**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

WASHINGTON, D.C. 20549

**FORM 10-Q**
| **x**                                                                                                                                                                                                             | **Quarterly Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934**  |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------------------|
| For the  quarterly period ended March 31, 2006                                                                                                                                                               |
|                                                                                                                                                                                                              |
| or                                                                                                                                                                                                                |
|                                                                                                                                                                                                              |
| o                                                                                                                                                                                                                 | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
| **For the  transition period from                                to** |
|                                                                                                                                                                                                              |

**Commission File Number:  1-12213**

**COVANCEINC**.

(Exact name ofRegistrant as specified in its Charter)
| **Delaware**             | **22-3265977**                        |
|--------------------------|---------------------------------------|
| (State of Incorporation) | (I.R.S. Employer  Identification No.) |

 
| **210 Carnegie Center, Princeton, New Jersey** | **08540**  |
|------------------------------------------------|------------|
| (Address of Principal Executive Offices)       | (Zip Code) |

 

**(609) 452-4440**(Registrant’s telephone number, including area code)

Indicate by check markwhether the Registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act (the “Exchange Act”) of 1934during the preceding 12 months (or for such shorter period that the Registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

YES x      NOo

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer or anon-accelerated filer (as described in Rule 12b-2 of the ExchangeAct).

Large AcceleratedFiler x                 Accelerated Filer  o                            Non-AcceleratedFiler o

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

YES o                    NOx

**APPLICABLE ONLY TO CORPORATE ISSUERS:**

As of April 14,2006, the Registrant had 63,556,557 shares of common stock outstanding.

 

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**CovanceInc.Form 10-Q For the Quarterly Period Ended March 31, 2006**

**INDEX**
|                                                                                                     | ** ** | **Page** |
|-----------------------------------------------------------------------------------------------------|------------|----------|
| **Part I. Financial Information**                                                              |       |     |
| ** **                                                                                          |       |     |
| Item 1. Financial Statements (Unaudited)                                                            |       |     |
|                                                                                                |       |     |
| Consolidated  Balance Sheets—March 31, 2006 and December 31, 2005                    |       | 2        |
|                                                                                                |       |     |
| Consolidated  Statements of Income—Three Months ended March 31, 2006 and 2005             |       | 3        |
|                                                                                                |       |     |
| Consolidated  Statements of Cash Flows—Three Months ended March 31, 2006 and 2005         |       | 4        |
|                                                                                                |       |     |
| Notes  to Consolidated Financial Statements                                                         |       | 5        |
|                                                                                                |       |     |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations |       | 16       |
|                                                                                                |       |     |
| Item 3. Quantitative and Qualitative Disclosure About  Market Risk                                  |       | 23       |
|                                                                                                |       |     |
| Item 4. Controls and Procedures                                                                     |       | 23       |
|                                                                                                |       |     |
| **Part II.  Other Information**                                                                |       |     |
| ** **                                                                                          |       |     |
| Item 1a. Risk Factors                                                                               |       | 24       |
|                                                                                                |       |     |
| Item 6. Exhibits                                                                                    |       | 28       |
|                                                                                                |       |     |
| **Signatures**                                                                                      |       | 29       |

1

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**COVANCEINC. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETSMARCH 31, 2006 AND DECEMBER 31, 2005**
| **(Dollars in thousands)**                                                                                                                                                                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                             | ** ** | **2006**           | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                                                                             | ** ** | **(UNAUDITED)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                             |       |               |       |                  |       |
| Current Assets:                                                                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                             |       | $                  | 191,097    |                  | $          | 160,717 |   |
| Accounts  receivable                                                                                                                                                                                                                   |       | 193,736            |       | 206,098               |       |
| Unbilled  services                                                                                                                                                                                                                     |       | 96,207             |       | 88,297                |       |
| Inventory                                                                                                                                                                                                                              |       | 40,520             |       | 40,293                |       |
| Deferred income  taxes                                                                                                                                                                                                                 |       | 2,085              |       | 2,062                 |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                             |       | 58,651             |       | 49,243                |       |
| Total Current  Assets                                                                                                                                                                                                                  |       | 582,296            |       | 546,710               |       |
| Property and equipment,  net                                                                                                                                                                                                           |       | 416,697            |       | 410,665               |       |
| Goodwill, net                                                                                                                                                                                                                          |       | 61,262             |       | 61,262                |       |
| Other assets                                                                                                                                                                                                                           |       | 38,335             |       | 37,966                |       |
| Total Assets                                                                                                                                                                                                                           |       | $                  | 1,098,590  |                  | $          | 1,056,603 |   |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                                         |       |               |       |                  |       |
| Current Liabilities:                                                                                                                                                                                                                   |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                       |       | $                  | 24,679     |                  | $          | 26,975 |   |
| Accrued payroll  and benefits                                                                                                                                                                                                          |       | 50,875             |       | 64,226                |       |
| Accrued expenses  and other current liabilities                                                                                                                                                                                        |       | 49,408             |       | 48,298                |       |
| Unearned revenue                                                                                                                                                                                                                       |       | 90,655             |       | 96,987                |       |
| Income taxes  payable                                                                                                                                                                                                                  |       | 18,450             |       | 16,242                |       |
| Total Current  Liabilities                                                                                                                                                                                                             |       | 234,067            |       | 252,728               |       |
| Deferred income taxes                                                                                                                                                                                                                  |       | 44,365             |       | 45,545                |       |
| Other liabilities                                                                                                                                                                                                                      |       | 28,385             |       | 26,559                |       |
| Total  Liabilities                                                                                                                                                                                                                     |       | 306,817            |       | 324,832               |       |
| Commitments and  Contingent Liabilities                                                                                                                                                                                                |       |               |       |                  |       |
| Stockholders’ Equity:                                                                                                                                                                                                             |       |               |       |                  |       |
| Preferred Stock  - Par value $1.00 per share; 10,000,000 shares authorized; no shares issued  and outstanding at March 31, 2006 and December 31, 2005                                                                        |       | 3⁄4             |       | 3⁄4                |       |
| Common Stock -  Par value $0.01 per share; 140,000,000 shares authorized; 72,524,708 and  71,813,112 shares issued and outstanding, including those held in treasury,  at March 31, 2006 and December 31, 2005, respectively |       | 725                |       | 718                   |       |
| Paid-in capital                                                                                                                                                                                                                        |       | 377,980            |       | 350,678               |       |
| Retained  earnings                                                                                                                                                                                                                     |       | 646,200            |       | 612,811               |       |
| Accumulated  other comprehensive income —  Cumulative translation adjustment                                                                                                                                                      |       | 13,234             |       | 13,367                |       |
| Treasury stock  at cost (9,012,448 and 9,002,620 shares at  March 31, 2006 and December 31, 2005, respectively)                                                                                                              |       | (246,366           | )          | (245,803              | )          |
| Total  Stockholders’ Equity                                                                                                                                                                                                       |       | 791,773            |       | 731,771               |       |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                                                                       |       | $                  | 1,098,590  |                  | $          | 1,056,603 |   |

 

The accompanying notes are an integral part of theseconsolidated financial statements.

2

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**COVANCEINC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOMEFOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005(UNAUDITED)**
| ** **                                                                      | ** ** | **Three Months Ended March 31** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
|                                                                            |       |                                                |       |   |   |
| Net revenues                                                                    |       | $                                                   | 320,509    |   | $ | 281,265 |   |
| Reimbursable  out-of-pockets                                                    |       | 13,129                                              |       | 11,518 |   |
| Total revenues                                                                  |       | 333,638                                             |       | 292,783 |   |
| Costs and expenses:                                                             |       |                                                |       |   |   |
| Cost of revenue  (excluding depreciation and amortization)                      |       | 213,660                                             |       | 186,772 |   |
| Reimbursed  out-of-pocket expenses                                              |       | 13,129                                              |       | 11,518 |   |
| Selling, general  and administrative                                            |       | 48,286                                              |       | 42,136 |   |
| Depreciation and  amortization                                                  |       | 12,719                                              |       | 11,501 |   |
| Total costs and  expenses                                                       |       | 287,794                                             |       | 251,927 |   |
| Income from operations                                                          |       | 45,844                                              |       | 40,856 |   |
| Other (income) expense,  net:                                                   |       |                                                |       |   |   |
| Interest income                                                                 |       | (1,905                                              | )          | (1,131 | ) |
| Interest expense                                                                |       | 92                                                  |       | 119 |   |
| Foreign exchange  transaction loss, net                                         |       | 262                                                 |       | 582 |   |
| Other income,  net                                                              |       | (1,551                                              | )          | (430 | ) |
| Income before taxes and  equity investee earnings                               |       | 47,395                                              |       | 41,286 |   |
| Taxes on income                                                                 |       | 14,256                                              |       | 12,718 |   |
| Equity investee  earnings                                                       |       | 250                                                 |       | 296 |   |
| Net income                                                                      |       | $                                                   | 33,389     |   | $ | 28,864 |   |
|                                                                            |       |                                                |       |   |   |
| Basic earnings per  share                                                       |       | $                                                   | 0.53       |   | $ | 0.46 |   |
| Weighted average shares  outstanding - basic                                    |       | 63,172,374                                          |       | 62,755,085 |   |
|                                                                            |       |                                                |       |   |   |
|                                                                            |       |                                                |       |   |   |
| Diluted earnings per  share                                                     |       | $                                                   | 0.52       |   | $ | 0.45 |   |
| Weighted average shares outstanding - diluted                                   |       | 64,446,222                                          |       | 63,990,948 |   |

 

The accompanying notesare an integral part of these consolidated financial statements.

3

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**COVANCEINC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005(UNAUDITED)**
| **(Dollars in thousands)**                                                          | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Cash flows from  operating activities:                                                        |       |                                                |       |   |   |
| Net income                                                                                    |       | $                                                   | 33,389     |   | $ | 28,864 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:            |       |                                                |       |   |   |
| Depreciation and  amortization                                                                |       | 12,719                                              |       | 11,501 |   |
| Non-cash  compensation expense associated with employee benefit and stock compensation  plans |       | 6,697                                               |       | 3,478 |   |
| Deferred income  tax provision (benefit)                                                      |       | (1,203                                              | )          | (1,052 | ) |
| Other                                                                                         |       | (195                                                | )          | 145 |   |
| Changes in  operating assets and liabilities:                                                 |       |                                                |       |   |   |
| Accounts receivable                                                                           |       | 12,362                                              |       | (4,451 | ) |
| Unbilled  services                                                                            |       | (7,910                                              | )          | (10,392 | ) |
| Inventory                                                                                     |       | (227                                                | )          | 1,926 |   |
| Accounts payable                                                                              |       | (2,296                                              | )          | (2,043 | ) |
| Accrued  liabilities                                                                          |       | (12,241                                             | )          | (19,582 | ) |
| Unearned revenue                                                                              |       | (6,332                                              | )          | (2,008 | ) |
| Income taxes  payable                                                                         |       | 5,260                                               |       | 15,044 |   |
| Other assets and  liabilities, net                                                            |       | (7,462                                              | )          | (15,079 | ) |
| Net cash provided by  operating activities                                                    |       | 32,561                                              |       | 6,351 |   |
| Cash flows from  investing activities:                                                        |       |                                                |       |   |   |
| Capital  expenditures                                                                         |       | (19,158                                             | )          | (23,659 | ) |
| Other, net                                                                                    |       | 22                                                  |       | 3⁄4 |   |
| Net cash used in  investing activities                                                        |       | (19,136                                             | )          | (23,659 | ) |
| Cash flows from  financing activities:                                                        |       |                                                |       |   |   |
| Stock issued  under employee stock purchase and option plans                                  |       | 17,560                                              |       | 19,035 |   |
| Purchase of  treasury stock                                                                   |       | (563                                                | )          | (12,072 | ) |
| Net cash provided by  financing activities                                                    |       | 16,997                                              |       | 6,963 |   |
| Effect of exchange rate  changes on cash                                                      |       | (42                                                 | )          | (4,657 | ) |
| Net change in cash and  cash equivalents                                                      |       | 30,380                                              |       | (15,002 | ) |
| Cash and cash  equivalents, beginning of period                                               |       | 160,717                                             |       | 177,712 |   |
| Cash and cash equivalents, end of period                                                      |       | $                                                   | 191,097    |   | $ | 162,710 |   |

 

The accompanying notes arean integral part of these consolidated financial statements.

4

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

**1. Basisof Presentation**

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith U.S. generally accepted accounting principles (“GAAP”) for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X. Accordingly, they do not include all of the information andfootnotes required by GAAP for complete financial statements. In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included. Operatingresults for the three months ended March 31, 2006 are not necessarilyindicative of the results that may be expected for the year ending December 31,2006. The balance sheet at December 31, 2005 has been derived from theaudited financial statements at that date but does not include all of theinformation and footnotes required by GAAP for complete financial statements. Youshould read these consolidated financial statements together with thehistorical consolidated financial statements of Covance Inc. and subsidiaries (“Covance”)for the years ended December 31, 2005, 2004 and 2003 included in ourAnnual Report on Form 10-K for the year ended December 31,2005.

**2.  Summary of Significant Accounting Policies**

**Principles of Consolidation**

These unauditedconsolidated financial statements include the accounts of all entitiescontrolled by Covance. All significant intercompany accounts and transactionsare eliminated. The equity method of accounting is used for investments inaffiliates in which Covance owns between 20 and 50 percent and does not havethe ability to exercise control. See Note 4.

**Use of Estimates**

These unauditedconsolidated financial statements have been prepared in conformity with GAAP,which requires management to make estimates and assumptions about future eventsthat affect the reported amounts of assets and liabilities, disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period. Actualresults could differ from these estimates.

**Prepaid Expenses and Other Current Assets**

In connection with themanagement of multi-site clinical trials, Covance pays on behalf of itscustomers fees to investigators, volunteers and other out-of-pocket costs (suchas travel, printing, meetings, couriers, etc.), for which we are reimbursed atcost, without mark-up or profit. Amounts receivable from customers inconnection with billed and unbilled investigator fees, volunteer payments andother out-of-pocket pass-through costs are included in prepaid expenses andother current assets in the accompanying Consolidated Balance Sheets andtotaled $25.5 million and $31.6 million at March 31, 2006 and December 31,2005, respectively. See Note 2 “Reimbursable Out-of-Pocket Expenses”.

**Inventory**

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

**Goodwill and OtherIntangible Assets and Impairment**

Goodwill representscosts in excess of the fair value of net tangible and identifiable netintangible assets acquired in business combinations. In accordance withStatement of Financial Accounting Standards (“SFAS”) No. 142, *Goodwill and Other Intangible Assets*, Covance performs anannual test for impairment of goodwill and other intangible assets during thefourth quarter. The most recent annual test for impairment performed for 2005did not identify any instances of impairment and there were no events through March 31,2006 that warranted a reconsideration of our impairment test results.

5

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

**Revenue Recognition**

Covance recognizesrevenue either as services are performed or products are delivered, dependingupon the nature of the work contracted. Historically, a majority of Covance’snet revenues have been earned under contracts which range in duration from afew 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-pricearrangements. In the case of fee-for-service contracts, revenue is recognizedas services are performed, based upon, for example, hours worked or samplestested. For long-term fixed-price service contracts, revenue isrecognized as services are performed, with performance generally assessed usingoutput measures, such as units-of-work performed to date as compared to thetotal units-of-work contracted. Changes in the scope of work generally resultin a renegotiation of contract pricing terms. Renegotiated amounts are notincluded in net revenues until earned and realization is assured. Estimates of coststo complete are made to provide, where appropriate, for losses expected oncontracts. Costs are not deferred in anticipation of contracts being awarded,but instead are expensed as incurred. In some cases, a portion of the contractfee is paid at the time the trial is initiated. These advances are deferred andrecognized as revenue as services are performed or products are delivered, asdiscussed above. Additional payments may be made based upon the achievement ofperformance-based milestones over the contract duration. Most contractsare terminable by the client either immediately or upon notice. These contractstypically require payment to Covance of expenses to wind down the study, feesearned to date and, in some cases, a termination fee or a payment to Covance ofsome portion of the fees or profits that could have been earned by Covanceunder the contract if it had not been terminated early. Termination fees areincluded in net revenues when realization is assured. In connection with themanagement of multi-site clinical trials, Covance pays on behalf of itscustomers fees to investigators, volunteers and other out-of-pocket costs (suchas for travel, printing, meetings, couriers, etc.), for which it is reimbursedat cost, without mark-up or profit. Investigator fees are not reflected intotal revenues or expenses where Covance acts in the capacity of an agent onbehalf of the pharmaceutical company sponsor, passing through these costswithout risk or reward to Covance. All other out-of-pocket costs are includedin total revenues and expenses.

Unbilled services are recorded for revenue recognizedto date and relate to amounts that are currently unbillable to the customerpursuant to contractual terms. In general, amounts become billable upon theachievement of milestones or in accordance with predetermined paymentschedules. Unbilled services are billable to customers within one year from therespective balance sheet date. Unearned revenue is recorded for cash receivedfrom customers for which revenue has not been recognized at the balance sheetdate.

**Taxes onIncome**

Covance uses the asset and liability method ofaccounting for income taxes. Under this method, deferred tax assets andliabilities are recognized for the expected future tax consequences ofdifferences between the carrying amounts of assets and liabilities and theirrespective tax bases using tax rates in effect for the year in which thetemporary differences are expected to reverse. The effect on deferred taxes ofa change in enacted tax rates is recognized in income in the period when thechange is effective.

Covance has established, and periodically reviews andreevaluates, an estimated income tax reserve which is included in accruedexpenses and other current liabilities on its consolidated balance sheet. Thisincome tax reserve is for exposures related to matters such as transferpricing, nexus, deemed dividends and the allocation of overhead costs acrossvarious Federal, state and foreign income tax jurisdictions. An accrual isestablished at the time an exposure is identified when it is both probable thata liability has been incurred and the amount of the liability can be reasonablyestimated. The amount of the accrual for each item for which an exposure existsis adjusted when either (a) matters are settled at amounts which aredifferent than the amount included in the reserve or (b) when factsindicate a significant change in either the probability or estimated amount ofthe potential exposure.

Covance’s historical policy has been to leave itsunremitted foreign earnings invested indefinitely outside the United States.Except for the one-time opportunity provided under the American Jobs CreationAct, pursuant to which Covance repatriated $103 million in accumulated foreignearnings in the fourth quarter of 2005, Covance intends to continue to leaveits unremitted foreign earnings invested indefinitely outside the United States.As a result, taxes have not been provided on any accumulated foreign unremittedearnings as of March 31, 2006.

6

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

**ComprehensiveIncome**

Covance’stotal comprehensive income, which represents net income plus the change in thecumulative translation adjustment equity account for the periods presented, was$33.3 million and $19.9 million for the three months ended March 31, 2006and 2005, respectively.

**Earnings Per Share (“EPS”)**

BasicEPS is computed by dividing net income available to common stockholders by theweighted average number of shares outstanding during the period. Thecomputation of diluted EPS is similar to the computation of basic EPS, exceptthat the denominator is increased to include the number of additional commonshares that would have been outstanding if the dilutive potential common shareshad been issued; computed under the treasury stock method in accordance withthe requirements of SFAS No. 128, *EarningsPer Share*. In computing diluted earnings per share for the threemonths ended March 31, 2006 and 2005, the denominator was increased by1,273,848 shares and 1,235,863 shares, respectively, representing the number ofadditional common shares that would have been outstanding if the dilutivepotential common shares had been issued for stock options outstanding at March 31,2006 and 2005 with exercise prices less than the average market price ofCovance’s Common Stock during each respective period. Excluded from thecomputation of diluted EPS for the three months ended March 31, 2006 wereoptions to purchase 130,864 shares of common stock at prices ranging from$56.18 to $59.52 per share because the exercise prices of such options weregreater than the average market price of Covance’s common stock during thisperiod.  Excluded from the computation ofdiluted EPS for the three months ended March 31, 2005 were options to purchase384,175 shares of common stock at prices ranging from $42.25 to $47.27 pershare because the exercise prices of such options were greater than the averagemarket price of Covance’s common stock during this period.

**ReimbursableOut-of-Pocket Expenses**

As discussed inNote 2 “Prepaid Expenses and Other Current Assets”, Covance pays on behalf ofits customers fees to investigators, volunteers and other out-of-pocket costsfor which we are reimbursed at cost, without mark-up or profit. In connectionwith the requirements of Financial Accounting Standards Board Emerging IssuesTask 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 otherout-of-pocket costs are reflected in operating expenses, while thereimbursements received are reflected in revenues in the ConsolidatedStatements of Income. Covance will continue to exclude from revenue and expensein the Consolidated Statements of Income fees paid to investigators and theassociated reimbursement since Covance acts as an agent on behalf of thepharmaceutical company sponsors with regard to investigator payments, inaccordance with the Financial Accounting Standards Board Emerging Issues TaskForce Rule No. 99-19 (“EITF 99-19”), *Reporting Revenue Gross as a Principal versus Net asan Agent*.

**Stock-Based Compensation**

The Company sponsors severalstock-based compensation plans pursuant to which non-qualified stock optionsand restricted stock awards are granted to eligible employees. These plans aredescribed more fully in Note 10 to our audited consolidated financialstatements included in our Annual Report on Form 10-K for the yearended December 31, 2005.

Through the year ended December 31,2005, the Company followed the disclosure-only provisions of Statement ofFinancial Accounting Standards No. 123,*Accounting forStock-Based Compensation*, (“SFAS 123”), and, accordingly, accountedfor awards under these plans pursuant to the recognition and measurementprinciples of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*, (“APB 25”) andrelated Interpretations, as permitted by SFAS 123. Under APB 25, compensationexpense was recognized in the financial statements relating to awards of stock.However, no compensation expense was recorded in the financial statements forstock option grants, as all options have been granted with an exercise priceequal to the market value of the underlying common stock on the date of grant. Additionally,no compensation expense was recorded in the financial statements for sharespurchased by employees under the Company’s Employee Stock Purchase Plan as thatplan was considered to be non-compensatory under APB 25.

7

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

Effective January 1,2006, the Company adopted the fair value recognition provisions of Statement ofFinancial Accounting Standards No. 123R, *Share-BasedPayments*, (“SFAS 123R”) using the modified prospective transitionmethod. SFAS 123R revises SFAS 123, supersedes APB 25 and amends Statement ofFinancial Accounting Standards No. 95, *Statement of Cash Flows*.Under the modified prospective transition method, compensation expense isrecognized in the financial statements on a go forward basis for (a) allshare-based payments granted prior to, but not vested as of January 1, 2006,based upon the grant-date fair value estimated in accordance with the originalprovisions of SFAS 123, and (b) share-based payments granted on or subsequentto January 1, 2006, based upon the grant-date fair value estimated inaccordance with the provisions of SFAS 123R. The grant-date fair value ofawards expected to vest is expensed on a straight-line basis over the vestingperiod of the related awards. Under the modified prospective transition method,results for prior periods are not restated.

**Supplemental Cash FlowInformation**

Cash paid for interest was $0.1 million for each of the three monthperiods ended March 31, 2006 and 2005. Cash paid for income taxes for thethree months ended March 31, 2006 totaled $5.5 million. Net cash receivedfrom income tax refunds for the three months ended March 31, 2005 totaled$2.0 million. The change in income taxes payable in the Consolidated Statementof Cash Flows for the three months ended March 31, 2006 reflects as anoperating cash outflow the excess tax benefit received from the exercise ofnon-qualified stock options as measured under SFAS 123R of $4.2 million (acorresponding cash inflow of $4.2 million has been reflected in financing cashflows). The change in income taxes payable in the Consolidated Statement ofCash Flows for the three months ended March 31, 2005 reflects the taxbenefit from employee exercise of non-qualified stock options of $6.8 millionas measured and accounted for under SFAS 123 and APB 25. Pursuant to thosestandards, both the reduction in taxes payable and the increase in equityresulting from the excess tax benefit received are reflected in operating cashflows.

**3. TreasuryStock**

In June 2004,the Covance Board of Directors authorized the repurchase of an additional 3.0million shares under Covance’s stock repurchase program. At March 31,2006, there are approximately 0.7 million shares remaining for purchase underthe 2004 authorization. Covance also reacquires shares of its common stock inconnection with certain employee benefit plans when employees tender shareseither in connection with reload stock options or to satisfy income taxwithholdings associated with the vesting of stock awards. The following tablesets forth the treasury stock activity during the three month periods ended March 31,2006 and 2005:     
| ** **                              | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| **(amounts in thousands)**    | ** ** | **$**                                               | ** ** | **#  shares** | ** ** | **$** | ** ** | **# shares** | ** ** |
| Shares repurchased in  connection with: |       |                                                |       |   |   |   |   |   |   |
| Board approved  buyback programs        |       | $                                                   | —     |   | — |   | $ | 10,318 |   | 232.3 |   |
| Employee benefit  plans                 |       | 563                                                 |       | 9.8 |   | 1,754 |   | 39.9 |   |
| Total                                   |       | $                                                   | 563        |   | 9.8 |   | $ | 12,072 |   | 272.2 |   |

 

**4. EquityMethod Investees**

Covancehas a 47% minority equity position in Noveprim Ltd., an existing supplier ofresearch products, which was acquired in March 2004 at a cost of $20.7million. The excess of the purchase price over the underlying equity inNoveprim’s net assets at the date of acquisition of $13.8 million representsgoodwill and is included in the carrying value of Covance’s investment. Thisinvestment is reflected in Other Assets on the Consolidated Balance Sheet.During the three month periods ended March 31, 2006 and 2005, Covancerecognized $0.3 million and $0.4 million, respectively, representing its shareof Noveprim’s earnings, less the elimination of profit on inventory purchasedfrom Noveprim Limited and still on hand at Covance at March 31, 2006 and2005. The carrying value of Covance’s investment in Noveprim as of March 31,2006 and December 31, 2005 was $22.5 million and $21.7 million,respectively.

8

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

Covancehas a minority equity position (approximately 21*%* atMarch 31, 2006) in Bio-Imaging Technologies, Inc. (“BITI”). BITI usesproprietary medical imaging technologies to process and analyze medical images,and also provides other services, including the data-basing and regulatorysubmission of medical images, quantitative data and text. During each of the threemonth periods ended March 31, 2006 and 2005, Covance recognized losses of$0.1 million, representing its pro rata share of BITI’s losses. The carryingvalue of Covance’s investment in BITI as of March 31, 2006 and December 31,2005 was $0.4 million and $0.5 million while the fair market value was $10.0million and $7.6 million, respectively.

**5. DefinedBenefit Plans**

Covance sponsors various pension and otherpost-retirement benefit plans. In accordance with the interim disclosureprovisions of SFAS No. 132 (revised 2003), *Employers’ Disclosure About Pensions and Other Post-Retirement Benefits*,the interim disclosures required are shown below.

**DefinedBenefit Pension Plans**

Covance sponsors two defined benefit pension plans forthe benefit of its employees at two United Kingdom subsidiaries and one definedbenefit pension plan for the benefit of its employees at a German subsidiary,all of which are legacy plans of previously acquired companies. Benefit amountsfor all three plans are based upon years of service and compensation. TheGerman plan is unfunded, while the UK plans are funded. Covance’s fundingpolicy has been to contribute annually a fixed percentage of the eligibleemployee’s salary at least equal to the local statutory funding requirements. Pensionplan assets are administered by the plans’ trustees and are principallyinvested in equity and debt securities. The components of net periodic pensionexpense for these plans for the three month periods ended March 31, 2006and 2005 are as follows:

 
| ** **                                                | ** ** | **United Kingdom Plans**                                                                                         | ** ** | **German Plan**                                                                                                 | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended March 31**                                                                        | ** ** | **Three Months Ended March 31**                                                                  | ** ** |
| ** **                                                | ** ** | **          2006         ** | ** ** | **         2005         ** | ** ** | **         2006         ** | ** ** | **         2005         ** | ** ** |
| Components of Net  Periodic Pension Cost:                 |       |                                                                                                                       |       |                                                                                                                 |       |   |   |   |   |
| Service cost                                              |       | $                                                                                                                          | 1,389      |                                                                                                                 | $          | 1,258 |   | $ | 96 |   | $ | 85 |   |
| Interest cost                                             |       | 1,484                                                                                                                      |       | 1,434                                                                                                                |       | 71 |   | 68 |   |
| Expected return  on plan assets                           |       | (1,687                                                                                                                     | )          | (1,459                                                                                                               | )          | — |   | — |   |
| Amortization of  net actuarial loss                       |       | 439                                                                                                                        |       | 391                                                                                                                  |       | 12 |   | 2 |   |
| Participant  contributions                                |       | (535                                                                                                                       | )          | (570                                                                                                                 | )          | — |   | — |   |
| Net periodic  pension cost                                |       | $                                                                                                                          | 1,090      |                                                                                                                 | $          | 1,054 |   | $ | 179 |   | $ | 155 |   |
|                                                      |       |                                                                                                                       |       |                                                                                                                 |       |   |   |   |   |
| Assumptions Used to  Determine Net Periodic Pension Cost: |       |                                                                                                                       |       |                                                                                                                 |       |   |   |   |   |
| Discount rate                                             |       | 5.00                                                                                                                       | %          | 5.75                                                                                                                 | %          | 4.65 | % | 5.25 | % |
| Expected rate of  return on assets                        |       | 6.75                                                                                                                       | %          | 6.75                                                                                                                 | %          | n/a |   | n/a |   |
| Salary increases                                          |       | 4.00                                                                                                                       | %          | 4.00                                                                                                                 | %          | 2.50 | % | 2.50 | % |

 

9

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**COVANCE INC. ANDSUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

**SupplementalExecutive Retirement Plan**

In addition tothese foreign defined benefit pension plans, Covance also has a non-qualifiedSupplemental Executive Retirement Plan (“SERP”). The SERP, which is not funded,is intended to provide retirement benefits for certain executive officers ofCovance. Benefit amounts are based upon years of service and compensation ofthe participating employees. The components of net periodic pension cost forthe three month periods ended March 31, 2006 and 2005 are as follows:

 
|                                                           | ** ** | **Three Months Ended March 31**                              | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------------------------------------|------------|
| ** **                                                | ** ** | **      2006      ** | ** ** | **      2005      ** | ** ** |
| Components of Net  Periodic Pension Cost:                 |       |                                                                             |       |   |   |
| Service cost                                              |       | $                                                                                | 231        |   | $ | 277 |   |
| Interest cost                                             |       | 164                                                                              |       | 147 |   |
| Amortization of  prior service cost                       |       | 19                                                                               |       | 19 |   |
| Amortization of  net actuarial loss                       |       | 8                                                                                |       | — |   |
| Net periodic  pension cost                                |       | $                                                                                | 422        |   | $ | 443 |   |
| Assumptions Used to  Determine Net Periodic Pension Cost: |       |                                                                             |       |   |   |
| Discount rate                                             |       | 5.50                                                                             | %          | 6.00 | % |
| Salary increases                                          |       | 4.00                                                                             | %          | 4.00 | % |

 

**Post-EmploymentRetiree Health and Welfare Plan**

Covance alsosponsors a post-employment retiree health and welfare plan for the benefit of eligibleemployees at certain U.S. subsidiaries who retire after satisfying service andage requirements. This plan is funded on a pay-as-you-go basis and the cost ofproviding these benefits is shared with the retirees. The components of netperiodic post-retirement benefits cost for the three month periods ended March 31,2006 and 2005 are as follows:

 
| ** **                                                                | ** ** | **Three Months Ended March 31** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Components of Net  Periodic Post-retirement Benefits Cost:                |       |                                                |       |   |   |
| Service cost                                                              |       | $                                                   | 44         |   | $ | 49 |   |
| Interest cost                                                             |       | 78                                                  |       | 90 |   |
| Amortization of  net actuarial loss                                       |       | 13                                                  |       | 36 |   |
| Net periodic  post-retirement benefits cost                               |       | $                                                   | 135        |   | $ | 175 |   |
|                                                                      |       |                                                |       |   |   |
| Assumptions Used to  Determine Net Periodic Post-retirement Benefit Cost: |       |                                                |       |   |   |
| Discount rate                                                             |       | 5.50                                                | %          | 6.00 | % |
| Health care cost  trend rate                                              |       | 9.00                                                | %(a)       | 9.00 | %(a) |

 

(a) decreasing to ultimate trend of 5.00% in 2009

10

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

**6.  Stock Compensation**

In June 2002, Covance’s Board of Directorsadopted the 2002 Employee Stock Option Plan (the “2002 ESOP”). The 2002 ESOPwill expire on June 24, 2012. The 2002 ESOP authorizes the Compensationand Organization Committee of the Board of Directors (the “CompensationCommittee”), or such committee as is appointed by the Covance Board ofDirectors, to administer the 2002 ESOP, to grant awards to employees of Covanceor entities in which Covance has a controlling or significant interest, exceptthat officers as defined in Rule 16(a)-1(f) of the SecuritiesExchange Act of 1934, and members of the Board of Directors are not eligible toreceive awards. The 2002 ESOP authorizes the Compensation Committee to grantthe following awards to eligible employees: options to purchase common stockand stock appreciation rights. The exercise period for stock options grantedunder the 2002 ESOP is determined by the Compensation Committee at the time ofgrant, and is generally ten years from the date of grant. The vesting periodfor stock options granted under the 2002 ESOP is determined by the CompensationCommittee at the time of grant and options vest over a two year period. Nostock appreciation rights have ever been granted under the 2002 ESOP. Thenumber of shares of Covance common stock initially available for grant underthe 2002 ESOP totaled 5.9 million. The Company issues authorized butpreviously unissued shares when options are exercised. At March 31, 2006,there were approximately 3.0 million shares remaining available for grantsor awards under the 2002 ESOP.

In May 2002, Covance’sshareholders approved the 2002 Employee Equity Participation Plan (the “2002EEPP”) in replacement of the 2000 Employee Equity Participation Plan (the “2000EEPP”). The 2002 EEPP became effective on May 7, 2002 and will expire on May 6,2012. The 2002 EEPP authorizes the Compensation Committee, or such committee asis appointed by the Covance Board of Directors, to administer the 2002 EEPP, togrant awards to employees and consultants of Covance or entities in whichCovance has a controlling or significant interest. The 2002 EEPP authorizes theCompensation Committee to grant the following awards to eligible employees:options to purchase common stock; stock appreciation rights; and other stockawards either singly or in combination. The exercise period for stock optionsgranted under the 2002 EEPP is determined by the Compensation Committee at thetime of grant, and is generally ten years from the date of grant. Thevesting period for stock options and stock awards granted under the 2002 EEPPis determined by the Compensation Committee at the time of grant. Options vestover a three year period for senior executives and over a two year period forall other employees. Stock awards generally vest over a three year period forall employees. The number of shares of Covance common stock initially availablefor grant under the 2002 EEPP totaled approximately 3.25 million plusapproximately 0.9 million shares remaining available under the 2000 EEPPat the time the 2002 EEPP was approved. Effective upon approval of the 2002EEPP, no further grants or awards were permitted under the 2000 EEPP. Allgrants and awards under the 2000 EEPP remaining outstanding are nowadministered and paid in accordance with the provisions of the 2000 EEPP out ofshares issuable under the 2002 EEPP. The Company issues authorized butpreviously unissued shares when options are exercised. At March 31, 2006there were approximately 3.6 million shares remaining available for grantsor awards under the 2002 EEPP.

Effective January 1,2006, the Company adopted the fair value recognition provisions of SFAS 123Rusing the modified prospective transition method. SFAS 123R revises SFAS 123,supersedes APB 25 and amends Statement of Financial Accounting Standards No. 95,*Statement of Cash Flows*. Under themodified prospective transition method, compensation expense is recognized inthe financial statements on a go forward basis for (a) all share-basedpayments granted prior to, but not vested as of January 1, 2006, basedupon the grant-date fair value estimated in accordance with the originalprovisions of SFAS 123, and (b) share-based payments granted on orsubsequent to January 1, 2006, based upon the grant-date fair value estimatedin accordance with the provisions of SFAS 123R. The grant-date fair value ofawards expected to vest is expensed on a straight-line basis over the vestingperiod of the related awards. Under the modified prospective transition method,results for prior periods are not restated.

As a result of the adoptionof SFAS 123R, income from operations and income before taxes for the threemonth period ended March 31, 2006 include incremental stock-basedcompensation expense of $4.0 million. The after tax impact of this incrementalstock-based compensation expense on net income, basic and diluted earnings pershare was $2.7 million, $0.04 and $0.04, respectively. Results of operationsfor the three month period ended March 31, 2006 include $4.3 million ($2.9million net of tax benefit of $1.4 million) of total stock-based compensationexpense, $1.8 million of which has been included in cost of revenue and $2.5million of which has been included in selling, general and administrativeexpenses.

11

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

Prior to January 1, 2006,Covance followed the disclosure-only provisions of SFAS 123 and, accordingly, accountedfor awards under its share based compensation plans pursuant to the recognitionand measurement principles of APB 25 and related Interpretations, as permittedby SFAS 123. Under APB 25, compensation expense was recognized in the financialstatements for the fair value of stock awards. However, no compensation expensewas recorded in the financial statements for stock option grants, as alloptions have been granted with an exercise price equal to the market value ofthe underlying common stock on the date of grant. Additionally, no compensationexpense was recorded in the financial statements for shares purchased byemployees under the Company’s Employee Stock Purchase Program as that plan wasconsidered to be non-compensatory under APB 25. The following table illustratesthe effect on net income and earnings per share for the three month periodended March 31, 2005 had Covance applied the fair value recognitionprovisions of SFAS 123 to all of its stock-based employeecompensation plans.

 

|                                                                                                                                               | ** ** | **Three months  ended,  March 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Net income, as  reported                                                                                                                      |       | $                                                       | 28,864     |   |
| Add: Stock award-based  employee compensation included in reported net income, net of related tax  effects                                    |       | 1,109                                                   |       |
| Deduct: Total  stock-based employee compensation expense determined under fair value  based method for all awards, net of related tax effects |       | (4,463                                                  | )          |
| Pro forma net  income                                                                                                                         |       | $                                                       | 25,510     |   |
|                                                                                                                                          |       |                                                    |       |
| Earnings per  share:                                                                                                                          |       |                                                    |       |
| Basic—as reported                                                                                                                        |       | $                                                       | 0.46       |   |
| Basic—pro forma                                                                                                                          |       | $                                                       | 0.41       |   |
|                                                                                                                                          |       |                                                    |       |
| Diluted—as reported                                                                                                                      |       | $                                                       | 0.45       |   |
| Diluted—pro  forma                                                                                                                       |       | $                                                       | 0.40       |   |

 

*Options* - The grant-date fair value of stock optionawards is estimated using an option pricing model. For stock options grantedprior to January 1, 2006, the Company used the Black-Scholes-Merton optionpricing formula to estimate the grant-date fair value of such awards. For stockoptions granted on or subsequent to January 1, 2006, the Company is usingthe Lattice-Binomial option pricing formula to estimate the grant-date fairvalue of stock option awards. The Company changed to the Lattice-Binomialoption pricing formula as it believes such formula may result in a betterestimate of fair value than the Black-Scholes-Merton formula. In order toestimate the grant-date fair value, option pricing models require the use ofestimates and assumptions as to (a) the expected term of the option, (b) theexpected volatility of the price of the underlying stock, (c) therisk-free interest rate for the expected term of the option and (d) pre-vestingforfeiture rates.

The Company has used the followingassumptions in determining the grant-date fair value for its option awards. Theexpected term of the option is based upon the contractual term, taking intoaccount expected employee exercise and expected post-vesting employmenttermination behavior. The expected volatility of the price of the underlyingstock is based upon the historical volatility of the Company’s stock computedover a period of time equal to the expected term of the option. The risk freeinterest rate is based upon the implied yields currently available from theU.S. Treasury zero-coupon yield curve for issues with a remaining durationequal to the expected term of the option. Pre-vesting forfeiture rates areestimated based upon past voluntary termination behavior and past option forfeitures.The following weighted-average assumptions were used to calculate the fairvalue of options granted for the three month periods ended March 31, 2006and 2005, respectively: expected volatility of 43.6% in both periods; risk-freeinterest rates of 4.59% and 3.65%; and an expected holding period of 4.33 yearsand 5.0 years.

12

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

The following table sets forthCovance’s stock option activity as of and for the three month period ended March 31,2006:
| ** **                                                   | ** ** | **Number  of Shares  (in thousands)** | ** ** | **Weighted  Average  Price** | ** ** | **Weighted  Average  Remaining  Contractual Life** | ** ** | **Aggregate  Intrinsic Value  (in millions)** | ** ** |
|--------------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| Options  outstanding, December 31, 2005                 |       | 3,841.9                                         |       | $                            | 28.58      |                                                    |       |                                                    |       |   |
| Granted                                                      |       | 347.7                                           |       | $                            | 55.75      |                                                    |       |                                                    |       |   |
| Exercised                                                    |       | (495.6                                          | )          | $                            | 25.10      |                                                    |       |                                                    |       |   |
| Forfeited                                                    |       | (106.0                                          | )          | $                            | 31.17      |                                                    |       |                                                    |       |   |
| Options  outstanding, March 31, 2006                    |       | 3,588.0                                         |       | $                            | 31.60      |                                                    | 7.2 years  |                                                    | $          | 97.4 |   |
|                                                         |       |                                            |       |                         |       |                                                    |       |                                                    |       |
| Vested and  unvested expected to vest at March 31, 2006 |       | 3,548.6                                         |       | $                            | 31.27      |                                                    | 7.2 years  |                                                    | $          | 97.5 |   |
| Exercisable at  March 31, 2006                          |       | 2,709.5                                         |       | $                            | 26.56      |                                                    | 6.6 years  |                                                    | $          | 87.3 |   |

 

The weighted-average grant-datefair value per share of options granted during the three month periods ended March 31,2006 and 2005 were $22.05 and $17.87, respectively. As of March 31, 2006,the total unrecognized compensation cost related to non-vested stock optionsgranted was $14.3 million and is expected to be recognized over a weighted averageperiod of 1.9 years. The aggregate intrinsic value of options exercised duringthe three month periods ended March 31, 2006 and 2005 was $15.9 millionand $21.7 million, respectively. The aggregate grant-date fair value of shareswhich vested during the three month periods ended March 31, 2006 and 2005was $12.1 million and $13.4 million, respectively.

Cash proceeds from stock optionsexercised during the three month periods ended March 31, 2006 and 2005totaled $12.4 million and $18.2 million, respectively. Prior to the adoption of SFAS 123R, theCompany presented the tax benefit of deductions resulting from the exercise ofstock options as an operating cash flow in the Statements of Cash Flows inaccordance with SFAS 123 and APB 25. For the three months ended March 31,2005, the tax benefit realized and included in operating cash flows totaled$6.8 million. SFAS 123R requires that the cash flows resulting from taxbenefits realized on tax deductions “in excess of” the compensation expenserecognized (either in the financial statements or the pro forma footnotedisclosures) for stock options exercised in the period be classified as afinancing cash flow. The “excess tax benefit” classified as a financing cashinflow during the three months ended March 31, 2006 was $4.2 million andwould have been classified as an operating cash inflow under SFAS 123. Theactual tax benefit realized on stock options exercised during the three monthperiod ended March 31, 2006 was $7.2 million. The difference between the actualtax benefit received and the “excess tax benefit” computed in accordance with SFAS 123Rof $3.0 million continues to be classified as an operating cash inflow.

*Restricted Stock Awards -* Restricted stock awards are granted subject tocertain restrictions, including in some cases service conditions (restrictedstock) and in other cases service and performance conditions (performanceshares). The grant-date fair value of restricted stock and performance shareawards, which has been determined based upon the market value of Covance’sshares on the grant date, is expensed over the vesting period. 

13

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

The following table sets forth Covance’s performanceshares and restricted stock activity as of and for the three month periodsended March 31, 2006:
| ** **                           | ** ** | **Performance Shares**                     | ** ** | **Restricted Stock**                               | ** ** |
|--------------------------------------|------------|-------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                           | ** ** | **Number  of Shares  (in thousands)** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** | **Number  of Shares  (in thousands)** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
| Nonvested at  December 31, 2005 |       | 175.2                                           |       | $                                                       | 34.12      |   | 30.0 |   | $ | 44.99 |   |
| Granted                              |       | 156.5                                           |       | $                                                       | 49.21      |   | 159.6 |   | $ | 56.18 |   |
| Vested                               |       | (7.7                                            | )          | $                                                       | 38.75      |   | — |   | — |   |
| Forfeited                            |       | (19.3                                           | )          | $                                                       | 33.15      |   | (2.2 | ) | $ | 48.67 |   |
| Nonvested at  March 31, 2006    |       | 304.7                                           |       | $                                                       | 41.82      |   | 187.4 |   | $ | 54.48 |   |

 

The weighted averagegrant-date fair value of shares granted during the three months ended March 31,2005 was $34.55. As of March 31, 2006, the total unrecognized compensationcost related to non-vested performance shares and restricted stock awards was$18.5 million. This cost is expected to be recognized over a weighted averageperiod of 2.7 years.

*Employee Stock Purchase Plan*- Covance also has an employee stock purchase plan(the “ESPP”) pursuant to which Covance may make available for sale to employeesshares of its common stock at a price equal to 85% of the lower of the marketvalue on the first or last day of each calendar quarter. The ESPP, administeredby the Compensation Committee, is intended to give Covance employees theopportunity to purchase shares of Covance common stock through payrolldeductions. A maximum of 3.0 million shares may be purchased by Covanceemployees under the ESPP.

**7.  Segment Information**

Covance has two reportable segments: early developmentand late-stage development. Early development services, which includes Covance’spreclinical and clinical pharmacology service capabilities, involve evaluatinga new compound for safety and early effectiveness as well as evaluating theabsorption, distribution, metabolism and excretion of the compound in the humanbody. It is at this stage that a pharmaceutical company, based on availabledata, will generally decide whether to continue further development of a drug. Late-stagedevelopment services, which include Covance’s central laboratory, clinicaldevelopment, periapproval, cardiac safety services, and market access services,are geared toward demonstrating the clinical effectiveness of a compound in treatingcertain diseases or conditions, obtaining regulatory approval and maximizingthe drug’s commercial potential.

14

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**COVANCEINC. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)(UNAUDITED)March 31, 2006 and 2005(dollars in thousands, unless otherwise indicated)**

The accounting policiesof the reportable segments are the same as those described in Note 2. Segmentnet revenues, operating income and total assets for the three months ended March 31,2006 and 2005 are as follows:
| ** **                                    | ** ** | **Early  Development** | ** ** | **Late-Stage  Development** | ** ** | **Other  Reconciling Items** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------------|------------|-----------------------------------|------------|-----------|------------|
| ***Three  months ended March 31, 2006*** |       |                   |       |                        |       |                              |       |      |       |
| Total revenues from external customers        |       | $                      | 142,439    |                        | $          | 178,070                           |       | $         | 13,129     | (a) | $ | 333,638 |   |
| Operating income                              |       | $                      | 35,499     |                        | $          | 31,983                            |       | $         | (21,638    | )(b) | $ | 45,844 |   |
| Total assets                                  |       | $                      | 558,945    |                        | $          | 381,766                           |       | $         | 157,879    | (c) | $ | 1,098,590 |   |
|                                          |       |                   |       |                        |       |                              |       |      |       |
| ***Three  months ended March 31, 2005*** |       |                   |       |                        |       |                              |       |      |       |
| Total revenues from external customers        |       | $                      | 130,951    |                        | $          | 150,314                           |       | $         | 11,518     | (a) | $ | 292,783 |   |
| Operating income                              |       | $                      | 31,976     |                        | $          | 25,644                            |       | $         | (16,764    | )(b) | $ | 40,856 |   |
| Total assets                                  |       | $                      | 483,970    |                        | $          | 392,324                           |       | $         | 70,040     | (c) | $ | 946,334 |   |

----

(a)                            Represents revenues associated withreimbursable out-of-pocket expenses.

(b)                            Represents corporate expenses (primarilyinformation technology, marketing, communications, human resources, finance andlegal). Beginning in 2006, incremental stock based compensation expense underSFAS 123R is now recorded in results of operations and has been included incorporate expenses.

(c)                            Represents corporate assets.

**8.  Subsequent Event**

On April 20, 2006, Covance entered into a definitive agreement toacquire the eight early phase clinical development sites of Radiant ResearchInc. for approximately $65 million in cash. The eight sites currently generateapproximately $25 million in annual revenue. The addition of these sites isexpected to bring Covance’s total global Phase I/IIa clinical research bedcapacity to more than 500 beds. Each site has a database of special patientpopulations for both Phase I and IIa studies. Covance expects this acquisition,which is subject to regulatory approval and other closing conditions, to closebefore the end of the second quarter of 2006.

15

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**Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

Youshould read the following discussion together with the unaudited Covanceconsolidated financial statements and the accompanying notes included in thisQuarterly Report on Form 10-Q for the quarter ended March 31,2006.

**Overview**

Covance is a leading drugdevelopment services company providing a wide range of early-stage andlate-stage product development services on a worldwide basis primarily to thepharmaceutical, biotechnology and medical device industries. Covance alsoprovides services such as laboratory testing to the chemical, agrochemical andfood industries. The foregoing services comprise two reportable segments forfinancial reporting purposes: early development services, which includespreclinical and clinical pharmacology service offerings; and late-stagedevelopment services, which includes central laboratory, clinical development,periapproval, cardiac safety services, and market access services. Althougheach segment has separate services within it, they can be combined in jointservice offerings and we believe clients increasingly are interested inopportunities for such combined services. Covance believes it is one of thelargest drug development services companies, based on annual net revenues, andone of a few that is capable of providing comprehensive global productdevelopment services. Covance offers its clients high quality services designedto provide data to clients as rapidly as possible and reduce productdevelopment time. We believe this enables Covance’s customers to introducetheir products into the marketplace faster and as a result, maximize the periodof market exclusivity and monetary return on their research and developmentinvestments. Additionally, Covance’s comprehensive services and broadexperience provide its customers with a variable cost alternative to fixed costinternal development capabilities.

**Critical Accounting Policies**

Covance’s consolidatedfinancial statements are prepared in accordance with U.S. generally acceptedaccounting principles (“GAAP”), which require management to make estimates andassumptions about future events that affect the amounts reported in thefinancial statements and the accompanying notes. Actual results could differfrom these estimates. The following discussion highlights what we believe to bethe critical accounting policies and judgments made in the preparation of theseconsolidated financial statements.

***Revenue Recognition.***Covancerecognizes revenue either as services are performed or products are delivered,depending upon the nature of the work contracted. Historically, a majority ofCovance’s net revenues have been earned under contracts which range in durationfrom a few months to two years, but can extend in duration up to five years orlonger. Service contracts generally take the form of fee-for-service orfixed-price arrangements. In the case of fee-for-service contracts, revenue isrecognized as services are performed, based upon, for example, hours worked orsamples tested. For long-term fixed-price service contracts, revenue is recognizedas services are performed, with performance generally assessed using outputmeasures, such as units-of-work performed to date as compared to the totalunits-of-work contracted. Changes in the scope of work generally result in arenegotiation of contract pricing terms. Renegotiated amounts are not includedin net revenues until earned and realization is assured. Estimates of costs tocomplete are made to provide, where appropriate, for losses expected oncontracts. Costs are not deferred in anticipation of contracts being awarded,but instead are expensed as incurred. In some cases, a portion of the contractfee is paid at the time the trial is initiated. These advances are deferred andrecognized as revenue as services are performed or products are delivered, asdiscussed above. Additional payments may be made based upon the achievement ofperformance-based milestones over the contract duration. Most contracts areterminable by the client either immediately or upon notice. These contractstypically require payment to Covance of expenses to wind down the study, feesearned to date and, in some cases, a termination fee or a payment to Covance ofsome portion of the fees or profits that could have been earned by Covanceunder the contract if it had not been terminated early. Termination fees areincluded in net revenues when realization is assured.

***Bad Debts.***Covance endeavors to assess and monitorthe creditworthiness of its customers to which it grants credit terms in theordinary course of business. Covance maintains a provision for doubtfulaccounts relating to amounts due that may not be collected. This bad debtprovision 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. Historicallybad debt write-offs have not been material.

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***Taxes on Income.***SinceCovance conducts operations on a global basis, its effective tax rate has andwill continue to depend upon the geographic distribution of its pre-taxearnings among locations with varying tax rates. Covance’s profits are furtherimpacted by changes in the tax rates of the various jurisdictions. Inparticular, as the geographic mix of Covance’s pre-tax earnings among varioustax jurisdictions changes, Covance’s effective tax rate may vary from period toperiod. In addition, Covance’s policy is to provide income taxes on earnings offoreign subsidiaries only to the extent those earnings are taxable or areexpected to be remitted. Covance’s historical policy has been to leave itsunremitted foreign earnings invested indefinitely outside the United States.Except for the amounts repatriated in the fourth quarter of 2005 under the Act,Covance intends to continue to leave its unremitted foreign earnings investedindefinitely outside the United States. As a result, taxes have not beenprovided on any accumulated foreign unremitted earnings as of March 31,2006.

Covance has established, and periodically reviews andreevaluates, an estimated income tax reserve which is included in accruedexpenses and other current liabilities on its consolidated balance sheet. Thisincome tax reserve is for exposures related to matters such as transferpricing, nexus, deemed dividends and the allocation of overhead costs acrossvarious Federal, state and foreign income tax jurisdictions. An accrual isestablished at the time an exposure is identified when it is both probable thata liability has been incurred and the amount of the liability can be reasonablyestimated. The amount of the accrual for each item for which an exposure existsis adjusted when either (a) matters are settled at amounts which aredifferent than the amount included in the reserve or (b) when factsindicate a significant change in either the probability or estimated amount ofthe potential exposure. While Covance believes that it has identified allreasonably identifiable exposures and that the reserve it has established foridentifiable exposures is appropriate under the circumstances, it is possiblethat additional exposures exist and that exposures will be settled at amountsdifferent than the amounts reserved. It is possible that changes in estimatesin the future could cause Covance to either materially increase or reduce thecarrying amount of its income tax reserve.

***Stock Based Compensation.***TheCompany sponsors several stock-based compensation plans pursuant to whichnon-qualified stock options and restricted stock awards are granted to eligibleemployees. Through the year ended December 31, 2005, the Company followedthe disclosure-only provisions of Statement of Financial Accounting Standards No. 123,*Accounting for Stock-Based Compensation*, (“SFAS 123”), and,accordingly, accounted for awards under these plans pursuant to the recognitionand measurement principles of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees*, (“APB 25”) andrelated Interpretations, as permitted by SFAS 123. Under APB 25, compensationexpense was recognized in the financial statements relating to awards of stock.However, no compensation expense was recorded in the financial statements forstock option grants, as all options have been granted with an exercise priceequal to the market value of the underlying common stock on the date of grant.Additionally, no compensation expense was recorded in the financial statementsfor shares purchased by employees under the Company’s Employee Stock PurchasePlan (pursuant to which employees are able to purchase shares of the Company’scommon stock at a price equal to 85% of the lower of the market value on thefirst or last day of each calendar quarter) as that plan was considered to benon-compensatory under APB 25.

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of Statement of Financial AccountingStandards No. 123R, *Share-Based Payments*,(“SFAS 123R”) using the modified prospective transition method. SFAS 123R revises SFAS 123, supersedes APB 25and amends Statement of Financial Accounting Standards No. 95, *Statement of Cash Flows*. Under that transitionmethod, compensation expense is now recognized in the financial statements on ago forward basis for (a) all share-based payments granted prior to, butnot vested as of January 1, 2006, based upon the grant-date fair valueestimated in accordance with the original provisions of SFAS 123, and (b) share-basedpayments granted on or subsequent to January 1, 2006, based upon thegrant-date fair value estimated in accordance with the provisions of SFAS 123R.The grant-date fair value of awards expected to vest is expensed on astraight-line basis over the vesting period of the related awards. Under themodified prospective transition method, results for prior periods have not beenrestated.

Prior to the adoption of SFAS123R, the Company usedstock options as the vehicle through which stock-based compensation awards weregranted to eligible employees, other than executive officers who historicallywere granted a combination of performance-based share awards and stockoptions.  As a result of the adoption ofSFAS123R, the Company is now using a mix of restricted share awards and stockoptions as the vehicles through which stock-based compensation awards aregranted to eligible employees, other than executive officers who continue toreceive a combination of performance-based share awards and stock options.

The grant-date fair value of stock awards is basedupon the underlying price of the stock on the date of grant. The grant-datefair value of stock option awards must be determined using an option pricingmodel. Option pricing models require the use of estimates and assumptions as to(a) the expected term of the option, (b) the expected volatility ofthe price of the underlying stock, (c) the risk-free interest rate for theexpected term of the option and (d) pre-vesting forfeiture rates. Forstock options granted prior to January 1, 2006, the Company used theBlack-Scholes-Merton option pricing formula for determining the grant-date fairvalue of such awards. For stock options granted on or subsequent to January 1,2006, the Company is using the Lattice-Binomial option pricing formula fordetermining the grant-date fair value of stock option awards. The Company changed to the Lattice-Binomialoption pricing formula as it believes such formula may result in a betterestimate of fair value than the Black-Scholes-Merton formula.

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The expected term of the option is based upon thecontractual term and expected employee exercise and expected post-vestingemployment termination behavior. The expected volatility of the price of theunderlying stock is based upon the historical volatility of the Company’s stockcomputed over a period of time equal to the expected term of the option. Therisk free interest rate is based upon the implied yields currently availablefrom the U.S. Treasury zero-coupon yield curve for issues with a remainingduration equal to the expected term of the option. Pre-vesting forfeiture ratesare estimated based upon past voluntary termination behavior and past optionforfeitures. The following weighted-average assumptions were used to calculatethe fair value of options granted for the three month periods ended March 31,2006 and 2005, respectively: expected volatility of 43.6% in both periods;risk-free interest rates of 4.59% and 3.65%; and an expected holding period of4.33 years and 5.0 years. Changes in any of these assumptions could impact,potentially materially, the amount of expense recorded in future periodsrelated to stock based awards.

***Impairment of Assets.***Covance reviews its long-lived assets other than goodwill and otherintangible assets for impairment, when events or changes in circumstances occurthat indicate that the carrying value of the asset may not be recoverable. Theassessment of possible impairment is based upon Covance’s judgment of itsability to recover the asset from the expected future undiscounted cash flowsof the related operations. Actual future cash flows may be greater or less thanestimated.

Covanceperforms an annual test for impairment of goodwill and other intangible assetsduring the fourth quarter. This test is performed by comparing, at thereporting unit level, the carrying value to its fair value. Covance assessesfair value based upon its best estimate of the present value of the future cashflows that it expects to be generated by the reporting unit. The test performedfor 2005 did not identify any instances of impairment. However, changes inexpectations as to the present value of the reporting unit’s future cash flowsmight impact subsequent years’ assessments of impairment.

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

**Foreign Currency Risks**

Since Covance operates on a global basis, it isexposed to various foreign currency risks. Two specific risks arise from thenature of the contracts Covance executes with its customers since from time totime contracts are denominated in a currency different than the particularCovance subsidiary’s local currency. These risks are generally applicable onlyto a portion of the contracts executed by Covance’s foreign subsidiariesproviding clinical services. The first risk occurs as revenue recognized forservices rendered is denominated in a currency different from the currency inwhich the subsidiary’s expenses are incurred. As a result, the subsidiary’s netrevenues and resultant earnings can be affected by fluctuations in exchangerates. Historically, fluctuations in exchange rates from those in effect at thetime contracts were executed have not had a material effect upon Covance’sconsolidated financial results. See “Risk Factors”.

The second risk results from the passage of timebetween the invoicing of customers under these contracts and the ultimatecollection of customer payments against such invoices. Because the contract isdenominated in a currency other than the subsidiary’s local currency, Covancerecognizes a receivable at the time of invoicing for the local currencyequivalent of the foreign currency invoice amount. Changes in exchange ratesfrom the time the invoice is prepared and payment from the customer is receivedwill result in Covance receiving either more or less in local currency than thelocal currency equivalent of the invoice amount at the time the invoice wasprepared and the receivable established. This difference is recognized byCovance as a foreign currency transaction gain or loss, as applicable, and isreported in other expense (income) in Covance’s Consolidated Statements ofIncome.

Finally, Covance’sconsolidated 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 financialresults into U.S. dollars for purposes of reporting Covance’s consolidatedfinancial results. The process by which each foreign subsidiary’s financialresults are translated into U.S. dollars is as follows: income statementaccounts are translated at average exchange rates for the period; balance sheetasset and liability accounts are translated at end of period exchange rates;and equity accounts are translated at historical exchange rates. Translation ofthe balance sheet in this manner affects the stockholders’ equity account,referred to as the cumulative translation adjustment account. This accountexists only in the foreign subsidiary’s U.S. dollar balance sheet and isnecessary to keep the foreign balance sheet stated in U.S. dollars in balance. AtMarch 31, 2006 the accumulated other comprehensive income — cumulativetranslation account balance was $13.2 million.

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### **Operating Expenses and ReimbursableOut-of-Pockets**

Covance segregates its recurringoperating expenses among four categories: cost of revenue; reimbursedout-of-pocket expenses; selling, general and administrative expenses; anddepreciation and amortization. Cost of revenue includes direct labor andrelated benefits, other direct costs, shipping and handling fees, and anallocation of facility charges and information technology costs, and excludesdepreciation and amortization. Cost of revenue, as a percentage of netrevenues, tends and is expected to fluctuate from one period to another, as aresult of changes in labor utilization and the mix of service offeringsinvolving hundreds of studies conducted during any period of time. Selling,general and administrative expenses consist primarily of administrative payrolland related benefit charges, advertising and promotional expenses,administrative travel and an allocation of facility charges and informationtechnology costs, and excludes depreciation and amortization.

In connection with the management of multi-siteclinical 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-upor profit. Investigator fees are not reflected in total revenues or expenseswhere Covance acts in the capacity of an agent on behalf of the pharmaceuticalcompany 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 tovariation, and are expected to continue to be subject to variation, as a resultof factors such as (1) delays in initiating or completing significant drugdevelopment trials, (2) termination or reduction in size of drugdevelopment trials, (3) acquisitions and divestitures, (4) changes inthe mix of our services, and (5) exchange rate fluctuations. Delays andterminations of trials are often the result of actions taken by Covance’scustomers or regulatory authorities and are not typically controllable byCovance. Since a large amount of Covance’s operating costs are relatively fixedwhile revenue is subject to fluctuation, moderate variations in thecommencement, progress or completion of drug development trials may causesignificant variations in quarterly results.

**Results of Operations**

**Items Affecting Comparability Between Periods**

Prior to 2006, the Company followed thedisclosure-only provisions of SFAS 123, and, accordingly, accounted for awardsunder these plans pursuant to the recognition and measurement principles of APB25 and related Interpretations, as permitted by SFAS 123. Under APB 25, compensationexpense was recognized in the financial statements relating to awards of stock.However, no compensation expense was recorded in the financial statements forstock option grants, as all options have been granted with an exercise priceequal to the market value of the underlying common stock on the date of grant.Additionally, no compensation expense was recorded in the financial statementsfor shares purchased by employees under the Company’s Employee Stock PurchasePlan (pursuant to which employees are able to purchase shares of the Company’scommon stock at a price equal to 85% of the lower of the market value on thefirst or last day of each calendar quarter) as that plan was considered to benon-compensatory under APB 25. Covance reflected the expense associated withthe fair value of stock-based awards in its required pro forma footnotedisclosure under SFAS 123 in its SEC filings.

Effective January 1, 2006, the Company adoptedthe fair value recognition provisions of SFAS 123R using the modifiedprospective transition method. SFAS 123R revises SFAS 123, supersedes APB 25 and amends Statement ofFinancial Accounting Standards No. 95, *Statement of Cash Flows*.Under that transition method, compensation expense is now recognized inthe financial statements on a go forward basis for (a) all share-basedpayments granted prior to, but not vested as of January 1, 2006, basedupon the grant-date fair value estimated in accordance with the originalprovisions of SFAS 123, and (b) share-based payments granted on orsubsequent to January 1, 2006, based upon the grant-date fair valueestimated in accordance with the provisions of SFAS 123R. The grant-date fairvalue of awards expected to vest is expensed on a straight-line basis over thevesting period of the related awards. Under the modified prospective transitionmethod, results for prior periods have not been restated.

Management believes that it may be useful forinvestors, in evaluating current period financial performance, to compare to2005 results that include stock-based compensation computed in accordance withSFAS 123. Management does not assert that such pro forma numbers are superiorto the 2005 “as reported” results; however, the pro forma numbers may helpinvestors compare results including stock option expense across both periods.

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Although the Company is now using the Lattice-Binomialoption pricing formula for valuing stock options granted beginning in 2006(whereas previously the Company had used the Black-Scholes-Merton optionpricing formula), management believes that the Lattice-Binomial and theBlack-Scholes-Merton option pricing formulas, with the assumptions used by theCompany, result in fair values which are substantially similar in all materialrespects. As a result, the Company believes that the 2006 “as reported” amountsunder SFAS 123R are comparable to the 2005 “pro forma” amounts as previouslydisclosed under SFAS 123.

***Three Months Ended March 31, 2006 Compared with Three Months EndedMarch 31, 2005.***Net revenues increased 14.0% to $320.5million for the three months ended March 31, 2006 from $281.3 million forthe corresponding 2005 period. Excluding the impact of foreign exchange ratevariances between both periods net revenues increased 17.2% as compared to the corresponding2005 period. Net revenues from Covance’s early development segment grew 8.8%, or 11.4% excluding the impact offoreign exchange rate variances between both periods, driven primarily bystrength in toxicology services. Net revenues from Covance’s late-stage developmentsegment increased 18.5%, or 22.2%excluding the impact of foreign exchange rate variances between both periods,on very strong performance in central laboratory services.

Cost of revenueincreased 14.4% to $213.7 million or 66.7% of net revenues for the three monthsended March 31, 2006 as compared to $186.8 million or 66.4% of netrevenues for the corresponding 2005 period. Comparisons to the prior year areimpacted by the inclusion of $1.8 million in stock-based compensation in costof revenue pursuant to SFAS 123R. These expenses reduced gross margins by 60basis points to 33.3% of net revenues. Had stock-based compensation beenincluded in cost of revenue for the three months ended March 31, 2005under SFAS 123, cost of revenue would have increased by $2.2 million and grossmargins would have been 80 basis points lower or 32.8% of net revenue on a proforma basis.

Overall, selling,general and administrative expenses increased 14.6% to $48.3 million for thethree months ended March 31, 2006 from $42.1 million for the corresponding2005 period. As a percentage of net revenues, selling, general andadministrative expenses increased 10 basis points to 15.1% for the three monthsended March 31, 2006 from 15.0% for the corresponding 2005 period. Comparisonsto the prior year are impacted by the inclusion of $2.5 million in stock-basedcompensation in selling, general and administrative expenses pursuant to SFAS123R. These expenses increased selling, general and administrative expenses asa percentage of revenue by 70 basis points. Had incremental stock-basedcompensation been included in selling, general and administrative expenses forthe three months ended March 31, 2005 under SFAS 123, selling, general andadministrative expenses would have increased by $2.7 million and selling,general and administrative expenses as a percentage of revenue would have been90 basis points higher or 15.9% of net revenue on a pro forma basis.

Depreciation andamortization increased 10.6% to $12.7 million or 4.0% of net revenues for thethree months ended March 31, 2006 from $11.5 million or 4.1% of netrevenues for the corresponding 2005 period.

Income fromoperations increased 12.2% to $45.8 million or 14.3% of net revenues for thethree months ended March 31, 2006 from $40.9 million or 14.5% of netrevenues for the corresponding 2005 period. Comparisons to the prior year areimpacted by the inclusion of $4.3 million in stock-based compensation inoperating expenses pursuant to SFAS 123R. These expenses reduced operating marginby 130 basis points. Had incremental stock-based compensation been included inoperating expenses for the three months ended March 31, 2005 under SFAS123, operating expenses would have increased by $4.9 million and operatingmargins would have been 170 basis points lower or 12.8% of net revenue on a proforma basis.

Income fromoperations from Covance’s early development segment increased $3.5 million or11.0% to $35.5 million or 24.9% of net revenues for the three months ended March 31,2006 from $32.0 million or 24.4% of net revenues for the corresponding 2005period driven primarily by strength in toxicology services. Income fromoperations from Covance’s late-stage development segment increased $6.3 millionor 24.7% to $32.0 million or 18% of net revenues for the three months ended March 31,2006 from $25.6 million or 17.1% of net revenues for the corresponding 2005period, primarily driven by very strong performance in central laboratoryservices. Corporate expense increased $4.8 million to $21.6 million or 6.8% ofnet revenues for the three months ended March 31, 2006 from $16.8 millionor 6.0% of net revenues for the three months ended March 31, 2005. Comparisonsto the prior year are impacted by the inclusion of $4.3 million or 1.3% of netrevenues in stock-based compensation in corporate expenses pursuant to SFAS123R. Had incremental stock-based compensation been included in corporateexpenses for the three months ended March 31, 2005 under SFAS 123,corporate expenses would have increased by $4.9 million to $21.7 million or7.7% of net revenue on a pro forma basis.

Other income, netincreased $1.1 million to $1.5 million for the three months ended March 31,2006 from $0.4 million for the corresponding 2005 period as a result of a $0.8 million increase in net interest incomedue primarily to higher average interest rates earned on invested cash balancescoupled with a $0.3 million decrease in foreign exchange losses.

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Covance’seffective tax rate for the three month period ended March 31, 2006 was30.1% compared to 30.8% for the corresponding 2005 period. The year-over-year70 basis point reduction in Covance’s effective tax rate is attributable to anumber of factors, including the mix of our pre-tax earnings across various taxjurisdictions, research and development tax credits in the United Kingdom, andother planning initiatives.

Covance has a minorityequity position (approximately 21% at March 31, 2006) in Bio-ImagingTechnologies, Inc. (“BITI”). BITI uses proprietary medical imaging technologiesto 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 each of the three month periods ended March 31,2006 and 2005, Covance recognized losses of $0.1 million, representing its prorata share of BITI’s losses.

Covance has a 47%minority equity position in Noveprim Limited, an existing supplier of researchproducts. For the three month periods ended March 31, 2006 and 2005, Covancerecognized $0.3 million and $0.4 million, respectively, representing its shareof Noveprim’s earnings, less the elimination of profit on inventory purchasedfrom Noveprim Limited and still on hand at Covance at March 31, 2006 and2005.

Net income of $33.4million for the three months ended March 31, 2006 increased $4.5 millionor 15.7% as compared to $28.9 million for the corresponding 2005 period.

**Liquidity andCapital Resources**

Covance’s expectedprimary cash needs on both a short and long-term basis are for capitalexpenditures, expansion of services, possible future acquisitions, geographicexpansion, working capital and other general corporate purposes, includingpossible share repurchases. Covance’s $75.0 million revolving credit facility(the “Credit Facility”) expires in June 2009 and may be expanded to $125.0million at Covance’s election. Covance believes cash from operations willprovide sufficient liquidity for the foreseeable future. At March 31,2006, there were no outstanding borrowings and $0.8 million of outstandingletters of credit under the Credit Facility. Interest on all outstandingborrowings under the Credit Facility is based upon the London Interbank OfferedRate (“LIBOR”) plus a 75 basis point margin. The Credit Facility contains variousfinancial and other covenants. At March 31, 2006, Covance was incompliance with the terms of the Credit Facility.******The Credit Facility is collateralizedby guarantees of certain of Covance’s domestic subsidiaries and a pledge of 65percent of the capital stock of certain of Covance’s foreign subsidiaries.

During the threemonths ended March 31, 2006 Covance’s operations provided net cash of$32.6 million, an increase of $26.2 million from the corresponding 2005 period.The change in net operating assets used $18.8 million in cash during the threemonths ended March 31, 2006, primarily due to a reduction in accruedpayroll and benefits (primarily attributable to incentive compensation paymentsmade during the first quarter of 2006 relating to 2005 incentive compensationaccruals) and an increase in prepaid expenses and other current assets andunbilled services, partially offset by an decrease in accounts receivable,while this net change used $36.6 million in cash during the three months ended March 31,2005, primarily due to a reduction in accrued payroll and benefits (primarilyattributable to incentive compensation payments made during the first quarterof 2005 relating to 2004 incentive compensation accruals) and an increase inprepaid expenses and other current assets and unbilled services, partiallyoffset by an increase in income taxes payable. Covance’s ratio of currentassets to current liabilities was 2.49 at March 31, 2006 and 2.16 at December 31,2005.

Investingactivities for the three months ended March 31, 2006 used $19.1 million,compared to using $23.7 million for the corresponding 2005 period. Capitalspending for the first three months of 2006 totaled $19.2 million, and wasprimarily for the expansion of our Madison, WI facility, outfitting of newfacilities, purchase of new equipment, and upgrade of existing equipment andsoftware for newly hired employees. Capital spending for the corresponding 2005period totaled $23.7 million, and was primarily for the expansion of ourMadison, WI and Harrogate, UK facilities, outfitting of new facilities,purchase of new equipment, upgrade of existing equipment and software for newlyhired employees.

Financing activities for the three months ended March 31,2006 provided $17.0 million and was comprised of proceeds from the exercise ofstock options of $12.4 million, excess tax benefits realized on the exercise ofstock options of $4.2 million (which are now required to be included infinancing cash flows pursuant to SFAS 123R) and employee contributions toCovance’s employee stock purchase plan of $0.9 million, partially offset by thepurchase into treasury of 9,828 shares for an aggregate cost of $0.6 million,in connection with employee benefit plans. Financing activities for the threemonths ended March 31, 2005 provided $7.0 million and consisted primarilyof $19.0 million received from stock option exercises and employeecontributions to Covance’s employee stock purchase plan, partially offset bythe purchase into treasury of 232***,***300 

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shares of common stockfor an aggregate cost of $10.3 million, in connection with a 3.0 million sharebuyback program authorized by Covance’s Board of Directors in June 2004.

On April 22, 2006, Covance and IBM amended the termsof the contract under which IBM had been providing certain informationtechnology services toCovance.  Pursuant to the terms of theamended contract, Covance will in-source certain elements of its informationtechnology infrastructure support which were being provided by IBM.  IBM will continue to provide informationtechnology support services in areas including help desk and desktop computersupport on a worldwide basis.  Thisamended contract is not expected to have a material impact upon Covance’s liquidity.

On April 20, 2006,Covance entered into a definitive agreement to acquire the eight early phaseclinical development sites of Radiant Research Inc. for approximately $65million in cash. The eight sites currently generate approximately $25 millionin annual revenue. The addition of these sites is expected to bring Covance’stotal global Phase I/IIa clinical research bed capacity to more than 500 beds. Eachsite has a database of special patient populations for both Phase I and IIastudies. Covance expects this acquisition, which is subject to regulatoryapproval and other closing conditions, to close before the end of the secondquarter of 2006.

**Inflation**

While most of Covance’s net revenues are earned undercontracts, the long-term contracts (those in excess of one year) generallyinclude an inflation or cost of living adjustment for the portion of theservices 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 materialadverse effect on its operations or financial condition.

***ForwardLooking Statements.****Statements in thisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, as well as in certain other parts of this Quarterly Report on Form 10-Qthat look forward in time, are forward looking statements made pursuant to thesafe 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, andassumptions and other statements which are other than statements of historicalfacts. All such forward looking statements are based on the currentexpectations of management and are subject to, and are qualified by, risks anduncertainties that could cause actual results to differ materially from thoseexpressed or implied by those statements. These risks and uncertaintiesinclude, without limitation, competitive factors, outsourcing trends in thepharmaceutical 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, risksassociated with acquisitions and investments, the Company’s ability to increaseorder volume, the pace of translation of orders into revenue in late-stagedevelopment services, our ability to obtain necessary regulatory approval on atimely basis and close the Radiant transaction, difficulties or delays in integratingthe business of Radiant and achieving anticipated efficiencies and synergies,and other factors described in Covance’s filings with the Securities andExchange Commission, including its Annual Report on Form 10-K.*

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**Item 3. Quantitativeand Qualitative Disclosure About Market Risk**

For thethree months ended March 31, 2006, approximately 37% of our net revenueswere derived from our operations outside the United States. We do not engage inderivative or hedging activities related to our potential foreign exchangeexposures. See “Management’s Discussion and Analysis of Financial Condition andResults of Operations — Foreign Currency Risks” for a more detailed discussionof our foreign currency risks and exposures.

**Item 4. Controlsand Procedures**

Disclosure controls andprocedures. The Company’s Principal Executive Officer and Principal FinancialOfficer have reviewed and evaluated the effectiveness of the Company’sdisclosure controls and procedures as of the end of the period covered in thisreport. Based on that evaluation, the Principal Executive Officer and thePrincipal Financial Officer have concluded that the Company’s currentdisclosure controls and procedures are effective. There have been nosignificant changes in the Company’s internal controls or in the other factorsthat significantly affect those controls.

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**Part II.Other Information**

**Item 1a. Risk Factors**

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

**Changes ingovernment regulation or in practices relating to the pharmaceutical industrycould decrease the need for the services we provide.**

Governmental agencies throughout the world, but particularly in theUnited States, strictly regulate the drug development process. Our businessinvolves helping pharmaceutical and biotechnology companies navigate theregulatory drug approval process. Changes in regulation, such as a relaxationin regulatory requirements or the introduction of simplified drug approvalprocedures, or an increase in regulatory requirements that we have difficultysatisfying or that make our services less competitive, could eliminate orsubstantially reduce the demand for our services. Also, if government effortsto contain drug costs and pharmaceutical and biotechnology company profits fromnew drugs, our customers may spend less, or reduce their growth in spending onresearch and development. If health insurers were to change their practiceswith respect to reimbursements for pharmaceutical products, our customers mayspend less, or reduce their growth in spending on research and development.

**Failure tocomply with existing regulations could result in a loss of revenue or earningsor in increased costs.**

Any failure on our part to comply with applicable regulations couldresult in the termination of on-going research or the disqualification of datafor submission to regulatory authorities. For example, if we were to fail toverify that patient participants were fully informed and have fully consentedto 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 trialat no further cost to our customer, but at substantial cost to us.

**We may bearfinancial losses because most of our contracts are of a fixed price nature andmay be delayed or terminated or reduced in scope for reasons beyond ourcontrol.**

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

·      thefailure of products to satisfy safety requirements;

·      unexpectedor undesired results of the products;

·      insufficientpatient enrollment;

·      insufficientinvestigator recruitment;

·      theclient’s decision to terminate the development of a product or to end aparticular study; and

·      ourfailure to perform properly our duties under the contract.

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

**We may bearfinancial risk if we under price our contracts or overrun cost estimates.**

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

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**We may not be able to successfully develop andmarket or acquire new services.**

We may seek to develop and market new services that complement or expandour existing business or expand our service offerings through acquisition. Ifwe are unable to develop new services and/or create demand for those newly developedservices, or expand our service offerings through acquisition, our futurebusiness, results of operations, financial condition, and cash flows could beadversely affected.

**Our quarterlyoperating results may vary.**

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

·      exchangerate fluctuations;

·      thecommencement, completion or cancellation of large contracts;

·      theprogress of ongoing contracts;

·      thetiming of and charges associated with completed acquisitions or other events;and

·      changesin the mix of our services.

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

**We depend on thepharmaceutical and biotechnology industries.**

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

**We operate in ahighly competitive industry.**

Competitors in the contract research organization industry range fromsmall, limited service providers to full service global contract researchorganizations. Our main competition consists of in-house departments ofpharmaceutical companies, full-service contract research organizations, anduniversities and teaching hospitals, although to a lesser degree. We compete ona variety of factors, including:

·                                          reputation for on-time quality performance andregulatory compliance;

·                                          expertise and experience in specific areas;

·                                          scope of service offerings;

·                                          strengths in various geographic markets;

·                                          price;

·                                          technological expertise and efficient drugdevelopment processes;

·                                          quality of facilities;

·                                          ability to acquire, process, analyze and reportdata in an accurate manner;

·                                          ability to manage large scale clinical trials bothdomestically and internationally;

·                                          expertise and experience in market accessservices; and

·                                          size.

For instance, our clinical development services have from time to timeexperienced periods of increased price competition which had a material adverseeffect on Covance’s late-stage development profitability and consolidated netrevenues and net income.

There is competition among thelarger contract research organizations for both clients and potentialacquisition candidates. Additionally, small, limited service entitiesconsidering entering the contract research organization industry will find fewbarriers to entry, thus further increasing possible competition. Thesecompetitive pressures may affect the attractiveness of our services and couldadversely affect our financial results.

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**We may expandour business through acquisitions.**

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

·      difficultiesand expenses in connection with integrating the acquired companies andachieving the expected benefits;

·      diversionof management’s attention from current operations;

·      thepossibility that we may be adversely affected by risk factors facing theacquired companies;

·                  acquisitions could be dilutive to earnings, or inthe event of acquisitions made through the issuance of our common stock to theshareholders of the acquired company, dilutive to the percentage of ownershipof our existing stockholders;

·                  potential losses resulting from undiscoveredliabilities of acquired companies not covered by the indemnification we mayobtain from the seller;

·                  risks of not being able to overcome differences inforeign business practices, language and other cultural barriers in connectionwith the acquisition of foreign companies; and

·                  loss of key employees of the acquired companies.

**We may beaffected by potential health care reform**.

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

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

**We rely on thirdparties for important services.**

We depend on third parties to provide us with services critical to ourbusiness. For instance, we have entered into an agreement with IBM to managecertain of our information technology assets including help desk and desktopcomputer support worldwide. The failure of any of these third parties toadequately provide the needed services could have a material adverse effect onour business.

**Our revenues andearnings are exposed to exchange rate fluctuations**.

We derive a large portion of our net revenues from internationaloperations. For the three months ended March 31, 2006, we derivedapproximately 37% of our net revenues from outside the United States. Ourfinancial statements are denominated in U.S. dollars. As a result, factorsassociated with international operations, including changes in foreign currencyexchange rates, could significantly affect our results of operations, financialcondition and cash flows.

**The loss of ourkey personnel could adversely affect our business.**

Our success depends to a significant extent upon the efforts of oursenior management team and other key personnel. The loss of the services ofsuch personnel could adversely affect our business. Also, because of the natureof our business, our success is dependent upon our ability to attract andretain technologically qualified personnel. There is substantial competitionfor qualified personnel, and an inability to recruit or retain qualifiedpersonnel may impact our ability to grow our business and compete effectivelyin our industry.

**Contractresearch services create a risk of liability**.

In contracting to work on drug development trials, we face a range ofpotential liabilities, for example:

·                  errors or omissions that create harm during atrial to study volunteers or after a trial to consumers of the drug afterregulatory approval of the drug;

·                  general risks associated with clinicalpharmacology facilities, including negative consequences from the administrationof 

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drugs to clinical trial participants or the professional malpractice ofclinical pharmacology medical care providers;

·                  errors or omissions from tests conducted for theagrochemical and food industries;

·                  risks that animals in our breeding facilities maybe infected with diseases that may be harmful and even lethal to themselves andhumans despite preventive measures contained in our company policies for thequarantine and handling of imported animals; and

·                  errors and omissions during a trial that mayundermine the usefulness of a trial or data from the trial.

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

·                                          contract provisions entitling us to be indemnifiedor entitling us to a limitation of liability;

·                                          insurance maintained by our clients,investigators, and by us; and

·                                          various regulatory requirements we must follow inconnection with our business.

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

**Reliance on airtransportation.**

Our central laboratories and certain of our other businesses are heavilyreliant on air travel for transport of clinical trial kits and other material,products and people, and a significant disruption to the air travel system, orour access to it, could have a material adverse effect on our business.

**Certain serviceofferings and research products are dependent on limited sources of supply ofservices or products which if interrupted could affect our business.**

We depend on a limited number of suppliers for certain services and forone of our large animal populations. Disruptions to the continued supply ofthese services or products may arise from export import restrictions orembargoes, foreign political or economic instability, or otherwise. Disruptionof supply could have a material adverse effect on our business.

**Actions ofanimal 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 andsell animals for biomedical research. Such activities are required for the developmentof new medicines and medical devices under regulatory regimes in the UnitedStates, Europe, Japan and other countries. Acts of vandalism and other acts byanimal rights extremists who object to the use of animals in drug developmentcould have a material adverse effect on our business.

**Our animalpopulations may suffer diseases that can damage our inventory, harm ourreputation, result in decreased sales of research products or result in otherliability to us.**

It is important that ourresearch products be free of diseases, including infectious diseases. Thepresence of diseases can distort or compromise the quality of research results,can cause loss of animals in our inventory, can result in harm to humans oroutside animal populations if the disease is not contained to animals ininventory, or can result in other losses. Such results could harm ourreputation or have a material adverse effect on our financial condition,results of operations, and cash flows.

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**Item 6. Exhibits**
| 31.1   |   | Certification — Joseph L. Herring. ***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 — Joseph L. Herring. ***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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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                         | **COVANCE INC.** |
|-------------------------|------------------|
| ** **              |             |   |
| Dated: May 9, 2006 | By:              | /s/ Joseph L. Herring |
|                    |             | Joseph L. Herring |
|                    |             | Chairman of the Board and Chief Executive Officer |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.
| **Signature**            | **Title** | **Date**                                |
|--------------------------|-----------|-----------------------------------------|
| /s/ Joseph L. Herring    |      | Chairman of the Board and               | May 9, 2006 |
| Joseph L. Herring        |      | Chief Executive Officer                 |   |
|                     |      | (Principal Executive Officer)           |   |
|                     |      |                                    |
|                     |      |                                    |
| /s/ William E. Klitgaard |      | Corporate Senior Vice President         | May 9, 2006 |
| William E. Klitgaard     |      | and Chief Financial Officer             |   |
|                     |      | (Principal Financial Officer)           |   |
|                     |      |                                    |
|                     |      |                                    |
|                     |      |                                    |
| /s/ Michael Giannetto    |      | Corporate Vice President and Controller | May 9, 2006 |
| Michael Giannetto        |      | (Principal Accounting Officer)          |   |

** **

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**EXHIBITINDEX**
| Exhibit    | ** ** | ** **                                                                                                                                                                                 |
|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Number** | ** ** | **Description**                                                                                                                                                                            |
| 31.1       |       | Certification — Joseph L. Herring. ***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 — Joseph L. Herring. ***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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