations may not be related to our future overall operating performance.

We depend on the pharmaceutical and biotechnology industries.

Our
revenues depend greatly on the expenditures made by the pharmaceutical and biotechnology industries in research and development. Accordingly, economic factors and industry trends
that affect our clients in these industries also affect our business. If companies in these industries were to reduce the number of research and development projects they outsource, our business could
be materially adversely affected.

We operate in a highly competitive industry.

Competitors in the contract research organization industry range from small, limited-service providers to full service global contract research organizations. Our
main competition consists of in-house departments of pharmaceutical companies, full-service contract research organizations,and
universities and teaching hospitals, although to a lesser degree. We compete on a variety of factors, including:



For
instance, our clinical development services have from time to time experienced periods of increased price competition which had a material adverse effect on Covance's
late-stage development profitability and consolidated net revenues and net income. Covance took actions in 2000 to mitigate the effects of this price competition; however, if market
conditions were to deteriorate, additional actions might be required in the future.

There
is competition among the larger contract research organizations for both clients and potential acquisition candidates. Additionally, small, limited-service entities considering
entering the contract research organization industry will find few barriers to entry, thus further increasing possible competition. These competitive pressures may affect the attractiveness of our
services and could adversely affect our financial results.

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We may expand our business through acquisitions.

We review many acquisition candidates and, in addition to acquisitions which we have already made, we are continually evaluating new acquisition opportunities.
Factors which may affect our ability to grow successfully through acquisitions include:



We may be affected by potential health care reform.

In recent years the United States Congress and state legislatures have considered various types of health care reform in order to control growing health care
costs. We are unable to predict what legislative proposals will be adopted in the future, if any. Similar reform movements have occurred in Europe and Asia.

Implementation
of health care reform legislation that contain costs could limit the profits that can be made from the development of new drugs. This could adversely affect research and
development expenditures by pharmaceutical and biotechnology companies which could in turn decrease the business opportunities available to us both in the United States and abroad. In addition, new
laws or regulations may create a risk of liability, increase our costs or limit our service offerings.

We rely on third parties for important services.

We depend on third parties to provide us with services critical to our business. For instance, we have entered into an agreement with IBM to manage our
information technology infrastructure including our computer and telephone network, e-mail system, help desks, computer support and data centers worldwide. The failure of any of these
third parties to adequately provide the needed services could have a material adverse effect on our business.

Our revenues and earnings are exposed to exchange rate fluctuations.

We
derive a large portion of our net revenues from international operations. In the nine month period ended September 30, 2004, we derived approximately 34% of our net revenues
from outside the United States. Our financial statements are denominated in U.S. dollars. As a result, factors associated with international operations, including changes in foreign currency exchange
rates, could significantly affect our results of operations, financial condition, and cash flows.

The loss of our key personnel could adversely affect our business.

Our success depends to a significant extent upon the efforts of our senior management team and other key personnel. The loss of the services of such personnel
could adversely affect our business. Also, because of the nature of our business, our success is dependent upon our ability to attract and retain technologically qualified personnel. There is
substantial competition for qualified personnel, and an inability to recruit or retain qualified personnel may impact our ability to grow our business and compete effectively in our industry.

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Contract research services create a risk of liability.

In
contracting to work on drug development trials, we face a range of potential liabilities. For example:



We
also contract with physicians, also referred to as investigators, to conduct the clinical trials to test new drugs on human volunteers. These tests can create a risk of liability for
personal injury or death to volunteers, resulting from negative reactions to the drugs administered or from professional malpractice by third party investigators,
particularly to volunteers with life-threatening illnesses. We believe that our risks in this area are generally reduced by the following:



Contractual
indemnifications generally do not protect us against liability arising from certain of our own actions, such as negligence or misconduct. We could be materially and adversely
affected if we were required to pay damages or bear the costs of defending any claim which is not covered by a contractual indemnification provision or in the event that a party who must indemnify us
does not fulfill its indemnification obligations or which is beyond the level of our insurance coverage. There can be no assurance that we will be able to maintain such insurance coverage on terms
acceptable to us.

Reliance on air transportation.

Our
central laboratories and, to a lesser extent, our other businesses, are heavily reliant on air travel for transport of clinical trial kits and other material and people, and a
significant disruption to the air travel system could have a material adverse effect on our business.

Actions of animal rights extremists may affect our business.

Our
early development services utilize animals (predominantly rodents) in preclinical testing of the safety and efficacy of drugs and also breed and sell animals for biomedical research.
Such activities are required for the development of new medicines and medical devices under regulatory regimes in the United States, Europe, Japan and other countries. Acts of vandalism and other acts
by animal rights extremists who object to the use of animals in drug development could have a material adverse effect on our business.

Our animal populations may suffer diseases that can damage our inventory, harm our reputation and result in decreased sales of research products.

It
is important that our research products be free of diseases, including infectious diseases. The presence of diseases can distort or compromise the quality of research results, can
cause loss of animals in our inventory or other losses. Such results could harm our reputation or have a material adverse effect on our financial condition, results of operations, and cash flows.

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Item 3. Quantitative and Qualitative Disclosure About Market Risk

For the nine months ended September 30, 2004, approximately 34% of our net revenues were derived from our operations outside the United States. We do not
engage in derivative or hedging activities related to our potential foreign exchange exposures. See "Management's Discussion and Analysis of Financial Condition and Results of
OperationsCritical Accounting EstimatesForeign Currency Risks" for a more detailed discussion of our foreign currency risks and exposures.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. The Company's Principal Executive Officer and Principal Financial Officer have reviewed and evaluated the
effectiveness of the Company's disclosure controls and procedures as of the end of the period covered in this report. Based on that evaluation, the Principal Executive Officer and the Principal
Financial Officer have concluded that the Company's current disclosure controls and procedures are effective. There have been no significant changes in the Company's internal controls or in other
factors that could significantly affect those controls.

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Part II. Other Information

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Repurchases of equity securities as reported on a settlement date basis during the quarter ended September 30, 2004 were as follows:

Issuer Purchases of Equity Securities(a)(b):

Period

Total # of
Shares
Purchased

Average Price
Paid Per
Share

Total # of
Shares
Purchased as
Part of
Currently
Authorized
Programs

Maximum # of
Shares that May
Yet Be Purchased
Under Currently
Authorized
ProgramsJuly 1, 2004July 31, 2004


125,000

$
36.4900


2,860,300

3,139,700(a),(b)August 1, 2004August 31, 2004


435,300

$
35.2488


3,295,600

2,704,400(b)September 1, 2004September 30, 2004








3,295,600

2,704,400(b)(a)    On February 27, 2003, the Company announced that its Board of Directors had approved the
repurchase of up to three million shares of common stock.
(b)    On June 28, 2004, the Company announced that its Board of Directors had approved the repurchase of up to an additional three million shares of
         common stock.


Item 6. Exhibits and Reports on Form 8-K

10.1



Form of Executive Officer Stock Option Agreement.Filed herewith.10.2



Form of Executive Officer Restricted Stock Agreement.Filed herewith.10.3



Form of Non-Employee Director Stock Option Agreement.Filed herewith.31.1



CertificationChristopher A. Kuebler.Filed herewith.31.2



CertificationWilliam E. Klitgaard.Filed herewith.32.1



Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002Christopher A. Kuebler.Filed
herewith.32.2



Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002William E. Klitgaard.Filed herewith.


During
the three month period ended September 30, 2004, one report on Form 8-K was filed. The report dated July 22, 2004, was filed reporting the
issuance of a press release on July 21, 2004 announcing Covance's financial results for the quarter ended June 30, 2004.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

COVANCE INC.Dated: October 26, 2004

By:

/s/CHRISTOPHER A. KUEBLERChristopher A. Kuebler
Chairman of the Board and Chief Executive Officer


Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on
the dates indicated.

Signature

Title

Date/s/ CHRISTOPHER A. KUEBLERChristopher A. Kuebler

Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)

October 26, 2004/s/ WILLIAM E. KLITGAARDWilliam E. Klitgaard

Corporate Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)

October 26, 2004/s/ MICHAEL GIANNETTOMichael Giannetto

Corporate Vice President and Controller
(Principal Accounting Officer)

October 26, 2004


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EXHIBIT INDEX

Exhibit
Number

Description10.1

Form of Executive Officer Stock Option Agreement.Filed herewith.10.2

Form of Executive Officer Restricted Stock Agreement.Filed herewith.10.3

Form of Non-Employee Director Stock Option Agreement.Filed herewith.31.1

CertificationChristopher A. Kuebler.Filed herewith.31.2

CertificationWilliam E. Klitgaard.Filed herewith.32.1

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002Christopher A. Kuebler.Filed herewith.32.2

Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002William E. Klitgaard.Filed herewith.


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