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**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-Q**

 

**x****    QuarterlyReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**For the quarterly period ended March 31, 2009**

 

**or**

 

**o****     TransitionReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934**

 

**           Forthe transition period from                                                to                                                **

 

**Commission File Number:  1-12213**

 

**COVANCE INC.**

(Exact name of Registrant 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’s telephonenumber, including area code:  **(609) 452-4440**

 

Indicate by checkmark whether the Registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act (the “ExchangeAct”) of 1934 during the preceding 12 months (or for such shorter period thatthe Registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

YES  x     NO  o

 

Indicate by check markwhether the Registrant has submitted electronically and posted on its corporateweb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T during the preceding 12months (or for such shorter period that the Registrant was required to submitand post such files).

YES  o     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 the definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” 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 April 24,2009, the Registrant had 63,919,960 shares of common stock outstanding.

 

 

 

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**CovanceInc.**

**Form 10-QFor the Quarterly Period Ended March 31, 2009**

 

**INDEX**

 
| ** **                                                                                          | **Page** |
|-----------------------------------------------------------------------------------------------------|----------|
| ** **                                                                                          |     |
| **Part I. Financial  Information**                                                             |     |
|                                                                                                |     |
| Item 1. Financial Statements (Unaudited)                                                            |     |
|                                                                                                |     |
| Consolidated  Balance Sheets—March 31, 2009 and December 31, 2008                    | 2        |
|                                                                                                |     |
| Consolidated  Statements of Income—Three Months ended March 31, 2009 and 2008             | 3        |
|                                                                                                |     |
| Consolidated  Statements of Cash Flows—Three Months ended March 31, 2009 and 2008         | 4        |
|                                                                                                |     |
| Notes to Consolidated Financial Statements                                                          | 5        |
|                                                                                                |     |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations | 17       |
|                                                                                                |     |
| 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. AND SUBSIDIARIES**

**CONSOLIDATED BALANCE SHEETS**

**MARCH 31, 2009 AND DECEMBER 31, 2008**

** **
| **(Dollars in thousands)**                                                                                                                                                                                                   | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                             | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| ** **                                                                                                                                                                                                                             | ** ** | **(UNAUDITED)**    | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                             | ** ** | ** **         | ** ** | ** **            | ** ** |
| Current Assets:                                                                                                                                                                                                                        |       |               |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                             |       | $                  | 190,182    |                  | $          | 221,334 |   |
| Accounts receivable                                                                                                                                                                                                                    |       | 259,035            |       | 228,951               |       |
| Unbilled services                                                                                                                                                                                                                      |       | 104,077            |       | 112,719               |       |
| Inventory                                                                                                                                                                                                                              |       | 74,607             |       | 68,206                |       |
| Deferred income taxes                                                                                                                                                                                                                  |       | 15,877             |       | 15,029                |       |
| Prepaid expenses and  other current assets                                                                                                                                                                                             |       | 101,224            |       | 91,451                |       |
| Total Current Assets                                                                                                                                                                                                                   |       | 745,002            |       | 737,690               |       |
| Property and equipment,  net                                                                                                                                                                                                           |       | 883,770            |       | 860,957               |       |
| Goodwill, net                                                                                                                                                                                                                          |       | 123,663            |       | 105,486               |       |
| Other assets                                                                                                                                                                                                                           |       | 49,461             |       | 48,955                |       |
| Total Assets                                                                                                                                                                                                                           |       | $                  | 1,801,896  |                  | $          | 1,753,088 |   |
| ** **                                                                                                                                                                                                                             |       |               |       |                  |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                         |       |               |       |                  |       |
| Current Liabilities:                                                                                                                                                                                                                   |       |               |       |                  |       |
| Accounts payable                                                                                                                                                                                                                       |       | $                  | 42,924     |                  | $          | 41,887 |   |
| Accrued payroll and  benefits                                                                                                                                                                                                          |       | 73,895             |       | 104,607               |       |
| Accrued expenses and  other current liabilities                                                                                                                                                                                        |       | 81,797             |       | 86,521                |       |
| Unearned revenue                                                                                                                                                                                                                       |       | 171,655            |       | 162,556               |       |
| Short-term debt                                                                                                                                                                                                                        |       | 80,000             |       | 50,000                |       |
| Income taxes payable                                                                                                                                                                                                                   |       | 23,544             |       | 14,224                |       |
| Total Current Liabilities                                                                                                                                                                                                              |       | 473,815            |       | 459,795               |       |
| Deferred income taxes                                                                                                                                                                                                                  |       | 50,684             |       | 51,385                |       |
| Other liabilities                                                                                                                                                                                                                      |       | 49,459             |       | 47,059                |       |
| Total Liabilities                                                                                                                                                                                                                      |       | 573,958            |       | 558,239               |       |
| Commitments and  Contingent Liabilities                                                                                                                                                                                                |       |               |       |                  |       |
| Stockholders’ Equity:                                                                                                                                                                                                             |       |               |       |                  |       |
| Preferred Stock - Par  value $1.00 per share; 10,000,000 shares authorized; no shares issued and  outstanding at March 31, 2009 and December 31, 2008                                                                        |       | 3⁄4             |       | 3⁄4                |       |
| Common Stock - Par  value $0.01 per share; 140,000,000 shares authorized; 76,050,115 and  75,447,578 shares issued and outstanding, including those held in treasury, at  March 31, 2009 and December 31, 2008, respectively |       | 760                |       | 754                   |       |
| Paid-in capital                                                                                                                                                                                                                        |       | 560,714            |       | 551,598               |       |
| Retained earnings                                                                                                                                                                                                                      |       | 1,169,864          |       | 1,129,569             |       |
| Accumulated other  comprehensive (loss) income                                                                                                                                                                                         |       | (28,200            | )          | (13,975               | )          |
| Treasury stock at cost  (12,204,114 and 12,150,495 shares at March 31, 2009 and  December 31, 2008, respectively)                                                                                                            |       | (475,200           | )          | (473,097              | )          |
| Total Stockholders’  Equity                                                                                                                                                                                                       |       | 1,227,938          |       | 1,194,849             |       |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                                                                       |       | $                  | 1,801,896  |                  | $          | 1,753,088 |   |

 

**Theaccompanying notes are an integral part of these consolidated financialstatements.**

** **

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** **

**COVANCE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND2008**

**(UNAUDITED)**

** **
| ** **                                                                      | ** ** | **Three Months Ended March 31** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| ** **                                                                      | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net revenues                                                                    |       | $                                                   | 441,236    |   | $ | 412,432 |   |
| Reimbursable  out-of-pockets                                                    |       | 27,221                                              |       | 21,605 |   |
| Total revenues                                                                  |       | 468,457                                             |       | 434,037 |   |
|                                                                            |       |                                                |       |   |   |
| Costs and expenses:                                                             |       |                                                |       |   |   |
| Cost of revenue  (excluding depreciation and amortization)                      |       | 301,725                                             |       | 273,330 |   |
| Reimbursed  out-of-pocket expenses                                              |       | 27,221                                              |       | 21,605 |   |
| Selling, general and  administrative (excluding depreciation and amortization)  |       | 63,954                                              |       | 59,017 |   |
| Depreciation and  amortization                                                  |       | 19,614                                              |       | 17,348 |   |
| Total costs and  expenses                                                       |       | 412,514                                             |       | 371,300 |   |
| Income from operations                                                          |       | 55,943                                              |       | 62,737 |   |
|                                                                            |       |                                                |       |   |   |
| Other (income) expense,  net:                                                   |       |                                                |       |   |   |
| Interest income                                                                 |       | (448                                                | )          | (2,858 | ) |
| Interest expense                                                                |       | 365                                                 |       | 262 |   |
| Foreign exchange  transaction gain, net                                         |       | (446                                                | )          | (1,065 | ) |
| Gain on sale of  business                                                       |       | 3⁄4                                              |       | (2,978 | ) |
| Other income, net                                                               |       | (529                                                | )          | (6,639 | ) |
| Income before taxes and  equity investee earnings                               |       | 56,472                                              |       | 69,376 |   |
| Taxes on income                                                                 |       | 16,349                                              |       | 20,723 |   |
| Equity investee  earnings                                                       |       | 172                                                 |       | 449 |   |
| Net income                                                                      |       | $                                                   | 40,295     |   | $ | 49,102 |   |
|                                                                            |       |                                                |       |   |   |
| Basic earnings per  share                                                       |       | $                                                   | 0.63       |   | $ | 0.78 |   |
| Weighted average shares  outstanding - basic                                    |       | 63,586,418                                          |       | 63,312,592 |   |
|                                                                            |       |                                                |       |   |   |
| Diluted earnings per  share                                                     |       | $                                                   | 0.63       |   | $ | 0.76 |   |
| Weighted average shares  outstanding - diluted                                  |       | 63,941,413                                          |       | 64,322,979 |   |

 

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

 

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** **

**COVANCE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**FOR THE THREE MONTHS ENDED MARCH 31, 2009 AND2008**

**(UNAUDITED)**

** **
| ** **                                                                                   | ** ** | **Three Months Ended March 31** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**                                                         | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
|                                                                                         |       |                                                |       |   |   |
| Cash flows from  operating activities:                                                       |       |                                                |       |   |   |
| Net income                                                                                   |       | $                                                   | 40,295     |   | $ | 49,102 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:           |       |                                                |       |   |   |
| Depreciation and  amortization                                                               |       | 19,614                                              |       | 17,348 |   |
| Non-cash compensation  expense associated with employee benefit and stock compensation plans |       | 5,879                                               |       | 6,044 |   |
| Deferred income tax  benefit                                                                 |       | (1,840                                              | )          | (779 | ) |
| Gain on sale of  business                                                                    |       | 3⁄4                                              |       | (2,978 | ) |
| Loss on sale of  property and equipment                                                      |       | 166                                                 |       | 13 |   |
| Equity investee  earnings                                                                    |       | (172                                                | )          | (449 | ) |
| Changes in operating  assets and liabilities, net of business acquired:                      |       |                                                |       |   |   |
| Accounts receivable                                                                          |       | (29,151                                             | )          | (2,532 | ) |
| Unbilled services                                                                            |       | 9,808                                               |       | (7,280 | ) |
| Inventory                                                                                    |       | (6,401                                              | )          | (4,051 | ) |
| Accounts payable                                                                             |       | 944                                                 |       | 1,215 |   |
| Accrued liabilities                                                                          |       | (36,361                                             | )          | (19,542 | ) |
| Unearned revenue                                                                             |       | 8,214                                               |       | (5,539 | ) |
| Income taxes payable                                                                         |       | 9,535                                               |       | 11,177 |   |
| Other assets and  liabilities, net                                                           |       | (11,301                                             | )          | (5,957 | ) |
| Net cash provided by  operating activities                                                   |       | 9,229                                               |       | 35,792 |   |
| Cash flows from investing  activities:                                                       |       |                                                |       |   |   |
| Capital expenditures                                                                         |       | (40,302                                             | )          | (62,576 | ) |
| Acquisition of  business, net of cash acquired                                               |       | (18,620                                             | )          | 3⁄4 |   |
| Proceeds from sale of  business                                                              |       | 3⁄4                                              |       | 2,978 |   |
| Other, net                                                                                   |       | 12                                                  |       | 77 |   |
| Net cash used in  investing activities                                                       |       | (58,910                                             | )          | (59,521 | ) |
| Cash flows from  financing activities:                                                       |       |                                                |       |   |   |
| Net borrowings under  revolving credit facility                                              |       | 30,000                                              |       | 43,000 |   |
| Payment of debt assumed  upon acquisition of business                                        |       | (5,431                                              | )          | 3⁄4 |   |
| Stock issued under  employee stock purchase and option plans                                 |       | 3,028                                               |       | 8,461 |   |
| Purchase of treasury  stock                                                                  |       | (2,103                                              | )          | (129,607 | ) |
| Net cash provided by  (used in) financing activities                                         |       | 25,494                                              |       | (78,146 | ) |
|                                                                                         |       |                                                |       |   |   |
| Effect of exchange rate  changes on cash                                                     |       | (6,965                                              | )          | 15,014 |   |
| Net change in cash and  cash equivalents                                                     |       | (31,152                                             | )          | (86,861 | ) |
|                                                                                         |       |                                                |       |   |   |
| Cash and cash  equivalents, beginning of period                                              |       | 221,334                                             |       | 319,485 |   |
|                                                                                         |       |                                                |       |   |   |
| Cash and cash  equivalents, end of period                                                    |       | $                                                   | 190,182    |   | $ | 232,624 |   |

 

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)**

**March 31,2009 and 2008**

**(dollarsin thousands, unless otherwise indicated)**

** **

**1.**              Basis ofPresentation

** **

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith U.S. generally accepted accounting principles (“GAAP”) for interimfinancial information and with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they 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)considered necessary for a fair presentation have been included.  Operating results for the three months ended March 31,2009 are not necessarily indicative of the results that may be expected for theyear ending December 31, 2009.  Thebalance sheet at December 31, 2008 has been derived from the auditedfinancial statements at that date but does not include all of the informationand footnotes required by GAAP for complete financial statements.  You should read these unaudited consolidatedfinancial statements together with the historical consolidated financialstatements of Covance Inc. and subsidiaries (“Covance” or the “Company”) forthe years ended December 31, 2008, 2007 and 2006 included in our AnnualReport on Form 10-K for the year ended December 31, 2008.

 

**2.****              Summaryof Significant Accounting Policies**

 

**Principles of Consolidation**

** **

These unauditedconsolidated financial statements include the accounts of all entitiescontrolled by Covance. All significant intercompany accounts and transactionsare eliminated.  The equity method ofaccounting is used for investments in affiliates in which Covance owns between20 and 50 percent and does not have the ability to exercise control.  For investments in which Covance owns lessthan 20 percent and does not have the ability to exercise significant influenceover operating or financial decisions of the investee, the cost method ofaccounting is applied.  Where the fairvalue of the shares of the cost method investee are readily available, Covanceaccounts for such investments as available-for-sale securities under Statementof Financial Accounting Standards (“SFAS”) No. 115, *Accounting for Certain Investments in Debt and EquitySecurities* (“SFAS 115”). See Note 4.

 

**Use of Estimates**

** **

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

 

**Inventory**

** **

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

 

**Prepaid Expenses and Other Current Assets**

** **

In connection withthe management of multi-site clinical trials, Covance pays on behalf of itscustomers fees to investigators, volunteers and other out-of-pocket costs (suchas travel, printing, meetings, couriers, etc.), for which we are reimbursed atcost, without mark-up or profit. Amounts receivable from customers inconnection with billed and unbilled investigator fees, volunteer payments andother out-of-pocket pass-through costs are included in prepaid expenses andother current assets in the accompanying consolidated balance sheets andtotaled $51.5 million and $52.7 million at March 31, 2009 and December 31,2008, respectively.  See Note 2 “ReimbursableOut-of-Pocket Expenses”.

 

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**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

** **

**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 with Statement of FinancialAccounting Standards No. 142, *Goodwill and OtherIntangible Assets*, Covance performs an annual test for impairment ofgoodwill and other indefinite lived intangible assets during the fourthquarter. This test is performed by comparing, at the reporting unit level, thecarrying value of the reporting unit to its fair value. Covance assesses fairvalue based upon its estimate of the present value of the future cash flowsthat it expects to be generated by the reporting unit.  The most recent annual test for impairmentperformed for 2008 did not identify any instances of impairment and there wereno events through March 31, 2009 that warranted a reconsideration of ourimpairment test results.

 

**Revenue Recognition**

** **

Covancerecognizes revenue either as services are performed or products are delivered,depending on the nature of the work contracted. Historically, a majority ofCovance’s net revenues have been earned under contracts which range in durationfrom a few months to two years, but can extend in duration up to five years orlonger. We also have dedicated capacity arrangements with certain clientsranging in duration from one to ten years. Underlying these arrangements areindividual project contracts for the specific services to be provided.Dedicated capacity arrangements enable our clients to secure space in ourfacilities in exchange for which they agree to provide a guaranteed annualminimum dollar value (“volume”) of work. Under these types of arrangements, ifthe annual minimum volume commitment is not reached, the client is required topay Covance for the shortfall. Progress towards the achievement of annualminimum volume guarantees is monitored throughout the year. Annual minimumguarantee shortfalls are included in net revenues when the amount of theshortfall is determinable and realization is assured.

 

Servicecontracts generally take the form of fee-for-service or fixed-pricearrangements. In cases where performance spans multiple accounting periods,revenue is recognized as services are performed, measured on aproportional-performance basis, generally using output measures that arespecific 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 totalcontractual payments, represents the aggregate contracted price for each of theagreed upon services to be provided. We do not have any contractualarrangements spanning multiple accounting periods where revenue is recognizedon a proportional-performance basis under which we have earned more than animmaterial amount of performance-based revenue (i.e. potential additionalrevenue tied to specific deliverables or performance). 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, for losses expected on contracts. Costs are notdeferred in anticipation of contracts being awarded, but instead are expensedas incurred.

 

Billingschedules and payment terms are generally negotiated on a contract-by-contractbasis. In some cases, we bill the client for the total contract value inprogress-based installments as we reach certain non-contingent billingmilestones over the contract duration, such as, but not limited to, contractsigning, initial dosing, investigator site initiation, patient enrollment ordatabase lock. The term “billing milestone” relates only to a billing triggerin a contract whereby amounts become billable and payable in accordance with anegotiated predetermined billing schedule throughout the term of a project.These billing milestones are not performance-based (i.e., potential additionalarrangement consideration tied to specific deliverables or performance). Inother cases, billing and payment terms are tied to the passage of time (e.g.,monthly billings). In either case, the total contract value and aggregateamounts billed to the client would be the same at the end of the project. Whilewe attempt to negotiate terms that provide for billing and payment of servicesprior to or within close proximity to the provision of services, this is notalways the case, as evidenced by fluctuations in the levels of unbilledreceivables and unearned revenue from period to period. While a project isongoing, cash payments are not necessarily representative of aggregate revenueearned at any particular point in time, as revenues are recognized when servicesare provided, while amounts billed and paid are in accordance with thenegotiated billing and payment terms.

 

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**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

Insome cases, payments received are in excess of revenue recognized.  For example, a contract invoicing schedulemay provide for an upfront payment of 10% of the full contract value uponcontract signing, but at the time of signing, performance of services has notyet begun, and therefore, no revenue has yet been recognized. Payments receivedin advance of services being provided, such as in this example, are deferred asunearned revenue on the balance sheet. As the contracted services aresubsequently performed and the associated revenue is recognized, the unearnedrevenue balance is reduced by the amount of revenue recognized during theperiod.

 

Inother cases, services may be provided and revenue is recognized before we haveinvoiced the client. In these cases, revenue recognized will exceed amountsbilled, and the difference, representing an unbilled receivable, is recordedfor this amount that is currently unbillable to the customer pursuant tocontractual terms. Once we have invoiced the client, the unbilled receivable isreduced for the amount billed, and a corresponding account receivable isrecorded. All unbilled receivables are billable to customers within one yearfrom the respective balance 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. In connectionwith the management of multi-site clinical trials, Covance pays on behalf ofits customers fees to investigators, volunteers and other out-of-pocket costs(such as for travel, printing, meetings, couriers, etc.), for which it isreimbursed at cost, without mark-up or profit. Investigator fees are notreflected in total revenues or expenses where Covance acts in the capacity ofan agent on behalf of the pharmaceutical company sponsor, passing through thesecosts without risk or reward to Covance. All other out-of-pocket costs areincluded in total revenues and expenses.

 

**Taxes**

 

Covance uses the asset and liability method of accounting for incometaxes.  Under this method, deferred taxassets and liabilities are recognized for the expected future tax consequencesof differences between the carrying amounts of assets and liabilities and theirrespective tax bases using enacted tax rates in effect for the year in which thetemporary differences are expected to reverse. The effect on deferred taxes of a change in enacted tax rates isrecognized in income in the period when the change is effective.

 

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, the Company mayrecognize the tax benefit from an uncertain tax position only if it is morelikely than not to be sustained upon examination based on the technical meritsof the position. The amount of the accrual for which an exposure exists ismeasured 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 March 31,2009, the balance of the reserve for unrecognized tax benefits was$12.1 million, including accrued interest of $1.4 million, of which$3.3 million is recorded as a current liability in accrued expenses andother current liabilities, and $8.8 million is recorded as a long-term liabilityin other liabilities on the consolidated balance sheet.  As of December 31, 2008, the balance ofthe reserve for unrecognized tax benefits was $11.9 million, includingaccrued interest of $1.2 million, of which $3.3 million was recordedas a current liability in accrued expenses and other current liabilities, and$8.6 million was recorded as a long-term liability in other liabilities onthe consolidated balance sheet.  Thisreserve relates to exposures for income tax matters such as transfer pricing,nexus, deemed income and research and development credits. The net increase inthe reserve for unrecognized tax benefits from December 31, 2008 to March 31,2009 resulted from the accrual of interest on existing reserves.

 

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**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

The Company alsomaintains a tax reserve related to exposures for non-income tax mattersincluding value-added tax and state sales and use and other taxes, which areaccounted for in accordance with Statement of Financial Accounting Standards No. 5,*Accounting for Contingencies*. Thebalance of this reserve at both March 31, 2009 and December 31, 2008is $0.9 million and is recorded as a current liability in accrued expensesand other current liabilities on the consolidated balance sheet.

 

While Covance believes it has identified all reasonably identifiableexposures and the reserve it has established for identifiable exposures isappropriate under the circumstances, it is possible that additional exposuresexist and that exposures may be settled at amounts different than the amountsreserved. It is also possible that changes in facts and circumstances couldcause Covance to either materially increase or reduce the carrying amount ofits tax reserve.

 

Covance’s historical policy has been to leave its unremitted foreignearnings invested indefinitely outside the United States. Covance intends tocontinue to leave its unremitted foreign earnings invested indefinitely outsidethe United States.  As a result, taxes havenot been provided on any of the remaining accumulated foreign unremittedearnings as of March 31, 2009.

 

**Comprehensive Income**

 

Covance’stotal comprehensive income represents net income plus the change in thecumulative translation adjustment equity account for the periods presented. Forthe three months ended March 31, 2009, comprehensive income also includesthe change in the unrealized gain on available-for-sale securities of$0.3 million, net of tax, resulting from the change in classification ofCovance’s minority equity investment in Bio-Imaging Technologies, Inc. (“BITI”)to an available-for-sale security in accordance with SFAS 115 in thefourth quarter of 2008. Total comprehensive income was $26.1 million and$73.8 million for the three months ended March 31, 2009 and 2008,respectively.

 

**Reimbursable Out-of-Pocket Expenses**

** **

As discussed inNote 2 “Prepaid Expenses and Other Current Assets”, Covance pays on behalf ofits customers fees to investigators, volunteers and other out-of-pocket costsfor which the Company is reimbursed at cost, without mark-up or profit.  In connection with the requirements ofFinancial Accounting Standards Board Emerging Issues Task Force Rule No. 01-14(“EITF 01-14”), *Income Statement Characterization ofReimbursements Received for “Out-of-Pocket” Expenses Incurred*,amounts paid to volunteers and other out-of-pocket costs are reflected inoperating expenses, while the reimbursements received are reflected in revenuesin the consolidated statements of income. Covance will continue to exclude from revenue and expense in theconsolidated statements of income fees paid to investigators and the associatedreimbursement since Covance acts as an agent on behalf of the pharmaceuticalcompany sponsors with regard to investigator payments, in accordance with theFinancial Accounting Standards Board Emerging Issues Task Force Rule No. 99-19(“EITF 99-19”), *Reporting Revenue Gross as aPrincipal Versus Net as an Agent.*

 

**Stock-BasedCompensation**

 

The Company sponsors several stock-based compensation plans pursuant towhich non-qualified stock options and restricted stock awards are granted toeligible employees.  These plans aredescribed more fully in Note 8 herein and Note 10 to our audited consolidatedfinancial statements included in our Annual Report on Form 10-K for theyear ended December 31, 2008. The Company recognizes stock-basedcompensation under the provisions of Statement of Financial AccountingStandards No. 123R, *Share-BasedPayments*, (“SFAS 123R”), pursuant to which the grant-date fair valueof awards expected to vest is expensed on a straight-line basis over thevesting period of the related awards.

 

8

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Table of Contents

 

**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

**Defined Benefit Pension Plans**

** **

**TheCompany sponsors various pension and other post-retirement benefit plans. Theseplans are described more fully in Note 7 herein and Note 9 to our auditedconsolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2008. The measurement of the relatedbenefit obligations and the net periodic benefit costs recorded each year arebased upon actuarial computations, which require management’s judgment as tocertain assumptions. These assumptions include the discount rates to use incomputing the present value of the benefit obligations and the net periodicbenefit costs, the expected future rate of salary increases (for pay-relatedplans) and the expected long-term rate of return on plan assets (for fundedplans). The discount rates are derived based on a hypothetical yield curverepresented by a series of annualized individual discount rates. The expectedlong-term rate of return on plan assets is based on the target asset allocationand the average expected rate of growth for the asset classes invested. Theaverage expected rate of growth is derived from a combination of historicreturns, current market indicators, the expected risk premium for each assetclass and the opinion of professional advisors.**

** **

**EffectiveDecember 31, 2008, Covance adopted the measurement date provisions ofStatement of Financial Accounting Standards No. 158, *Employers’ Accounting for Defined Benefit Pension andOther Postretirement Plans — an amendment of FASB Statements Nos. 87, 88, 106and 132(R) *(“SFAS 158”). The measurement date provision ofSFAS 158 eliminated the early measurement date option and requires a plan’sfunded status to be measured as of the employer’s fiscal year end. As such,liabilities related to all of Covance’s pension and other post-retirementbenefit plans are now measured as of December 31.**

** **

**Earnings Per Share (“EPS”)**

** **

BasicEPS is computed by dividing net income available to common stockholders by theweighted average number of shares outstanding during the period.  The computation of diluted EPS is similar tothe computation of basic EPS, except that the denominator is increased toinclude the number of additional common shares that would have been outstandingif the dilutive potential common shares had been issued; computed under thetreasury stock method in accordance with the requirements of Statement ofFinancial Accounting Standards No. 128, *EarningsPer Share*.

 

Incomputing diluted EPS for the three months ended March 31, 2009 and 2008,the denominator was increased by 354,995 shares and 1,010,387 shares,respectively, representing the dilutive effect of stock options outstanding at March 31,2009 and 2008, 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 March 31, 2009 were options to purchase1,580,475 shares of common stock at prices ranging from $39.08 to $94.34per share because the exercise prices of such options were greater than theaverage market price of Covance’s common stock during this period.  Excluded from the computation of diluted EPSfor the three months ended March 31, 2008 were options to purchase15,618 shares of common stock at prices ranging from $86.17 to $87.33 pershare because the exercise prices of such options were greater than the averagemarket price of Covance’s common stock during this period.

 

**SupplementalCash Flow Information**

 

Cash paid forinterest for the three month periods ended March 31, 2009 and 2008 was$0.3 million and $0.2 million, respectively. Cash paid for incometaxes for the three months ended March 31, 2009 and 2008 totaled$6.8 million and $9.0 million, respectively. The change in incometaxes payable in the consolidated statement of cash flows for the three monthsended March 31, 2008 includes as an operating cash outflow the excess taxbenefit received from the exercise of non-qualified stock options as measuredunder SFAS 123R of $1.7 million (a corresponding cash inflow of$1.7 million has been included in financing cash flows). During the threemonths ended March 31, 2009, there was no excess tax benefit received fromthe exercise of non-qualified stock options.

 

9

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**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

**RecentlyIssued Accounting Standards**

 

In December 2008,the FASB issued FASB Staff Position 132(R)-1 (“FSP 132(R)-1”), which providesguidance on an employer’s disclosures about plan assets of a defined benefitpension or other postretirement plan. FSP 132(R)-1 requires disclosure ofinvestment allocation methodologies and information that enables users offinancial statements to assess the inputs and valuation techniques used todevelop fair value measurements of plan assets in order to provide users withan understanding of significant concentrations of risk in plan assets. FSP132(R)-1 is effective for years ending after December 15, 2009. FSP132(R)-1 requires additional disclosure only and therefore will not impactCovance’s consolidated results of operations or financial position.

 

**3.   Treasury Stock**

** **

In February 2007,the Covance Board of Directors authorized the repurchase of an additional 3.0million shares under Covance’s stock repurchase program. At March 31,2009, there are approximately 0.8 million shares remaining for purchase underthe 2007 authorization.  Covance alsoreacquires shares of its common stock in connection with certain employeebenefit plans primarily when employees tender shares to satisfy income taxwithholdings associated with the vesting of stock awards.  The following table sets forth the treasurystock activity during the three month periods ended March 31, 2009 and2008:

 
| ** **                              | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                              | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| **(amounts in thousands)**    | ** ** | **$**                                               | ** ** | **# shares** | ** ** | **$** | ** ** | **# shares** | ** ** |
| Shares repurchased in  connection with: |       |                                                |       |   |   |   |   |   |   |
| Board approved buyback  programs        |       | $                                                   | —     |   | 3⁄4 |   | $ | 126,709 |   | 1,500.0 |   |
| Employee benefit plans                  |       | 2,103                                               |       | 53.6 |   | 2,898 |   | 35.0 |   |
| Total                                   |       | $                                                   | 2,103      |   | 53.6 |   | $ | 129,607 |   | 1,535.0 |   |

 

**4.**              Equity Investments

** **

In December 2008,Covance acquired a minority equity position (less than 20%) in CaprionProteomics (“Caprion”), a privately held company headquartered in Montreal,Canada for a total cost of $3.1 million. Caprion is a leading provider ofproteomics-based services to the pharmaceutical industry. Under the terms ofthe agreement, Covance will serve as the exclusive contract researchorganization distributor of Caprion’s proteomic biomarker services and Caprionwill serve as Covance’s exclusive proteomic discovery provider. As Covance ownsless than a 20% interest in Caprion and does not exercise significant influenceover the operating or financial decisions of Caprion, the investment isaccounted for under the cost method of Accounting Principles Board Opinion No. 18,*The Equity Method of Accounting forInvestments in Common Stock*. This investment is included in otherassets on the consolidated balance sheet.

 

Covancehas a 47% minority equity position in Noveprim Limited (“Noveprim”), a supplierof research products, which was acquired in March 2004 at a total cost of$20.7 million.  The excess of the purchaseprice over the underlying equity in Noveprim’s net assets at the date ofacquisition of $13.8 million represents goodwill and is included in thecarrying value of Covance’s investment. This investment is reflected in other assets on the consolidated balancesheet. During the three month periods ended March 31, 2009 and 2008,Covance recognized income of $0.2 million and $0.3 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 March 31,2009 and 2008.  The carrying value ofCovance’s investment in Noveprim at March 31, 2009 and December 31,2008 was $22.5 million and $23.4 million, respectively.

 

10

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Table of Contents

 

**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

**(dollars in thousands, unless otherwiseindicated)**

 

Covancehas a minority equity position (less than 20*%*) inBio-Imaging Technologies, Inc. (“BITI”). BITI uses proprietary medical imaging technologies to process andanalyze medical images, and also provides other services, including thedata-basing and regulatory submission of medical images, quantitative data andtext.  During the three month periodended March 31, 2008, Covance recognized income of $0.2 millionrepresenting its pro rata share of BITI’s earnings. In the fourth quarter of2008, Covance suspended the use of the equity method of accounting as itsownership interest in BITI fell below 20% and it could no longer exercisesignificant influence over BITI’s operations. In the fourth quarter of 2008,Covance began accounting for its investment in BITI as an available-for-salesecurity in accordance with SFAS 115. The carrying value of Covance’s investment in BITI as of March 31,2009 and December 31, 2008 was $8.2 million and $8.6 million,respectively.  The $0.4 milliondecrease in the carrying value of the investment results in a $0.3 millionreduction in the unrealized gain on investment, net of tax, which is includedwithin accumulated other comprehensive income on the consolidated balancesheet. Accordingly, the balance in the unrealized gain on investment at March 31,2009 and December 31, 2008 was $4.1 million and $4.4 million,net of tax, respectively.

 

**5.   Acquisitions and Divestitures**

** **

In March 2009,Covance acquired 100% of the stock of Swiss Pharma Contract Ltd. (“Swiss Pharma”),and its 50-bed clinical research facility based in Basel, Switzerland, for cashpayments aggregating $19.4 million ($18.6 million net of cashacquired). Additionally, Covance repaid the entire $5.4 million balance ofmortgage debt assumed in the Swiss Pharma acquisition. Transaction relatedcosts of $0.5 million were reported as selling, general &administrative expense in the period incurred. This acquisition expands Covance’sclinical pharmacology presence in Europe and provides access to special patientpopulations for Phase I/IIa clinical studies. Swiss Pharma’s assets andliabilities acquired are included in the consolidated balance sheet at March 31,2009 based on their estimated fair value as determined in a preliminarypurchase price allocation. Results of operations for Swiss Pharma will bereported in Covance’s Early Development segment.

 

In addition to theinitial cash consideration of $19.4 million, Covance accrued a liability of$3.4 million for the estimated fair value of future contingent considerationexpected to be payable by Covance based upon Swiss Pharma reaching specificperformance metrics over the next three years of operation. The potentialcontingent consideration in this transaction ranges from zero to$4.6 million and is payable in three annual installments based uponoperational performance in 2009, 2010 and 2011. The table below summarizes thepreliminary purchase price allocation for the Swiss Pharma acquisition:

 
| Estimated fair value of  tangible assets and liabilities acquired:               |
|----------------------------------------------------------------------------------|
| Cash                                                                             |   | $ | 750 |   |
| Accounts receivable and  unbilled, net                                           |   | 1,987 |   |
| Property and equipment                                                           |   | 7,465 |   |
| Unearned revenue                                                                 |   | (838 | ) |
| Mortgage debt                                                                    |   | (5,436 | ) |
| Other net liabilities                                                            |   | (1,116 | ) |
| Fair value of  intangible assets acquired (7 year weighted average useful life): |   |   |   |
| Customer list (10 year  useful life)                                             |   | 1,243 |   |
| Non-compete agreements  (3 year useful life)                                     |   | 437 |   |
| Order backlog (1 year  useful life)                                              |   | 162 |   |
| Goodwill                                                                         |   | 18,177 |   |
| Net assets acquired                                                              |   | $ | 22,831 |   |

 

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**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

Intangible assetswill be amortized on a straight-line basis over their estimated useful lives.The estimated amortization expense expected to be recorded in future periods isas follows: 

 
| 2009            |   | $   | 364    |   |
|-----------------|--------|-----|--------|--------|
| 2010            |   | 270 |   |
| 2011            |   | 270 |   |
| 2012            |   | 161 |   |
| 2013            |   | 124 |   |
| 2014 and beyond |   | 653 |   |
|            |   | $   | 1,842  |   |

 

The purchase priceallocation is based upon preliminary estimates pending completion of a closingbalance sheet, using available information and making assumptions managementbelieves are reasonable. Accordingly, the purchase price allocation is subjectto finalization. The goodwill of $18.2 million resulting from theacquisition arises largely from the synergies expected from combining the SwissPharma operations with our existing European clinical pharmacology operations,as well as from the benefits derived from the assembled Swiss Pharma workforce.None of the goodwill recognized is expected to be deductible for tax purposes.

 

In October 2008,Covance acquired certain assets from Eli Lilly and Company (“Lilly”) for cashpayments totaling $51.6 million (including transaction related costs of$1.6 million). The acquired assets consisted of 450-acres of Lilly’s earlydrug development campus (land, buildings and equipment) located in Greenfield,Indiana (“Greenfield”). In addition, Covance and Lilly entered into a 10-yearagreement with a minimum value of $1.6 billion pursuant to which Covancewill provide Lilly a broad range of drug development services. The results ofoperations for Greenfield and the acquired assets, which are now part ofCovance’s Early Development segment, are included in Covance’s consolidatedfinancial statements beginning in October 2008.

 

In November 2007,Covance sold its centralized ECG business (“Cardiac Safety Services”), part ofCovance’s late-stage development segment, to eResearchTechnology Inc. (“eRT”)for initial cash proceeds of $35.2 million and a pre-tax gain of$6.6 million ($4.1 million after tax). Simultaneously therewith,Covance entered into a ten year marketing agreement with eRT under whichCovance will continue to offer its clients cardiac safety services. During thethree months ended March 31, 2009, there were no additional proceeds fromthis sale reflecting contingent consideration related to transferred backlogand therefore no additional pre-tax gain was recognized in this period. Duringthe three months ended March 31, 2008, Covance received contingentconsideration associated with this sale related to transferred backlog totaling$3.0 million and recognized an additional pre-tax gain of$3.0 million ($1.9 million after tax).  Covance may receive up to approximately$8.1 million in 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-TermDebt**

 

At March 31,2009, there were $80.0 million of outstanding borrowings and no outstandingletters of credit under Covance’s $125.0 million revolving credit facility(the “Credit Facility”). At December 31, 2008, there were$50.0 million of outstanding borrowings and $1.4 million ofoutstanding letters of credit under the Credit Facility.  Interest on all outstanding borrowings underthe Credit Facility is based upon the London Interbank Offered Rate (“LIBOR”)plus a 75 basis point margin and approximated 1.26% and 3.47% per annum duringthe three months ended March 31, 2009 and 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 March 31, 2009, Covance was incompliance with the terms of the Credit Facility.

 

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**COVANCE INC. AND SUBSIDIARIES**

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

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

**7.****              DefinedBenefit Plans**

 

Covance sponsors various pension and other post-retirementbenefit plans. As of December 31, 2008, Covance adopted the measurementdate provisions of SFAS 158. Each of the benefit plans described below has a2008 measurement date of December 31. Prior to 2008, the measurement dates for the various plans ranged from September 30to December 31.

 

**DefinedBenefit Pension Plans**

 

Covance sponsorstwo defined benefit pension plans for the benefit of its employees at twoUnited 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 month periods ended March 31,2009 and 2008 are as follows:

 
| ** **                                                | ** ** | **United Kingdom Plans**              | ** ** | **German Plan**                       | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------|------------|---------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended  March 31** | ** ** | **Three Months Ended  March 31** | ** ** |
| ** **                                                | ** ** | **2009**                              | ** ** | **2008**                              | ** ** | **2009** | ** ** | **2008** | ** ** |
| Components of Net  Periodic Pension Cost:                 |       |                                  |       |                                  |       |   |   |   |   |
| Service  cost                                             |       | $                                     | 733        |                                  | $          | 1,383 |   | $ | 133 |   | $ | 146 |   |
| Interest  cost                                            |       | 1,676                                 |       | 2,075                                 |       | 137 |   | 139 |   |
| Expected  return on plan assets                           |       | (1,759                                | )          | (2,353                                | )          | — |   | — |   |
| Amortization  of net actuarial loss                       |       | 271                                   |       | 319                                   |       | 2 |   | 11 |   |
| Participant  contributions                                |       | (450                                  | )          | (531                                  | )          | — |   | — |   |
| Net  periodic pension cost                                |       | $                                     | 471        |                                  | $          | 893 |   | $ | 272 |   | $ | 296 |   |
| ** **                                                | ** ** | ** **                            | ** ** | ** **                            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Assumptions Used to  Determine Net Periodic Pension Cost: |       |                                  |       |                                  |       |   |   |   |   |
| Discount  rate                                            |       | 6.25                                  | %          | 5.50                                  | %          | 6.25 | % | 5.60 | % |
| Expected  rate of return on assets                        |       | 6.75                                  | %          | 6.75                                  | %          | n/a |   | n/a |   |
| Salary  increases                                         |       | 4.25                                  | %          | 4.25                                  | %          | 3.00 | % | 3.00 | % |

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**March 31,2009 and 2008**

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

 

**Supplemental Executive RetirementPlan**

 

In addition tothese foreign defined benefit pension plans, Covance also has a non-qualifiedSupplemental Executive Retirement Plan (“SERP”).  The SERP, which is not funded, is intended 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 month periods ended March 31, 2009 and 2008 are as follows:

 
| ** **                                                | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Components of Net  Periodic Pension Cost:                 |       |                                                |       |   |   |
| Service cost                                              |       | $                                                   | 424        |   | $ | 309 |   |
| Interest cost                                             |       | 149                                                 |       | 217 |   |
| Amortization of prior  service cost (credit)              |       | (29                                                 | )          | (29 | ) |
| Amortization of net  actuarial loss                       |       | —                                              |       | 26 |   |
| Net periodic pension  cost                                |       | $                                                   | 544        |   | $ | 523 |   |
|                                                      |       |                                                |       |   |   |
| Assumptions Used to  Determine Net Periodic Pension Cost: |       |                                                |       |   |   |
| Discount rate                                             |       | 6.00                                                | %          | 5.50 | % |
| Salary increases                                          |       | 4.00                                                | %          | 4.00 | % |

 

**Post-Employment Retiree 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 benefit cost for the three month periods ended March 31,2009 and 2008 are as follows:

 
| ** **                                                                | ** ** | **Three Months Ended March 31** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Components of Net Periodic  Post-retirement Benefit Cost:                 |       |                                                |       |   |   |
| Service cost                                                              |       | $                                                   | 28         |   | $ | 38 |   |
| Interest cost                                                             |       | 82                                                  |       | 81 |   |
| Net periodic  post-retirement benefit cost                                |       | $                                                   | 110        |   | $ | 119 |   |
|                                                                      |       |                                                |       |   |   |
| Assumptions Used to  Determine Net Periodic Post-retirement Benefit Cost: |       |                                                |       |   |   |
| Discount rate                                                             |       | 6.00                                                | %          | 5.50 | % |
| Health care cost trend  rate                                              |       | 8.00                                                | %(a)       | 9.00 | %(a) |

 

----

(a) decreasingto ultimate trend of 5.00% in 2014

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**March 31,2009 and 2008**

**(dollarsin thousands, unless otherwise indicated)**

 

**8.  Stock-Based Compensation Plans**

 

Covance sponsors several employee stock-basedcompensation plans which are described more fully in Note 10 to our auditedconsolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

In May 2007, Covance’s shareholders approved the2007 Employee Equity Participation Plan (the “2007 EEPP”) in replacement of the2002 Employee Equity Participation Plan (the “2002 EEPP”). Effective uponapproval of the 2007 EEPP, no further grants or awards were permitted under the2002 EEPP. Shares remaining for grant under the 2002 EEPP are available forgrant under the 2007 EEPP. In addition, the Covance Board of Directors directedthat, effective May 3, 2007, no further grants would be permitted underthe 2002 Employee Stock Option Plan (the “2002 ESOP”) and, unlike the 2002EEPP, shares remaining for grant under the 2002 ESOP are not available forgrant under the 2007 EEPP. The 2007 EEPP became effective on May 3, 2007and will expire on May 2, 2017.  The2007 EEPP authorizes the Compensation and Organization Committee of the Boardof Directors (the “Compensation Committee”), or such committee as is appointedby the Covance Board of Directors, to administer the 2007 EEPP, to grant awardsto employees and consultants of Covance or entities in which Covance has acontrolling or significant equity interest. The 2007 EEPP authorizes the Compensation Committee to grant thefollowing awards: 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 or three year period forall other optionees.  Stock awardsgenerally vest over a three year period for all employees. The number of sharesof Covance common stock initially available for grant under the 2007 EEPPtotaled approximately 1.6 million plus approximately 3.3 millionshares remaining available under the 2002 EEPP at the time the 2007 EEPP wasapproved. All stock option grants under the 2002 EEPP remaining outstanding arenow administered in accordance with the provisions of the 2002 EEPP out ofshares issuable under the 2007 EEPP. The Company issues authorized butpreviously unissued shares when options are exercised or for stock awards.There have been no grants of stock appreciation rights or grants of options topurchase common stock or other stock awards to consultants of Covance oremployees or consultants of entities in which Covance has a controlling orsignificant equity interest under the 2002 ESOP, the 2002 EEPP or the 2007EEPP. At March 31, 2009 there were approximately 2.9 million sharesremaining available for option grants or stock awards under the 2007 EEPP, upto 1.0 million of which are available for issuance as stock awards.

 

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, 2008.  Thegrant-date fair value of options expected to vest is expensed on astraight-line basis over the vesting period of the related awards.

 

The following table sets forth the weighted-averageassumptions used to calculate the fair value of options granted for the threemonth periods ended March 31, 2009 and 2008:

 
| ** **                        | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Expected stock price  volatility  |       | 36%                                                 |       | 39% |   |
| Risk free interest  rate(s)       |       | 0.3% - 2.6%                                         |       | 1.9% - 3.7% |   |
| Expected life of  options (years) |       | 4.6                                                 |       | 4.4 |   |

 

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 and performance-based share awards, which has been determinedbased upon the market value of Covance’s shares on the grant date, is expensedon a straight-line basis over the vesting period of the related awards.

 

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**COVANCE INC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**March 31,2009 and 2008**

**(dollarsin thousands, unless otherwise indicated)**

 

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.

 

Resultsof operations for the three month period ended March 31, 2009 include totalstock-based compensation expense of $5.8 million ($3.9 million net of taxbenefit of $1.9 million), $2.4 million of which has been included incost of revenue and $3.4 million of which has been included in selling,general and administrative expenses. Results of operations for the three month period ended March 31,2008 include total stock-based compensation expense of $6.1 million($4.1 million net of tax benefit of $2.0 million), $2.3 million ofwhich has been included in cost of revenue and $3.8 million of which hasbeen included in selling, general and administrative expenses.

 

**9.  SegmentInformation**

 

Covancehas two reportable segments: early development and late-stage development.  Early development services, which includesCovance’s preclinical and clinical pharmacology service capabilities, involveevaluating a new compound for safety and early effectiveness as well asevaluating the absorption, distribution, metabolism and excretion of thecompound in the human body.  It is atthis stage that a pharmaceutical company, based on available data, willgenerally decide whether to continue further development of a drug.  Late-stage development services, whichincludes Covance’s central laboratory, clinical development andcommercialization services (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.

 

Segment revenues, operating income and total assets for the threemonths ended March 31, 2009 and 2008 are as follows:

 
| ** **                                    | ** ** | **Early  Development** | ** ** | **Late-Stage  Development** | ** ** | **Other  Reconciling  Items** | ** ** | **Total**  | ** ** |
|-----------------------------------------------|------------|------------------------|------------|-----------------------------|------------|-------------------------------|------------|------------|------------|
| ** **                                    | ** ** | ** **             | ** ** | ** **                  | ** ** | ** **                    | ** ** | ** ** | ** ** |
| ***Three  months ended March 31, 2009*** |       |                   |       |                        |       |                          |       |       |       |
| Total revenues from  external customers       |       | $                      | 192,505    |                        | $          | 248,731                       |       | $          | 27,221     | (a) | $ | 468,457 |   |
| Operating income                              |       | $                      | 27,160     |                        | $          | 56,328                        |       | $          | (27,545    | )(b) | $ | 55,943 |   |
| Total assets                                  |       | $                      | 1,170,385  |                        | $          | 498,074                       |       | $          | 133,437    | (c) | $ | 1,801,896 |   |
|                                          |       |                   |       |                        |       |                          |       |       |       |
| ***Three  months ended March 31, 2008*** |       |                   |       |                        |       |                          |       |       |       |
| Total revenues from  external customers       |       | $                      | 202,045    |                        | $          | 210,387                       |       | $          | 21,605     | (a) | $ | 434,037 |   |
| Operating income                              |       | $                      | 50,574     |                        | $          | 38,870                        |       | $          | (26,707    | )(b) | $ | 62,737 |   |
| Total assets                                  |       | $                      | 983,454    |                        | $          | 491,210                       |       | $          | 75,451     | (c) | $ | 1,550,115 |   |

 

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(a)         Represents revenues associated withreimbursable 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.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial 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 endedMarch 31, 2009.

 

**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 device industries.Covance also provides services such as laboratory testing to the chemical,agrochemical and food industries. The foregoing services comprise tworeportable segments for financial reporting purposes: early developmentservices, which includes preclinical and clinical pharmacology serviceofferings; and late-stage development services, which includes centrallaboratory, clinical development and commercialization services (periapprovaland market access services). Although each segment has separate services withinit, they can be combined in joint service offerings and we believe clientsincreasingly are interested 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 providedata to clients as rapidly as possible and reduce product developmenttime.  We believe this enables Covance’scustomers to introduce their products into the marketplace faster and as aresult, maximize the period of market exclusivity and monetary return on theirresearch and development investments. Additionally, Covance’s comprehensiveservices and broad experience provide its customers with a variable costalternative to fixed cost internal development capabilities.

 

**CriticalAccounting 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.

 

***Revenue Recognition.***  Covance recognizes revenue either as servicesare performed or products are delivered, depending on the nature of the workcontracted. Historically, a majority of Covance’s net revenues have been earnedunder contracts which range in duration from a few months to two years, but canextend in duration up to five years or longer. We also have dedicated capacityarrangements with certain clients ranging in duration from one to ten years.Underlying these arrangements are individual project contracts for the specificservices to be provided. Dedicated capacity arrangements enable our clients tosecure space in our facilities in exchange for which they agree to provide aguaranteed annual minimum dollar value (“volume”) of work. Under these types ofarrangements, if the annual minimum volume commitment is not reached, theclient is required to pay Covance for the shortfall. Progress towards theachievement of annual minimum volume guarantees is monitored throughout theyear. Annual minimum guarantee shortfalls are included in net revenues when theamount of the shortfall is determinable and realization is assured.

 

We donot have any individual significant contracts as pertains to revenuerecognition. By way of background, at any point in time we are working onthousands of active clients projects, which are governed by individualcontracts. In addition, we have not had a single customer who accounted formore than ten percent of our aggregate net revenues during any one of the lastthree years. In 2008, we served in excess of 300 biopharmaceutical companiesand at December 31, 2008, we had over 8,000 active client projects. Mostprojects are customized based on the needs of the client, the type of servicesbeing provided, therapeutic indication of the drug, geographic locations andother variables. Project specific terms related to pricing, billing milestonesand the scope and type of services to be provided are generally negotiated andcontracted on a project-by-project basis.

 

Servicecontracts generally take the form of fee-for-service or fixed-pricearrangements. In cases where performance spans multiple accounting periods,revenue is recognized as services are performed, measured on aproportional-performance basis, generally using output measures that arespecific 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 

 

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dividing the actual units of work completed by thetotal units of work required under the contract and multiplying that percentageby 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 inthe scope of work are common, especially under long-term contracts, andgenerally result in a change in contract value. Once the client has agreed tothe changes in scope and renegotiated pricing terms, the contract value isamended and revenue is recognized as described above. Estimates of costs tocomplete are made to provide, where appropriate, for losses expected oncontracts. Costs are not deferred in anticipation of contracts being awarded,but instead are expensed as incurred. For the quarter ended March 31,2009, we did not experience a change in the estimates used to determine theamounts recognized as revenue (i.e. output measures or costs to complete) forany project resulting in a material impact on our financial position, resultsof operations or cash flows.

 

Billingschedules and payment terms are generally negotiated on a contract-by-contractbasis. In some cases, we bill the client for the total contract value inprogress-based installments as we reach certain non-contingent billingmilestones over the contract duration, such as, but not limited to, contractsigning, initial dosing, investigator site initiation, patient enrollment ordatabase lock. The term “billing milestone” relates only to a billing triggerin a contract whereby amounts become billable and payable in accordance with anegotiated predetermined billing schedule throughout the term of a project.These billing milestones are not performance-based (i.e., potential additionalarrangement consideration tied to specific deliverables or performance). Inother cases, billing and payment terms are tied to the passage of time (e.g.,monthly billings). In either case, the total contract value and aggregateamounts billed to the client would be the same at the end of the project. Whilewe attempt to negotiate terms that provide for billing and payment of servicesprior to or within close proximity to the provision of services, this is notalways the case, as evidenced by fluctuations in the levels of unbilledreceivables and unearned revenue from period to period. While a project isongoing, cash payments are not necessarily representative of aggregate revenueearned at any particular point in time, as revenues are recognized whenservices are provided, while amounts billed and paid are in accordance with thenegotiated billing and payment terms.

 

Insome cases, payments received are in excess of revenue recognized. For example,a contract invoicing schedule may provide for an upfront payment of 10% of thefull contract value upon contract signing, but at the time of signing,performance of services has not yet begun, and therefore, no revenue has yetbeen recognized. Payments received in advance of services being provided, suchas in this example, are deferred as unearned revenue on the balance sheet. Asthe contracted services are subsequently performed and the associated revenueis recognized, the unearned revenue balance is reduced by the amount of revenuerecognized during the period.

 

Inother cases, services may be provided and revenue is recognized before we haveinvoiced the client. In these cases, revenue recognized will exceed amountsbilled, and the difference, representing an unbilled receivable, is recordedfor this amount that is currently unbillable to the customer pursuant tocontractual terms. Once we have invoiced the client, the unbilled receivable isreduced for the amount billed, and a corresponding account receivable isrecorded. All unbilled receivables are billable to customers within one yearfrom the respective balance 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.

 

***Bad Debts. ***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.

 

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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, the Company mayrecognize the tax benefit from an uncertain tax position only if it is morelikely than not to be sustained upon examination based on the technical meritsof the position. The amount of the accrual for which an exposure exists ismeasured 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 March 31,2009, the balance of the reserve for unrecognized tax benefits was$12.1 million, including accrued interest of $1.4 million, of which$3.3 million is recorded as a current liability in accrued expenses andother current liabilities, and $8.8 million is recorded as a long-termliability in other liabilities on the consolidated balance sheet.  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 March 31, 2009 is$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 policyis to provide income taxes on earnings of foreign subsidiaries only to theextent those earnings are taxable or are expected to be remitted. Covance’shistorical policy has been to leave its unremitted foreign earnings investedindefinitely outside the United States. Covance intends to continue to leave its unremitted foreign earnings investedindefinitely outside the United States. As a result, taxes have not been provided on any of the remainingaccumulated foreign unremitted earnings as of March 31, 2009.

 

***Stock-Based Compensation.*** 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 10 to our audited financialstatements included in our Annual Report on Form 10-K for the year ended December 31,2008 and Note 8 to our consolidated financial statements in our QuarterlyReport on Form 10-Q for the quarter ended March 31, 2009 includedelsewhere herein.

 

TheCompany recognizes stock-based compensation under the provisions of Statementof Financial Accounting Standards No. 123R, *Share-Based Payments*, (“SFAS 123R), pursuant to whichthe grant-date fair value of awards expected to vest is expensed on astraight-line basis over the vesting period of the related awards. 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 volatility of the Company’sstock computed over a period of time equal to the expected term of theoption.  The risk free interest rate isbased 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.

 

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The following table setsforth the weighted-average assumptions used to calculate the fair value ofoptions granted for the three month periods ended March 31, 2009 and 2008:

 
| ** **                        | ** ** | **Three Months Ended March 31** | ** ** |
|-----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
| Expected stock price  volatility  |       | 36%                                                 |       | 39% |   |
| Risk free interest  rate(s)       |       | 0.3% - 2.6%                                         |       | 1.9% - 3.7% |   |
| Expected life of  options (years) |       | 4.6                                                 |       | 4.4 |   |

 

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

 

***Impairment of Assets.***Covance reviews its long-lived assets other thangoodwill 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. This test is performed by comparing, at thereporting unit level, the carrying value of the reporting unit to its fairvalue.  Covance assesses fair value basedupon its estimate of the present value of the future cash flows that it expectsto be generated by the reporting unit. The most recent test for impairment performed for 2008 did not identifyany instances of impairment and there were no events through March 31,2009 that warranted a reconsideration of our impairment test results.  However, changes in expectations as to thepresent value of the reporting unit’s future cash flows might impact subsequentyears’ assessments of impairment.

 

***Defined Benefit Pension Plans.***Covance sponsors defined benefit pensionplans for the benefit of its employees at three foreign subsidiaries, as wellas a non-qualified supplemental executive retirement plan and a post-employmentretiree health and welfare plan for the benefit of eligible employees atcertain U.S. subsidiaries. The measurement of the related benefit obligationand net periodic benefit cost recorded each year is based upon actuarialcomputations which require the use of judgment as to certain assumptions. Themore significant of these assumptions are: (a) the appropriate discountrate to use in computing the present value of the benefit obligation; (b) theexpected return on plan assets (for funded plans); and (c) the expectedfuture rate of salary increases (for pay-related plans). Actual results (suchas the return on plan assets, future rate of salary increases and planparticipation rates) will likely differ from the assumptions used. Those differences,along with changes that may be made in the assumptions used from period toperiod, will impact the amounts reported in the financial statements andfootnote disclosures.

 

Set forth below is a discussion of the impact that (a) differencesbetween assumed results and actual results and (b) assumption changes havehad on our results of operations for the years ended December 31, 2008,2007 and 2006 and on the financial position of the plans as of December 31,2008 and 2007 for our United Kingdom defined benefit pension plans (the largestof our defined benefit-type pension plans).

 
| ** **                                                                 | ** ** | **United Kingdom Plans** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                        | ** ** | **2008**                           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
| Net periodic pension  cost                                                 |       | $                                  | 3.4        |   | $ | 4.0 |   | $ | 4.6 |   | $ | 4.1 |   |
|                                                                       |       |                               |       |   |   |   |   |   |   |
| Weighted average assumptions  used to determine net periodic pension cost: |       |                               |       |   |   |   |   |   |   |
| Discount rate                                                              |       | 5.50                               | %          | 5.25 | % | 5.00 | % | 5.75 | % |
| Expected rate of return  on assets                                         |       | 6.75                               | %          | 6.75 | % | 6.75 | % | 6.75 | % |
| Salary increases                                                           |       | 4.25                               | %          | 4.00 | % | 4.00 | % | 4.00 | % |
|                                                                            |            |                                    |            |  |  |  |  |  |  |  |  |  |  |

 

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The increase (decrease) in the net periodic benefitcost from period to period is attributable to the following:

 
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                          | ** ** | **2007 to 2008**         | ** ** | **2006 to 2007** | ** ** | **2005 to 2006** | ** ** |
| Change in discount rate                                                      |       | $                                  | (1.1       | ) | $ | (1.3 | ) | $ | 2.4 |   |
| Change in rate of  salary increases                                          |       | (0.1                               | )          | — |   | — |   |
| Other, including  differences between actual experience and assumptions used |       | 0.9                                |       | 0.3 |   | (1.9 | ) |
| Foreign currency  exchange rate changes                                      |       | (0.3                               | )          | 0.4 |   | — |   |
| Net change in periodic  benefit cost                                         |       | $                                  | (0.6       | ) | $ | (0.6 | ) | $ | 0.5 |   |
|                                                                         | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Weighted average  assumptions used to determine benefit obligation:          | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Discount rate                                                                |       | 6.25                               | %          | 5.50 | % | 5.25 | % |
| Salary increases                                                             |       | 4.25                               | %          | 4.25 | % | 4.00 | % |

 

The change in the projected benefit obligation from period to period isattributable to the following:

 
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                          | ** ** | **2007 to 2008**         | ** ** | **2006 to 2007** | ** ** |
| Projected benefit  obligation, beginning of year                             |       | $                                  | 152.1      |   | $ | 141.3 |   |
| Service/interest cost  components of net periodic benefit cost in year       |       | 13.1                               |       | 13.5 |   |
| Benefits paid                                                                |       | (1.7                               | )          | (2.1 | ) |
| Actuarial gain (loss):                                                       |       |                               |       |   |   |
| Increase in discount  rate                                                   |       | (23.5                              | )          | (8.5 | ) |
| Other, including  differences between actual experience and assumptions used |       | 8.1                                |       | 6.3 |   |
| Foreign currency  exchange rate changes                                      |       | (36.2                              | )          | 1.6 |   |
| Projected benefit  obligation, end of year                                   |       | $                                  | 111.9      |   | $ | 152.1 |   |

 

**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 

 

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amount as of the invoicedate. Subsequent changes in exchange rates from the time the invoice isprepared to the time payment from the customer is received will result inCovance receiving either more or less in local currency than the local currencyequivalent of the invoice amount at the time the invoice was prepared and thereceivable was recorded. This difference is recognized by Covance as a foreigncurrency transaction gain or loss, as applicable, in the consolidated statementsof income.

 

Finally,Covance’s consolidated financial statements are denominated in U.S. dollars.Accordingly, changes in exchange rates between the applicable foreign currencyand the U.S. dollar will affect the translation of each foreign subsidiary’sfinancial results into U.S. dollars for purposes of reporting Covance’sconsolidated financial results. The process by which each foreign subsidiary’sfinancial results are translated into U.S. dollars is as follows: incomestatement accounts are translated at average exchange rates for the period;balance sheet asset and liability accounts are translated at end of periodexchange rates; and equity accounts are translated at historical exchangerates. Translation of the balance sheet in this manner affects the stockholders’equity account, referred to as the cumulative translation adjustment account.This account exists only in the foreign subsidiary’s U.S. dollar balance sheetand is necessary to keep the foreign balance sheet stated in U.S. dollars in balance.  At March 31, 2009, accumulated othercomprehensive loss on the consolidated balance sheet includes the cumulativetranslation account balance of $9.2 million.

 

### **Operating Expenses andReimbursable 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 fluctuate from one period to another, as aresult of changes in labor utilization and the mix of service offeringsinvolving hundreds of studies conducted during any period of time. Selling,general and administrative expenses consist primarily of administrative payrolland related benefit charges, advertising and promotional expenses,administrative travel and an allocation of facility charges and informationtechnology costs, and excludes depreciation and amortization.

 

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 ofOperations**

** **

***Three Months Ended March 31,2009 Compared with Three Months Ended March 31, 2008. ***Net revenues totaling $441.2million for the three months ended March 31, 2009 increased 7.0%, or 13.8%excluding the unfavorable impact of foreign exchange rate variances betweenboth periods, as compared to $412.4 million for the corresponding 2008period.  Net revenues from Covance’searly development segment decreased 4.7%, but increased 2.0% excluding theunfavorable impact of foreign exchange rate variances between both periods.Softness inthe early development segment was driven by a 3.5% decrease in net revenues inour preclinical laboratory services, resulting from lower market demand fromour biopharmaceutical clients across many of our service offerings. Netrevenues from Covance’s late-stage development segment grew 18.2%, or 25.0%excluding the unfavorable impact of foreign exchange rate variances betweenboth periods.  Growth was broad based across the late-stagedevelopment segment, led by a strong performance in our central laboratoryservices, where net revenues grew 24.6% on increased investigator and patientenrollment and an overall higher level of study activity. Also driving growthin the late-stage development segment was a strong performance in our clinicaldevelopment services, where net revenues grew 9.7% on increased study activity.

 

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Cost of revenue increased 10.4% to $301.7 millionor 68.4% of net revenues for the three months ended March 31, 2009 ascompared to $273.3 million or 66.3% of net revenues for the corresponding2008 period.  Gross margins decreased by210 basis points to 31.6% for the three months ended March 31, 2009from 33.7% for the corresponding 2008 period as softness in pre-clinicallaboratory services net revenues more than offset strength in late-stagedevelopment services net revenues.

 

Overall, selling,general and administrative expenses increased 8.4% to $64.0 million forthe three months ended March 31, 2009 from $59.0 million for thecorresponding 2008 period. As a percentage of net revenues, selling, generaland administrative expenses slightly increased by 20 basis points to 14.5%for the three months ended March 31, 2009 from 14.3% for the corresponding2008 period. Selling, general and administrative expenses as a percentage ofnet revenues can and does vary depending on the timing and nature of variousprofessional fees and other discretionary spending.

 

Depreciation and amortization increased 13.1% to$19.6 million for the three months ended March 31, 2009 from$17.3 million for the corresponding 2008 period primarily as a result ofhigher levels of capital spending related to assets placed into service overthe last two years. As a percentage of net revenues, depreciation andamortization increased slightly by 20 basis points to 4.4% for the threemonths ended March 31, 2009 from 4.2% for the corresponding 2008 period.

 

Income from operations decreased 10.8% to$55.9 million or 12.7% of net revenues for the three months ended March 31,2009 from $62.7 million or 15.2% of net revenues for the corresponding2008 period.

 

Income from operations from Covance’s earlydevelopment segment for the three months ended March 31, 2009 decreased46.3% or $23.4 million to $27.2 million as compared to$50.6 million for the corresponding 2008 period. As a percentage of netrevenues, early development income from operations declined 1090 basis pointsfrom 25.0% of net revenues in the three months ended March 31, 2008 to14.1% in the corresponding 2009 period. The softness in pre-clinical netrevenues in the three month period ended March 31, 2009 explained abovedrove $18.6 million of the reduction in operating income or 970 basispoints of the 1090 basis point reduction in operating income as a percentage ofnet revenues. Additionally, comparability between periods was impacted by costsincurred in connection with the following activities in the three month periodended March 31, 2009: the launch and growth of our service offerings atthe Greenfield, Indiana site recently purchased from Eli Lilly in the fourthquarter of 2008; the staffing and validation of our new pre-clinical facilityin Chandler, Arizona which opened in late March 2009; and costs incurredto close two of our small clinical pharmacology sites.

 

Income from operations from Covance’s late-stagedevelopment segment for the three months ended March 31, 2009 increased44.9% or $17.5 million to $56.3 million as compared to$38.9 million for the corresponding 2008 period. As a percentage of netrevenues, late-stage development income from operations increased 410 basispoints from 18.5% of net revenues in the three month period ended March 31,2008 to 22.6% of net revenues in the corresponding 2009 period. The strength incentral laboratory and clinical development revenues explained above, coupledwith increased efficiency gained from leveraging existing support functionsacross a larger base of revenues, drove $15.0 million of the$17.5 million increase in operating income or 390 basis points of the 410basis point increase in operating income as a percentage of net revenues. Theremainder of the increase was due to revenue growth in all other service linesin the segment.

 

Corporate expense increased $0.8 million to$27.5 million for the three months ended March 31, 2009 as comparedto $26.7 million for the corresponding 2008 period. As a percentage of netrevenues, Corporate expense decreased 30 basis points from 6.5% of net revenuesfor the three month period ended March 31, 2008 to 6.2% of net revenuesfor the corresponding 2009 period. Included in Corporate expense is stock-basedcompensation expense of $5.8 million or 1.3% of net revenues for the threemonths ended March 31, 2009, as compared to $6.1 million or 1.5% ofnet revenues for the corresponding 2008 period.

 

Other income, net decreased $6.1 million to$0.5 million for the three months ended March 31, 2009 from$6.6 million for the corresponding 2008 period primarily as a result ofthe $3.0 million gain from the receipt of contingent consideration ontransferred backlog on the sale of Covance’s cardiac safety service offering inthe prior year. Additionally, there was a $2.4 million decrease ininterest income due to lower interest rates on lower invested cash balances,and a $0.6 million decrease in foreign exchange gains.

 

Covance’s effective tax rate for the three monthsended March 31, 2009 was 29.0% compared to 29.9% for the corresponding2008 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 andtax planning initiatives.

 

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Covance has a 47% minority equity position in NoveprimLimited (“Noveprim”), a supplier of research products.  For the three month periods ended March 31,2009 and 2008, Covance recognized $0.2 million and $0.3 million,respectively, representing its share of Noveprim’s earnings, less theelimination of profit on inventory purchased from Noveprim and still on hand atCovance at March 31, 2009 and 2008.

 

Covance has a minority equity position (less than 20%) 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 thethree month period ended March 31, 2008, Covance recognized income of$0.2 million, representing its pro rata share of BITI’s earnings. In thefourth quarter of 2008, Covance suspended the use of the equity method ofaccounting for its investment in BITI as its ownership interest fell below 20%and it could no longer exercise significant influence over BITI’soperations.  In the fourth quarter of2008, Covance began accounting for its investment in BITI as anavailable-for-sale security in accordance with Statement of FinancialAccounting Standards No. 115, *Accountingfor Certain Investments in Debt and Equity Securities* (“SFAS 115”).Accordingly, Covance no longer records in equity earnings its pro-rata share ofBITI results but rather, reflects the fair value of its investment in BITI onits consolidated balance sheet. See note 4 to the unaudited consolidatedfinancial statements included elsewhere in this quarterly report.

 

Net income of $40.3 million for the three monthsended March 31, 2009 decreased $8.8 million or 17.9% as compared to$49.1 million for the corresponding 2008 period.

 

**Liquidity and CapitalResources**

** **

Cash and cash equivalents at March 31, 2009 and December 31,2008 were $190.2 million and $221.3 million, respectively.  Amounts are principally invested inshort-term money market funds and bank deposits with major financialinstitutions in countries whose governments guarantee those investments(primarily in Ireland and the United Kingdom). Covance’s expected primary cash needs on both a short and long-termbasis are for capital expenditures, expansion of services, possible futureacquisitions, geographic expansion, working capital and other general corporatepurposes, including possible share repurchases. Covance’s $125.0 millionrevolving credit facility (the “Credit Facility”) expires in June 2009,and Covance is in the process of securing a new revolving credit facility.  Covance believes its credit quality, strengthof earnings and bank relationships will provide adequate options for bankparticipation and will result in replacement of its Credit Facility atcommercially reasonable terms.  Covancebelieves cash on hand plus cash from operations and available borrowings underthe Credit Facility and the planned replacement credit facility will providesufficient liquidity for the foreseeable future.  At March 31, 2009, there were$80.0 million of outstanding borrowings and no outstanding letters ofcredit under the Credit Facility. Interest on all outstanding borrowings underthe Credit Facility is based upon the London Interbank Offered Rate (“LIBOR”)plus a 75 basis point margin and approximated 1.26% per annum during thequarter ended March 31, 2009.  TheCredit Facility contains various financial and other covenants.  At March 31, 2009, Covance was incompliance with the terms of the Credit Facility. The Credit Facility iscollateralized by guarantees of certain of Covance’s domestic subsidiaries anda pledge of 65 percent of the capital stock of certain of Covance’s foreignsubsidiaries.

 

During the three months ended March 31, 2009, Covance’soperations provided net cash of $9.2 million, a decrease of $26.6 millionfrom the corresponding 2008 period.  Thechange in net operating assets used $54.7 million in cash during the threemonths ended March 31, 2009, primarily due to a reduction in accruedpayroll and benefits (primarily attributable to incentive compensation paymentsmade during the first quarter of 2009 relating to 2008 incentive compensationaccruals) and an increase in accounts receivable.  The change in net operating assets used$32.5 million in cash during the three months ended March 31, 2008,primarily due to a reduction in accrued payroll and benefits (primarilyattributable to incentive compensation payments made during the first quarterof 2008 relating to 2007 incentive compensation accruals) and unearned revenueand an increase in prepaid expenses and other current assets, unbilled servicesand inventory, partially offset by an increase in income taxes payable.  Covance’s ratio of current assets to currentliabilities was 1.57 at March 31, 2009 and 1.60 at December 31, 2008.

 

Investing activities for the three months ended March 31,2009 used $58.9 million, compared to using $59.5 million for thecorresponding 2008 period.  Capitalspending for the first three months of 2009 totaled $40.3 million, and wasprimarily for the expansion of preclinical facilities in North America andEurope, outfitting of new facilities, upgrade of existing equipment, and thepurchase of new equipment, hardware and software.  Approximately $35.5 million of capitalspending in the first three months of 2009 represents expenditures primarilyrelated to ongoing significant facility expansions and transformationalinformation technology projects that were not placed in service at March 31,2009. Capital spending for the corresponding 2008 

 

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period totaled$62.6 million, and was primarily for the expansion of preclinicalfacilities in North America and Europe, outfitting of new facilities, upgradeof existing equipment, and the purchase of new equipment, hardware andsoftware.

 

In March 2009, Covance acquired 100% of the stockof Swiss Pharma Contract Ltd. (“Swiss Pharma”), and its 50-bed clinicalresearch facility based in Basel, Switzerland, for cash payments aggregating$19.4 million ($18.6 million net of cash acquired). Transactionrelated costs of $0.5 million were reported as selling, general &administrative expense in the three month period ended March 31, 2009.This acquisition expands Covance’s clinical pharmacology presence in Europe andprovides access to special patient populations for Phase I/IIa clinicalstudies. Swiss Pharma’s assets and liabilities acquired are included in Covance’sconsolidated balance sheet at March 31, 2009 based on their estimated fairvalue of $2.8 million on a net basis, as determined by a preliminarypurchase price allocation. Intangible assets acquired were valued at $1.8 million.The remaining purchase price of $18.2 million represents goodwill. Inaddition to the initial cash consideration of $19.4 million, Covanceaccrued a liability of $3.4 million for the estimated fair value of futurecontingent consideration expected to be payable by Covance based upon SwissPharma reaching specific performance metrics over the next three years ofoperation. Swiss Pharma is expected to be accretive to earnings in 2009.Results of operations for Swiss Pharma will be reported in Covance’s EarlyDevelopment segment. See note 5 to the unaudited consolidated financialstatements included elsewhere in this quarterly report.

 

Investing activities for the three months ended March 31,2008 also included $3.0 million of additional proceeds received during thequarter reflecting contingent consideration related to transferred backlog fromthe sale of Covance’s cardiac safety service offering in November 2007.

 

Financing activities for the three months ended March 31,2009 provided $25.5 million. Financing activities for the three months ended March 31, 2008 used$78.1 million.  During the threemonths ended March 31, 2009, Covance borrowed an additional $30.0 millionunder the Credit Facility. Additionally, $1.4 million in proceeds werereceived from the exercise of stock options and $1.6 million was received fromemployee contributions to the Company’s employee stock purchase plan, partiallyoffset by $2.1 million used to purchase into treasury 53,619 sharesof common stock in connection with employee benefit plans. In March 2009,Covance repaid the entire $5.4 million balance of mortgage debt assumed inthe Swiss Pharma acquisition. During the three months ended March 31,2008, $126.7 million was used to purchase into treasury1,500,000 shares of common stock under the share buyback programauthorized by Covance’s Board of Directors and $2.9 million was used topurchase into treasury 34,980 shares of common stock in connection withemployee benefit plans; partially offset by $5.4 million in proceeds fromthe exercise of stock options, $1.7 million in excess tax benefitsrealized on the exercise of stock options and $1.4 million from employeecontributions to the Company’s employee stock purchase plan.  Additionally, Covance borrowed$43.0 million under the Credit Facility during the first quarter of 2008to partially fund the purchase into treasury of common stock.

 

**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 Accounting Standards**

 

In December 2008, the FASB issued FASB StaffPosition 132(R)-1 (“FSP 132(R)-1”), which provides guidance on an employer’sdisclosures about plan assets of a defined benefit pension or otherpostretirement plan. FSP 132(R)-1 requires disclosure of investment allocationmethodologies and information that enables users of financial statements toassess the inputs and valuation techniques used to develop fair valuemeasurements of plan assets in order to provide users with an understanding ofsignificant concentrations of risk in plan assets. FSP 132(R)-1 is effectivefor years ending after December 15, 2009. FSP 132(R)-1 requires additionaldisclosure only and therefore will not impact Covance’s consolidated results ofoperations or financial position.

 

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***Forward-LookingStatements. ****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, areforward-looking statements made pursuant to the safe harbor provisions of thePrivate Securities Litigation Reform Act of 1995. Forward-looking statementsinclude statements concerning plans, objectives, goals, strategies, futureevents or performance, expectations, predictions, and assumptions and otherstatements which are other than statements of historical facts. All suchforward-looking statements are based on the current expectations of managementand are subject to, and are qualified by, risks and uncertainties that couldcause actual results to differ materially from those expressed or implied bythose statements. These risks and uncertainties include, without limitation,competitive factors, outsourcing trends in the pharmaceutical industry, levelsof industry research and development spending, the Company’s ability tocontinue to attract and retain qualified personnel, the fixed price nature ofcontracts or the loss of large contracts, risks associated with acquisitionsand investments, the Company’s ability to increase order volume, the pace oftranslation of orders into revenue in late-stage development services,fluctuations in currency exchange rates, and other factors described in Covance’sfilings with the Securities and Exchange Commission, including its AnnualReport on Form 10-K.*

 

**Item 3. Quantitative and Qualitative Disclosure About Market Risk**

 

For the three monthsended March 31, 2009, approximately 39% of our net revenues were derivedfrom our operations outside the United States. We do not engage in material orlong-term derivative or hedging activities related to our potential foreignexchange 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-terminvestments are with major financial institutions in countries whosegovernments guarantee those investments (primarily in Ireland and the UnitedKingdom).  These short-term investmentsare in bank deposits and money market funds which can be readily purchased andsold using established markets.  Covance’scash investment policy is to maximize utilization of excess cash according tothe following specific criteria (in order of priority):  (1) preserve capital (minimize financialmarket risk); (2) maintain liquidity; (3) manage foreign exchangerate exposure (internal hedging); (4) maximize rate of return; and (5) enhancestrategic relationships with select financial institutions.  Covance also has strong operating cash flowand ready access to credit available under its Credit Facility as evidenced byits ability to expand the Credit Facility to $125 million in August 2008and its ability to borrow an additional $30 million under the CreditFacility during the three months ended March 31, 2009.

 

**Item 4.  Controls and Procedures**

 

Disclosure controls andprocedures. The Company’s Principal Executive Officer and Principal FinancialOfficer have reviewed and evaluated the effectiveness of the Company’sdisclosure controls and procedures as of the end of the period covered in thisreport.  Based on that evaluation, thePrincipal Executive Officer and the Principal Financial Officer have concludedthat the Company’s current disclosure controls and procedures areeffective.  There have been no significantchanges in the Company’s internal controls or in the other factors thatsignificantly affect those 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 the events outlined below were to occurindividually or in the aggregate, our business, results of operations,financial condition, and cash flows could be materially adversely affected.

 

**Changes in government regulation orin practices relating to the pharmaceutical industry could decrease the needfor the services we provide.**

 

Governmentalagencies throughout the world, including in the United States, strictlyregulate the drug development process. Our business involves helpingpharmaceutical and biotechnology companies navigate the regulatory drugapproval process. Changes in regulation, such as a relaxation in regulatoryrequirements or the introduction of simplified drug approval procedures, or anincrease in regulatory requirements that we have difficulty satisfying or thatmake our services less competitive, could eliminate or substantially reduce thedemand for our services. Also, if government efforts to contain drug costs andpharmaceutical and biotechnology company profits from new drugs, our customersmay spend less, or reduce their growth in spending on research and development.If health insurers were to change their practices with respect toreimbursements for pharmaceutical products, our customers may spend less, orreduce 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.**

 

Anyfailure on our part to comply with applicable regulations could result in thetermination of on-going research or the disqualification of data for submissionto regulatory authorities. For example, if we were to fail to properly monitorcompliance by clinical trial investigators with study protocols, the datacollected from that trial could be disqualified. If this were to happen, wecould be contractually required to repeat the trial at no further cost to ourcustomer, but at substantial cost to us.

 

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

 

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

 

·                  the failure ofproducts to satisfy safety requirements;

·                  unexpected orundesired results of the products;

·                  insufficient patient enrollment;

·                  insufficientinvestigator recruitment;

·                  the client’sdecision to terminate the development of a product or to end a particularstudy; and

·                  our failure toperform properly our duties under the contract.

 

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

 

**We may bear financial risk if weunder price our contracts or overrun cost estimates.**

 

Sinceour contracts are often structured as fixed price or fee-for-service with acap, we bear the financial risk if we initially under price our contracts orotherwise overrun our cost estimates. Such under pricing or significant costoverruns could have a material adverse effect on our business, results ofoperations, financial condition, and cash flows.

 

**We may not be able to successfullydevelop and market or acquire new services.**

 

Wemay seek to develop and market new services that complement or expand ourexisting business or expand our service offerings through acquisition. If weare unable to develop new services and/or create demand for those newly developedservices, or to expand our service offerings through acquisition, our futurebusiness, results of operations, financial condition, and cash flows could beadversely affected.

 

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**Our quarterly operating results mayvary.**

 

Ouroperating results may vary significantly from quarter to quarter and areinfluenced by factors over which we have little control such as:

 

·                  changes in thegeneral global economy;

·                  exchange ratefluctuations;

·                  thecommencement, completion and delay or cancellation of large projects or groupsof projects;

·                  the progress ofongoing contracts;

·                  the timing ofand charges associated with completed acquisitions or other events; and

·                  changes in themix of our services.

 

Webelieve that operating results for any particular quarter are not necessarily ameaningful indication of future results. While fluctuations in our quarterlyoperating results could negatively or positively affect the market price of ourcommon stock, these fluctuations may not be related to our future overalloperating performance.

 

**We depend on the pharmaceutical andbiotechnology industries.**

 

Ourrevenues depend greatly on the expenditures made by the pharmaceutical andbiotechnology industries in research and development. In some instances,companies in these industries are reliant on their ability to raise capital inorder to fund their research and development projects. Accordingly, economicfactors and industry trends that affect our clients in these industries alsoaffect our business. If companies in these industries were to reduce the numberof research and development projects they conduct or outsource, our businesscould be materially adversely affected.

 

**We operate in a highly competitiveindustry.**

 

Competitorsin the contract research organization industry range from small, limitedservice providers to full service global contract research organizations. Ourmain competition consists of in-house departments of pharmaceutical companies,full-service and functional contract research organizations, and, to a lesserdegree, universities and teaching hospitals. We compete on a variety offactors, including:

 

·                  reputation foron-time quality performance and regulatory compliance;

·                  expertise andexperience in specific areas;

·                  scope of serviceofferings;

·                  strengths invarious geographic markets;

·                  price;

·                  technologicalexpertise and efficient drug development processes;

·                  quality offacilities;

·                  ability toacquire, process, analyze and report data in an accurate manner;

·                  ability tomanage large scale clinical trials both domestically and internationally;

·                  expertise andexperience in market access services; and

·                  size.

 

Forinstance, our clinical development services have from time-to-time experiencedperiods of increased price competition which had a material adverse effect onCovance’s late-stage development profitability and consolidated net revenuesand net income.

 

Thereis competition among the larger contract research organizations for bothclients and potential acquisition candidates. Additionally, small, limitedservice entities considering entering the contract research organizationindustry will find few barriers to entry, thus further increasing possiblecompetition. These competitive pressures may affect the attractiveness of ourservices and could adversely affect our financial results.

 

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**Unfavorable general economic conditions could negativelyimpact our operating results and financial condition.**

 

Unfavorable globaleconomic conditions, including the current recession in the United States andthe recent financial crisis affecting the banking system and financial markets,could negatively affect our business. While it is difficult for us to predictthe impact of general economic conditions on our business, these conditionscould reduce customer demand for some of our services, which could cause ourrevenue to decline. Also, our customers, particularly smaller biotechnologycompanies which are especially reliant on the credit and capital markets, maynot be able to obtain adequate access to credit or equity funding, which couldaffect their ability to make timely payments to us. If that were to occur, wecould be required to increase our allowance for doubtful accounts, and thenumber of days outstanding for our accounts receivable could increase. Forthese reasons, among others, if the current economic conditions persist ordecline, our operating results and financial condition could be adverselyaffected.

 

**Weaknesses in the credit markets could negatively impact theCompany’s access to capital.**

 

The Company’searly development services have in the past required continuing infrastructureexpansions and acquisition of capital assets. The Company has been able to fundits capital needs largely from cash on hand and cash from operations as well asfrom its revolving credit facility. The Company’s present Credit Facility willexpire in June 2009 and while the Company believes its credit quality,strength of earnings and bank relationships will provide adequate options forbank participation and will result in replacement of its Credit Facility atcommercially reasonable terms, the recent turmoil in the credit markets couldaffect the Company’s ability to replace this facility and/or further increasethe Company’s funding costs.

 

**We may expand our business throughacquisitions.**

 

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

 

·                  difficulties andexpenses in connection with integrating the acquired companies and achievingthe expected benefits;

·                  diversion ofmanagement’s attention from current operations;

·                  the possibilitythat we may be adversely affected by risk factors facing the acquiredcompanies;

·                  acquisitionscould be dilutive to earnings, or in the event of acquisitions made through theissuance of our common stock to the shareholders of the acquired company,dilutive to the percentage of ownership of our existing stockholders;

·                  potential lossesresulting from undiscovered liabilities of acquired companies not covered bythe indemnification we may obtain from the seller;

·                  risks of notbeing able to overcome differences in foreign business practices, language andother cultural barriers in connection with the acquisition of foreigncompanies; and

·                  loss of keyemployees of the acquired companies.

 

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

 

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

 

Implementationof health care reform legislation that contain costs could limit the profitsthat can be made from the development of new drugs. This could adversely affectresearch and development expenditures by pharmaceutical and biotechnologycompanies which could in turn decrease the business opportunities available tous both in the United States and abroad. In addition, new laws or regulationsmay create a risk of liability, increase our costs or limit our service offerings.

 

**We rely on third parties forimportant services.**

 

Wedepend on third parties to provide us with services critical to ourbusiness.  The failure of any of thesethird parties to adequately provide the needed services could have a materialadverse effect on our business.

 

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**Our revenues and earnings are exposedto exchange rate fluctuations.**

 

Wederive a large portion of our net revenues from international operations. Forthe three months ended March 31, 2009, we derived approximately 39% of ournet revenues from our operations outside the United States. Since our financialstatements are denominated in U.S. dollars, fluctuations in exchange rates fromperiod to period will have an impact on our reported results.  For example, in the first quarter of 2009,the U.S. Dollar was considerably stronger against the currencies of our mostsignificant foreign operations (the British Pound, the Swiss Franc and theEuro) than in the first quarter of the prior year. This strengthening of theU.S. Dollar negatively impacted Covance’s first quarter 2009 year over yearrevenue growth by approximately $27 million or 680 basis points. 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 personnel couldadversely affect our business.**

 

Oursuccess depends to a significant extent upon the efforts of our seniormanagement team and other key personnel. The loss of the services of suchpersonnel could adversely affect our business. Also, because of the nature ofour business, our success is dependent upon our ability to attract and retaintechnologically 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.

 

**Contract research services create arisk of liability.**

 

Incontracting to work on drug development trials and studies, we face a range ofpotential liabilities, for example:

 

·                  errors oromissions that create harm during a trial to study volunteers or after a trialto consumers of the drug after regulatory approval of the drug;

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

·                  errors oromissions from tests conducted for the agrochemical and food industries;

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

·                  errors andomissions during a trial that may undermine the usefulness of a trial or datafrom the trial or study.

 

Wealso contract with physicians, also referred to as investigators, to conductthe clinical trials to test new drugs on human volunteers. These tests cancreate a risk of liability for personal injury or death to volunteers,resulting from negative reactions to the drugs administered or fromprofessional malpractice by third party investigators. We believe that ourrisks in this area are generally reduced by the following:

 

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

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

·                  our efforts tocomply with various regulatory requirements we must follow in connection withour business.

 

Contractualindemnifications generally do not protect us against liability arising fromcertain of our own actions, such as negligence or misconduct. We could bematerially and adversely affected if we were required to pay damages or bearthe costs of defending any claim which is not covered by a contractualindemnification provision or in the event that a party who must indemnify usdoes not fulfill its indemnification obligations or which is beyond the levelof our insurance coverage. There can be no assurance that we will be able tomaintain such insurance coverage on terms acceptable to us.

 

**Hardwareand software failures, delays in the operation of our computer andcommunications systems or the failure to implement system enhancements may harmour business.**

 

Oursuccess depends on the efficient and uninterrupted operation of our computerand communications systems. A failure of our network or data gatheringprocedures could impede the processing of data, delivery of databases andservices, client orders and day-to-day management of our business and couldresult in the corruption or loss of data. While certain of our operations haveappropriate disaster recovery plans in place, we currently do not haveredundant facilities everywhere in the 

 

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world to provide ITcapacity in the event of a system failure. Despite any precautions we may take,damage from fire, floods, hurricanes, power loss, telecommunications failures,computer viruses, break-ins and similar events at our various computerfacilities could result in interruptions in the flow of data to our servers andfrom our servers to our clients. In addition, any failure by our computerenvironment to provide our required data communications capacity could resultin interruptions in our service. In the event of a delay in the delivery ofdata, we could be required to transfer our data collection operations to analternative provider of server hosting services. Such a transfer could resultin delays in our ability to deliver our products and services to our clients.Additionally, significant delays in the planned delivery of systemenhancements, improvements and inadequate performance of the systems once theyare completed could damage our reputation and harm our business. Finally,long-term disruptions in the infrastructure caused by events such as naturaldisasters, the outbreak of war, the escalation of hostilities, and acts ofterrorism (particularly involving cities in which we have offices) could adverselyaffect our businesses. Although we carry property and business interruptioninsurance, our coverage may not be adequate to compensate us for all lossesthat may occur.

 

**Relianceon facilities.**

 

Covancerelies on certain of its facilities.  Inparticular, Covance’s preclinical and central laboratory facilities are highlyspecific and would be difficult to replace in a short period of time.  Any event that causes a disruption of theoperation of these facilities might impact the Company’s ability to provideservice to its customers and therefore could have a material adverse affect onits financial condition, results of operations and cash flows.

 

**Reliance on 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.

 

**Certain service offerings andresearch products are dependent on limited sources of supply of services orproducts which if interrupted could affect our business.**

 

Wedepend on a limited number of suppliers for certain services and for certainanimal populations. Disruptions to the continued supply of these services orproducts may arise from export import restrictions or embargoes, foreignpolitical or economic instability, or otherwise. Disruption of supply couldhave a material adverse effect on our business.

 

**Actions of animal rights extremistsmay affect our business.**

 

Ourearly development services utilize animals in preclinical testing of the safetyand efficacy of drugs and also breed and sell animals for biomedical research.Such activities are required for the development of new medicines and medicaldevices under regulatory regimes in the United States, Europe, Japan and othercountries. Acts of vandalism and other acts by animal rights extremists whoobject to the use of animals in drug development could have a material adverseeffect on our business.

 

**Our animal populations may sufferdiseases that can damage our inventory, harm our reputation, result indecreased sales of research products or result in other liability to us.**

 

Itis important that our research products be free of diseases, includinginfectious diseases. The presence of diseases can distort or compromise thequality of research results, can cause loss of animals in our inventory, canresult in harm to humans or outside animal populations if the disease is not containedto animals in inventory, or can result in other losses. Such results could harmour reputation or have a material adverse effect on our financial condition,results of operations, and cash flows.

 

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**Item 6. Exhibits**

 

31.1                                                                           Certification— Joseph L. Herring.  ***Filed herewith.***

 

31.2                                                                           Certification— William E. Klitgaard.  ***Filed herewith.***

 

32.1                                                                           CertificationPursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906of the Sarbanes-Oxley Act of 2002 — Joseph L. Herring.  ***Filed herewith.***

 

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

 

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**SIGNATURES**

 

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
| ** **               |   | **COVANCE INC.**                                   |
|--------------------------|--------|----------------------------------------------------|
|                     |   |                                               |
|                     |   |                                               |
| Dated:  May 4, 2009 | 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                |   | May 4, 2009 |
|                                          |   | and  Chief Executive Officer          |   |             |
|                                          |   | (Principal Executive  Officer)        |   |             |
|                                          |   |                                  |   |             |
| /s/  William E. Klitgaard                     |   |                                  |   |             |
|     William  E. Klitgaard |   | Corporate  Senior Vice President      |   | May 4, 2009 |
|                                          |   | and  Chief Financial Officer          |   |             |
|                                          |   | (Principal  Financial Officer)        |   |             |
|                                          |   |                                  |   |             |
| /s/  Michele A. Kennedy                       |   |                                  |   |             |
|     Michele  A. Kennedy   |   | Corporate Vice  President, Controller |   | May 4, 2009 |
|                                          |   | and  Chief Accounting Officer         |   |             |
|                                          |   | (Principal  Accounting Officer)       |   |             |

 

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**EXHIBIT INDEX**

 
| **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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