Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**x**  **Quarterly Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

 

**For thequarterly period ended September 30, 2008**

 

**or**

 

**o**  **Transition Report Pursuant to Section 13 or 15(d) of theSecurities Exchange Act of 1934**

 

**For thetransition period from                                                to                                                            **

 

**CommissionFile 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)                            |

 

Registrant’stelephone number, including area code:  **(609) 452-4440**

 

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        NO   o

 

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer or a smaller reporting company. (See definition of “smallerreporting company, accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act).
| Large Accelerated Filer x |   | Accelerated Filer o          |   |   |
|--------------------------------|--------|-----------------------------------|--------|--------|
| Non-Accelerated Filer o   |   | Smaller Reporting  Company o |   |   |

 

Indicate by check markwhether the Registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

YES   o        NO   x

 

APPLICABLE ONLY TOCORPORATE ISSUERS:

 

As of October 17,2008, the Registrant had 63,284,772 shares of common stock outstanding.

 

 

 

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** **

**Covance Inc.**

**Form 10-Q For the QuarterlyPeriod Ended September 30, 2008**

 

**INDEX**

 
| ** **                                                                                            | ** **                                                                                  | **Page**   |
|-------------------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|------------|
| ** **                                                                                            | ** **                                                                                  | ** ** |
| **Part I. Financial****Information**                                                             |                                                                                        |
|                                                                                                  |                                                                                        |       |
| Item 1.                                                                                               | Financial  Statements (Unaudited)                                                           |       |
|                                                                                                  |                                                                                        |
| Consolidated  Balance Sheets—September 30, 2008 and December 31, 2007                  | 2                                                                                           |
|                                                                                                  |                                                                                        |
| Consolidated  Statements of Income—Three and Nine Months ended September 30, 2008 and  2007 | 3                                                                                           |
|                                                                                                  |                                                                                        |
| Consolidated  Statements of Cash Flows—Nine Months ended September 30, 2008 and 2007        | 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                                  | 26         |
|                                                                                                  |                                                                                        |
| Item 4.                                                                                               | Controls  and Procedures                                                                    | 26         |
|                                                                                                  |                                                                                        |
| **Part II. Other  Information**                                                                  |                                                                                        |
|                                                                                                  |                                                                                        |
| Item 1a.                                                                                              | Risk Factors                                                                                | 27         |
|                                                                                                  |                                                                                        |
| Item 6.                                                                                               | Exhibits                                                                                    | 32         |
|                                                                                                  |                                                                                        |
| **Signatures**                                                                                        | 33                                                                                          |
|                                                                                                       |                                                                                             |            |  |

 

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**COVANCE INC. ANDSUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETSSEPTEMBER 30, 2008 AND DECEMBER 31, 2007**

** **
| ** **                                                                                                                                                                                                                                 | ** ** | **September 30,** | ** **   | **December 31,** | ** **   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|--------------|-----------------------|--------------|
| **(Dollars in thousands)**                                                                                                                                                                                                       | ** ** | **2008**               | ** **   | **2007**              | ** **   |
| ** **                                                                                                                                                                                                                                 | ** ** | **(UNAUDITED)**        | ** **   | ** **            | ** **   |
| **Assets**                                                                                                                                                                                                                                 |       |                   |         |                  |         |
| Current Assets:                                                                                                                                                                                                                            |       |                   |         |                  |         |
| Cash and cash  equivalents                                                                                                                                                                                                                 |       | $                      | 209,094      |                  | $            | 319,485 |   |
| Accounts  receivable                                                                                                                                                                                                                       |       | 240,761                |         | 217,657               |         |
| Unbilled  services                                                                                                                                                                                                                         |       | 103,960                |         | 88,835                |         |
| Inventory                                                                                                                                                                                                                                  |       | 67,644                 |         | 54,788                |         |
| Deferred income  taxes                                                                                                                                                                                                                     |       | 9,997                  |         | 7,825                 |         |
| Prepaid expenses  and other current assets                                                                                                                                                                                                 |       | 89,324                 |         | 81,467                |         |
| Total Current  Assets                                                                                                                                                                                                                      |       | 720,780                |         | 770,057               |         |
| Property and  equipment, net                                                                                                                                                                                                               |       | 790,429                |         | 646,040               |         |
| Goodwill, net                                                                                                                                                                                                                              |       | 105,486                |         | 105,486               |         |
| Other assets                                                                                                                                                                                                                               |       | 38,211                 |         | 38,602                |         |
| Total Assets                                                                                                                                                                                                                               |       | $                      | 1,654,906    |                  | $            | 1,560,185 |   |
|                                                                                                                                                                                                                                       |       |                   |         |                  |         |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                             |       |                   |         |                  |         |
| Current  Liabilities:                                                                                                                                                                                                                      |       |                   |         |                  |         |
| Accounts payable                                                                                                                                                                                                                           |       | $                      | 44,677       |                  | $            | 32,252 |   |
| Accrued payroll  and benefits                                                                                                                                                                                                              |       | 91,450                 |         | 95,313                |         |
| Accrued expenses  and other current liabilities                                                                                                                                                                                            |       | 64,500                 |         | 66,838                |         |
| Unearned revenue                                                                                                                                                                                                                           |       | 145,701                |         | 144,870               |         |
| Short-term debt                                                                                                                                                                                                                            |       | 23,000                 |         | 3⁄4                |         |
| Income taxes  payable                                                                                                                                                                                                                      |       | 27,734                 |         | 18,887                |         |
| Total Current Liabilities                                                                                                                                                                                                                  |       | 397,062                |         | 358,160               |         |
| Deferred income  taxes                                                                                                                                                                                                                     |       | 29,111                 |         | 32,562                |         |
| Other  liabilities                                                                                                                                                                                                                         |       | 58,694                 |         | 59,275                |         |
| Total  Liabilities                                                                                                                                                                                                                         |       | 484,867                |         | 449,997               |         |
| 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 September 30, 2008 and December 31, 2007                                                                   |       | 3⁄4                 |         | 3⁄4                |         |
| Common Stock -  Par value $0.01 per share; 140,000,000 shares authorized; 75,348,104 and  74,590,229 shares issued and outstanding, including those held in treasury, at  September 30, 2008 and December 31, 2007, respectively |       | 753                    |    | 746                   |    |
| Paid-in capital                                                                                                                                                                                                                            |       | 543,572                |         | 492,373               |         |
| Retained earnings                                                                                                                                                                                                                          |       | 1,084,188              |         | 933,106               |         |
| Accumulated  other comprehensive income                                                                                                                                                                                                    |       | 12,321                 |         | 24,154                |         |
| Treasury stock  at cost (12,094,980 and 10,548,248 shares at September 30, 2008 and  December 31, 2007, respectively)                                                                                                            |       | (470,795               | )            | (340,191              | )            |
| Total  Stockholders’ Equity                                                                                                                                                                                                           |       | 1,170,039              |         | 1,110,188             |         |
| Total  Liabilities and Stockholders’ Equity                                                                                                                                                                                           |       | $                      | 1,654,906    |                  | $            | 1,560,185 |   |

 

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

 

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**COVANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOMEFOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007**

**(UNAUDITED)**

** **
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September 30**            | ** ** | **September 30**           | ** ** |
| **(Dollars in thousands, except per share data)** | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                            |       |                             |       |                            |       |   |   |   |   |   |   |   |   |
| Net revenues                                                                    |       | $                                | 440,109    |                            | $          | 395,989 |   | $ | 1,289,453 |   | $ | 1,135,453 |   |
| Reimbursable  out-of-pockets                                                    |       | 27,263                           |       | 18,712                          |       | 73,779 |   | 60,361 |   |
| Total revenues                                                                  |       | 467,372                          |       | 414,701                         |       | 1,363,232 |   | 1,195,814 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Cost and  expenses:                                                             |       |                             |       |                            |       |   |   |   |   |
| Cost of revenue  (excluding depreciation and amortization)                      |       | 287,804                          |       | 258,355                         |       | 848,018 |   | 743,812 |   |
| Reimbursed  out-of-pocket expenses                                              |       | 27,263                           |       | 18,712                          |       | 73,779 |   | 60,361 |   |
| Selling, general  and administrative (excluding depreciation and amortization)  |       | 64,850                           |       | 61,089                          |       | 189,109 |   | 174,972 |   |
| Depreciation and  amortization                                                  |       | 17,493                           |       | 16,447                          |       | 52,172 |   | 49,015 |   |
| Total costs and  expenses                                                       |       | 397,410                          |       | 354,603                         |       | 1,163,078 |   | 1,028,160 |   |
| Income from  operations                                                         |       | 69,962                           |       | 60,098                          |       | 200,154 |   | 167,654 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Other (income)  expense, net:                                                   |       |                             |       |                            |       |   |   |   |   |
| Interest income                                                                 |       | (1,916                           | )          | (2,415                          | )          | (6,689 | ) | (7,150 | ) |
| Interest expense                                                                |       | 385                              |       | 117                             |       | 1,061 |   | 379 |   |
| Foreign exchange  transaction (gain) loss, net                                  |       | 730                              |       | (284                            | )          | (816 | ) | (238 | ) |
| Gain on sale of  business                                                       |       | 3⁄4                           |       | 3⁄4                          |       | (3,927 | ) | 3⁄4 |   |
| Other income,  net                                                              |       | (801                             | )          | (2,582                          | )          | (10,371 | ) | (7,009 | ) |
| Income before  taxes and equity investee earnings                               |       | 70,763                           |       | 62,680                          |       | 210,525 |   | 174,663 |   |
| Taxes on income                                                                 |       | 20,167                           |       | 18,469                          |       | 61,220 |   | 51,326 |   |
| Equity investee  earnings                                                       |       | 511                              |       | 403                             |       | 1,777 |   | 1,683 |   |
| Net income                                                                      |       | $                                | 51,107     |                            | $          | 44,614 |   | $ | 151,082 |   | $ | 125,020 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Basic earnings  per share                                                       |       | $                                | 0.81       |                            | $          | 0.70 |   | $ | 2.40 |   | $ | 1.96 |   |
| Weighted average  shares outstanding - basic                                    |       | 63,055,229                       |       | 63,711,628                      |       | 63,065,488 |   | 63,718,720 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Diluted earnings  per share                                                     |       | $                                | 0.80       |                            | $          | 0.69 |   | $ | 2.36 |   | $ | 1.93 |   |
| Weighted average  shares outstanding – diluted                             |       | 63,994,532                       |       | 64,728,253                      |       | 64,052,224 |   | 64,758,890 |   |

 

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

 

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**COVANCE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWSFOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007**

**(UNAUDITED)**

** **
| ** **                                                                                    | ** ** | **Nine Months Ended September 30** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| **(Dollars in thousands)**                                                          | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| ** **                                                                                    | ** ** | ** **                                             | ** ** | ** ** | ** ** |
| Cash flows from  operating activities:                                                        |       |                                                   |       |   |   |
| Net income                                                                                    |       | $                                                      | 151,082    |   | $ | 125,020 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:            |       |                                                   |       |   |   |
| Depreciation and  amortization                                                                |       | 52,172                                                 |       | 49,015 |   |
| Non-cash  compensation expense associated with employee benefit and stock compensation  plans |       | 19,190                                                 |       | 21,472 |   |
| Deferred income  tax (benefit) provision                                                      |       | (5,623                                                 | )          | (2,475 | ) |
| Gain on sale of  business                                                                     |       | (3,927                                                 | )          | 3⁄4 |   |
| Loss (gain) on  sale of property and equipment                                                |       | 795                                                    |       | (1,740 | ) |
| Equity investee  earnings                                                                     |       | (1,777                                                 | )          | (1,683 | ) |
| Changes in  operating assets and liabilities:                                                 |       |                                                   |       |   |   |
| Accounts  receivable                                                                          |       | (23,104                                                | )          | (17,007 | ) |
| Unbilled  services                                                                            |       | (15,125                                                | )          | (15,851 | ) |
| Inventory                                                                                     |       | (12,856                                                | )          | (5,161 | ) |
| Accounts payable                                                                              |       | 12,425                                                 |       | 6,963 |   |
| Accrued  liabilities                                                                          |       | (5,818                                                 | )          | 18,901 |   |
| Unearned revenue                                                                              |       | 831                                                    |       | 12,616 |   |
| Income taxes payable                                                                          |       | 11,322                                                 |       | (749 | ) |
| Other assets and  liabilities, net                                                            |       | (6,361                                                 | )          | (13,222 | ) |
| Net cash  provided by operating activities                                                    |       | 173,226                                                |       | 176,099 |   |
| Cash flows from  investing activities:                                                        |       |                                                   |       |   |   |
| Capital  expenditures                                                                         |       | (206,179                                               | )          | (104,820 | ) |
| Proceeds from  sale of business                                                               |       | 3,927                                                  |       | 3⁄4 |   |
| Other, net                                                                                    |       | 366                                                    |       | 111 |   |
| Net cash used in  investing activities                                                        |       | (201,886                                               | )          | (104,709 | ) |
| Cash flows from  financing activities:                                                        |       |                                                   |       |   |   |
| Net borrowings  under revolving credit facility                                               |       | 23,000                                                 |       | 3⁄4 |   |
| Stock issued  under employee stock purchase and option plans                                  |       | 29,158                                                 |       | 25,948 |   |
| Purchase of  treasury stock                                                                   |       | (130,604                                               | )          | (61,562 | ) |
| Net cash used in  financing activities                                                        |       | (78,446                                                | )          | (35,614 | ) |
|                                                                                          |       |                                                   |       |   |   |
| Effect of  exchange rate changes on cash                                                      |       | (3,285                                                 | )          | 4,245 |   |
| Net change in  cash and cash equivalents                                                      |       | (110,391                                               | )          | 40,021 |   |
|                                                                                          |       |                                                   |       |   |   |
| Cash and cash  equivalents, beginning of period                                               |       | 319,485                                                |       | 219,810 |   |
|                                                                                          |       |                                                   |       |   |   |
| Cash and cash  equivalents, end of period                                                     |       | $                                                      | 209,094    |   | $ | 259,831 |   |

 

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

 

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** **

**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unless otherwise indicated)**

** **

**1.  Basis ofPresentation**

** **

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with U.S. generally accepted accounting principles (“GAAP”) forinterim financial information and with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they donot include all of the information and footnotes required by GAAP for completefinancial statements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals) considerednecessary for a fair presentation have been included.  Operating results for the three and ninemonths ended September 30, 2008 are not necessarily indicative of theresults that may be expected for the year ending December 31, 2008.  The balance sheet at December 31, 2007has been derived from the audited financial statements at that date but doesnot include all of the information and footnotes required by GAAP for completefinancial statements.  You should readthese unaudited consolidated financial statements together with the historicalconsolidated financial statements of Covance Inc. and subsidiaries (“Covance”or the “Company”) for the years ended December 31, 2007, 2006, and 2005included in our Annual Report on Form 10-K for the year ended December 31,2007.

 

**2.  Summaryof Significant Accounting Policies**

 

**Principles ofConsolidation**

** **

Theseunaudited consolidated financial statements include the accounts of allentities controlled by Covance.  Allsignificant intercompany accounts and transactions are eliminated.  The equity method of accounting is used forinvestments in affiliates in which Covance owns between 20 and 50 percent orhas the ability to exercise influence over operating or financial decisions, but,in each case, does not have the ability to exercise control.  See Note 4.

 

**Use of Estimates**

** **

Theseunaudited consolidated financial statements have been prepared in conformitywith GAAP, which requires management to make estimates and assumptions aboutfuture events that affect the reported amounts of assets and liabilities,disclosure of contingent assets and liabilities at the date of the financialstatements, and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from these estimates.

 

**Inventory**

 

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

 

**Prepaid Expenses and Other Current Assets**

** **

Inconnection with the management of multi-site clinical trials, Covance pays onbehalf of its customers fees to investigators, volunteers and otherout-of-pocket costs (such as travel, printing, meetings, couriers, etc.), forwhich we are reimbursed at cost, without mark-up or profit. Amounts receivablefrom customers in connection with billed and unbilled investigator fees,volunteer payments and other out-of-pocket pass-through costs are included inprepaid expenses and other current assets in the accompanying consolidatedbalance sheets and totaled $46.8 million and $47.4 million at September 30,2008 and December 31, 2007, respectively. See Note 2 “Reimbursable Out-of-Pocket Expenses”.

 

**Goodwill and Other Intangible Assets and Impairment**

** **

Goodwillrepresents costs in excess of the fair value of net tangible and identifiablenet intangible assets acquired in business combinations. In accordance withStatement of Financial Accounting Standards No. 142, *Goodwill andOther Intangible Assets*, Covance performs an annual test forimpairment of goodwill and other indefinite lived intangible assets during thefourth quarter. This test is performed by comparing, at the reporting unitlevel, the carrying value of the reporting unit to its fair value. Covanceassesses fair value based upon its best estimate of the present value of thefuture cash flows that it expects to be generated by the reporting unit. Themost recent annual test for impairment performed for 2007 did not identify anyinstances of impairment and there were no events through September 30,2008 that warranted a reconsideration of our impairment test results.

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unless otherwise indicated)**

** **

**Revenue Recognition**

** **

Covance recognizesrevenue either as services are performed or products are delivered, dependingon the nature of the work contracted. Historically, a majority of Covance’s netrevenues have been earned under contracts which range in duration from a fewmonths to two years, but can extend in duration up to five years orlonger.  Service contracts generally takethe form of fee-for-service or fixed-price arrangements. In cases whereperformance spans multiple accounting periods, revenue is recognized asservices are performed, measured on a proportional performance basis, generallyusing output measures that are specific to the service provided.  Examples of output measures in our earlydevelopment segment include the number of slides read, dosings performed, orspecimens prepared for preclinical laboratory services, or number of dosings ornumber of volunteers enrolled for clinical pharmacology. Examples of outputmeasures in our late-stage development segment’s clinical development serviceoffering include among others, number of investigators enrolled, number ofsites initiated, number of patients enrolled and number of monitoring visitscompleted. Revenue is determined by dividing the actual units of work completedby the total units of work required under the contract and multiplying thatpercentage by the total contract value. The total contract value, or total contractualpayments, represents the aggregate contracted price for each of the agreed uponservices to be provided.  We do not haveany contractual arrangements spanning multiple accounting periods where revenueis recognized on a proportional-performance basis under which we have earnedmore than an immaterial amount of performance-based revenue (i.e. potentialadditional revenue tied to specific deliverables or performance).  Changes in the scope of work are common, especiallyunder long-term contracts, and generally result in a change in contract value.Once the client has agreed to the changes in scope and renegotiated pricingterms, the contract value is amended and revenue is recognized as describedabove. Estimates of costs to complete are made to provide, where appropriate,for losses expected on contracts. Costs are not deferred in anticipation ofcontracts being awarded, but instead are expensed as incurred.

 

Billing schedules andpayment terms are generally negotiated on a contract-by-contract basis. In somecases, we bill the client for the total contract value in progress-basedinstallments as we reach certain non-contingent billing milestones over thecontract duration, such as, but not limited to, contract signing, initialdosing, investigator site initiation, patient enrollment or database lock.  The term “billing milestone” relates only toa billing trigger in a contract whereby amounts become billable and payable inaccordance with a negotiated predetermined billing schedule throughout the termof a project.  These billing milestonesare not performance-based (i.e., potential additional arrangement considerationtied to specific deliverables or performance). In other cases, billing and payment terms are tied to the passage oftime (e.g., monthly billings).  In eithercase, the total contract value and aggregate amounts billed to the client wouldbe the same at the end of the project. While we attempt to negotiate terms that provide for billing and paymentof services prior to or within close proximity to the provision of services,this is not always the case, as evidenced by fluctuations in the levels ofunbilled receivables and unearned revenue from period to period.  While a project is ongoing, cash payments arenot necessarily representative of aggregate revenue earned at any particularpoint in time, as revenues are recognized when services are provided, whileamounts billed and paid are in accordance with the negotiated billing andpayment terms.

 

In some cases, paymentsreceived are in excess of revenue recognized. For example, a contract invoicing schedule may provide for an upfrontpayment of 10% of the full contract value upon contract signing, but at thetime of signing, performance of services has not yet begun, and therefore, norevenue has yet been recognized. Payments received in advance of services being provided, such as in thisexample, are deferred as unearned revenue on the balance sheet. As thecontracted services are subsequently performed and the associated revenue isrecognized, the unearned revenue balance is reduced by the amount of revenuerecognized during the period.

 

In other cases, services may be provided and revenueis recognized before we have invoiced the client.  In these cases, revenue recognized willexceed amounts billed, and the difference, representing an unbilled receivable,is recorded for this amount that is currently unbillable to the customerpursuant to contractual terms.  Once wehave invoiced the client, the unbilled receivable is reduced for the amountbilled, and a corresponding account receivable is recorded. All unbilledreceivables are billable to customers within one year from the respectivebalance sheet date.

 

Mostcontracts are terminable by the client either immediately or upon notice. Thesecontracts typically require payment to Covance of expenses to wind down thestudy, fees earned to date and, in some cases, a termination fee or a paymentto Covance of some portion of the fees or profits that could have been earnedby Covance under the contract if it had not been terminated

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

early. Termination fees are included in net revenueswhen realization is assured. 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.

 

**Taxes on Income**

 

Covance uses the asset and liability method ofaccounting for income taxes.  Under thismethod, deferred tax assets and liabilities are recognized for the expectedfuture tax consequences of differences between the carrying amount of assetsand liabilities and their respective tax bases using enacted tax rates ineffect for the year in which the temporary differences are expected toreverse.  The effect on deferred taxes ofa change in enacted tax rates is recognized in income in the period when thechange is effective.

 

TheCompany accounts for uncertain income tax positions in accordance with theprovisions of Financial Accounting Standards Board Interpretation No. 48, *Accounting for Uncertainty in Income Taxes – anInterpretation of FASB Statement No. 109* (“FIN 48”).  Under the guidance of FIN 48, theCompany may recognize the tax benefit from an uncertain tax position only if itis more likely than not to be sustained upon examination based on the technicalmerits of the position. The amount of the accrual for which an exposure existsis measured as the largest amount of benefit determined on a cumulativeprobability basis that the Company believes is more likely than not to berealized upon ultimate settlement of the position.  Components of the reserve are classified aseither a current or long-term liability in the consolidated balance sheet basedon when the Company expects each of the items to be settled.  Covance records interest and penaltiesaccrued in relation to unrecognized tax benefits as a component of income taxexpense.

 

As of September 30,2008, the balance of the reserve for unrecognized tax benefits is$10.3 million, of which $3.2 million is recorded as a currentliability in accrued expenses and other current liabilities, and$7.1 million is recorded as a long-term liability in other liabilities onthe consolidated balance sheet, including accrued interest of$1.5 million.  As of December 31,2007, the balance of the reserve for unrecognized tax benefits was$8.9 million, of which $2.6 million was recorded as a currentliability in accrued expenses and other current liabilities, and$6.3 million was recorded as a long-term liability in other liabilities onthe consolidated balance sheet, including accrued interest of $1.3 million.  This reserve relates to exposures for incometax matters such as transfer pricing, nexus, deemed income and research anddevelopment credits.

 

TheCompany also maintains a tax reserve related to exposures for non-income taxmatters including value-added tax and state sales and use and other taxes,which are accounted for in accordance with Statement of Financial AccountingStandards No. 5, *Accounting forContingencies*. The balance of this reserve at September 30,2008 and December 31, 2007 is $0.9 million and $0.8 million,respectively, and is recorded as a current liability in accrued expenses andother current liabilities on the consolidated balance sheet.

 

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 may be settled at amountsdifferent than the amounts reserved. It is also possible that changes in factsand circumstances could cause Covance to either materially increase or reducethe carrying amount of its tax reserve.

 

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 accumulatedforeign earnings in the fourth quarter of 2005, Covance intends to continue toleave its unremitted foreign earnings invested indefinitely outside the UnitedStates.  As a result, taxes have not beenprovided on any of the remaining accumulated foreign unremitted earnings as of September 30,2008.

 

7

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Tableof Contents

 

**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

**Comprehensive Income**

 

Covance’s total comprehensive income, which represents net income plusthe change in the cumulative translation adjustment equity account for theperiods presented, was $23.3 million and $54.0 million for the threemonths ended September 30, 2008 and 2007, respectively, and$139.2 million and $135.8 million for the nine months ended September 30,2008 and 2007, respectively.

 

**Reimbursable Out-of-Pocket Expenses**

** **

Asdiscussed in Note 2 “Prepaid Expenses and Other Current Assets”, Covance payson behalf of its customers fees to investigators, volunteers and otherout-of-pocket costs for which we are reimbursed at cost, without mark-up orprofit.  In connection with therequirements of Financial Accounting Standards Board Emerging Issues Task ForceRule No. 01-14 (“EITF 01-14”), *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred*, amounts paid to volunteers and other out-of-pocket costsare reflected in operating expenses, while the reimbursements received arereflected in revenues in the consolidated statements of income.  Covance will continue to exclude from revenueand expense in the consolidated statements of income fees paid to investigatorsand the associated reimbursement since Covance acts as an agent on behalf ofthe pharmaceutical company sponsors with regard to investigator payments, inaccordance with the Financial Accounting Standards Board Emerging Issues TaskForce Rule No. 99-19 (“EITF 99-19”), *ReportingRevenue Gross as a Principal versus Net as an Agent*.

 

**Stock-BasedCompensation**

 

The Company sponsors several stock-basedcompensation plans pursuant to which non-qualified stock options and restrictedstock awards are granted to eligible employees. These plans are described more fully in Note 8 herein and Note 10 to ouraudited consolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

The Company recognizes stock-based compensationunder the provisions of Statement of Financial Accounting Standards No. 123R,*Share-Based Payments*, (“SFAS 123R”)using the modified prospective transition method.  Under the modified prospective transitionmethod, compensation expense is recognized in the financial statements on a prospectivebasis for (a) all share-based payments granted prior to, but not vested asof January 1, 2006, based upon the grant-date fair value estimated inaccordance 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 ofSFAS 123R.  The grant-date fairvalue of awards expected to vest is expensed on a straight-line basis over thevesting period of the related awards. See Note 8.

 

**Earnings Per Share (“EPS”)**

** **

Basic EPS is computed by dividing net income available to commonstockholders by the weighted average number of shares outstanding during theperiod.  The computation of diluted EPSis similar to the computation of basic EPS, except that the denominator isincreased to include the number of additional common shares that would havebeen outstanding if the dilutive potential common shares had been issued;computed under the treasury stock method in accordance with the requirements ofStatement of Financial Accounting Standards No. 128, *Earnings PerShare*.

 

In computing diluted earnings per share for the three months ended September 30,2008 and 2007, the denominator was increased by 939,303 shares and 1,016,625shares, respectively, and for the nine months ended September 30, 2008 and2007, the denominator was increased by 986,736 shares and 1,040,170 shares,respectively, representing the dilutive effect of stock options outstanding at September 30,2008 and 2007 with exercise prices less than the average market price ofCovance’s common stock during each respective period.  Excluded from the computation of diluted EPSfor the three months ended September 30, 2008 were options to purchase2,730 shares of common stock at a price of $94.34 per share because theexercise prices of such options were greater than the average market price ofCovance’s common stock during this period. Excluded from the computation of diluted EPS for the nine months endedSeptember 30, 2008 were options to purchase 3,978 shares of common stock atprices ranging from $87.33 to $94.34 per share because the exercise prices ofsuch options were greater than 

 

8

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Tableof Contents

 

**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

the average market price of Covance’s common stockduring this period.  Excluded from thecomputation of diluted EPS for the three months ended September 30, 2007were options to purchase 1,200 shares of common stock at prices ranging from$73.32 to $77.90 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 nine months ended September 30, 2007 were options topurchase 10,789 shares of common stock at prices ranging from $66.55 to $77.90per share because the exercise prices of such options were greater than theaverage market price of Covance’s common stock during this period.

 

**Supplemental Cash Flow Information**

 

Cashpaid for interest for the nine month periods ended September 30, 2008 and2007 totaled $0.9 million and $0.2 million, respectively. Cash paidfor income taxes for the nine month periods ended September 30, 2008 and2007 totaled $44.5 million and $51.5 million, respectively.  The change in income taxes payable in theconsolidated statement of cash flows for the nine months ended September 30,2008 and 2007 includes as an operating cash outflow the excess tax benefitreceived from the exercise of non-qualified stock options as measured underSFAS 123R of $7.2 million and $4.3 million, respectively (acorresponding cash inflow of $7.2 million and $4.3 million, respectively,has been included in financing cash flows).

 

**RecentlyIssued Accounting Standards**

 

In September 2006, the Financial AccountingStandards Board (the “FASB”) issued Statement of Financial Accounting StandardsNo. 158, *Employers’ Accounting forDefined Benefit Pension and Other Postretirement Plans, an amendment of FASBStatements No. 87, 88, 106 and 132(R)*, (“SFAS 158”). As of December 31,2006, Covance has adopted the recognition and disclosure provisions of SFAS158, which require an employer to recognize the over funded or under fundedstatus of its defined benefit postretirement plans – measured as the differencebetween the fair value of plan assets and the projected benefit obligation - asan asset or liability, respectively, in its balance sheet and to recognizechanges in the funded status of the plan in the year in which such changesoccur through other comprehensive income. The adoption of SFAS 158 did not havean impact on our consolidated results of operations. SFAS 158 also requires,effective for fiscal years ending after December 15, 2008, that themeasurement of the over funded or under funded status of a plan be made as ofthe employer’s fiscal year end and not as of an earlier measurement date.  Covance will be required to conform themeasurement dates of its plans to December 31st for its fiscalyear ending December 31, 2008. Covance does not expect this change inmeasurement dates to have a material impact on its consolidated results ofoperations or financial position.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), *Business Combinations* (“SFAS 141R”) which replaces SFASNo. 141, *Business Combinations*.  The scope of SFAS 141R is broader thanthat of SFAS No. 141, which applied only to business combinations in whichcontrol was obtained by transferring consideration.  SFAS 141R revises accounting andreporting standards for business combinations and applies to all transactionsor other events in which an entity obtains control of one or more businesses bytransferring consideration as well as combinations achieved without thetransfer of consideration. By applying the same method of accounting – theacquisition method – to all transactions and other events in which one entityobtains control over one or more other businesses, this statement is intendedto improve the comparability of the information about business combinationsprovided in financial reports. SFAS 141R applies prospectively to business combinations with anacquisition date on or after the beginning of the first annual reporting periodbeginning on or after December 15, 2008. Beginning January 1, 2009, Covance will adopt SFAS 141R and the impactof implementing this statement will depend on the nature and significance ofbusiness combinations consummated that would be subject to this statement.

 

On February 12, 2008, the FASB issued FASB StaffPosition 157-2 (“FSP 157-2”), which delays the effective date of theapplication of SFAS No. 157, *Fair ValueMeasurements,* (“SFAS 157”) to fiscal years beginning after November 15,2008 for all non-financial assets and liabilities that are recognized ordisclosed at fair value in the financial statements on a non-recurringbasis.  Covance’s assets and liabilitiessubject to the provisions of SFAS 157 are limited to non-recurringnon-financial assets such as goodwill and other indefinite lived intangibleassets measured at fair value for impairment testing.  As such, the adoption of SFAS 157, as amendedby FSP 157-2, is deferred until our fiscal year beginning January 1,2009.  Covance does not expect theadoption of SFAS 157, as amended, to have a material impact on its consolidatedresults of operations or financial position.

 

9

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

**3.  TreasuryStock**

 

In February 2007,the Covance Board of Directors authorized the repurchase of an additional3.0 million shares under Covance’s stock repurchase program.  At September 30, 2008, there areapproximately 0.8 million shares remaining for purchase under the 2007authorization.  Covance also reacquiresshares of its common stock in connection with certain employee benefit plansprimarily when employees tender shares to satisfy income tax withholdingsassociated with the vesting of stock awards. The following table sets forth the treasury stock activity during thenine month periods ended September 30, 2008 and 2007.

 
| ** **                              | ** ** | **Nine Months Ended September 30** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                              | ** ** | **2008**                                               | ** ** | **2007** | ** ** |
| **(amounts in thousands)**    | ** ** | **$**                                                  | ** ** | **# shares** | ** ** | **$** | ** ** | **# shares** | ** ** |
| Shares  repurchased in connection with: |       |                                                   |       |   |   |   |   |   |   |
| Board approved  buyback programs        |       | $                                                      | 126,709    |   | 1,500.0 |   | $ | 59,628 |   | 977.0 |   |
| Employee benefit  plans                 |       | 3,895                                                  |       | 46.7 |   | 1,934 |   | 30.6 |   |
| Total                                   |       | $                                                      | 130,604    |   | 1,546.7 |   | $ | 61,562 |   | 1,007.6 |   |

** **

**4.  EquityMethod Investees**

** **

Covance has a minority equity position in Noveprim Limited (“Noveprim”),an existing supplier of research products, which was acquired in March 2004at a total cost of $20.7 million.  Theexcess of the purchase price over the underlying equity in Noveprim’s netassets at the date of acquisition of $13.8 million represents goodwill and isincluded in the carrying value of Covance’s investment.  This investment is reflected in other assetson the consolidated balance sheet. During the three and nine month periods ended September 30, 2008,Covance recognized $0.3 million and $1.3 million, respectively,representing its share of Noveprim’s earnings, less the elimination of profiton inventory purchased from Noveprim and still on hand at Covance at September 30,2008.  During the three and nine monthperiods ended September 30, 2007, Covance recognized $0.3 million and$1.4 million, respectively, representing its share of Noveprim’s earnings,less the elimination of profit on inventory purchased from Noveprim and stillon hand at Covance at September 30, 2007. The carrying value of Covance’s investment in Noveprim at September 30,2008 and December 31, 2007 was $22.8 million and $23.2 million,respectively.

 

Covance has a minority equity position in Bio-Imaging Technologies, Inc.(“BITI”).  BITI uses proprietary medicalimaging technologies to process and analyze medical images, and also providesother services, including the data-basing and regulatory submission of medicalimages, quantitative data and text. During the three and nine month periods ended September 30, 2008,Covance recognized $0.2 million and $0.5 million, respectively,representing its pro rata share of BITI’s earnings.  During the three and nine month periods endedSeptember 30, 2007, Covance recognized $0.1 million and$0.3 million, respectively, representing its pro rata share of BITI’searnings.  The carrying value of Covance’sinvestment in BITI as of September 30, 2008 and December 31, 2007 was$1.4 million and $0.9 million, respectively, while the fair marketvalue was $18.2 million and $19.0 million, respectively.

 

**5.  Divestiture**

** **

On November 28,2007, Covance sold its centralized ECG business (“Cardiac Safety Services”),part of Covance’s late stage development segment, to eResearchTechnology Inc. (“eRT”)and simultaneously therewith entered into a ten year marketing agreement witheRT under which Covance will continue to offer its clients cardiac safety services.  Covance received initial cash proceeds of$35.2 million in connection with the sale and recorded a pre-tax gain of$6.6 million ($4.1 million after tax) during the quarter ended December 31,2007.  During the three months ended September 30,2008, there were no additional proceeds from this sale reflecting contingentconsideration related to transferred backlog and therefore no additionalpre-tax gain was recognized in this period. During the nine months ended September 30, 2008, Covance receivedadditional proceeds from this sale reflecting contingent consideration relatedto transferred backlog totaling $3.9 million and recognized an additionalpre-tax gain of $3.9 million ($2.6 million after tax).  Covance may receive up to approximately$8.6 million in

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

additional future contingent consideration relating totransferred backlog and revenues generated by eRT from new contracts securedunder the first three years of the marketing agreement.  In addition, Covance expects to receivereferral fees during the term of the long-term marketing agreement.

 

**6. Short-Term Debt**

 

In August 2008,Covance elected to expand its revolving credit facility (the “Credit Facility”)to $125.0 million.  At September 30,2008, there were $23.0*** ***millionof outstanding borrowings and $1.1 million of outstanding letters ofcredit under the Credit Facility.  At December 31,2007, there were no outstanding borrowings and $1.1 million of outstandingletters of credit under the Credit Facility. Interest on all outstanding borrowings under the Credit Facility isbased upon the London Interbank Offered Rate (“LIBOR”) plus a 75 basispoint margin and approximated 3.23% and 3.33% per annum during the three andnine months ended September 30, 2008, respectively.  The Credit Facility, which expires in June 2009,contains various financial and other covenants and is collateralized byguarantees of certain of Covance’s domestic subsidiaries and a pledge of 65percent of the capital stock of certain of Covance’s foreign subsidiaries.  At September 30, 2008, Covance was incompliance with the terms of the Credit Facility.

 

**7.  DefinedBenefit Plans**

** **

Covance sponsorsvarious pension and other post-retirement benefit plans.

 

**Defined Benefit Pension Plans**

 

Covancesponsors two defined benefit pension plans for the benefit of its employees attwo United Kingdom subsidiaries and one defined benefit pension plan for thebenefit of its employees at a German subsidiary, all of which are legacy plansof previously acquired companies. Benefit amounts for all three plans are based upon years of service andcompensation.  The German plan isunfunded while the United Kingdom plans are funded.  Covance’s funding policy has been tocontribute annually a fixed percentage of the eligible employee’s salary atleast equal to the local statutory funding requirements.  Pension plan assets are administered by theplans’ trustees and are principally invested in equity and debtsecurities.  The components of netperiodic pension expense for these plans for the three and nine month periodsended September 30, 2008 and 2007 are as follows:

 
| ** **                                                | ** ** | **United Kingdom Plans**                      | ** ** | **German Plan**                                    | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended September 30** | ** ** | **Three Months Ended September 30** | ** ** |
| ** **                                                | ** ** | **2008**                                                | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Components of  Net Periodic Pension Cost:                 |       |                                                    |       |                                                    |       |   |   |   |   |
| Service cost                                              |       | $                                                       | 1,268      |                                                    | $          | 1,495 |   | $ | 136 |   | $ | 128 |   |
| Interest cost                                             |       | 1,897                                                   |       | 1,885                                                   |       | 127 |   | 97 |   |
| Expected return  on plan assets                           |       | (2,153                                                  | )          | (2,165                                                  | )          | — |   | — |   |
| Amortization of  net actuarial loss                       |       | 294                                                     |       | 358                                                     |       | 11 |   | 16 |   |
| Participant  contributions                                |       | (484                                                    | )          | (565                                                    | )          | — |   | — |   |
| Net periodic  pension cost                                |       | $                                                       | 822        |                                                    | $          | 1,008 |   | $ | 274 |   | $ | 241 |   |
|                                                      |       |                                                    |       |                                                    |       |   |   |   |   |
| Assumptions Used  to Determine Net Periodic Pension Cost: |       |                                                    |       |                                                    |       |   |   |   |   |
| Discount rate                                             |       | 5.50                                                    | %          | 5.25                                                    | %          | 5.60 | % | 4.65 | % |
| Expected rate of  return on assets                        |       | 6.75                                                    | %          | 6.75                                                    | %          | n/a |   | n/a |   |
| Salary increases                                          |       | 4.25                                                    | %          | 4.00                                                    | %          | 3.00 | % | 2.50 | % |
|                                                           |            |                                                         |            |                                                         |            |  |  |  |  |  |  |  |  |  |

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 
| ** **                                                | ** ** | **United Kingdom Plans**                     | ** ** | **German Plan**                                   | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                | ** ** | **Nine Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
| ** **                                                | ** ** | **2008**                                               | ** ** | **2007**                                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Components of  Net Periodic Pension Cost:                 |       |                                                   |       |                                                   |       |   |   |   |   |
| Service cost                                              |       | $                                                      | 4,030      |                                                   | $          | 4,441 |   | $ | 428 |   | $ | 373 |   |
| Interest cost                                             |       | 6,035                                                  |       | 5,595                                                  |       | 404 |   | 278 |   |
| Expected return  on plan assets                           |       | (6,847                                                 | )          | (6,427                                                 | )          | — |   | — |   |
| Amortization of  net actuarial loss                       |       | 931                                                    |       | 1,063                                                  |       | 36 |   | 51 |   |
| Participant  contributions                                |       | (1,542                                                 | )          | (1,675                                                 | )          | — |   | — |   |
| Net periodic  pension cost                                |       | $                                                      | 2,607      |                                                   | $          | 2,997 |   | $ | 868 |   | $ | 702 |   |
|                                                      |       |                                                   |       |                                                   |       |   |   |   |   |
| Assumptions Used  to Determine Net Periodic Pension Cost: |       |                                                   |       |                                                   |       |   |   |   |   |
| Discount rate                                             |       | 5.50                                                   | %          | 5.25                                                   | %          | 5.60 | % | 4.65 | % |
| Expected rate of  return on assets                        |       | 6.75                                                   | %          | 6.75                                                   | %          | n/a |   | n/a |   |
| Salary increases                                          |       | 4.25                                                   | %          | 4.00                                                   | %          | 3.00 | % | 2.50 | % |

## ** **

## **SupplementalExecutive Retirement Plan**

## ** **

In addition to theseforeign defined benefit pension plans, Covance also has a non-qualifiedSupplemental Executive Retirement Plan (“SERP”).  The SERP, which is not funded, is intended toprovide retirement benefits for certain executive officers of Covance.  Benefit amounts are based upon years ofservice and compensation of the participating employees.  The components of net periodic pension costfor the three and nine month periods ended September 30, 2008 and 2007 areas follows:

 
| ** **                                                | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                | ** ** | **2008**                                                | ** ** | **2007**                                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Components of  Net Periodic Pension Cost:                 |       |                                                    |       |                                                   |       |   |   |   |   |
| Service cost                                              |       | $                                                       | 309        |                                                   | $          | 271 |   | $ | 926 |   | $ | 814 |   |
| Interest cost                                             |       | 217                                                     |       | 193                                                    |       | 651 |   | 579 |   |
| Amortization of  prior service cost                       |       | (30                                                     | )          | 19                                                     |       | (89 | ) | 57 |   |
| Amortization of  net actuarial loss                       |       | 27                                                      |       | 10                                                     |       | 80 |   | 31 |   |
| Net periodic  pension cost                                |       | $                                                       | 523        |                                                   | $          | 493 |   | $ | 1,568 |   | $ | 1,481 |   |
|                                                      |       |                                                    |       |                                                   |       |   |   |   |   |
| Assumptions Used  to Determine Net Periodic Pension Cost: |       |                                                    |       |                                                   |       |   |   |   |   |
| Discount rate                                             |       | 5.50                                                    | %          | 5.50                                                   | %          | 5.50 | % | 5.50 | % |
| Salary increases                                          |       | 4.00                                                    | %          | 4.00                                                   | %          | 4.00 | % | 4.00 | % |

 

## **Post-EmploymentRetiree Health and Welfare Plan**

## ** **

Covance also sponsors apost-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 ona pay-as-you-go basis and the cost of providing these benefits is shared withthe retirees.  The components of netperiodic post-retirement benefits cost for the three and nine month periodsended September 30, 2008 and 2007 are as follows:

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 
| ** **                                                                 | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                                | ** ** | **2007**                                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Components of  Net Periodic Post-retirement Benefits Cost:                 |       |                                                    |       |                                                   |       |   |   |   |   |
| Service cost                                                               |       | $                                                       | 38         |                                                   | $          | 41 |   | $ | 115 |   | $ | 123 |   |
| Interest cost                                                              |       | 82                                                      |       | 70                                                     |       | 244 |   | 210 |   |
| Net periodic  post-retirement benefits cost                                |       | $                                                       | 120        |                                                   | $          | 111 |   | $ | 359 |   | $ | 333 |   |
|                                                                       |       |                                                    |       |                                                   |       |   |   |   |   |
| Assumptions Used  to Determine Net Periodic Post-retirement Benefits Cost: |       |                                                    |       |                                                   |       |   |   |   |   |
| Discount rate                                                              |       | 5.50                                                    | %          | 5.50                                                   | %          | 5.50 | % | 5.50 | % |
| Health care cost  trend rate                                               |       | 9.00                                                    | %(a)       | 9.00                                                   | %(a)       | 9.00 | %(a) | 9.00 | %(a) |

 

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**(a) decreasing to ultimate trend of 5.00% in 2011**

** **

**8.  Stock-Based Compensation Plans**

** **

Covancesponsors several employee stock-based compensation plans which are describedmore fully in Note 10 to our audited consolidated financial statements includedin our Annual Report on Form 10-K for the year ended December 31,2007.

 

In May 2007,Covance’s shareholders approved the 2007 Employee Equity Participation Plan(the “2007 EEPP”) in replacement of the 2002 Employee Equity Participation Plan(the “2002 EEPP”). Effective upon approval of the 2007 EEPP, no further grantsor awards were permitted under the 2002 EEPP. Shares remaining for grant underthe 2002 EEPP will be available for grant under the 2007 EEPP. In addition, theCovance Board of Directors directed that, effective May 3, 2007, nofurther grants would be permitted under the 2002 Employee Stock Option Plan(the “2002 ESOP”) and, unlike the 2002 EEPP, shares remaining for grant underthe 2002 ESOP would not be available for grant under the 2007 EEPP. The 2007EEPP became effective on May 3, 2007 and will expire on May 2,2017.  The 2007 EEPP authorizes theCompensation and Organization Committee of the Board of Directors (the “CompensationCommittee”), or such committee as is appointed by the Covance Board ofDirectors, to administer the 2007 EEPP, to grant awards to employees andconsultants of Covance or entities in which Covance has a controlling orsignificant equity interest.  The 2007EEPP authorizes the Compensation Committee to grant the following awards toeligible employees: options to purchase common stock; stock appreciation rights;and other stock awards either singly or in combination.  The exercise period for stock options grantedunder the 2007 EEPP 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 and stock awards granted under the 2007 EEPP is determined bythe Compensation Committee at the time of grant. Generally, options vest over athree year period for senior executives and over a two year period for allother optionees.  Stock awards generallyvest over a three year period for all employees. The number of shares ofCovance common stock initially available for grant under the 2007 EEPP totaledapproximately 1.6 million plus approximately 3.3 million shares remainingavailable under the 2002 EEPP at the time the 2007 EEPP was approved. All stockoption grants under the 2002 EEPP remaining outstanding are now administered inaccordance with the provisions of the 2002 EEPP out of shares issuable underthe 2007 EEPP. The Company issues authorized but previously unissued shareswhen options are exercised or for stock awards. At September 30, 2008 there were approximately 4.4 millionshares remaining available for grants or awards under the 2007 EEPP, up to1.6 million of which are available for issuance as stock awards.  There have been no grants of stockappreciation rights or grants to consultants of Covance or entities in whichCovance has a controlling or significant equity interest under the 2002 ESOP,the 2002 EEPP or the 2007 EEPP.

 

Thegrant-date fair value of stock option awards is estimated using an optionpricing model as more fully described in Note 10 to our audited consolidatedfinancial statements included in our Annual Report on Form 10-K for theyear ended December 31, 2007.  Thegrant-date fair value of options expected to vest is expensed on astraight-line basis over the vesting period of the related awards.

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

The following table sets forth the weighted-averageassumptions used to calculate the fair value of options granted for the threeand nine month periods ended September 30, 2008 and 2007:

 
| ** **                        | ** ** | **Three Months Ended September 30** | ** ** | **Nine Months Ended September 30** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------|------------|--------------------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                                | ** ** | **2007**                                               | ** ** | **2008** | ** ** | **2007** | ** ** |
| Expected stock  price volatility  |       | 39%                                                     |       | 42%                                                    |       | 39% |   | 42% |   |
| Risk free  interest rate(s)       |       | 1.9% - 3.7%                                             |       | 4.7% - 5.1%                                            |       | 1.9% - 3.7% |   | 4.7% - 5.1% |   |
| Expected life of  options (years) |       | 4.4                                                     |       | 4.3                                                    |       | 4.4 |   | 4.3 |   |

 

Restrictedstock awards are granted subject to certain restrictions, including in somecases service conditions and in other cases service and performanceconditions.  The grant-date fair value ofrestricted stock awards expected to vest, which has been determined based uponthe market value of Covance’s shares on the grant date, is expensed on astraight-line basis over the vesting period of the related awards.

 

Covancealso has an employee stock purchase plan (“ESPP”) pursuant to which Covance maymake available for sale to its employees shares of its common stock at a priceequal to 85% of the lower of the market value on the first or last day of eachcalendar quarter.  The ESPP is intendedto give Covance employees the opportunity to purchase shares of Covance commonstock through payroll deductions.

 

Results of operations for the three month periodended September 30, 2008 include total stock-based compensation expense of$6.7 million ($4.5 million net of tax benefit of $2.2 million),$2.5 million of which has been included in cost of revenue and$4.2 million of which has been included in selling, general and administrativeexpenses.  Results of operations for thenine month period ended September 30, 2008 include total stock-basedcompensation expense of $19.3 million ($13.0 million net of taxbenefit of $6.3 million), $7.3 million of which has been included incost of revenue and $12.0 million of which has been included in selling,general and administrative expenses. Results of operations for the three month period ended September 30,2007 include total stock-based compensation expense of $5.7 million($3.8 million net of tax benefit of $1.9 million), $1.9 millionof which has been included in cost of revenue and $3.8 million of whichhas been included in selling, general and administrative expenses. Results ofoperations for the nine month period ended September 30, 2007 includetotal stock-based compensation expense of $16.8 million($11.3 million net of tax benefit of $5.5 million), $5.8 millionof which has been included in cost of revenue and $11.0 million of whichhas been included in selling, general and administrative expenses.

 

**9.  Segment Information**

** **

Covance has two reportable segments: early development and late-stagedevelopment. Early development services, which includes Covance’s preclinicaland clinical pharmacology service capabilities, involve evaluating a newcompound 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 apharmaceutical company, based on available data, will generally decide whetherto continue further development of a drug. Late-stage development services, which include Covance’s centrallaboratory, clinical development, periapproval and market access services, aregeared toward demonstrating the clinical effectiveness of a compound intreating certain diseases or conditions, obtaining regulatory approval andmaximizing the drug’s commercial potential. The accounting policies of thereportable segments are the same as those described in Note 2.

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS (continued)**

**(UNAUDITED)**

**September 30, 2008 and 2007**

**(dollars in thousands, unlessotherwise indicated)**

 

Segment net revenues, operating income and total assets for the threeand nine months ended September 30, 2008 and 2007 are as follows:

 
| ** **                                        | ** ** | **Early  Development** | ** ** | **Late-Stage  Development** | ** ** | **Other  Reconciling Items** | ** ** | **Total**  | ** ** |
|---------------------------------------------------|------------|------------------------|------------|-----------------------------|------------|-----------------------------------|------------|------------|------------|
| ** **                                        | ** ** | ** **             | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** ** | ** ** |
| ***Three  months ended September 30, 2008*** |       |                   |       |                        |       |                              |       |       |       |
| Total revenues  from external customers           |       | $                      | 215,390    |                        | $          | 224,719                           |       | $          | 27,263     | (a) | $ | 467,372 |   |
| Operating income                                  |       | $                      | 54,846     |                        | $          | 44,272                            |       | $          | (29,156    | )(b) | $ | 69,962 |   |
| Total assets                                      |       | $                      | 1,081,422  |                        | $          | 480,607                           |       | $          | 92,877     | (c) | $ | 1,654,906 |   |
|                                              |       |                   |       |                        |       |                              |       |       |       |
| ***Three  months ended September 30, 2007*** |       |                   |       |                        |       |                              |       |       |       |
| Total revenues  from external customers           |       | $                      | 199,486    |                        | $          | 196,503                           |       | $          | 18,712     | (a) | $ | 414,701 |   |
| Operating income                                  |       | $                      | 51,777     |                        | $          | 34,426                            |       | $          | (26,105    | )(b) | $ | 60,098 |   |
| Total assets                                      |       | $                      | 871,099    |                        | $          | 472,472                           |       | $          | 116,356    | (c) | $ | 1,459,927 |   |
|                                              |       |                   |       |                        |       |                              |       |       |       |
| ***Nine  months ended September 30, 2008***  |       |                   |       |                        |       |                              |       |       |       |
| Total revenues  from external customers           |       | $                      | 630,554    |                        | $          | 658,899                           |       | $          | 73,779     | (a) | $ | 1,363,232 |   |
| Operating income                                  |       | $                      | 159,640    |                        | $          | 126,146                           |       | $          | (85,632    | )(b) | $ | 200,154 |   |
| Total assets                                      |       | $                      | 1,081,422  |                        | $          | 480,607                           |       | $          | 92,877     | (c) | $ | 1,654,906 |   |
|                                              |       |                   |       |                        |       |                              |       |       |       |
| ***Nine  months ended September 30, 2007***  |       |                   |       |                        |       |                              |       |       |       |
| Total revenues  from external customers           |       | $                      | 569,804    |                        | $          | 565,649                           |       | $          | 60,361     | (a) | $ | 1,195,814 |   |
| Operating income                                  |       | $                      | 144,450    |                        | $          | 95,536                            |       | $          | (72,332    | )(b) | $ | 167,654 |   |
| Total assets                                      |       | $                      | 871,099    |                        | $          | 472,472                           |       | $          | 116,356    | (c) | $ | 1,459,927 |   |

 

----

| (a) |   | Represents revenues associated with reimbursable  out-of-pocket expenses.                                                                                            |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (b) |   | Represents corporate expenses (primarily information  technology, marketing, communications, human resources, finance, legal and  stock-based compensation expense). |
| (c) |   | Represents corporate assets.                                                                                                                                         |

 

**10. Subsequent Event**

** **

On October 3, 2008, Covance acquired Eli Lilly and Company’s earlydevelopment campus in Greenfield, Indiana for approximately $50 millionand in connection with this transaction, Covance borrowed an additional$50 million under the Credit Facility.

 

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

You should read the following discussion together withthe unaudited Covance consolidated financial statements and the accompanyingnotes included in this Quarterly Report on Form 10-Q for the quarter endedSeptember 30, 2008.

 

**Overview**

 

Covanceis a leading drug development services company providing a wide range ofearly-stage and late-stage product development services on a worldwide basisprimarily to the pharmaceutical, biotechnology and medical deviceindustries.  Covance also providesservices such as laboratory testing to the chemical, agrochemical and foodindustries. 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 and market access services. Although each segment has separate services within it, they can becombined in joint service offerings and we believe clients increasingly areinterested in opportunities for such combined services.  Covance believes it is one of the largestdrug development services companies, based on annual net revenues, and one of afew that is capable of providing comprehensive global product developmentservices. Covance offers its clients high quality services designed to provide datato clients as rapidly as possible and reduce product development time.  We believe this enables Covance’s customersto introduce their products into the marketplace faster and as a result,maximize the period of market exclusivity and monetary return on their researchand development investments. Additionally, Covance’s comprehensive services andbroad experience provide its customers with a variable cost alternative tofixed cost internal 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 differ from theseestimates.  The following discussionhighlights what we believe to be the critical accounting policies and judgmentsmade in the preparation of these consolidated financial statements.

 

***RevenueRecognition.***Covance recognizes revenue either asservices are performed or products are delivered, depending on the nature ofthe work contracted. Historically, a majority of Covance’s net revenues havebeen earned under contracts which range in duration from a few months to twoyears, but can extend in duration up to five years or longer.

 

We do not have anyindividual significant contracts as pertains to revenue recognition.  By way of background, at any point in time,we are working on thousands of active client projects, which are governed byindividual contracts.  In addition, wehave not had a single customer who accounted for more than ten percent of ouraggregate net revenues during any one of the last three years.  In 2007, we served in excess of 300biopharmaceutical companies and at December 31, 2007, we had over 8,000active client projects.  Most projectsare customized based on the needs of the client, the type of services beingprovided, therapeutic indication of the drug, geographic locations, and othervariables.  Project specific termsrelated to pricing, billing milestones, and the scope and type of services tobe provided are generally negotiated and contracted on a project-by-projectbasis.

 

Service contractsgenerally take the form of fee-for-service or fixed-price arrangements. Incases where performance spans multiple accounting periods, revenue isrecognized as services are performed, measured on a proportional performancebasis, generally using output measures that are specific to the serviceprovided.  Examples of output measures inour early development segment include the number of slides read, dosingsperformed, or specimens prepared for preclinical laboratory services, or numberof dosings or number of volunteers enrolled for clinical pharmacology. Examplesof output measures in our late-stage development segment’s clinical developmentservice offering include among others, number of investigators enrolled, numberof sites initiated, number of patients enrolled and number of monitoring visitscompleted. Revenue is determined by dividing the actual units of work completedby the total units of work required under the contract and multiplying thatpercentage by the total contract value. The total contract value, or totalcontractual payments, represents the aggregate contracted price for each of theagreed upon services to be provided.  Wedo not have any contractual arrangements spanning multiple accounting periodswhere revenue is recognized on a proportional-performance basis under which wehave earned more than an immaterial amount of performance-based revenue (i.e.potential additional revenue tied to specific deliverables orperformance).  Changes in the scope ofwork are common, especially under long-term contracts, and generally result ina change in contract value. Once the client has agreed to the changes in scopeand renegotiated pricing terms, the contract value is amended and revenue isrecognized as described above. Estimates of costs to complete are made toprovide, where appropriate, 

 

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for losses expected oncontracts. Costs are not deferred in anticipation of contracts being awarded,but instead are expensed as incurred. For the three and nine months ended September 30, 2008, we did notexperience a change in the estimates used to determine the amounts recognizedas revenue (i.e., output measures or costs to complete) for any projectresulting in a material impact on our financial position, results of operationsor cash flows.

 

Billing schedules andpayment terms are generally negotiated on a contract-by-contract basis. In somecases, we bill the client for the total contract value in progress-basedinstallments as we reach certain non-contingent billing milestones over thecontract duration, such as, but not limited to, contract signing, initialdosing, investigator site initiation, patient enrollment or database lock.  The term “billing milestone” relates only toa billing trigger in a contract whereby amounts become billable and payable inaccordance with a negotiated predetermined billing schedule throughout the termof a project.  These billing milestones arenot performance-based (i.e., potential additional arrangement considerationtied to specific deliverables or performance). In other cases, billing and payment terms are tied to the passage oftime (e.g., monthly billings).  In eithercase, the total contract value and aggregate amounts billed to the client wouldbe the same at the end of the project. While we attempt to negotiate terms that provide for billing and paymentof services prior to or within close proximity to the provision of services,this is not always the case, as evidenced by fluctuations in the levels ofunbilled receivables and unearned revenue from period to period.  While a project is ongoing, cash payments arenot necessarily representative of aggregate revenue earned at any particular pointin time, as revenues are recognized when services are provided, while amountsbilled and paid are in accordance with the negotiated billing and paymentterms.

 

In some cases, paymentsreceived are in excess of revenue recognized. For example, a contract invoicing schedule may provide for an upfrontpayment of 10% of the full contract value upon contract signing, but at thetime of signing, performance of services has not yet begun, and therefore, norevenue has yet been recognized. Payments received in advance of services being provided, such as in thisexample, are deferred as unearned revenue on the balance sheet. As thecontracted services are subsequently performed and the associated revenue isrecognized, the unearned revenue balance is reduced by the amount of revenuerecognized during the period.

 

In other cases, services may be provided and revenueis recognized before we have invoiced the client.  In these cases, revenue recognized willexceed amounts billed, and the difference, representing an unbilled receivable,is recorded for this amount that is currently unbillable to the customerpursuant to contractual terms.  Once wehave invoiced the client, the unbilled receivable is reduced for the amountbilled, and a corresponding account receivable is recorded. All unbilledreceivables are billable to customers within one year from the respectivebalance sheet date.

 

Mostcontracts are terminable by the client either immediately or upon notice. Thesecontracts typically require payment to Covance of expenses to wind down thestudy, fees earned to date and, in some cases, a termination fee or a paymentto Covance of some portion of the fees or profits that could have been earnedby Covance under the contract if it had not been terminated early. Terminationfees are included in net revenues when realization is assured.

 

***BadDebts. ***Covanceendeavors to assess and monitor the creditworthiness of its customers to whichit grants credit terms in the ordinary course of business.  Covance maintains a provision for doubtfulaccounts relating to amounts due that may not be collected.  This bad debt provision is monitored on amonthly basis and adjusted as circumstances warrant.  Since the recorded bad debt provision isbased upon management’s judgment, actual bad debt write-offs may be greater orless than the amount recorded. Historically bad debt write-offs have not been material.

 

***Taxes. ***Since Covance conductsoperations on a global basis, its effective tax rate has and will continue todepend upon the geographic distribution of its pre-tax earnings among locationswith varying tax rates. Covance’s profits are further impacted by changes inthe tax rates of the various jurisdictions in which Covance operates. Inaddition, Covance maintains a reserve for unrecognized tax benefits, changes towhich could impact Covance’s effective tax rate in the period such changes aremade.

 

The Companyaccounts for uncertain income tax positions in accordance with the provisionsof Financial Accounting Standards Board Interpretation No. 48, *Accounting for Uncertainty in Income Taxes – anInterpretation of FASB Statement No. 109* (“FIN 48”).  Under the guidance of FIN 48, theCompany may recognize the tax benefit from an uncertain tax position only if itis more likely than not to be sustained upon examination based on the technicalmerits of the position. The amount of the accrual for which an exposure existsis measured as the largest amount of benefit determined on a cumulativeprobability basis that the Company believes is more likely than not to berealized upon ultimate settlement of the position.  Components of the reserve are classified aseither a current or long-term liability in the consolidated balance sheet basedon when the Company expects each of the items to be settled.  Covance records interest and penaltiesaccrued in relation to unrecognized tax benefits as a component of income taxexpense.

 

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As of September 30,2008, the balance of the reserve for unrecognized tax benefits is$10.3 million, of which $3.2 million is recorded as a currentliability in accrued expenses and other current liabilities, and$7.1 million is recorded as a long-term liability in other liabilities onthe consolidated balance sheet, including accrued interest of$1.5 million.  This reserve relatesto exposures for income tax matters such as transfer pricing, nexus, deemedincome and research and development credits.

 

TheCompany also maintains a tax reserve related to exposures for non-income taxmatters including value-added tax and state sales and use and other taxes,which are accounted for in accordance with Statement of Financial Accounting StandardsNo. 5, *Accounting for Contingencies*.The balance of this reserve at September 30, 2008 is approximately$0.9 million and is recorded as a current liability in accrued expensesand other current liabilities on the consolidated balance sheet.

 

While Covancebelieves that it has identified all reasonably identifiable exposures and thatthe reserve it has established for identifiable exposures is appropriate underthe circumstances, it is possible that additional exposures exist and thatexposures will be settled at amounts different than the amounts reserved. It isalso possible that changes in facts and circumstances could cause Covance toeither materially increase or reduce the carrying amount of its tax reserve.

 

Covance’s policy is toprovide income taxes on earnings of foreign subsidiaries only to the extentthose earnings are taxable or are expected to be remitted. Covance’s historicalpolicy has been to leave its unremitted foreign earnings invested indefinitelyoutside the United States. Except for the amounts repatriated in the fourthquarter of 2005 under the American Jobs Creation Act of 2004, Covance intendsto continue to leave its unremitted foreign earnings invested indefinitelyoutside the United States.  As a result,taxes have not been provided on any of the remaining accumulated foreignunremitted earnings as of September 30, 2008.

 

***Stock-Based Compensation.***The Company sponsorsseveral stock-based compensation plans pursuant to which non-qualified stockoptions and restricted stock awards are granted to eligible employees.  These plans are described more fully in Note10 to our audited financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2007 and Note 8 to our consolidatedfinancial statements in our Quarterly Report on Form 10-Q for the quarterended September 30, 2008 included elsewhere herein.

 

Thegrant-date fair value of stock awards is based upon the underlying price of thestock on the date of grant.  Thegrant-date fair value of stock option awards must be determined using an optionpricing model.  Option pricing modelsrequire the use of estimates and assumptions as to (a) the expected termof the option, (b) the expected volatility of the price of the underlyingstock, (c) the risk-free interest rate for the expected term of the optionand (d) pre-vesting forfeiture rates.

 

Theexpected term of the option is based upon the contractual term and expectedemployee exercise and expected post-vesting employment terminationbehavior.  The expected volatility of theprice of the underlying stock is based upon the historical volatility of theCompany’s stock computed over a period of time equal to the expected term ofthe option.  The risk free interest rateis based upon the implied yields currently available from the U.S. Treasuryzero-coupon yield curve for issues with a remaining duration equal to theexpected term of the option.  Pre-vestingforfeiture rates are estimated based upon past voluntary termination behaviorand past option forfeitures.

 

The following table sets forth the weighted-averageassumptions used to calculate the fair value of options granted for the threeand nine month periods ended September 30, 2008 and 2007:

 
| ** **                       | ** ** | **Three  Months Ended September 30** | ** ** | **Nine  Months Ended September 30** |
|----------------------------------|------------|-------------------------------------------|------------|------------------------------------------|
| ** **                       | ** ** | **2008**                                  | ** ** | **2007**                                 | ** ** | **2008** | ** ** | **2007** |
| Expected stock price volatility  |       | 39%                                       |       | 42%                                      |   | 39% |   | 42% |
| Risk free interest  rate(s)      |       | 1.9% - 3.7%                               |       | 4.7% - 5.1%                              |   | 1.9% - 3.7% |   | 4.7% - 5.1% |
| Expected life of options (years) |       | 4.4                                       |       | 4.3                                      |   | 4.4 |   | 4.3 |

 

Changesin any of these assumptions could impact, potentially materially, the amount ofexpense recorded in future periods related to stock-based awards.

 

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***Impairmentof Assets.***Covance reviews its long-lived assets otherthan goodwill and other indefinite lived intangible assets for impairment, whenevents or changes in circumstances occur that indicate that the carrying valueof 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 futurecash flows may be greater or less than estimated.

 

Covance performs anannual test for impairment of goodwill and other indefinite lived intangibleassets during the fourth quarter.  Thistest is performed by comparing, at the reporting unit level, the carrying valueof the reporting unit to its fair value. Covance assesses fair value based upon its estimate of the present valueof the future cash flows that it expects to be generated by the reportingunit.  The most recent test forimpairment performed for 2007 did not identify any instances of impairment andthere were no events through September 30, 2008 that warranted areconsideration of our impairment test results. However, changes in expectations as to the present value of thereporting unit’s future cash flows might impact subsequent years’ assessmentsof impairment.

 

***Defined Benefit Pension Plans******.***Covancesponsors defined benefit pension plans for the benefit of its employees atthree foreign subsidiaries, as well as a non-qualified supplemental executiveretirement plan and a post-employment retiree health and welfare plan for thebenefit of eligible employees at certain U.S. subsidiaries. The measurement ofthe related benefit obligation and net periodic benefit cost recorded each yearis based upon actuarial computations, which require the use of judgment as tocertain assumptions. The more significant of these assumptions are: (a) theappropriate discount rate to use in computing the present value of the benefitobligation; (b) the expected return on plan assets (for funded plans); and(c) the expected future rate of salary increases (for pay-related plans).Actual results (such as the return on plan assets, future rate of salaryincreases and plan participation rates) will likely differ from the assumptionsused. Those differences, along with changes that may be made in the assumptionsused from period to period, will impact the amounts reported in the financialstatements and footnote disclosures.

 

Set forth below isa discussion of the impact that (a) differences between assumed results andactual results and (b) assumption changes have had on our results ofoperations for the years ended December 31, 2007, 2006 and 2005 and on thefinancial position of the plans as of December 31, 2007 and 2006 for ourUnited Kingdom defined benefit pension plans (the largest of our definedbenefit-type pension plans).

 
| ** **                                                                                                         | ** ** | **United Kingdom Plans** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                                                                | ** ** | **2007**                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net periodic  pension cost                                                                                         |       | $                                  | 4.0        |   | $ | 4.6 |   | $ | 4.1 |   | $ | 4.3 |   |
|                                                                                                               |       |                               |       |   |   |   |   |   |   |
| Weighted average  assumptions used to determine net periodic pension cost:                                         |       |                               |       |   |   |   |   |   |   |
| Discount rate                                                                                                      |       | 5.25                               | %          | 5.00 | % | 5.75 | % | 6.00 | % |
| Expected rate of  return on assets                                                                                 |       | 6.75                               | %          | 6.75 | % | 6.75 | % | 6.00 | % |
| Salary increases                                                                                                   |       | 4.00                               | %          | 4.00 | % | 4.00 | % | 3.50 | % |
|                                                                                                               |       |                               |       |   |   |   |   |   |   |
| The increase  (decrease) in the net periodic benefit cost from period to period is  attributable to the following: |
|                                                                                                                    |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                          | ** ** | **2006 to 2007**         | ** ** | **2005 to 2006** | ** ** | **2004 to 2005** | ** ** |
| Change in discount rate                                                      |       | $                                  | (1.3       | ) | $ | 2.4 |   | $ | 0.4 |   |
| Change in expected rate of return on assets                                  |       | —                             |       | — |   | (0.6 | ) |
| Change in rate of salary increases                                           |       | —                             |       | — |   | 0.4 |   |
| Other, including differences between actual  experience and assumptions used |       | 0.3                                |       | (1.9 | ) | (0.4 | ) |
| Foreign currency exchange rate changes                                       |       | 0.4                                |       | — |   | — |   |
| Net change in periodic benefit cost                                          |       | $                                  | (0.6       | ) | $ | 0.5 |   | $ | (0.2 | ) |
|                                                                         |       |                               |       |   |   |   |   |
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
| ** **                                                                   | ** ** | **2007**                           | ** ** | **2006** | ** ** | **2005** | ** ** |
| Weighted average assumptions used to determine  benefit obligation:          |       |                               |       |   |   |   |   |
| Discount rate                                                                |       | 5.50                               | %          | 5.25 | % | 5.00 | % |
| Salary increases                                                             |       | 4.25                               | %          | 4.00 | % | 4.00 | % |

 

 

 

 

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The change in theprojected benefit obligation from period to period is attributable to thefollowing:

 
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                          | ** ** | **2006 to 2007**         | ** ** | **2005 to 2006** | ** ** |
| Projected  benefit obligation, beginning of year                             |       | $                                  | 141.3      |   | $ | 119.8 |   |
| Service/interest  cost components of net periodic benefit cost in year       |       | 13.5                               |       | 12.2 |   |
| Benefits paid                                                                |       | (2.1                               | )          | (1.3 | ) |
| Increase in discount  rate                                                   |       | (8.5                               | )          | (8.6 | ) |
| Other, including  differences between actual experience and assumptions used |       | 6.3                                |       | 3.9 |   |
| Foreign currency  exchange rate changes                                      |       | 1.6                                |       | 15.3 |   |
| Projected  benefit obligation, end of year                                   |       | $                                  | 152.1      |   | $ | 141.3 |   |

 

**ForeignCurrency Risks**

 

Since Covance operates ona global basis, it is exposed to various foreign currency risks. Two specificrisks arise from the nature of certain contracts. The first risk can occur whenCovance executes contracts with its customers where the contracts aredenominated in a currency different than the local currencies of the Covancesubsidiaries performing work under the contracts. As a result, revenuerecognized for services rendered may be denominated in a currency differentfrom the currencies in which the subsidiaries’ expenses are incurred.Fluctuations in exchange rates (from those in effect at the time the contractis executed and pricing is established to the time services are rendered andrevenue is recognized) can affect the subsidiary’s net revenues and resultantearnings. This risk is generally applicable only to a portion of the contractsexecuted by Covance’s subsidiaries providing clinical services. Historically,fluctuations in exchange rates from those in effect at the time contracts wereexecuted have not had a material effect upon Covance’s consolidated financialresults. See “Risk Factors”.

 

We also have othercross-currency contracts executed by other Covance subsidiaries where theforeign currency amounts billed are determined by converting local currencyrevenue amounts to the contract billing currency using the exchange rates ineffect at the time services are rendered. These contracts do not give rise to foreign currency denominated revenueand local currency denominated expenses, but they do give rise to a second typeof risk.  This second type of riskresults from the passage of time between the invoicing of customers under bothof these types of contracts and the ultimate collection of customer paymentsagainst such invoices. Because such invoices are denominated in a currencyother than the subsidiary’s local currency, Covance recognizes a receivable atthe time of invoicing for the local currency equivalent of the foreign currencyinvoice amount as of the invoice date. Subsequent changes in exchange ratesfrom the time the invoice is prepared to the time payment from the customer isreceived will result in Covance receiving either more or less in local currencythan the local currency equivalent of the invoice amount at the time the invoicewas prepared and the receivable was recorded. This difference is recognized byCovance as a foreign currency transaction gain or loss, as applicable, in theconsolidated statements of income.

 

Finally, Covance’s consolidated financial statementsare denominated in U.S. dollars. Accordingly, changes in exchange rates betweenthe applicable foreign currency and the U.S. dollar will affect the translationof each foreign subsidiary’s financial results into U.S. dollars for purposesof reporting Covance’s consolidated financial results. The process by whicheach foreign subsidiary’s financial results are translated into U.S. dollars isas follows: income statement accounts are translated at average exchange ratesfor the period; balance sheet asset and liability accounts are translated atend of period exchange rates; and equity accounts are translated at historicalexchange rates. Translation of the balance sheet in this manner affects thestockholders’ equity account, referred to as the cumulative translationadjustment account. This account exists only in the foreign subsidiary’s U.S.dollar balance sheet and is necessary to keep the foreign balance sheet statedin U.S. dollars in balance.  At September 30,2008, accumulated other comprehensive income on the consolidated balance sheetincludes the cumulative translation account balance of $33.5 million.

 

**OperatingExpenses and Reimbursable Out-of-Pockets**

 

Covance segregates itsrecurring operating 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 

 

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fluctuate from oneperiod to another, as a result of changes in labor utilization and the mix ofservice offerings involving hundreds of studies conducted during any period oftime. Selling, general and administrative expenses consist primarily ofadministrative payroll and related benefit charges, advertising and promotionalexpenses, administrative travel and an allocation of facility charges andinformation technology costs, and excludes depreciation and amortization.

 

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

 

**Quarterly Results**

** **

Covance’squarterly operating results are subject to variation, and are expected tocontinue to be subject to variation, as a result of factors such as (1) delaysin initiating or completing significant drug development trials, (2) terminationor reduction in size of drug development trials, (3) acquisitions anddivestitures, (4) changes in the mix of our services, and (5) exchangerate fluctuations. Delays and terminations of trials are often the result ofactions taken by Covance’s customers or regulatory authorities and are nottypically controllable by Covance. Since a large amount of Covance’s operatingcosts are relatively fixed while revenue is subject to fluctuation, moderatevariations in the commencement, progress or completion of drug developmenttrials may cause significant variations in quarterly results.

 

**Results of Operations**

** **

***Three Months Ended September 30,2008 Compared with Three Months Ended September 30, 2007. ***Net revenues increased11.1%, or 9.6% excluding the favorable impact of foreign exchange ratevariances between both periods, to $440.1 million for the three monthsended September 30, 2008 from $396.0 million for the corresponding2007 period.  Net revenues from Covance’searly development segment grew 8.0%, or 8.8% excluding the unfavorable impactof foreign exchange rate variances between both periods.  Growth in the segment was driven by a 9.9% increasein net revenues in our preclinical laboratory services, resulting from anincrease in available capacity due to our facility expansions, sustained highlevels of client satisfaction resulting in more repeat business, and favorablemarket conditions. Net revenues from Covance’s late-stage developmentsegment grew 14.4%, or 10.5% excluding the favorable impact of foreign exchangerate variances between both periods.  Growth in thesegment was led by a strong performance in our central laboratory services,where net revenues grew 21.0% on increased investigator and patient enrollment,overall higher level of study activity and the favorable impact of foreignexchange rate variances between both periods. Also contributing to growth was a strong performance in our clinicaldevelopment services, where net revenues grew 26.8% on increased study activityand the favorable impact of foreign exchange rate variances between bothperiods. Negatively impacting growth over the prior year was the divestiture ofour cardiac safety service offering in November 2007, which contributed$7.4 million of net revenue in the three months ended September 30, 2007.

 

Cost of revenue increased11.4% to $287.8 million or 65.4% of net revenues for the three monthsended September 30, 2008 as compared to $258.4 million or 65.2% ofnet revenues for the corresponding 2007 period. Gross margins decreased by 20 basis points to 34.6% for the three monthsended September 30, 2008 from 34.8% for the corresponding 2007 period.

 

Overall, selling, general and administrative expensesincreased 6.2% to $64.9 million for the three months ended September 30,2008 from $61.1 million for the corresponding 2007 period.  As a percentage of net revenues, selling,general and administrative expenses decreased******70 basis points to 14.7% for the threemonth period ended September 30, 2008 from 15.4% for the corresponding2007 period. This percentage can vary from quarter to quarter depending on thetiming and nature of various professional fees and other discretionaryspending.  The 70 basis point decreaseover the corresponding 2007 period also reflects increased efficiencies gainedfrom the leveraging of our existing support functions across a larger base ofrevenues.

 

Depreciation and amortization increased 6.4% to$17.5 million or 4.0% of net revenues for the three months ended September 30,2008 from $16.4 million or 4.2% of net revenues for the corresponding 2007period primarily as a result of higher levels of capital spending related toassets placed into service over the last fifteen months.

 

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Income from operations increased 16.4% to$70.0 million or 15.9% of net revenues for the three months ended September 30,2008 from $60.1 million or 15.2% of net revenues for the corresponding2007 period.  Income from operations fromCovance’s early development segment increased $3.1 million or 5.9% to$54.8 million or 25.5% of net revenues for the three months ended September 30,2008 from $51.8 million or 26.0% of net revenues for the corresponding2007 period.  The $3.1 millionincrease in the segment over the prior year was driven by additional incomefrom operations resulting from the 9.9% growth in preclinical laboratoryservices net revenues explained above.  Income from operations from Covance’slate-stage development segment increased $9.8 million or 28.6% to$44.3 million or 19.7% of net revenues for the three months ended September 30,2008 from $34.4 million or 17.5% of net revenues for the corresponding2007 period.  Growth was driven bycentral laboratory and clinical development services, where income fromoperations grew 23.5% and 134.5%, respectively, over the prior year primarilyon the increase in net revenues explained above.  Additionally contributing to the clinicaldevelopment services growth in operating income was increased efficiency gainedfrom leveraging existing support functions across a larger base of revenues.*** ***Partially offsetting the growth from central laboratoryand clinical was weakness in our commercialization services, where operatingmargin declined 31.5% over the prior year due to a decline in netrevenues.  Corporate expense increased$3.1 million to $29.2 million or 6.6% of net revenues for the threemonths ended September 30, 2008 from $26.1 million or 6.6% of netrevenues for the three months ended September 30, 2007.  Included in Corporate expense is stock-basedcompensation expense of $6.7 million or 1.5% of net revenues for the threemonths ended September 30, 2008, as compared to $5.7 million or 1.4%of net revenues for the corresponding 2007 period.  The higher level of Corporate expenses forthe three months ended September 30, 2008 as compared to the corresponding2007 period also reflects an increase in compensation-related expenses andinvestments in infrastructure to support higher levels of current and expectedfuture growth.

 

Other income, netdecreased $1.8 million to $0.8 million for the three months ended September 30,2008 from $2.6 million for the corresponding 2007 period.  This decrease is driven by fluctuations inforeign exchange rates resulting in net foreign exchange transaction lossestotaling $0.7 million during the three month period ended September 30,2008 compared to net foreign exchange transaction gains totaling $0.3 millionduring corresponding 2007 period. Additionally, interest income decreased $0.5 million compared to thecorresponding 2007 period due to a decrease in invested cash balances coupledwith lower interest rates on those balances.

 

Covance’s effective tax rate for the three monthsended September 30, 2008 was 28.5% compared to 29.5% for the corresponding2007 period.  The year over year decreasein Covance’s effective tax rate is attributable to a number of factors,including the mix of our pre-tax earnings across various tax jurisdictions andother planning initiatives.

 

Covance has a minority equity position in Bio-ImagingTechnologies, Inc. (“BITI”).  BITIuses proprietary medical imaging technologies to process and analyze medicalimages, and also provides other services, including the data-basing andregulatory submission of medical images, quantitative data and text.  For the three month periods ended September 30,2008 and 2007, Covance recognized income of $0.2 million and$0.1 million, respectively, representing its pro rata share of BITI’searnings.

 

Covance has a minority equity position in NoveprimLimited (“Noveprim”), a supplier of research products.  For each of the three month periods ended September 30,2008 and 2007, Covance recognized $0.3 million, representing its share ofNoveprim’s earnings, less the elimination of profit on inventory purchased fromNoveprim and still on hand at Covance at September 30, 2008 and 2007.

 

Net income of $51.1 million for the three monthsended September 30, 2008 increased $6.5 million or 14.6% as comparedto $44.6 million for the corresponding 2007 period.

 

***Nine Months Ended September 30,2008 Compared with Nine Months Ended September 30, 2007. ***Net revenues increased13.6%, or 10.7% excluding the favorable impact of foreign exchange ratevariances between both periods, to $1.29 billion for the nine months endedSeptember 30, 2008 from $1.14 billion for the corresponding 2007period.  Net revenues from Covance’searly development segment grew 10.7%, or 10.3% excluding the favorable impactof foreign exchange rate variances between both periods.  Growth in the segment was driven by a 12.5%increase in net revenues in our preclinical laboratory services, resulting froman increase in available capacity due to our facility expansions, sustainedhigh levels of client satisfaction resulting in more repeat business, andfavorable market conditions.  Netrevenues from Covance’s late-stage development segment increased 16.5%, or11.1% excluding the favorable impact of foreign exchange rate variances betweenboth periods.  Growth in the segment was led by a strongperformance in our central laboratory services, where net revenues grew 27.0%on increased investigator and patient enrollment, overall higher level of studyactivity and the favorable 

 

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impact of foreign exchange rate variances betweenboth periods.  Also contributing togrowth was a strong performance in our clinical development services, where netrevenues grew 21.0% on increased study activity and the favorable impact offoreign exchange rate variances between both periods.  Negatively impacting growth over the prioryear was the divestiture of our cardiac safety service offering in November 2007,which contributed $19.1 million of net revenue in the nine months ended September 30,2007.

 

Cost of revenue increased14.0% to $848.0 million or 65.8% of net revenues for the nine months endedSeptember 30, 2008 as compared to $743.8 million or 65.5% of netrevenues for the corresponding 2007 period. Gross margins decreased by 30 basis points to 34.2% for the nine monthsended September 30, 2008 from 34.5% for the corresponding 2007 period.

 

Overall, selling, general and administrative expensesincreased 8.1% to $189.1 million for the nine months ended September 30,2008 from $175.0 million for the corresponding 2007 period.  As a percentage of net revenues, selling,general and administrative expenses decreased******70 basis points to 14.7% for the ninemonths ended September 30, 2008 from 15.4% for the corresponding 2007period. This percentage can vary from quarter to quarter depending on thetiming and nature of various professional fees and other discretionaryspending.  The 70 basis point decreaseover the corresponding 2007 period also reflects increased efficiencies gainedfrom the leveraging of our existing support functions across a larger base ofrevenues.

 

Depreciation and amortization increased 6.4% to$52.2 million or 4.0% of net revenues for the nine months ended September 30,2008 from $49.0 million or 4.3% of net revenues for the corresponding 2007period primarily as a result of higher levels of capital spending related toassets placed into service over the last fifteen months.

 

Income from operations increased 19.4% to$200.2 million or 15.5% of net revenues for the nine months ended September 30,2008 from $167.7 million or 14.8% of net revenues for the corresponding2007 period.  Income from operations fromCovance’s early development segment increased $15.2 million or 10.5% to$159.6 million or 25.3% of net revenues for the nine months ended September 30,2008 from $144.4 million or 25.4% of net revenues for the corresponding2007 period.  The $15.2 millionincrease in the segment over the prior year was driven by additional incomefrom operations resulting from the 12.5% growth in preclinical laboratoryservices net revenues explained above.  Income from operations from Covance’slate-stage development segment increased $30.6 million or 32.0% to$126.1 million or 19.1% of net revenues for the nine months ended September 30,2008 from $95.5 million or 16.9% of net revenues for the corresponding2007 period.  Growth was driven bycentral laboratory and clinical development services, where income fromoperations grew 43.0% and 38.9%, respectively, over the prior year primarily onthe increase in net revenues explained above. Partially offsetting the growth from central laboratory and clinical wasweakness in our commercialization services, where operating margin declined25.9% over the prior year on a decline in net revenues.  Corporate expense increased$13.3 million to $85.6 million or 6.6% of net revenue for the ninemonths ended September 30, 2008 from $72.3 million or 6.4% of netrevenue for the nine months ended September 30, 2007.  Included in Corporate expense is stock-based compensationexpense of $19.3 million or 1.5% of net revenues for the nine months endedSeptember 30, 2008, as compared to $16.8 million or 1.5% of netrevenues for the corresponding 2007 period. The higher level of Corporate expenses for the nine months ended September 30,2008 as compared to the corresponding 2007 period also reflects an increase incompensation-related expenses and investments in infrastructure to supporthigher levels of current and expected future growth.

 

Other income, net increased $3.4 million to$10.4 million for the nine months ended September 30, 2008 from$7.0 million for the corresponding 2007 period. Included in other incomein the 2008 period is an additional $3.9 million gain from the receipt ofcontingent consideration on transferred backlog on the November 2007 saleof Covance’s cardiac safety service offering and a $0.6 million increase inforeign exchange transaction gains. Partially offsetting these increases is a $0.5 million decrease ininterest income compared to the corresponding 2007 period due to a decrease ininvested cash balances coupled with lower interest rates on those balances.

 

Covance’s effective tax rate for the nine months endedSeptember 30, 2008 was 29.1% compared to 29.4% for the corresponding 2007period.  The year over year decrease inCovance’s effective tax rate is attributable to a number of factors, includingthe mix of our pre-tax earnings across various tax jurisdictions and otherplanning initiatives, partially offset by the higher effective tax rate on thegain on sale of business.

 

Covance has a minority equity position in Bio-ImagingTechnologies, Inc. (“BITI”).  BITIuses proprietary medical imaging technologies to process and analyze medicalimages, and also provides other services, including the data-basing andregulatory submission of medical images, quantitative data and text.  During the nine month periods ended September 30,2008 

 

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and 2007, Covancerecognized income of $0.5 million and $0.3 million, respectively,representing its pro rata share of BITI’s earnings.

 

Covance has a minority equity position in NoveprimLimited (“Noveprim”), a supplier of research products.  For the nine month periods ended September 30,2008 and 2007, Covance recognized $1.3 million and $1.4 million,respectively, representing its share of Noveprim’s earnings, less theelimination of profit on inventory purchased from Noveprim and still on hand atCovance at September 30, 2008 and 2007.

 

Net income of $151.1 million for the nine monthsended September 30, 2008 increased $26.1 million or 20.8% as comparedto $125.0 million for the corresponding 2007 period.

 

**Liquidity andCapital Resources**

** **

Cash and cash equivalentsat September 30, 2008 and December 31, 2007 were $209.1 millionand $319.5 million, respectively. Amounts are principally invested in short-term money market funds andbank deposits.  Covance’s expected primarycash needs on both a short and long-term basis are for capital expenditures,expansion of services, possible future acquisitions, geographic expansion,working capital and other general corporate purposes, including possible sharerepurchases.  On August 12, 2008,Covance’s revolving credit facility (the “Credit Facility”), which expires in June 2009,was expanded to $125.0 million at Covance’s election. Covance believes cash onhand plus cash from operations and available borrowings under the CreditFacility will provide sufficient liquidity for the foreseeable future.  At September 30, 2008, there were$23.0 million of outstanding borrowings and $1.1 million ofoutstanding letters of credit under the Credit Facility.  At December 31, 2007, there were nooutstanding borrowings and $1.1 million of outstanding letters of creditunder the Credit Facility.  Interest onall outstanding borrowings under the Credit Facility is based upon the LondonInterbank Offered Rate (“LIBOR”) plus a 75 basis point margin and approximated3.33% per annum during the nine months ended September 30, 2008.  The Credit Facility contains variousfinancial and other covenants.  At September 30,2008, Covance was in compliance with the terms of the Credit Facility.  The Credit Facility is collateralized byguarantees 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 nine months ended September 30, 2008,Covance’s operations provided net cash of $173.2 million, a decrease of$2.9 million from the corresponding 2007 period. The change in netoperating assets used $38.7 million in cash during the nine months ended September 30,2008, primarily due to an increase in accounts receivable, unbilled servicesand inventory, partially offset by an increase in accounts payable.  The change in net operating assets used$13.5 million in cash during the nine months ended September 30,2007, primarily due to an increase in accounts receivable, unbilled servicesand other current assets, partially offset by an increase in accrued expensesand unearned revenue.  Covance’s ratio ofcurrent assets to current liabilities was 1.82 at September 30, 2008 and2.15 at December 31, 2007.

 

Investing activities for the nine months ended September 30,2008 used $201.9 million, compared to using $104.7 million for thecorresponding 2007 period.  Capitalspending for the first nine months of 2008 totaled $206.2 million, and wasprimarily for the expansion of our preclinical facilities in North America andEurope, outfitting of new facilities, upgrade of existing equipment, and thepurchase of new equipment, hardware and software.  Approximately $171.2 million of capitalspending in the first nine months of 2008 represents expenditures primarilyrelated to ongoing significant facility expansions and transformationalinformation technology projects that have not yet been placed in service.  Capital spending for the corresponding 2007period totaled $104.8 million, and was primarily for the expansion of ourpreclinical facilities in North America and Europe, outfitting of newfacilities, upgrade of existing equipment, and the purchase of new equipment,hardware and software for newly hired employees.  Investing activities for the nine monthsended September 30, 2008 also included $3.9 million of additionalproceeds received during the period reflecting contingent consideration relatedto transferred backlog from the sale of Covance’s cardiac safety serviceoffering on November 28, 2007.

 

Financingactivities for the nine months ended September 30, 2008 and 2007 used$78.4 million and $35.6 million, respectively.  During the nine months ended September 30,2008, $126.7 million was used to purchase into treasury 1,500,000 sharesof common stock under the share buyback program authorized by Covance’s Boardof Directors and $3.9 million was used to purchase into treasury46,732 shares of common stock in connection with employee benefit plans;partially offset by $17.0 million in proceeds from the exercise of stockoptions, $4.9 million from employee contributions to the Company’semployee stock purchase plan and $7.2 million in excess tax benefitsrealized on the exercise of stock options. Additionally, Covance borrowed $43.0 million under the CreditFacility during the first quarter of 2008 to partially fund the purchase intotreasury of common stock and repaid $20.0 million of these borrowingsduring the second and third quarters of 2008, for net borrowings of $23.0 millionduring the first nine months of 2008. During the nine months ended September 30,

 

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2007, $59.6 million was used to purchase intotreasury 977,000 shares of common stock under the share buyback programauthorized by Covance’s Board of Directors and $1.9 million was used topurchase into treasury 30,573 shares of common stock in connection withemployee benefit plans; partially offset by $17.7 million in proceeds fromthe exercise of stock options, $4.3 million in excess tax benefitsrealized on the exercise of stock options and $4.0 million from employeecontributions to the Company’s employee stock purchase plan.

 

In October 2008,Covance borrowed an additional $50 million under the Credit Facility inconnection with the purchase of Eli Lilly and Company’s early drug developmentcampus in Greenfield, Indiana.

 

**Inflation**

 

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

 

**Recently Issued AccountingStandards**

** **

In September 2006,the Financial Accounting Standards Board (the “FASB”) issued Statement ofFinancial Accounting Standards No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106 and 132(R),* (“SFAS158”). As of December 31, 2006, Covance has adopted the recognition anddisclosure provisions of SFAS 158, which require an employer to recognize theover funded or under funded status of its defined benefit postretirement plans –measured as the difference between the fair value of plan assets and theprojected benefit obligation - as an asset or liability, respectively, in itsbalance sheet and to recognize changes in the funded status of the plan in theyear in which such changes occur through other comprehensive income. Theadoption of SFAS 158 did not have an impact on our consolidated results ofoperations.  SFAS 158 also requires,effective for fiscal years ending after December 15, 2008, that themeasurement of the over funded or under funded status of a plan be made as ofthe employer’s fiscal year end and not as of an earlier measurement date.  Covance will be required to conform themeasurement dates of its plans to December 31st forits fiscal year ending December 31, 2008. Covance does not expect thischange in measurement dates to have a material impact on its consolidatedresults of operations or financial position.

 

In December 2007,the FASB issued SFAS No. 141 (revised 2007), *Business Combinations* (“SFAS 141R”) which replaces SFAS No. 141,*Business Combinations*.  The scope of SFAS 141R is broader than thatof SFAS No. 141, which applied only to business combinations in whichcontrol was obtained by transferring consideration.  SFAS 141R revises accounting and reportingstandards for business combinations and applies to all transactions or otherevents in which an entity obtains control of one or more businesses bytransferring consideration as well as combinations achieved without thetransfer of consideration. By applying the same method of accounting – theacquisition method – to all transactions and other events in which one entityobtains control over one or more other businesses, this statement is intendedto improve the comparability of the information about business combinationsprovided in financial reports.  SFAS 141Rapplies prospectively to business combinations with an acquisition date on orafter the beginning of the first annual reporting period beginning on or after December 15,2008.  Beginning January 1, 2009, Covancewill adopt SFAS 141R and the impact of implementing this statement will dependon the nature and significance of business combinations consummated that wouldbe subject to this statement.

 

On February 12,2008, the FASB issued FASB Staff Position 157-2 (“FSP 157-2”), which delays theeffective date of the application of SFAS No. 157, *Fair Value Measurements,* (“SFAS 157”) tofiscal years beginning after November 15, 2008 for all non-financialassets and liabilities that are recognized or disclosed at fair value in thefinancial statements on a non-recurring basis. Covance’s assets and liabilities subject to the provisions of SFAS 157are limited to non-recurring non-financial assets such as goodwill and otherindefinite lived intangible assets measured at fair value for impairmenttesting.  As such, the adoption of SFAS157, as amended by FSP 157-2, is deferred until our fiscal year beginning January 1,2009.  Covance does not expect theadoption of SFAS 157, as amended, to have a material impact on its consolidatedresults of operations or financial position.

 

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***Forward Looking Statements.****Statements in this Management’s Discussion and Analysis of FinancialCondition and Results of Operations, as well as in certain other parts of thisQuarterly Report on Form 10-Q that look forward in time, are forwardlooking statements made pursuant to the safe harbor provisions of the PrivateSecurities Litigation Reform Act of 1995. Forward looking statements includestatements concerning plans, objectives, goals, strategies, future events orperformance, expectations, predictions, and assumptions and other statementswhich are other than statements of historical facts. All such forward lookingstatements are based on the current expectations of management and are subjectto, and are qualified by, risks and uncertainties that could cause actual resultsto differ materially from those expressed or implied by those statements. Theserisks and uncertainties include, without limitation, competitive factors,outsourcing trends in the pharmaceutical industry, levels of industry researchand development spending, the Company’s ability to continue to attract andretain qualified personnel, the fixed price nature of contracts or the loss oflarge contracts, risks associated with acquisitions and investments, theCompany’s ability to increase order volume, the pace of translation of ordersinto revenue in late-stage development services, and other factors described inCovance’s filings with the Securities and Exchange Commission, including itsAnnual Report on Form 10-K.*

 

**Item 3.  Quantitative and Qualitative Disclosure AboutMarket Risk**

 

For the nine months ended September 30, 2008,approximately 41% of our net revenues were derived from our operations outsidethe United States.  We do not engage inmaterial or long-term derivative or hedging activities related to our potentialforeign exchange exposures.  See “Management’sDiscussion and Analysis of Financial Condition and Results of Operations –Foreign Currency Risks” for a more detailed discussion of our foreign currencyrisks and exposures.

 

Covance’s short-term investments are with majorfinancial institutions in countries whose governments guarantee thoseinvestments (primarily in Ireland and the United Kingdom).  These short-term investments are in bankdeposits and money market funds which can be readily purchased and sold usingestablished markets.  Covance’s cashinvestment policy is to maximize utilization of excess cash by followingspecific criteria as follows (in order of priority): (1) preserve capital(minimize financial market risk); (2) maintain liquidity; (3) manageforeign exchange rate exposure (internal hedging); (4) maximize rate ofreturn; and (5) enhance strategic relationships with select financialinstitutions.  Covance also has strongoperating cash flow and ready access to credit available under its CreditFacility, as evidenced by its recent ability to expand the Credit Facility to$125 million in August 2008 and its ability to borrow $50 million underthe Credit Facility in early October 2008.

 

**Item 4.  Controls and Procedures**

 

Disclosurecontrols and procedures.  The Company’sPrincipal Executive Officer and Principal Financial Officer have reviewed andevaluated the effectiveness of the Company’s disclosure controls and proceduresas of the end of the period covered in this report.  Based on that evaluation, the PrincipalExecutive Officer and the Principal Financial Officer have concluded that theCompany’s current disclosure controls and procedures are effective.  There have been no significant changes in theCompany’s internal controls or in the other factors that significantly affectthose controls.

 

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**Part II. Other Information**

 

**Item 1a. Risk Factors**

 

Thissection discusses various risk factors that are attendant with our business andthe provision of our services.  If theevents outlined below were to occur individually or in the aggregate, ourbusiness, results of operations, financial condition, and cash flows could bematerially adversely affected.

 

**Changes in governmentregulation or in practices relating to the pharmaceutical industry coulddecrease the need for the services we provide.**

** **

Governmental agencies throughout the world, includingin the United States, strictly regulate the drug development process.  Our business involves helping pharmaceuticaland biotechnology companies navigate the regulatory 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 to comply with existingregulations could result in a loss of revenue or earnings or in increasedcosts.**

 

Any failure on our part to comply with applicableregulations could result in the termination of on-going research or thedisqualification of data for submission to regulatory authorities.  For example, if we were to fail to properlymonitor compliance by clinical trial investigators with study protocols, thedata collected from that trial could be disqualified.  If this were to happen, we could becontractually required to repeat the trial at no further cost to our customer,but at substantial cost to us.

 

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

 

Many of our contractsprovide for services on a fixed price or fee-for-service with a cap basis andthey may be terminated or reduced in scope either immediately or uponnotice.  Cancellations may occur for avariety of reasons, including:

 

·                  thefailure of products to satisfy safety requirements;

·                  unexpectedor undesired results of the products;

·                  insufficient patientenrollment;

·                  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 inscope or delay of a large contract or the loss or delay of multiple contractscould materially adversely affect our business, although our contractsfrequently entitle us to receive the costs of winding down the terminatedprojects, as well as all fees earned by us up to the time of termination.  Some contracts also entitle us to atermination fee.

 

**We may bear financial risk if we under price ourcontracts or overrun cost estimates.**

 

Since our contracts areoften structured as fixed price or fee-for-service with a cap, we bear thefinancial risk if we initially under price our contracts or otherwise overrunour 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 developand market new services that complement or expand our existing business orexpand our service offerings through acquisition. If we are unable to developnew services and/or create demand for those newly developed services, or toexpand our service offerings through acquisition, our future business, resultsof operations, financial condition, and cash flows could be adversely affected.

 

**Our quarterly operating resultsmay vary.**

 

Our operatingresults may vary significantly from quarter to quarter and are influenced byfactors 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 thatoperating results for any particular quarter are not necessarily a meaningfulindication of future results.  Whilefluctuations in our quarterly operating results could negatively or positivelyaffect the market price of our common stock, these fluctuations may not berelated to our future overall operating performance.

 

**We depend on the pharmaceuticaland biotechnology industries**.

 

Our revenuesdepend greatly on the expenditures made by the pharmaceutical and biotechnologyindustries in research and development. In some instances, companies in these industries are reliant on theirability to raise capital in order to fund their research and developmentprojects.  Accordingly, economic factorsand industry trends that affect our clients in these industries also affect ourbusiness.  If companies in theseindustries were to reduce the number of research and development projects theyconduct or outsource, our business could be materially adversely affected.

 

**We operate in a highlycompetitive industry.**

 

Competitors in thecontract research organization industry range from small, limited-serviceproviders to full service global contract research organizations.  Our main competition consists of in-housedepartments of pharmaceutical companies, full-service and functional contractresearch organizations**,** anduniversities and teaching hospitals, although to a lesser degree.  We compete on a variety of factors,including:

 

·                  reputation for on-time qualityperformance and regulatory compliance;

·                  expertise and experience in specificareas;

·                  scope of service offerings;

·                  strengths in various geographicmarkets;

·                  price;

·                  technological expertise and efficientdrug development processes;

·                  quality of facilities;

·                  ability to acquire, process, analyzeand report data in an accurate manner;

·                  ability to manage large-scaleclinical trials both domestically and internationally;

·                  expertise and experience in marketaccess services; and

·                  size.

 

For instance, ourclinical development services have from time to time experienced periods ofincreased price competition which had a material adverse effect on Covance’slate-stage development profitability and consolidated net revenues and netincome.

 

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

 

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**We may expand our businessthrough acquisitions.**

 

We review manyacquisition candidates and, in addition to acquisitions which we have alreadymade, we are continually evaluating new acquisition opportunities.  Factors which may affect our ability to growsuccessfully through acquisitions include:

 

·                  difficulties and expenses inconnection with integrating the acquired companies and achieving the expectedbenefits;

·                  diversion of management’s attentionfrom current operations;

·                  the possibility that we may beadversely affected by risk factors facing the acquired companies;

·                  acquisitions could be dilutive toearnings, or in the event of acquisitions made through the issuance of ourcommon stock to the shareholders of the acquired company, dilutive to thepercentage of ownership of our existing stockholders;

·                  potential losses resulting fromundiscovered liabilities of acquired companies not covered by theindemnification we may obtain from the seller;

·                  risks of not being able to overcomedifferences in foreign business practices, language and other cultural barriersin connection with the acquisition of foreign companies; and

·                  loss of key employees of the acquiredcompanies.

 

**We may be affected by potentialhealth care reform.**

 

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

 

Implementation of healthcare reform legislation that contain costs could limit the profits that can bemade 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 third parties forimportant services.**

 

We depend on thirdparties to provide us with services critical to our business.  The failure of any of these third parties toadequately provide the needed services could have a material adverse effect onour business.

 

**Our revenues and earnings areexposed to exchange rate fluctuations**.

 

We derive a largeportion of our net revenues from international operations.  For the nine month period ended September 30,2008, we derived approximately 41% of our net revenues from outside the UnitedStates.  Our financial statements aredenominated in U.S. dollars.  Inaddition, in certain circumstances, we may incur costs in one currency relatedto our services or products for which we are paid in a different currency. As aresult, factors associated with international operations, including changes inforeign currency exchange rates, could significantly affect our results ofoperations, financial condition and cash flows.

 

**The loss of our key personnelcould adversely affect our business.**

 

Our success dependsto a significant extent upon the efforts of our senior management team andother key personnel. The loss of the services of such personnel could adverselyaffect our business.  Also, because ofthe nature of our business, our success is dependent upon our ability toattract and retain technologically qualified personnel.  There is substantial competition forqualified personnel, and an inability to recruit or retain qualified personnelmay impact our ability to grow our business and compete effectively in ourindustry.

 

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**Contract research services createa risk of liability**.

 

In contracting towork on drug development trials and studies, we face a range of potentialliabilities, for example:

 

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

·                  generalrisks associated with clinical pharmacology facilities, including negativeconsequences from the administration of drugs to clinical trial participants orthe professional malpractice of clinical pharmacology medical care providers;

·                  errorsor omissions from tests conducted for the agrochemical and food industries;

·                  risksthat animals in our breeding facilities may be infected with diseases that maybe harmful and even lethal to themselves and humans despite preventive measurescontained in our company policies for the quarantine and handling of importedanimals; and

·                  errorsand omissions during a trial that may undermine the usefulness of a trial ordata from the trial or study.

 

Wealso contract with physicians, also referred to as investigators, to conduct theclinical trials to test new drugs on human volunteers.  These tests can create a risk of liabilityfor personal injury or death to volunteers, resulting from negative reactionsto the drugs administered or from professional malpractice by third party investigators.  We believe that our risks in this area aregenerally reduced by the following:

 

·                  contractprovisions entitling us to be indemnified or entitling us to a limitation ofliability;

·                  insurancemaintained by our clients, investigators, and by us; and

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

 

Contractualindemnifications generally do not protect us against liability arising fromcertain of our own actions, such as negligence or misconduct.  We could be materially and adversely affectedif we were required to pay damages or bear the costs of defending any claimwhich is not covered by a contractual indemnification provision or in the eventthat a party who must indemnify us does not fulfill its indemnificationobligations or which is beyond the level of our insurance coverage.  There can be no assurance that we will beable to maintain such insurance coverage on terms acceptable to us.

 

**Hardware and software failures, delays in the operation ofour computer and communications systems or the failure to implement systemenhancements may harm our business.**

 

Our success depends on the efficient anduninterrupted operation of our computer and communications systems. A failureof our network or data gathering procedures could impede the processing ofdata, delivery of databases and services, client orders and day-to-daymanagement of our business and could result in the corruption or loss of data.While certain of our operations have appropriate disaster recovery plans inplace, we currently do not have redundant facilities everywhere in the world toprovide IT capacity in the event of a system failure. Despite any precautionswe may take, damage from fire, floods, hurricanes, power loss,telecommunications failures, computer viruses, break-ins and similar events atour various computer facilities could result in interruptions in the flow ofdata to our servers and from our servers to our clients. In addition, anyfailure by our computer environment to provide our required data communicationscapacity could result in interruptions in our service. In the event of a delayin the delivery of data, we could be required to transfer our data collectionoperations to an alternative provider of server hosting services. Such atransfer could result in delays in our ability to deliver our products andservices to our clients. Additionally, significant delays in the planneddelivery of system enhancements, improvements and inadequate performance of thesystems once they are completed could damage our reputation and harm ourbusiness. Finally, long-term disruptions in the infrastructure caused by eventssuch as natural disasters, the outbreak of war, the escalation of hostilities,and acts of terrorism (particularly involving cities in which we have offices)could adversely affect our businesses. Although we carry property and businessinterruption insurance, our coverage may not be adequate to compensate us forall losses that may occur.

 

**Reliance on facilities.**

 

Covance relies on certain of its facilities.  In particular, Covance’s preclinical and centrallaboratory facilities are highly specific and would be difficult to replace ina short period of time.  Any event thatcauses a disruption of the operation of these facilities might impact theCompany’s ability to provide service to its customers and therefore could havea material adverse affect on its financial condition, results of operations andcash flows.

 

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**Relianceon air transportation**.

 

Ourcentral laboratories and certain of our other businesses are heavily reliant onair travel for transport of clinical trial kits and other material, productsand people, and a significant disruption to the air travel system, or ouraccess to it, could have a material adverse effect on our business.

 

**Certainservice offerings and research products are dependent on limited sources ofsupply of services or products which if interrupted could affect our business.**

 

We depend on a limited number of suppliers for certainservices and for certain animal populations. Disruptions to the continuedsupply of these services or products may arise from export import restrictionsor embargoes, foreign political or economic instability, or otherwise.Disruption of supply could have a material adverse effect on our business.

 

**Actions of animal rights extremists may affect ourbusiness.**

 

Our early developmentservices utilize animals in preclinical testing of the safety and efficacy of drugsand also breed and sell animals for biomedical research.  Such activities are required for thedevelopment of new medicines and medical devices under regulatory regimes inthe United States, Europe, Japan and other countries.  Acts of vandalism and other acts by animalrights extremists who object to the use of animals in drug development couldhave a material adverse effect on our business.

 

**Our animal populations may suffer diseases thatcan damage our inventory, harm our reputation, result in decreased sales ofresearch products or result in other liability to us.**

 

It is important that ourresearch products be free of diseases, including infectious diseases.  The presence of diseases can distort orcompromise the quality of research results, can cause loss of animals in ourinventory, can result in harm to humans or outside animal populations if thedisease is not contained to animals in inventory, or can result in otherlosses.  Such results could harm our reputationor have a material adverse effect on our financial condition, results ofoperations, 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, thereunto dulyauthorized.

 
| ** **                    | ** ** | **COVANCE INC.**                   |   |
|-------------------------------|------------|------------------------------------|--------|
|                          |       |                               |   |
|                          |       |                               |   |
| Dated: October 31,  2008 | 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       |       |                                      |       |                   |   |
|  Joseph L. Herring     |       | Chairman of the Board  and                |       | October 31, 2008  |
|                        |       | Chief Executive Officer                   |       |                   |
|                        |       | (Principal Executive  Officer)            |       |                   |
|                        |       |                                      |       |                   |
| /s/ William E.  Klitgaard   |       |                                      |       |                   |   |
|  William  E. Klitgaard |       | Corporate Senior Vice  President and      |       | October 31,  2008 |
|                        |       | Chief Financial Officer                   |       |                   |
|                        |       | (Principal Financial  Officer)            |       |                   |
|                        |       |                                      |       |                   |
| /s/ Michele A. Kennedy      |       |                                      |       |                   |   |
|  Michele  A. Kennedy   |       | Corporate Vice  President, Controller and |       | October 31,  2008 |
|                        |       | Chief Accounting  Officer                 |       |                   |
|                        |       | (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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