**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,D.C.  20549**

**FORM 10-Q**
| **x**                                                                                                                                                                                                                                                                                                                                                              | ** ** | **Quarterly Report Pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934**  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                               |       |                                                                                          |
| **For the  quarterly period ended June 30, 2007**                                                                                                                                                                                                                                                                                                                  |
| ** **                                                                                                                                                                                                                                                                                                                                                         | ** ** | ** **                                                                                    |
| **or**                                                                                                                                                                                                                                                                                                                                                             |
|                                                                                                                                                                                                                                                                                                                                                               |       |                                                                                          |
| **o**                                                                                                                                                                                                                                                                                                                                                              | ** ** | **Transition Report Pursuant to Section 13 or  15(d) of the Securities Exchange Act of 1934** |
|                                                                                                                                                                                                                                                                                                                                                               |       |                                                                                          |
| **For the  transition period from                              to                           ** |

 

**CommissionFile Number:  1-12213**

**COVANCE INC**.

(Exact name ofRegistrant as specified in its Charter)

| **Delaware**              |   | **22-3265977**                        |
|---------------------------|--------|---------------------------------------|
| (State of  Incorporation) |   | (I.R.S. Employer  Identification No.) |

 

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

 

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

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

YES  x                  NO  o

Indicate by check markwhether the Registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. (See definition of “accelerated filer and largeaccelerated filer” in Rule 12b-2 of the Exchange Act).

LargeAccelerated Filer  x                Accelerated Filer  o            Non-Accelerated Filer  o

Indicate by checkmark whether 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 July 20, 2007, theRegistrant had 63,705,135 shares of common stock outstanding.

 

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**Covance Inc.**

**Form 10-QFor the Quarterly Period Ended June 30, 2007**

**INDEX**
|                                                                                           | **Page**                                                                                    |
|-------------------------------------------------------------------------------------------|---------------------------------------------------------------------------------------------|
| ** **                                                                                |                                                                                        |
| **Part I. Financial Information**                                                         |                                                                                        |
| ** **                                                                                |                                                                                        |
| Item 1.                                                                                   | Financial Statements (Unaudited)                                                            |   |
|                                                                                      |                                                                                        |
| Consolidated  Balance Sheets—June 30, 2007 and December 31, 2006                     | 2                                                                                           |
|                                                                                      |                                                                                        |
| Consolidated  Statements of Income—Three and Six Months ended June 30, 2007 and 2006 | 3                                                                                           |
|                                                                                      |                                                                                        |
| Consolidated  Statements of Cash Flows—Six Months ended June 30, 2007 and 2006       | 4                                                                                           |
|                                                                                      |                                                                                        |
| Notes to  Consolidated Financial Statements                                               | 5                                                                                           |
|                                                                                      |                                                                                        |
| Item 2.                                                                                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 15 |
|                                                                                      |                                                                                        |
| Item 3.                                                                                   | Quantitative  and Qualitative Disclosure About Market Risk                                  | 23 |
|                                                                                      |                                                                                        |
| Item 4.                                                                                   | Controls and Procedures                                                                     | 23 |
|                                                                                      |                                                                                        |
| **Part II. Other Information**                                                            |                                                                                        |
| ** **                                                                                |                                                                                        |
| Item  1a.                                                                                 | Risk  Factors                                                                               | 24 |
|                                                                                      |                                                                                        |
| Item 2.                                                                                   | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 28 |
|                                                                                      |                                                                                        |
| Item 4.                                                                                   | Submission  of Matters to a Vote of Security Holders                                        | 28 |
|                                                                                      |                                                                                        |
| Item  6.                                                                                  | Exhibits                                                                                    | 28 |
|                                                                                      |                                                                                        |
| **Signatures**                                                                            | 29                                                                                          |
|                                                                                           |                                                                                             |  |  |

 

1

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**COVANCE INC. AND SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**JUNE 30, 2007 AND DECEMBER 31, 2006**

 
| ** **                                                                                                                                                                                                                  | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| **(Dollars in  thousands)**                                                                                                                                                                                                 | ** ** | **2007**          | ** ** | **2006**              | ** ** |
| ** **                                                                                                                                                                                                                  | ** ** | **(UNAUDITED)**   | ** ** | ** **            | ** ** |
| **Assets**                                                                                                                                                                                                                  |       |              |       |                  |       |
| Current Assets:                                                                                                                                                                                                             |       |              |       |                  |       |
| Cash and cash  equivalents                                                                                                                                                                                                  |       | $                 | 208,008    |                  | $          | 219,810 |   |
| Accounts  receivable                                                                                                                                                                                                        |       | 220,327           |       | 205,473               |       |
| Unbilled  services                                                                                                                                                                                                          |       | 103,696           |       | 89,139                |       |
| Inventory                                                                                                                                                                                                                   |       | 51,583            |       | 49,628                |       |
| Deferred income  taxes                                                                                                                                                                                                      |       | 4,258             |       | 4,320                 |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                  |       | 70,779            |       | 71,196                |       |
| Total Current  Assets                                                                                                                                                                                                       |       | 658,651           |       | 639,566               |       |
| Property and equipment,  net                                                                                                                                                                                                |       | 543,202           |       | 500,057               |       |
| Goodwill, net                                                                                                                                                                                                               |       | 119,725           |       | 119,725               |       |
| Other assets                                                                                                                                                                                                                |       | 41,584            |       | 38,330                |       |
| Total Assets                                                                                                                                                                                                                |       | $                 | 1,363,162  |                  | $          | 1,297,678 |   |
| ** **                                                                                                                                                                                                                  |       |              |       |                  |       |
| **Liabilities and Stockholders’  Equity**                                                                                                                                                                              |       |              |       |                  |       |
| Current Liabilities:                                                                                                                                                                                                        |       |              |       |                  |       |
| Accounts payable                                                                                                                                                                                                            |       | $                 | 32,077     |                  | $          | 35,479 |   |
| Accrued payroll  and benefits                                                                                                                                                                                               |       | 71,410            |       | 76,657                |       |
| Accrued expenses  and other current liabilities                                                                                                                                                                             |       | 48,966            |       | 50,855                |       |
| Unearned revenue                                                                                                                                                                                                            |       | 134,230           |       | 109,559               |       |
| Income taxes  payable                                                                                                                                                                                                       |       | 6,670             |       | 17,154                |       |
| Total Current  Liabilities                                                                                                                                                                                                  |       | 293,353           |       | 289,704               |       |
| Deferred income taxes                                                                                                                                                                                                       |       | 30,436            |       | 31,052                |       |
| Other liabilities                                                                                                                                                                                                           |       | 58,802            |       | 53,627                |       |
| Total  Liabilities                                                                                                                                                                                                          |       | 382,591           |       | 374,383               |       |
|                                                                                                                                                                                                                        |       |              |       |                  |       |
| 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 June 30, 2007 and December 31, 2006                                                              |       | 3⁄4            |       | 3⁄4                |       |
| Common Stock -  Par value $0.01 per share; 140,000,000 shares authorized; 74,168,743 and  73,427,001 shares issued and outstanding, including those held in treasury, at  June 30, 2007 and December 31, 2006, respectively |       | 742               |       | 734                   |       |
| Paid-in capital                                                                                                                                                                                                             |       | 464,338           |       | 426,806               |       |
| Retained  earnings                                                                                                                                                                                                          |       | 837,583           |       | 757,809               |       |
| Accumulated  other comprehensive income                                                                                                                                                                                     |       | 13,168            |       | 11,781                |       |
| Treasury stock  at cost (10,491,139 and 9,485,549 shares at June 30, 2007 and December 31,  2006, respectively)                                                                                                             |       | (335,260          | )          | (273,835              | )          |
| Total  Stockholders’ Equity                                                                                                                                                                                            |       | 980,571           |       | 923,295               |       |
| Total Liabilities and  Stockholders’ Equity                                                                                                                                                                            |       | $                 | 1,363,162  |                  | $          | 1,297,678 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

2

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**COVANCE INC. AND SUBSIDIARIES**

**CONSOLIDATED STATEMENTS OF INCOME**

**FOR THE THREE AND SIXMONTHS ENDED JUNE 30, 2007 AND 2006**

**(UNAUDITED)**
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                                      | ** ** | **June 30**                 | ** ** | **June 30**               | ** ** |
| **(Dollars in thousands, except per share data)** | ** ** | **2007**                         | ** ** | **2006**                       | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Net revenues                                                                    |       | $                                | 381,145    |                           | $          | 335,240 |   | $ | 739,464 |   | $ | 655,749 |   |
| Reimbursable  out-of-pockets                                                    |       | 23,029                           |       | 21,934                         |       | 41,649 |   | 35,063 |   |
| Total revenues                                                                  |       | 404,174                          |       | 357,174                        |       | 781,113 |   | 690,812 |   |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Cost and  expenses:                                                             |       |                             |       |                           |       |   |   |   |   |
| Cost of revenue (excluding depreciation and  amortization)                      |       | 251,078                          |       | 222,723                        |       | 485,457 |   | 436,383 |   |
| Reimbursed out-of-pocket expenses                                               |       | 23,029                           |       | 21,934                         |       | 41,649 |   | 35,063 |   |
| Selling, general and administrative (excluding  depreciation and amortization)  |       | 58,092                           |       | 51,312                         |       | 113,883 |   | 99,598 |   |
| Depreciation and amortization                                                   |       | 16,457                           |       | 14,165                         |       | 32,568 |   | 26,884 |   |
| Total costs and expenses                                                        |       | 348,656                          |       | 310,134                        |       | 673,557 |   | 597,928 |   |
| Income from  operations                                                         |       | 55,518                           |       | 47,040                         |       | 107,556 |   | 92,884 |   |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Other (income)  expense, net:                                                   |       |                             |       |                           |       |   |   |   |   |
| Interest income                                                                 |       | (2,138                           | )          | (1,717                         | )          | (4,735 | ) | (3,622 | ) |
| Interest expense                                                                |       | 145                              |       | 35                             |       | 262 |   | 127 |   |
| Foreign exchange transaction (gain) loss, net                                   |       | (103                             | )          | (195                           | )          | 46 |   | 67 |   |
| Other income, net                                                               |       | (2,096                           | )          | (1,877                         | )          | (4,427 | ) | (3,428 | ) |
| Income before  taxes and equity investee earnings                               |       | 57,614                           |       | 48,917                         |       | 111,983 |   | 96,312 |   |
| Taxes on income                                                                 |       | 16,816                           |       | 14,407                         |       | 32,857 |   | 28,663 |   |
| Equity investee  earnings                                                       |       | 714                              |       | 510                            |       | 1,280 |   | 760 |   |
| Net income                                                                      |       | $                                | 41,512     |                           | $          | 35,020 |   | $ | 80,406 |   | $ | 68,409 |   |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Basic earnings  per share                                                       |       | $                                | 0.65       |                           | $          | 0.55 |   | $ | 1.26 |   | $ | 1.08 |   |
| Weighted average  shares outstanding - basic                                    |       | 63,598,821                       |       | 63,626,078                     |       | 63,722,266 |   | 63,399,226 |   |
|                                                                            |       |                             |       |                           |       |   |   |   |   |
| Diluted earnings  per share                                                     |       | $                                | 0.64       |                           | $          | 0.54 |   | $ | 1.24 |   | $ | 1.06 |   |
| Weighted average shares  outstanding – diluted                             |       | 64,628,294                       |       | 64,849,638                     |       | 64,745,006 |   | 64,623,847 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

3

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**COVANCEINC. AND SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**FOR THE SIX MONTHS ENDED JUNE 30, 2007 AND 2006**

**(UNAUDITED)**
| ** **                                                                                   | ** ** | **Six Months Ended June 30** | ** ** |
|----------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **(Dollars in thousands)**                                                         | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
|                                                                                         |       |                                             |       |   |   |
| Cash flows from  operating activities:                                                       |       |                                             |       |   |   |
| Net income                                                                                   |       | $                                                | 80,406     |   | $ | 68,409 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:           |       |                                             |       |   |   |
| Depreciation and amortization                                                                |       | 32,568                                           |       | 26,884 |   |
| Non-cash compensation expense associated with employee  benefit and stock compensation plans |       | 15,817                                           |       | 14,331 |   |
| Deferred income tax provision (benefit)                                                      |       | (1,802                                           | )          | (697 | ) |
| Other                                                                                        |       | (2,994                                           | )          | (713 | ) |
| Changes in operating assets and liabilities, net of businesses  acquired:                    |       |                                             |       |   |   |
| Accounts receivable                                                                          |       | (14,854                                          | )          | 6,466 |   |
| Unbilled services                                                                            |       | (14,557                                          | )          | (12,426 | ) |
| Inventory                                                                                    |       | (1,955                                           | )          | (2,826 | ) |
| Accounts payable                                                                             |       | (3,402                                           | )          | 2,223 |   |
| Accrued liabilities                                                                          |       | (2,982                                           | )          | (2,691 | ) |
| Unearned revenue                                                                             |       | 24,671                                           |       | (4,121 | ) |
| Income taxes payable                                                                         |       | (6,143                                           | )          | (386 | ) |
| Other assets and liabilities, net                                                            |       | (12,909                                          | )          | (15,658 | ) |
| Net cash  provided by operating activities                                                   |       | 91,864                                           |       | 78,795 |   |
|                                                                                         |       |                                             |       |   |   |
| Cash flows from  investing activities:                                                       |       |                                             |       |   |   |
| Capital expenditures                                                                         |       | (61,840                                          | )          | (49,335 | ) |
| Acquisition of businesses                                                                    |       | —                                           |       | (74,323 | ) |
| Other, net                                                                                   |       | 85                                               |       | 586 |   |
| Net cash used in  investing activities                                                       |       | (61,755                                          | )          | (123,072 | ) |
|                                                                                         |       |                                             |       |   |   |
| Cash flows from  financing activities:                                                       |       |                                             |       |   |   |
| Stock issued under employee stock purchase and  option plans                                 |       | 19,553                                           |       | 27,603 |   |
| Purchase of treasury stock                                                                   |       | (61,425                                          | )          | (8,701 | ) |
| Net cash (used  in) provided by financing activities                                         |       | (41,872                                          | )          | 18,902 |   |
|                                                                                         |       |                                             |       |   |   |
| Effect of  exchange rate changes on cash                                                     |       | (39                                              | )          | 2,296 |   |
| Net change in  cash and cash equivalents                                                     |       | (11,802                                          | )          | (23,079 | ) |
| Cash and cash  equivalents, beginning of period                                              |       | 219,810                                          |       | 160,717 |   |
| Cash and cash  equivalents, end of period                                                    |       | $                                                | 208,008    |   | $ | 137,638 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

4

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**COVANCEINC. AND SUBSIDIARIES**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(UNAUDITED)**

**June30, 2007 and 2006**

**(dollars in 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 10 ofRegulation S-X.  Accordingly, they do notinclude 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 and sixmonths ended June 30, 2007 are not necessarily indicative of the results thatmay be expected for the year ending December 31, 2007.  The balance sheet at December 31, 2006 hasbeen derived from the audited financial statements at that date but does notinclude all of the information and footnotes required by GAAP for completefinancial statements.  You should readthese unaudited consolidated financial statements together with the historicalconsolidated financial statements of Covance Inc. and subsidiaries (“Covance”or the “Company”) for the years ended December 31, 2006, 2005, and 2004included in our Annual Report on Form 10-K for the year ended December 31,2006.

**2.  Summary of Significant Accounting Policies**

**Principles ofConsolidation**

These unauditedconsolidated financial statements include the accounts of all entitiescontrolled by Covance.  All significantintercompany accounts and transactions are eliminated.  The equity method of accounting is used forinvestments in affiliates in which Covance owns between 20 and 50 percent anddoes not have the ability to exercise control. See Note 4.

**Use of Estimates**

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

**Inventory**

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

**Prepaid Expenses andOther Current Assets**

In connection with themanagement of multi-site clinical trials, Covance pays on behalf of itscustomers fees to investigators, volunteers and other out-of-pocket costs (suchas travel, printing, meetings, couriers, etc.), for which we are reimbursed atcost, without mark-up or profit. Amounts receivable from customers inconnection with billed and unbilled investigator fees, volunteer payments andother out-of-pocket pass-through costs are included in prepaid expenses andother current assets in the accompanying Consolidated Balance Sheets andtotaled $35.2 million and $37.7 million at June 30, 2007 and December 31, 2006,respectively.  See Note 2 “ReimbursableOut-of-Pocket Expenses”.

**Goodwill and OtherIntangible Assets and Impairment**

Goodwill represents costsin excess of the fair value of net tangible and identifiable net intangibleassets acquired in business combinations. In accordance with Statement ofFinancial Accounting 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 best estimate of the present value of the future cashflows that it expects to be generated by the reporting unit. The most recentannual test for impairment performed for 2006 did not identify any instances ofimpairment and there were no events through June 30, 2007 that warranted a reconsiderationof our impairment test results.

5

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**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

**Revenue Recognition**

Covance recognizes revenueeither as services are performed or products are delivered, depending upon thenature of the work contracted. Historically, a majority of Covance’s netrevenues have been earned under contracts which range in duration from a fewmonths to two years, but can extend in duration up to five years or longer.Service contracts generally take the form of fee-for-service or fixed-pricearrangements. In the case of fee-for-service contracts, revenue is recognizedas services are performed, based upon, for example, hours worked or samplestested. For long-term fixed-price service contracts, revenue isrecognized as services are performed, with performance generally assessed usingoutput measures, such as units-of-work performed to date as compared to thetotal units-of-work contracted. Changes in the scope of work generally resultin a renegotiation of contract pricing terms. Renegotiated amounts are notincluded in net revenues until earned and realization is assured. Estimates ofcosts to complete are made to provide, where appropriate, for losses expectedon contracts. Costs are not deferred in anticipation of contracts beingawarded, but instead are expensed as incurred. In some cases, a portion of thecontract fee is paid at the time the trial is initiated. These advances aredeferred and recognized as revenue as services are performed or products aredelivered, as discussed above. Additional payments may be made based upon theachievement of performance-based milestones over the contract duration.Most contracts are terminable by the client either immediately or upon notice.These contracts typically require payment to Covance of expenses to wind downthe study, fees earned to date and, in some cases, a termination fee or apayment to Covance of some portion of the fees or profits that could have beenearned by Covance under the contract if it had not been terminated early.Termination fees are included in net revenues when realization is assured. 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. Investigatorfees are not reflected in total revenues or expenses where Covance acts in thecapacity of an agent on behalf of the pharmaceutical company sponsor, passingthrough these costs without risk or reward to Covance. All other out-of-pocketcosts are included in total revenues and expenses.

Unbilled services are recorded for revenue recognized to date andrelate to amounts that are currently unbillable to the customer pursuant tocontractual terms. In general, amounts become billable upon the achievement ofmilestones or in accordance with predetermined payment schedules. Unbilledservices are billable to customers within one year from the respective balancesheet date. Unearned revenue is recorded for cash received from customers forwhich revenue has not been recognized at the balance sheet date.

**Taxes on Income**

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 amount of assets and liabilities and theirrespective tax bases using enacted tax rates in effect for the year in whichthe temporary differences are expected to reverse.  The effect on deferred taxes of a change inenacted tax rates is recognized in income in the period when the change iseffective.

Covance maintains areserve for uncertain tax positions. Effective January 1, 2007, the Companyadopted the provisions of Financial Accounting Standards Board InterpretationNo. 48, *Accounting for Uncertainty in IncomeTaxes – an Interpretation of FASB Statement No. 109* (“FIN 48”).  This authoritative interpretation clarifiedand standardized the manner by which companies are required to account foruncertain income tax positions. 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 is measuredas the largest amount of benefit determined on a cumulative probability basisthat the Company believes is more likely than not to be realized upon ultimatesettlement of the position.

On January 1, 2007, theCompany recognized a $0.6 million increase in its liability for uncertainincome tax positions, which was accounted for as a reduction to retainedearnings, for the cumulative effect change of adopting FIN 48. The reserve foruncertain income tax positions at January 1, 2007, as calculated under themeasurement provisions of FIN 48, was $9.1 million. Components of the reserveare classified as either a current or long-term liability in the consolidatedbalance sheet based on when the Company expects each of the items to besettled. Accordingly, the Company recorded a current liability of 

6

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**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

$3.5 million inaccrued expenses and other current liabilities and a long-term liability of$5.6 million in other liabilities on its balance sheet at January 1, 2007,including accrued interest of approximately $1.3 million. Consistent withhistorical practice, Covance records interest and penalties accrued in relationto uncertain income tax positions as a component of income tax expense.

Any changes in the $9.1million liability for uncertain tax positions would impact the effective taxrate of Covance. Over the next twelve months, it is reasonably possible thatthe uncertainty surrounding a portion of the reserve for uncertain income taxpositions, related to certain foreign tax withholding and income taxes,dividend income, transfer pricing and state tax issues, will be resolved as aresult of the expiration of the statute of limitations or the conclusion ofvarious state and foreign tax audits. If such resolutions are favorable,Covance would reduce the carrying value of its reserve for these items by up to$2.0 million.  The following tax years remainopen to investigation as of January 1, 2007 for the Company’s major taxjurisdictions:

| Tax Jurisdiction      | ** ** | **Years** |
|-----------------------|------------|-----------|
| US Federal and  State |       | 2002-2006 |
| United Kingdom        |       | 2004-2006 |
| Switzerland           |       | 2002-2006 |
| Germany               |       | 2006      |

 

As of June 30, 2007, thebalance of the reserve for uncertain income tax positions is $9.1 million, ofwhich $3.3 million is recorded as a current liability in accrued expenses andother current liabilities, and $5.8 million is recorded as a long-termliability in other liabilities on the consolidated balance sheet, includingaccrued interest of approximately $1.7 million.

The Company alsomaintains a tax reserve related to exposures for non-income tax matters such asvalue-added tax and state sales and use taxes, which are accounted for inaccordance with Statement of Financial Accounting Standards No. 5, *Accounting for Contingencies*. The balanceof this reserve at June 30, 2007 is approximately $1.1 million and is recordedas a current liability in accrued expenses and other current liabilities on theconsolidated balance sheet.

While Covance believes that it has identified all reasonablyidentifiable exposures and that the reserve it has established for identifiableexposures is appropriate under the circumstances, it is possible thatadditional exposures exist and that exposures may be settled at amountsdifferent than the amounts reserved. It is also possible that changes in factsand circumstances could cause Covance to either materially increase or reducethe carrying amount of its tax reserve.

Covance’s historical policy has been to leave its unremitted foreignearnings invested indefinitely outside the United States. Except for theone-time opportunity provided under the American Jobs Creation Act, pursuant towhich Covance repatriated $103 million in accumulated foreign earnings in thefourth quarter of 2005, Covance intends to continue to leave its unremittedforeign earnings invested indefinitely outside the United States.  As a result, taxes have not been provided onany accumulated foreign unremitted earnings as of June 30, 2007.

**ComprehensiveIncome**

Covance’s totalcomprehensive income, which represents net income plus the change in thecumulative translation adjustment equity account for the periods presented, was$41.8 million and $45.2 million for the three months ended June 30, 2007 and2006, respectively, and $81.8 million and $78.4 million for the six monthsended June 30, 2007 and 2006, respectively.

7

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

**ReimbursableOut-of-Pocket Expenses**

As discussed in Note 2 “PrepaidExpenses and Other Current Assets”, Covance pays on behalf of its customersfees to investigators, volunteers and other out-of-pocket costs for which weare 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**

TheCompany sponsors several stock-based compensation plans pursuant to whichnon-qualified stock options and restricted stock awards are granted to eligibleemployees.  These plans are describedmore fully in Note 7 herein and Note 10 to our audited consolidated financialstatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2006.

EffectiveJanuary 1, 2006, the Company adopted the fair value recognition provisions ofStatement of Financial Accounting Standards No. 123R, *Share-BasedPayments*, (“SFAS 123R”) using the modified prospective transitionmethod.  SFAS 123R revised Statement ofFinancial Accounting Standards No. 123, *Accountingfor Stock-Based Compensation*, (“SFAS 123”) superseded Accounting PrinciplesBoard Opinion No. 25, *Accounting for StockIssued to Employees*, (“APB 25”) and amended Statement of FinancialAccounting Standards No. 95, *Statement of Cash Flows*.  Under the modified prospective transitionmethod, compensation expense is recognized in the financial statements on aprospective basis for (a) all share-based payments granted prior to, but notvested as of January 1, 2006, based upon the grant-date fair value estimated inaccordance with the original provisions of SFAS 123, and (b) share-basedpayments granted on or subsequent to January 1, 2006, based upon the grant-datefair value estimated in accordance with the provisions of SFAS 123R.  The grant-date fair value of awards expectedto vest is expensed on a straight-line basis over the vesting period of therelated awards.  See Note 7.

**Earnings Per Share (“EPS”)**

Basic EPS iscomputed 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 the treasurystock method in accordance with the requirements of Statement of FinancialAccounting Standards No. 128, *Earnings Per Share*.

In computingdiluted earnings per share for the three months ended June 30, 2007 and 2006,the denominator was increased by 1,029,473 shares and 1,223,560 shares,respectively, and for the six months ended June 30, 2007 and 2006, thedenominator was increased by 1,022,740 shares and 1,224,621 shares,respectively, representing the dilutive effect of stock options outstanding atJune 30, 2007 and 2006 with exercise prices less than the average market priceof Covance’s Common Stock during each respective period.  Excluded from the computation of diluted EPSfor the three months ended June 30, 2007 were options to purchase 6,775 sharesof common stock at prices ranging from $66.55 to $68.56 per share because theexercise prices of such options were greater than the average market price ofCovance’s common stock during this period. Excluded from the computation of diluted EPS for the six months endedJune 30, 2007 were options to purchase 11,189 shares of common stock at pricesranging from $63.18 to $68.56 per share because the exercise prices of suchoptions were greater than the average market price of Covance’s common stockduring this period.  Excluded from thecomputation of diluted EPS for the three months ended June 30, 2006 wereoptions to purchase 4,015 shares of common stock at prices ranging from $58.88to $61.26 per share because the exercise prices of such options were greaterthan the average market price of Covance’s common stock during thisperiod.  Excluded from the computation ofdiluted EPS for the six months ended June 30, 2006 were options to purchase8,779 shares of common stock at prices ranging from $57.47 to $61.26 per sharebecause the exercise prices of such options were greater than the averagemarket price of Covance’s common stock during this period.

8

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

**SupplementalCash Flow Information**

Cash paid for interestwas $0.2 million for each of the six month periods ended June 30, 2007 and2006. Cash paid for income taxes for the six month periods ended June 30, 2007and 2006 totaled $37.9 million and $26.2 million, respectively.  The change in income taxes payable in theconsolidated statement of cash flows for the six months ended June 30, 2007 and2006 includes as an operating cash outflow the excess tax benefit received fromthe exercise of non-qualified stock options as measured under SFAS 123R of $3.3million and $5.4 million, respectively (a corresponding cash inflow of $3.3million and $5.4 million, respectively, has been included in financing cashflows).

**RecentlyIssued Accounting Standards**

In September 2006,the Financial Accounting Standards Board (the “FASB”) issued Statement ofFinancial Accounting Standards No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106 and 132(R)*, (“SFAS 158”).As of December 31, 2006, Covance has adopted the recognition and disclosureprovisions of SFAS 158, which require an employer to recognize the over fundedor under funded status of its defined benefit postretirement plans — measuredas the difference between the fair value of plan assets and the projectedbenefit obligation - as an asset or liability, respectively, in its balancesheet and to recognize changes in the funded status of the plan in the year inwhich such changes occur through other comprehensive income. SFAS 158 alsorequires, effective for fiscal years ending after December 15, 2008, that themeasurement of the over funded or under funded status of a plan be made as ofthe employer’s fiscal year end and not as of an earlier measurement date.  Covance will be required to conform themeasurement dates of its plans to December 31st for its fiscal year ending December 31, 2008.Covance does not expect this change in measurement dates to have a materialimpact on its consolidated results of operations or financial position.

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements,* (“SFAS 157”).SFAS 157, which applies whenever other standards require (or permit) fair valuemeasurement, defines fair value and provides guidance for using fair value tomeasure assets and liabilities.  SFAS 157also requires expanded disclosures about the extent to which companies measureassets and liabilities at fair value, the information used in thosemeasurements and the effect of fair value measurements on earnings. Covancewill be required to adopt SFAS 157, which is effective for fiscal yearsbeginning after November 15, 2007, no later than the quarter beginning January1, 2008. Covance is currently in the process of evaluating SFAS 157, and hasnot yet determined the impact, if any, SFAS 157 will have on its consolidatedresults of operations or financial position.

**3.  TreasuryStock**

In February 2007, theCovance Board of Directors authorized the repurchase of an additional 3.0million shares under Covance’s stock repurchase program.  At June 30, 2007, there are approximately 2.3million shares remaining for purchase under the 2007 authorization.  Covance also reacquires shares of its commonstock in connection with certain employee benefit plans when employees tendershares either in connection with reload stock options or to satisfy income taxwithholdings associated with the vesting of stock awards.  The following table sets forth the treasurystock activity during the six month periods ended June 30, 2007 and 2006.
| ** **                              | ** ** | **Six Months Ended June 30** | ** ** |
|-----------------------------------------|------------|--------------------------------------------------|------------|
| ** **                              | ** ** | **2007**                                         | ** ** | **2006** | ** ** |
| **(amounts in thousands)**    | ** ** | **$**                                            | ** ** | **# shares** | ** ** | **$ ** | ** ** | **# shares** | ** ** |
| Shares  repurchased in connection with: |       |                                             |       |   |   |   |   |   |   |
| Board approved buyback programs         |       | $                                                | 59,628     |   | 977.0 |   | $ | 7,799 |   | 134.3 |   |
| Employee benefit plans                  |       | 1,797                                            |       | 28.6 |   | 902 |   | 15.7 |   |
| Total                                   |       | $                                                | 61,425     |   | 1,005.6 |   | $ | 8,701 |   | 150.0 |   |

 

9

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

**4.  EquityMethod Investees**

Covance has a 47%minority equity position in Noveprim Ltd. (“Noveprim”), a supplier of researchproducts, which was acquired in March 2004 at a total cost of $20.7million.  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 and six monthperiods ended June 30, 2007, Covance recognized $0.6 million and $1.1 million,respectively, representing its share of Noveprim’s earnings, less theelimination of profit on inventory purchased from Noveprim and still on hand atCovance at June 30, 2007.  During thethree and six month periods ended June 30, 2006, Covance recognized $0.5million and $0.8 million, respectively, representing its share of Noveprim’searnings, less the elimination of profit on inventory purchased from Noveprimand still on hand at Covance at June 30, 2006. The carrying value of Covance’s investment in Noveprim at June 30, 2007and December 31, 2006 was $23.7 million and $23.0 million, respectively.

Covance has aminority equity position (approximately 20% at June 30, 2007) in Bio-ImagingTechnologies, Inc. (“BITI”).  BITI usesproprietary medical imaging technologies to process and analyze medical images,and also provides other services, including the data-basing and regulatorysubmission of medical images, quantitative data and text.  During the three and six month periods endedJune 30, 2007, Covance recognized $0.1 million and $0.2 million, respectively,representing its pro rata share of BITI’s earnings.  During the three and six month periods endedJune 30, 2006, Covance recognized losses of $0.01 million and $0.08 million,respectively, representing its pro rata share of BITI’s losses.  The carrying value of Covance’s investment inBITI as of June 30, 2007 and December 31, 2006 was $0.7 million and $0.5million, respectively, while the fair market value was $16.1 million and $19.0million, respectively.

**5.  Acquisitions**

InMay 2006, Covance acquired the stock of Radiant Research Inc. (“Radiant”) in amerger transaction for cash payments aggregating $66.6 million (includingdirect acquisition costs of $0.5 million). The Radiant acquisition includedeight early development clinical sites performing Phase I/IIa clinical trialservices.  Results of operations forRadiant, which are part of Covance’s Early Development segment serviceoffering, and the fair value of Radiant’s assets and liabilities acquired, areincluded in Covance’s consolidated financial statements beginning in June 2006.

InMay 2006, Covance also acquired certain assets and liabilities of SignetLaboratories, Inc. (“Signet”) for cash payments totaling $9.1 million(including direct acquisition costs of $0.2 million).  Signet specializes in the development ofmonoclonal antibodies and diagnostic assays for cancer, infectious diseases andneurodegenerative diseases.  Results ofoperations for Signet, which are part of Covance’s Early Development segmentservice offering, and the fair value of Signet’s assets and liabilitiesacquired, are included in Covance’s consolidated financial statements beginningin June 2006.

Thetable below summarizes the purchase price allocations for the Radiant andSignet acquisitions:
|                                                                                 | ** ** | **Radiant** | ** ** | **Signet** | ** ** |
|---------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|
| Estimated fair  value of net tangible assets acquired                           |       | $           | 9,183      |       | $          | 352 |   |
| Fair value of  intangible assets acquired (8 year weighted average useful life) |       | 6,820       |       | 850        |       |
| Goodwill                                                                        |       | 50,567      |       | 7,896      |       |
| Net assets  acquired                                                            |       | $           | 66,570     |       | $          | 9,098 |   |

 

Thegoodwill resulting from the Signet acquisition is deductible for tax purposes,while the goodwill resulting from the merger with Radiant is not deductible fortax purposes.

10

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

**6.  DefinedBenefit Plans**

Covance sponsors various pension and otherpost-retirement benefit plans.  Asrequired by SFAS 158, Covance recognizes the over funded or under funded statusof its defined benefit postretirement plans – measured as the differencebetween the fair value of plan assets and the projected benefit obligation – asan asset or liability, respectively, in its balance sheet and recognizeschanges in the funded status of the plan through other comprehensive income (inthe year such changes occur).

**DefinedBenefit Pension Plans**

Covance sponsors twodefined benefit pension plans for the benefit of its employees at two UnitedKingdom subsidiaries and one defined benefit pension plan for the benefit ofits employees at a German subsidiary, all of which are legacy plans ofpreviously acquired companies.  Benefitamounts for all three plans are based upon years of service and compensation.  The German plan is unfunded while the UnitedKingdom plans are funded.  Covance’sfunding policy has been to contribute annually a fixed percentage of theeligible employee’s salary at least equal to the local statutory fundingrequirements.  Pension plan assets areadministered by the plans’ trustees and are principally invested in equity anddebt securities.  The components of netperiodic pension expense for these plans for the three and six month periodsended June 30, 2007 and 2006 are as follows:
| ** **                                                | ** ** | **United Kingdom Plans**                 | ** ** | **German Plan**                               | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                | ** ** | **Three Months Ended June 30** | ** ** | **Three Months Ended June 30** | ** ** |
| ** **                                                | ** ** | **2007**                                           | ** ** | **2006**                                           | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of  Net Periodic Pension Cost:                 |       |                                               |       |                                               |       |   |   |   |   |
| Service cost                                              |       | $                                                  | 1,482      |                                               | $          | 1,462 |   | $ | 122 |   | $ | 101 |   |
| Interest cost                                             |       | 1,869                                              |       | 1,563                                              |       | 91 |   | 75 |   |
| Expected return on plan assets                            |       | (2,146                                             | )          | (1,777                                             | )          | — |   | — |   |
| Amortization of net actuarial loss                        |       | 355                                                |       | 463                                                |       | 18 |   | 12 |   |
| Participant contributions                                 |       | (560                                               | )          | (563                                               | )          | — |   | — |   |
| Net periodic pension cost                                 |       | $                                                  | 1,000      |                                               | $          | 1,148 |   | $ | 231 |   | $ | 188 |   |
|                                                      |       |                                               |       |                                               |       |   |   |   |   |
| Assumptions Used  to Determine Net Periodic Pension Cost: |       |                                               |       |                                               |       |   |   |   |   |
| Discount rate                                             |       | 5.25                                               | %          | 5.00                                               | %          | 4.65 | % | 4.65 | % |
| Expected rate of return on assets                         |       | 6.75                                               | %          | 6.75                                               | %          | n/a |   | n/a |   |
| Salary increases                                          |       | 4.00                                               | %          | 4.00                                               | %          | 2.50 | % | 2.50 | % |

 
| ** **                                                | ** ** | **United Kingdom Plans**               | ** ** | **German Plan**                             | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                | ** ** | **Six Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
| ** **                                                | ** ** | **2007**                                         | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of  Net Periodic Pension Cost:                 |       |                                             |       |                                             |       |   |   |   |   |
| Service cost                                              |       | $                                                | 2,946      |                                             | $          | 2,851 |   | $ | 245 |   | $ | 197 |   |
| Interest cost                                             |       | 3,710                                            |       | 3,047                                            |       | 181 |   | 146 |   |
| Expected return on plan assets                            |       | (4,262                                           | )          | (3,464                                           | )          | — |   | — |   |
| Amortization of net actuarial loss                        |       | 705                                              |       | 902                                              |       | 35 |   | 24 |   |
| Participant contributions                                 |       | (1,110                                           | )          | (1,098                                           | )          | — |   | — |   |
| Net periodic pension cost                                 |       | $                                                | 1,989      |                                             | $          | 2,238 |   | $ | 461 |   | $ | 367 |   |
|                                                      |       |                                             |       |                                             |       |   |   |   |   |
| Assumptions Used  to Determine Net Periodic Pension Cost: |       |                                             |       |                                             |       |   |   |   |   |
| Discount rate                                             |       | 5.25                                             | %          | 5.00                                             | %          | 4.65 | % | 4.65 | % |
| Expected rate of return on assets                         |       | 6.75                                             | %          | 6.75                                             | %          | n/a |   | n/a |   |
| Salary increases                                          |       | 4.00                                             | %          | 4.00                                             | %          | 2.50 | % | 2.50 | % |

 

11

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

## **Supplemental Executive Retirement Plan**

In addition tothese foreign defined benefit pension plans, Covance also has a non-qualifiedSupplemental Executive Retirement Plan (“SERP”).  The SERP, which is not funded, is intended toprovide retirement benefits for certain executive officers of Covance.  Benefit amounts are based upon years of serviceand compensation of the participating employees.  The components of net periodic pension costfor the three and six month periods ended June 30, 2007 and 2006 are asfollows:
| ** **                                                | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                | ** ** | **2007**                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of Net  Periodic Pension Cost:                 |       |                                               |       |                                             |       |   |   |   |   |
| Service cost                                              |       | $                                                  | 272        |                                             | $          | 232 |   | $ | 543 |   | $ | 463 |   |
| Interest cost                                             |       | 193                                                |       | 164                                              |       | 386 |   | 328 |   |
| Amortization of  prior service cost                       |       | 19                                                 |       | 19                                               |       | 38 |   | 38 |   |
| Amortization of  net actuarial loss                       |       | 10                                                 |       | 8                                                |       | 21 |   | 16 |   |
| Net periodic  pension cost                                |       | $                                                  | 494        |                                             | $          | 423 |   | $ | 988 |   | $ | 845 |   |
|                                                      |       |                                               |       |                                             |       |   |   |   |   |
| Assumptions Used to  Determine Net Periodic Pension Cost: |       |                                               |       |                                             |       |   |   |   |   |
| Discount rate                                             |       | 5.50                                               | %          | 5.50                                             | %          | 5.50 | % | 5.50 | % |
| Salary increases                                          |       | 4.00                                               | %          | 4.00                                             | %          | 4.00 | % | 4.00 | % |

 

#### **Post-Employment Retiree Health and WelfarePlan**

Covance alsosponsors a post-employment retiree health and welfare plan for the benefit ofeligible employees at certain U.S. subsidiaries who retire after satisfyingservice and age requirements.  This planis funded on a pay-as-you-go basis and the cost of providing these benefits isshared with the retirees.  The componentsof net periodic post-retirement benefits cost for the three and six monthperiods ended June 30, 2007 and 2006 are as follows:
| ** **                                                                | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|---------------------------------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                | ** ** | **2007**                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Components of Net  Periodic Post-retirement Benefits Cost:                |       |                                               |       |                                             |       |   |   |   |   |
| Service cost                                                              |       | $                                                  | 42         |                                             | $          | 44 |   | $ | 83 |   | $ | 88 |   |
| Interest cost                                                             |       | 69                                                 |       | 78                                               |       | 139 |   | 156 |   |
| Amortization of  net actuarial loss                                       |       | —                                             |       | 13                                               |       | — |   | 26 |   |
| Net periodic  post-retirement benefits cost                               |       | $                                                  | 111        |                                             | $          | 135 |   | $ | 222 |   | $ | 270 |   |
|                                                                      |       |                                               |       |                                             |       |   |   |   |   |
| Assumptions Used to  Determine Net Periodic Post-retirement Benefit Cost: |       |                                               |       |                                             |       |   |   |   |   |
| Discount rate                                                             |       | 5.50                                               | %          | 5.50                                             | %          | 5.50 | % | 5.50 | % |
| Health care cost trend  rate                                              |       | 9.00                                               | %(a)       | 9.00                                             | %(a)       | 9.00 | %(a) | 9.00 | %(a) |

 

----

(a) decreasing toultimate trend of 5.00% in 2011

12

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

**7.  Stock-Based Compensation Plans**

Covance sponsors severalemployee stock-based compensation plans which are described more fully in Note10 to our audited consolidated financial statements included in our AnnualReport on Form 10-K for the year ended December 31, 2006.

In May 2007, Covance’sshareholders approved the 2007 Employee Equity Participation Plan (the “2007EEPP”) in replacement of the 2002 Employee Equity Participation Plan (the “2002EEPP”). Effective upon approval of the 2007 EEPP, no further grants or awardswere permitted under the 2002 EEPP. Shares remaining for grant under the 2002EEPP will be available for grant under the 2007 EEPP. In addition, the CovanceBoard of Directors directed that, effective May 3, 2007, no further grantswould be permitted under the 2002 Employee Stock Option Plan (the “2002 ESOP”)and, unlike the 2002 EEPP, shares remaining for grant under the 2002 ESOP wouldnot be available for grant under the 2007 EEPP. The 2007 EEPP became effectiveon May 3, 2007 and will expire on May 2, 2017. The 2007 EEPP authorizes the Compensation and Organization Committee ofthe Board of Directors (the “Compensation Committee”), or such committee as isappointed by the Covance Board of Directors, to administer the 2007 EEPP, togrant awards to employees and consultants of Covance or entities in whichCovance has a controlling or significant equity interest.  The 2007 EEPP authorizes the CompensationCommittee to grant the following awards to eligible employees: options topurchase common stock; stock appreciation rights; and other stock awards eithersingly or in combination.  The exerciseperiod for stock options granted under the 2007 EEPP is determined by theCompensation Committee at the time of grant, and is generally ten years fromthe date of grant. The vesting period for stock options and stock awardsgranted under the 2007 EEPP is determined by the Compensation Committee at thetime of grant. Generally, options vest over a three year period for seniorexecutives and over a two year period for all other optionees.  Stock awards generally vest over a three yearperiod for all employees. The number of shares of Covance common stockinitially available for grant under the 2007 EEPP totaled approximately 1.6million plus approximately 3.3 million shares remaining available under the2002 EEPP at the time the 2007 EEPP was approved. All stock option grants underthe 2002 EEPP remaining outstanding are now administered in accordance with theprovisions of the 2002 EEPP out of shares issuable under the 2007 EEPP. The Companyissues authorized but previously unissued shares when options are exercised orfor stock awards.  At June 30, 2007 therewere approximately 4.9 million shares remaining available for grants or awardsunder the 2007 EEPP.  No stockappreciation rights have been granted under the 2002 ESOP, the 2002 EEPP or the2007 EEPP.

The grant-date fair valueof stock option awards is estimated using an option pricing model as more fullydescribed in Note 10 to our audited consolidated financial statements included inour Annual Report on Form 10-K for the year ended December 31, 2006.  The grant-date fair value of options expectedto vest is expensed on a straight-line basis over the vesting period of therelated awards.

Thefollowing table sets forth the weighted-average assumptions used to calculatethe fair value of options granted for the three and six month periods endedJune 30, 2007 and 2006:
| ** **                        | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected stock  price volatility  |       | 42%                                                |       | 44%                                              |       | 42% |   | 44% |   |
| Risk free  interest rate(s)       |       | 4.7%  - 5.1%                                       |       | 3.9%  - 4.5%                                     |       | 4.7%  - 5.1% |   | 3.9%  - 4.5% |   |
| Expected life of  options (years) |       | 4.3                                                |       | 4.3                                              |       | 4.3 |   | 4.3 |   |

 

Restricted stock awards aregranted subject to certain restrictions, including in some cases serviceconditions and in other cases service and performance conditions.  The grant-date fair value of restricted stockawards expected to vest, which has been determined based upon the market valueof Covance’s shares on the grant date, is expensed on a straight-line basisover the vesting period of the related awards.

Covance also has an employeestock purchase plan (“ESPP”) pursuant to which Covance may make available forsale to its employees shares of its common stock at a price equal to 85% of thelower of the market value on the first or last day of each calendarquarter.  The ESPP is intended to giveCovance employees the opportunity to purchase shares of Covance common stockthrough payroll deductions.

13

----

**COVANCEINC. AND SUBSIDIARIES**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS (continued)**

**(UNAUDITED)**

**June30, 2007 and 2006**

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

Resultsof operations for the three month period ended June 30, 2007 include totalstock-based compensation expense of $5.6 million ($3.8 million net of taxbenefit of $1.8 million), $1.9 million of which has been included in cost ofrevenue and $3.7 million of which has been included in selling, general andadministrative expenses.  Results ofoperations for the six month period ended June 30, 2007 include totalstock-based compensation expense of $11.1 million ($7.5 million net of taxbenefit of $3.6 million), $3.9 million of which has been included in cost ofrevenue and $7.2 million of which has been included in selling, general and administrativeexpenses.  Results of operations for thethree month period ended June 30, 2006 include total stock-based compensationexpense of $5.1 million ($3.5 million net of tax benefit of $1.6 million), $1.7million of which has been included in cost of revenue and $3.4 million of whichhas been included in selling, general and administrative expenses. Results ofoperations for the six month period ended June 30, 2006 include totalstock-based compensation expense of $9.4 million ($6.4 million net of tax benefitof $3.0 million), $3.5 million of which has been included in cost of revenueand $5.9 million of which has been included in selling, general andadministrative expenses.

**8.  Segment Information**

Covance has tworeportable segments: early development and late-stage development. Earlydevelopment services, which includes Covance’s preclinical and clinicalpharmacology service capabilities, involve evaluating a new compound for safetyand early effectiveness as well as evaluating the absorption, distribution,metabolism and excretion of the compound in the human body.  It is at this stage that a pharmaceuticalcompany, based on available data, will generally decide whether to continuefurther development of a drug. Late-stage development services, which include Covance’s centrallaboratory, clinical development, cardiac safety services, periapproval andmarket access services, are geared toward demonstrating the clinicaleffectiveness of a compound in treating certain diseases or conditions,obtaining regulatory approval and maximizing the drug’s commercial potential.The accounting policies of the reportable segments are the same as thosedescribed in Note 2.

Segment netrevenues, operating income and total assets for the three and six months endedJune 30, 2007 and 2006 are as follows:
| ** **                              | ** **   | **Early  Development** | ** **   | **Late-Stage  Development** | ** **   | **Other  Reconciling Items** | ** **   | **Total**    | ** **   |
|-----------------------------------------|--------------|------------------------|--------------|-----------------------------|--------------|-----------------------------------|--------------|--------------|--------------|
| ***Three months ended June 30,  2007*** |         |                   |         |                        |         |                              |         |         |         |
| Total revenues from external customers  |         | $                      | 191,102      |                        | $            | 190,043                           |         | $            | 23,029       | (a) | $ | 404,174 |   |
| Operating income                        |         | $                      | 48,996       |                        | $            | 31,898                            |         | $            | (25,376      | )(b) | $ | 55,518 |   |
| Total assets                            |         | $                      | 829,561      |                        | $            | 451,427                           |         | $            | 82,174       | (c) | $ | 1,363,162 |   |
| *** ***                            | *** *** | *** ***           | *** *** | *** ***                | *** *** | *** ***                      | *** *** | *** *** | *** *** |
| ***Three months ended June 30,  2006*** | *** *** | *** ***           | *** *** | *** ***                | *** *** | *** ***                      | *** *** | *** *** | *** *** |
| Total revenues from external customers  |         | $                      | 155,749      |                        | $            | 179,491                           |         | $            | 21,934       | (a) | $ | 357,174 |   |
| Operating income                        |         | $                      | 39,135       |                        | $            | 28,530                            |         | $            | (20,625      | )(b) | $ | 47,040 |   |
| Total assets                            |         | $                      | 679,032      |                        | $            | 399,699                           |         | $            | 88,256       | (c) | $ | 1,166,987 |   |
| *** ***                            | *** *** | *** ***           | *** *** | *** ***                | *** *** | *** ***                      | *** *** | *** *** | *** *** |
| ***Six months ended June 30, 2007***    | *** *** | *** ***           | *** *** | *** ***                | *** *** | *** ***                      | *** *** | *** *** | *** *** |
| Total revenues from external customers  |         | $                      | 370,318      |                        | $            | 369,146                           |         | $            | 41,649       | (a) | $ | 781,113 |   |
| Operating income                        |         | $                      | 92,673       |                        | $            | 61,110                            |         | $            | (46,227      | )(b) | $ | 107,556 |   |
| Total assets                            |         | $                      | 829,561      |                        | $            | 451,427                           |         | $            | 82,174       | (c) | $ | 1,363,162 |   |
| *** ***                            | *** *** | *** ***           | *** *** | *** ***                | *** *** | *** ***                      | *** *** | *** *** | *** *** |
| ***Six months ended June 30, 2006***    | *** *** | *** ***           | *** *** | *** ***                | *** *** | *** ***                      | *** *** | *** *** | *** *** |
| Total revenues from external customers  |         | $                      | 298,188      |                        | $            | 357,561                           |         | $            | 35,063       | (a) | $ | 690,812 |   |
| Operating income                        |         | $                      | 74,634       |                        | $            | 60,513                            |         | $            | (42,263      | )(b) | $ | 92,884 |   |
| Total assets                            |         | $                      | 679,032      |                        | $            | 399,699                           |         | $            | 88,256       | (c) | $ | 1,166,987 |   |

 

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(a)              Representsrevenues associated with reimbursable out-of-pocket expenses.

(b)             Represents corporate expenses(primarily information technology, marketing, communications, human resources,finance, legal and stock-based compensation expense).

(c)              Representscorporate assets.

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**Item 2. Management’s Discussion and Analysis of Financial Condition and Resultsof Operations**

Youshould read the following discussion together with the unaudited Covanceconsolidated financial statements and the accompanying notes included in thisQuarterly Report on Form 10-Q for the quarter ended June 30, 2007.

**Overview**

Covance is a leading drugdevelopment services company providing a wide range of early-stage andlate-stage product development services on a worldwide basis primarily to thepharmaceutical, biotechnology and medical device industries.  Covance also provides services such aslaboratory testing to the chemical, agrochemical and food industries. Theforegoing services comprise two reportable segments for financial reportingpurposes: early development services, which includes preclinical and clinicalpharmacology service offerings; and late-stage development services, whichincludes central laboratory, clinical development, cardiac safety services,periapproval and market access services. Although each segment has separate services within it, they can becombined in joint service offerings and we believe clients increasingly areinterested in opportunities for such combined services.  Covance believes it is one of the largestdrug development services companies, based on annual net revenues, and one of afew that is capable of providing comprehensive global product developmentservices. Covance offers its clients high quality services designed to 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.

**Critical Accounting Policies**

Covance’sconsolidated financial statements are prepared in accordance with U.S.generally accepted accounting principles (“GAAP”), which require management tomake estimates and assumptions about future events that affect the amountsreported in the financial statements and the accompanying notes.  Actual results could differ from these estimates.  The following discussion highlights what webelieve to be the critical accounting policies and judgments made in thepreparation of these consolidated financial statements.

***Revenue Recognition.***Covance recognizes revenueeither as services are performed or products are delivered, depending upon thenature of the work contracted. 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. Service contracts generally take the form of fee-for-service orfixed-price arrangements.  In the case offee-for-service contracts, revenue is recognized as services are performed,based upon, for example, hours worked or samples tested.  For long-term fixed-price service contracts,revenue is recognized as services are performed, with performance generallyassessed using output measures, such as units-of-work performed to date ascompared to the total units-of-work contracted. Changes in the scope of work generally result in a renegotiation ofcontract pricing terms.  Renegotiatedamounts are not included in net revenues until earned and realization isassured.  Estimates of costs to completeare made to provide, where appropriate, for losses expected on contracts.  Costs are not deferred in anticipation ofcontracts being awarded, but instead are expensed as incurred.  In some cases, a portion of the contract feeis paid at the time the trial is initiated. These advances are deferred and recognized as revenue as services areperformed or products are delivered, as discussed above.  Additional payments may be made based uponthe achievement of performance-based milestones over the contractduration.  Most contracts are terminableby the client either immediately or upon notice.  These contracts typically require payment toCovance of expenses to wind down the study, fees earned to date and, in somecases, a termination fee or a payment to Covance of some portion of the fees orprofits that could have been earned by Covance under the contract if it had notbeen terminated early.  Termination feesare 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.

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***Taxes on Income.***SinceCovance conducts operations on a global basis, its effective tax rate has andwill continue to depend upon the geographic distribution of its pre-taxearnings among locations with varying tax rates. Covance’s profits are furtherimpacted by changes in the tax rates of the various jurisdictions in whichCovance operates. In addition, Covance maintains a reserve for uncertain incometax positions, changes in which also impact Covance’s effective tax rate in theperiod in which such changes are made.

Effective January 1, 2007, the Company adopted the provisionsof Financial Accounting Standards Board Interpretation No. 48, *Accounting for Uncertainty in Income Taxes — anInterpretation of FASB Statement No. 109* (“FIN 48”).  This authoritative interpretation clarifiedand standardized the manner by which companies are required to account foruncertain income tax positions. 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. On January 1, 2007, theCompany recognized a $0.6 million increase its liability for uncertain incometax positions, which was accounted for as a reduction to retained earnings, forthe cumulative effect change of adopting FIN 48. The reserve for uncertainincome tax positions at January 1, 2007, as calculated under the measurementprovisions of FIN 48, was $9.1 million. Components of the reserve areclassified as either a current or long-term liability in the consolidatedbalance sheet based on when the Company expects each of the items to besettled. Accordingly, the Company recorded a current liability of $3.5 millionin accrued expenses and other current liabilities and a long-term liability of$5.6 million in other liabilities on its balance sheet at January 1, 2007,including accrued interest of approximately $1.3 million. Consistent withhistorical practice, Covance records interest and penalties accrued in relationto uncertain income tax positions as a component of income tax expense.

Any changes in the $9.1million liability for uncertain tax positions would impact the effective taxrate of Covance. Over the next twelve months, it is reasonably possible thatthe uncertainty surrounding a portion of the reserve for uncertain income taxpositions, related to certain foreign tax withholding and income taxes,dividend income, transfer pricing and state tax issues, will be resolved as aresult of the expiration of the statute of limitations or the conclusion ofvarious state and foreign tax audits. If such resolutions are favorable,Covance would reduce the carrying value of its reserve for these items by up to$2.0 million.  The following tax yearsremain open to investigation as of January 1, 2007 for the Company’s major taxjurisdictions:

| Tax Jurisdiction      | ** ** | **Years** |
|-----------------------|------------|-----------|
| US Federal and  State |       | 2002-2006 |
| United Kingdom        |       | 2004-2006 |
| Switzerland           |       | 2002-2006 |
| Germany               |       | 2006      |

 

As of June 30, 2007, thebalance of the reserve for uncertain income tax positions is $9.1 million, ofwhich $3.3 million is recorded as a current liability in accrued expenses andother current liabilities, and $5.8 million is recorded as a long-termliability in other liabilities on the consolidated balance sheet, includingaccrued interest of approximately $1.7 million.

The Company alsomaintains a tax reserve related to exposures for non-income tax matters such asvalue-added tax and state sales and use taxes, which are accounted for inaccordance with Statement of Financial Accounting Standards No. 5, *Accounting for Contingencies*. The balanceof this reserve at June 30, 2007 is approximately $1.1 million and is recordedas a current liability in accrued expenses and other current liabilities on theconsolidated balance sheet.

While Covance believes that it has identified allreasonably identifiable exposures and that the reserve it has established foridentifiable exposures is appropriate under the circumstances, it is possiblethat additional exposures exist and that exposures will be settled at amountsdifferent than the amounts reserved. It is also possible that changes in factsand circumstances could cause Covance to either materially increase or reducethe carrying amount of its tax reserve.

Covance’s policy is toprovide income taxes on earnings of foreign subsidiaries only to the extentthose earnings are taxable or are expected to be remitted. Covance’s historicalpolicy has been to leave its unremitted foreign earnings invested indefinitelyoutside the United States. Except for the amounts repatriated in the fourthquarter of 2005 under the American Jobs Creation Act of 2004, Covance intendsto continue to leave its unremitted foreign earnings invested indefinitelyoutside the United States.  As a result,taxes have not been provided on any accumulated foreign unremitted earnings asof June 30, 2007.

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***Stock-BasedCompensation.***The Company sponsors several stock-basedcompensation plans pursuant to which non-qualified stock options and restrictedstock awards are granted to eligible employees. These plans are described more fully in Note 10 to our audited financialstatements included in our Annual Report on Form 10-K for the year endedDecember 31, 2006 and Note 7 to our consolidated financial statements in ourQuarterly Report on Form 10-Q for the quarter ended June 30, 2007 includedelsewhere herein.

The grant-date fair valueof stock awards is based upon the underlying price of the stock on the date ofgrant.  The grant-date fair value ofstock option awards must be determined using an option pricing model.  Option pricing models require the use ofestimates and assumptions as to (a) the expected term of the option, (b) theexpected volatility of the price of the underlying stock, (c) the risk-free interestrate for the expected term of the option and (d) pre-vesting forfeiturerates.  For stock options granted priorto January 1, 2006, the Company used the Black-Scholes-Merton option pricingformula for determining the grant-date fair value of such awards.  For stock options granted on or subsequent toJanuary 1, 2006, the Company is using the Lattice-Binomial option pricingformula for determining the grant-date fair value of stock option awards.  The Company changed to the Lattice-Binomial option pricing formula asit believes such formula may result in a better estimate of fair value than theBlack-Scholes-Merton formula.

The expected term of theoption is based upon the contractual term and expected employee exercise andexpected post-vesting employment termination behavior.  The expected volatility of the price of theunderlying stock is based upon the historical volatility of the Company’s stockcomputed over a period of time equal to the expected term of the option.  The risk free interest rate is based upon theimplied yields currently available from the U.S. Treasury zero-coupon yieldcurve for issues with a remaining duration equal to the expected term of theoption.  Pre-vesting forfeiture rates areestimated based upon past voluntary termination behavior and past optionforfeitures.

Thefollowing table sets forth the weighted-average assumptions used to calculatethe fair value of options granted for the three and six month periods endedJune 30, 2007 and 2006:
| ** **                        | ** ** | **Three Months Ended June 30** | ** ** | **Six Months Ended June 30** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2007**                                           | ** ** | **2006**                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
| Expected stock  price volatility  |       | 42%                                                |       | 44%                                              |       | 42% |   | 44% |   |
| Risk free  interest rate(s)       |       | 4.7%  - 5.1%                                       |       | 3.9%  - 4.5%                                     |       | 4.7%  - 5.1% |   | 3.9%  - 4.5% |   |
| Expected life of  options (years) |       | 4.3                                                |       | 4.3                                              |       | 4.3 |   | 4.3 |   |

 

Changes in any of theseassumptions could impact, potentially materially, the amount of expenserecorded in future periods related to stock-based awards.

***Impairment of Assets.***Covance reviews its long-lived assets other than goodwill and otherindefinite lived intangible assets for impairment, when events or changes incircumstances occur that indicate that the carrying value of the asset may notbe recoverable.  The assessment ofpossible impairment is based upon Covance’s judgment of its ability to recoverthe asset from the expected future undiscounted cash flows of the relatedoperations.  Actual future cash flows maybe greater or less than estimated.

Covanceperforms an annual test for impairment of goodwill and other indefinite livedintangible assets during the fourth quarter. This test is performed by comparing, at the reporting unit level, thecarrying value of the reporting unit to its fair value.  Covance assesses fair value based upon itsbest estimate of the present value of the future cash flows that it expects tobe generated by the reporting unit.  Themost recent test for impairment performed for 2006 did not identify anyinstances of impairment and there were no events through June 30, 2007 thatwarranted 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 sponsorsdefined benefit pension plans for the benefit of its employees at three foreignsubsidiaries, as well as a non-qualified supplemental executive retirement planand a post-employment retiree health and welfare plan for the benefit ofeligible employees at certain U.S. subsidiaries. The measurement of the relatedbenefit obligation and net periodic benefit cost recorded each year is basedupon actuarial computations, which require the use of judgment as to certainassumptions. The more significant of these assumptions are: (a) the appropriatediscount rate to use in computing the present value of the benefit obligation;(b) the expected 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 plan

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participation rates) will likelydiffer from the assumptions used. Those differences, along with changes thatmay be made in the assumptions used from period to period, will impact theamounts reported in the financial statements and footnote disclosures.

Set forth below is a discussionof the impact that (a) differences between assumed results and actualresults and (b) assumption changes have had on our results of operations forthe years ended December 31, 2006, 2005 and 2004 and on the financial positionof the plans as of December 31, 2006 and 2005 for our United Kingdom definedbenefit pension plans (the largest of our defined benefit-type pension plans).
| ** **                                                                 | ** ** | **United Kingdom Plans**     | ** ** |
|----------------------------------------------------------------------------|------------|----------------------------------------|------------|
| **(amounts in millions)**                                        | ** ** | **   2006  ** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|  Net periodic pension cost                                            |       | $                                      | 4.6        |   | $ | 4.1 |   | $ | 4.3 |   | $ | 4.1 |   |
|                                                                       |       |                                   |       |   |   |   |   |   |   |
| Weighted average  assumptions used to determine net periodic pension cost: |       |                                   |       |   |   |   |   |   |   |
| Discount rate                                                              |       | 5.00                                   | %          | 5.75 | % | 6.00 | % | 6.00 | % |
| Expected rate of return on assets                                          |       | 6.75                                   | %          | 6.75 | % | 6.00 | % | 6.00 | % |
| Salary increases                                                           |       | 4.00                                   | %          | 4.00 | % | 3.50 | % | 3.50 | % |
|                                                                            |            |                                        |            |  |  |  |  |  |  |  |  |  |  |

 

The increase(decrease) in the net periodic benefit cost from period to period isattributable to the following:
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                          | ** ** | **2005 to 2006**         | ** ** | **2004 to 2005** | ** ** | **2003 to 2004** | ** ** |
| Change in  discount rate                                                     |       | $                                  | 2.4        |   | $ | 0.4 |   | — |   |
| Change in  expected rate of return on assets                                 |       | —                             |       | (0.6 | ) | — |   |
| Change in rate  of salary increases                                          |       | —                             |       | 0.4 |   | — |   |
| Other, including  differences between actual experience and assumptions used |       | (1.9                               | )          | (0.4 | ) | $ | (0.3 | ) |
| Foreign currency  exchange rate changes                                      |       | —                             |       | — |   | 0.5 |   |
| Net change in periodic  benefit cost                                         |       | $                                  | 0.5        |   | $ | (0.2 | ) | $ | 0.2 |   |

 
| ** **                                                          | ** ** | **United Kingdom Plans** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                           | ** ** | **2005** | ** ** | **2004** | ** ** |
| Weighted average  assumptions used to determine benefit obligation: | ** ** | ** **                         | ** ** | ** ** | ** ** | ** ** | ** ** |
| Discount rate                                                       |       | 5.25                               | %          | 5.00 | % | 5.75 | % |
| Salary increases                                                    |       | 4.00                               | %          | 4.00 | % | 4.00 | % |

 

The change in theprojected benefit obligation from period to period is attributable to thefollowing:
| ** **                                                                   | ** ** | **United Kingdom Plans** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------|------------|
| **(amounts in millions)**                                          | ** ** | **2005 to 2006**         | ** ** | **2004 to 2005** | ** ** |
| Projected  benefit obligation, beginning of year                             |       | $                                  | 119.8      |   | $ | 103.3 |   |
| Service/interest  cost components of net periodic benefit cost in year       |       | 12.2                               |       | 10.5 |   |
| Benefits paid                                                                |       | (1.3                               | )          | (1.2 | ) |
| (Increase)/reduction  in discount rate                                       |       | (8.6                               | )          | 18.6 |   |
| Other, including  differences between actual experience and assumptions used |       | 3.9                                |       | (0.5 | ) |
| Foreign currency  exchange rate changes                                      |       | 15.3                               |       | (10.9 | ) |
| Projected benefit  obligation, end of year                                   |       | $                                  | 141.3      |   | $ | 119.8 |   |

 

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**Foreign Currency Risks**

Since Covance operates on a global basis, it isexposed to various foreign currency risks. Two specific risks arise from thenature of the contracts Covance executes with its customers since from time totime contracts are denominated in a currency different than the particularCovance subsidiary’s local currency. These risks are generally applicable onlyto a portion of the contracts executed by Covance’s subsidiaries providingclinical services. The first risk occurs when revenue recognized for servicesrendered is denominated in a currency different from the currency in which thesubsidiary’s expenses are incurred. As a result, the subsidiary’s net revenuesand resultant earnings can be affected by fluctuations in exchange rates.  Historically, fluctuations in exchange ratesfrom those in effect at the time contracts were executed have not had amaterial effect upon Covance’s consolidated financial results.  See “Risk Factors”.

Thesecond risk results from the passage of time between the invoicing of customersunder these contracts and the ultimate collection of customer payments againstsuch invoices. Because the contract is denominated in a currency other than thesubsidiary’s local currency, Covance recognizes a receivable at the time ofinvoicing for the local currency equivalent of the foreign currency invoiceamount. Changes in exchange rates from the time the invoice is prepared andpayment from the customer is received will result in Covance receiving eithermore or less in local currency than the local currency equivalent of theinvoice amount at the time the invoice was prepared and the receivableestablished. This difference is recognized by Covance as a foreign currencytransaction gain or loss, as applicable, and is reported in other expense(income) in Covance’s consolidated statements of income.

Finally, Covance’sconsolidated financial statements are denominated in U.S. dollars. Accordingly,changes in exchange rates between the applicable foreign currency and the U.S.dollar will affect the translation of each foreign subsidiary’s financialresults into U.S. dollars for purposes of reporting Covance’s consolidatedfinancial results. The process by which each foreign subsidiary’s financialresults are translated into U.S. dollars is as follows: income statementaccounts are translated at average exchange rates for the period; balance sheetasset and liability accounts are translated at end of period exchange rates;and equity accounts are translated at historical exchange rates. Translation ofthe balance sheet in this manner affects the stockholders’ equity account,referred to as the cumulative translation adjustment account. This accountexists only in the foreign subsidiary’s U.S. dollar balance sheet and isnecessary to keep the foreign balance sheet stated in U.S. dollars inbalance.  At June 30, 2007, accumulatedother comprehensive income on the consolidated balance sheet includes thecumulative translation account balance of $36.6 million.

**Operating Expenses and Reimbursable Out-of-Pockets**

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

In connection with themanagement of multi-site clinical trials, Covance pays on behalf of itscustomers fees to investigators, volunteers and other out-of-pocket costs (suchas for travel, printing, meetings, couriers, etc.), for which it is reimbursedat cost, without mark-up or profit. Investigator fees are not reflected in total revenues or expenses whereCovance acts in the capacity of an agent on behalf of the pharmaceuticalcompany sponsor, passing through these costs without risk or reward toCovance.  All other out-of-pocket costsare included in total revenues and expenses.

**Quarterly Results**

Covance’s quarterlyoperating results are subject to variation, and are expected to continue to besubject to variation, as a result of factors such as (1) delays in initiatingor completing significant drug development trials, (2) termination or reductionin size of drug development trials, (3) acquisitions and divestitures, (4)changes in the mix of our services, and (5) exchange rate fluctuations. Delaysand terminations of trials are often the result of actions taken by Covance’scustomers or regulatory authorities and are not typically controllable byCovance. Since a large amount of Covance’s operating costs are relatively fixedwhile revenue is subject to fluctuation, moderate variations in thecommencement, progress or completion of drug development trials may causesignificant variations in quarterly results.

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**Results of Operations**

***Three Months Ended June 30, 2007 Compared with Three Months Ended June30, 2006. ***Netrevenues increased 13.7% to $381.1 million for the three months ended June 30,2007 from $335.2 million for the corresponding 2006 period.  Excluding the impact of foreign exchange ratevariances between both periods net revenues increased 11.5% as compared to thecorresponding 2006 period.  Net revenuesfrom Covance’s early development segment grew 22.7%, or 20.0% excluding theimpact of foreign exchange rate variances between both periods, driven bystrength in toxicology, chemistry and clinical pharmacology.  Net revenues from Covance’s late-stagedevelopment segment grew 5.9%, or 4.2% excluding the impact of foreign exchangerate variances between both periods. Strength in clinical development more thanoffset softness in: (1) central laboratory services, due to a shift in mix ofstudies; (2) commercialization services, due primarily to fewer new biologicalservice launches; and (3) cardiac safety services, due to low orders.

Cost of revenue increased 12.7% to $251.1 million or65.9% of net revenues for the three months ended June 30, 2007 as compared to$222.7 million or 66.4% of net revenues for the corresponding 2006 period.  Gross margins increased by 50 basis points to34.1% for the three months ended June 30, 2007 from 33.6% for the corresponding2006 period.

Overall,selling, general and administrative expenses increased 13.2% to $58.1 millionfor the three months ended June 30, 2007 from $51.3 million for thecorresponding 2006 period.  As apercentage of net revenues, selling, general and administrative expensesdecreased 10 basis points to 15.2% for the three month period ended June 30,2007 from 15.3% for the corresponding 2006 period.

Depreciationand amortization increased 16.2 % to $16.5 million or 4.3% of net revenues forthe three months ended June 30, 2007 from $14.2 million or 4.2% of net revenuesfor the corresponding 2006 period primarily as a result of higher levels ofcapital spending over the last twelve months.

Incomefrom operations increased 18.0% to $55.5 million or 14.6% of net revenues forthe three months ended June 30, 2007 from $47.0 million or 14.0% of netrevenues for the corresponding 2006 period. Income from operations from Covance’s early development segmentincreased $9.9 million or 25.2% to $49.0 million or 25.6% of net revenues forthe three months ended June 30, 2007 from $39.1 million or 25.1% of netrevenues for the corresponding 2006 period. The expansion in early development operating margin was driven primarilyby toxicology, chemistry and a significant improvement in profit from the eightclinical pharmacology sites acquired from Radiant Research Inc. in the secondquarter of 2006. Income from operations from Covance’s late-stage developmentsegment increased $3.4 million or 11.8% to $31.9 million or 16.8% of netrevenues for the three months ended June 30, 2007 from $28.5 million or 15.9%of net revenues for the corresponding 2006 period.  Strong improvement in clinical developmentdrove the year-over-year 90 basis point increase in late-stage developmentoperating margin, and more than offset the impact on operating margin ofrevenue softness in central laboratories, commercialization and cardiac safetyservices. Corporate expense increased $4.8 million to $25.4 million or 6.7% ofnet revenues for the three months ended June 30, 2007 from $20.6 million or6.2% of net revenues for the three months ended June 30, 2006.  Included in Corporate expense is stock-basedcompensation expense of $5.6 million or 1.5% of net revenues for the threemonths ended June 30, 2007, as compared to $5.1 million or 1.5% of net revenuesfor the corresponding 2006 period.  Thehigher level of Corporate expenses for the three months ended June 30, 2007 ascompared to the corresponding 2006 period also reflects an increase incompensation-related expenses and investments in infrastructure to supporthigher levels of current and expected future growth.

Otherincome, net increased $0.2 million to $2.1 million for the three months endedJune 30, 2007 from $1.9 million for the corresponding 2006 period primarily asa result of a $0.3******millionincrease in net interest income due to higher average invested cash balances inthe second quarter of 2007 and higher average interest rates earned on thosebalances.

Covance’seffective tax rate for the three months ended June 30, 2007 was 29.2% comparedto 29.5% for the corresponding 2006 period. The year over year 30 basis point reduction in Covance’s effective taxrate is attributable to a number of factors, including the mix of our pre-taxearnings across various tax jurisdictions and other planning initiatives.

Covancehas a minority equity position (approximately 20% at June 30, 2007) 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.  For the three month period endedJune 30, 2007, Covance recognized income of $0.1 million, representing its prorata share of BITI’s earnings.  For thethree month period ended June 30, 2006, Covance recognized a loss of $0.01million, representing its pro rata share of BITI’s losses.

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 Covance has a 47% minority equity position inNoveprim Limited (“Noveprim”), a supplier of research products.  For the three month periods ended June 30,2007 and 2006, Covance recognized $0.6 million and $0.5 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 June 30,2007 and 2006.

Netincome of $41.5 million for the three months ended June 30, 2007 increased $6.5million or 18.5% as compared to $35.0 million for the corresponding 2006period.

***Six Months Ended June 30, 2007 Compared with Six Months Ended June 30,2006. ***Net revenuesincreased 12.8% to $739.5 million for the six months ended June 30, 2007 from$655.7 million for the corresponding 2006 period. Excluding the impact offoreign exchange rate variances between both periods, net revenues increased10.3% as compared to the corresponding 2006 period.  Net revenues from Covance’s early developmentsegment grew 24.2%, or 21.1% excluding the impact of foreign exchange ratevariances between both periods, driven primarily by strength in toxicology,chemistry and clinical pharmacology.  Netrevenues from Covance’s late-stage development segment increased 3.2%, or 1.3%excluding the impact of foreign exchange rate variances between bothperiods.  Strength in clinicaldevelopment more than offset softness in (1) commercialization services, dueprimarily to fewer new biological service launches; (2) central laboratoryservices, due to delays in enrollment and longer trial durations and a shift inmix of studies; and (3) cardiac safety services, due to low orders.

Cost of revenue increased 11.2% to $485.5 million or65.6% of net revenues for the six months ended June 30, 2007 as compared to$436.4 million or 66.5% of net revenues for the corresponding 2006 period.  Gross margins increased by 90 basis points to34.4% for the six months ended June 30, 2007 from 33.5% for the corresponding2006 period.

Overall,selling, general and administrative expenses increased 14.3% to $113.9 millionfor the six months ended June 30, 2007 from $99.6 million for the corresponding2006 period.  As a percentage of netrevenues, selling, general and administrative expenses increased 20 basispoints to 15.4% for the six months ended June 30, 2007 from 15.2% for thecorresponding 2006 period.

Depreciationand amortization increased 21.1% to $32.6 million or 4.4% of net revenues forthe six months ended June 30, 2007 from $26.9 million or 4.1% of net revenuesfor the corresponding 2006 period primarily as a result of higher levels ofcapital spending over the last twelve months.

Incomefrom operations increased 15.8% to $107.6 million or 14.5% of net revenues forthe six months ended June 30, 2007 from $92.9 million or 14.2% of net revenuesfor the corresponding 2006 period. Income from operations from Covance’s early development segmentincreased $18.0 million or 24.2% to $92.7 million or 25.0% of net revenues forthe six months ended June 30, 2007 from $74.6 million or 25.0% of net revenuesfor the corresponding 2006 period.  Theexpansion in early development operating margin was driven primarily bytoxicology, chemistry and a significant improvement in profit from the eightclinical pharmacology sites acquired from Radiant Research Inc. in the secondquarter of 2006. Income from operations from Covance’s late-stage developmentsegment increased $0.6 million or 1.0% to $61.1 million for the six months endedJune 30, 2007 from $60.5 million for the corresponding 2006 period.  Income from operations as a percentage of netrevenues decreased to 16.6% for the six months ended June 30, 2007 from 16.9%for the corresponding 2006 period. Strength in clinical development operating margin was offset by theoperating margin impact of revenue softness in central laboratories,commercialization and cardiac safety services. Corporate expense increased $4.0 million to $46.2 million for the sixmonths ended June 30, 2007 from $42.2 million for the six months ended June 30,2006.  Corporate expense as a percentageof net revenues decreased to 6.3% for the six months ended June 30, 2007 from6.4% for the corresponding 2006 period. Included in Corporate expense is stock-based compensation expense of$11.1 million or 1.5% of net revenues for the six months ended June 30, 2007,as compared to $9.4 million or 1.4% of net revenues for the corresponding 2006period.  The higher level of Corporateexpenses for the six months ended June 30, 2007 as compared to thecorresponding 2006 period also reflects an increase in compensation-relatedexpenses and investments in infrastructure to support higher levels of currentand expected future growth.

Otherincome, net increased $1.0 million to $4.4 million for the six months endedJune 30, 2007 from $3.4 million for the corresponding 2006 period. Thisincrease is the result of a $1.0 million increase in net interest income due tohigher average invested cash balances in the first half of 2007 and higheraverage interest rates earned on those balances.

Covance’seffective tax rate for the six months ended June 30, 2007 was 29.3% compared to29.8% for the corresponding 2006 period. The 50 basis point reduction in Covance’s effective tax rate year overyear is attributable to a number of factors, including the mix of our pre-taxearnings across various tax jurisdictions and other planning initiatives.

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Covancehas a minority equity position (approximately 20% at June 30, 2007) 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 six month period endedJune 30, 2007, Covance recognized income of $0.2 million, representing its prorata share of BITI’s earnings.  Duringthe six month period ended June 30, 2006, Covance recognized a loss of $0.08million, representing its pro rata share of BITI’s losses.

Covancehas a 47% minority equity position in Noveprim Limited (“Noveprim”), a supplierof research products.  For the six monthperiods ended June 30, 2007 and 2006, Covance recognized $1.1 million and $0.8million, respectively, representing its share of Noveprim’s earnings, less theelimination of profit on inventory purchased from Noveprim and still on hand atCovance at June 30, 2007 and 2006.

Netincome of $80.4 million for the six months ended June 30, 2007 increased $12.0million or 17.5% as compared to $68.4 million for the corresponding 2006period.

**Liquidity and CapitalResources**

Covance’sexpected primary cash needs on both a short and long-term basis are for capitalexpenditures, expansion of services, possible future acquisitions, geographicexpansion, working capital and other general corporate purposes, includingpossible share repurchases.  Covance’s$75.0 million revolving credit facility (the “Credit Facility”) expires in June2009 and may be expanded to $125.0 million at Covance’s election. Covancebelieves cash from operations will provide sufficient liquidity for theforeseeable future.  At June 30, 2007,there were no outstanding borrowings and $1.1 million of outstanding letters ofcredit under the Credit Facility. Interest on all outstanding borrowings under the Credit Facility isbased upon the London Interbank Offered Rate (“LIBOR”) plus a 75 basis pointmargin.  The Credit Facility containsvarious financial and other covenants. At June 30, 2007, Covance was in compliance with the terms of the CreditFacility.  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.

Duringthe six months ended June 30, 2007, Covance’s operations provided net cash of$91.9 million, an increase of $13.1  million from the corresponding 2006 period. The change in net operatingassets used $32.1 million in cash during the six months ended June 30, 2007,primarily due to an increase in accounts receivable, unbilled services andother current assets, partially offset by an increase in unearned revenue,while this net change used $29.4 million in cash during the six months endedJune 30, 2006, primarily due to an increase in prepaid expenses and othercurrent assets and unbilled services, partially offset by a decrease inaccounts receivable.  Covance’s ratio ofcurrent assets to current liabilities was 2.24 at June 30, 2007 and 2.21 atDecember 31, 2006.

  Investing activities for the six months endedJune 30, 2007 used $61.8 million, compared to using $123.1 million for thecorresponding 2006 period.  Capitalspending for the first six months of 2007 totaled $61.8 million, and wasprimarily for the expansion of our preclinical facilities in North America andEurope, outfitting of new facilities, upgrade of existing equipment, and thepurchase of new equipment, hardware and software for newly hiredemployees.  Capital spending for thecorresponding 2006 period totaled $49.3 million, and was primarily for theexpansion of our Madison, WI and Harrogate, UK facilities, outfitting of newfacilities, upgrade of existing equipment, and the purchase of new equipmentand software for newly hired employees. Investment activities for the sixmonths ended June 30, 2006 included cash payments totaling $74.3 million forthe acquisitions of Radiant Research Inc. and Signet Laboratories, Inc.

Financing activities forthe six months ended June 30, 2007 used $41.9 million and was primarilycomprised of the purchase into treasury of 977,000 shares of common stock underthe share buyback program authorized by Covance’s Board of Directors, and thepurchase into treasury of 28,590 shares of common stock in connection with employeebenefit plans, for an aggregate cost of $61.4 million, partially offset byproceeds from the exercise of stock options of $13.4 million, excess taxbenefits realized on the exercise of stock options of $3.3 million and employeecontributions to Covance’s employee stock purchase plan of $2.8 million.  Financing activities for the six months endedJune 30, 2006 provided $18.9 million and was primarily comprised of proceedsfrom the exercise of stock options of $19.9 million, excess tax benefits realizedon the exercise of stock options of $5.4 million and employee contributions toCovance’s employee stock purchase plan of $2.3 million, partially offset by thepurchase into treasury of 149,951 shares for an aggregate cost of $8.7 million,primarily in connection with the share buyback program authorized by Covance’sBoard of Directors.

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**Inflation**

While most of Covance’snet revenues are earned under contracts, the long-term contracts (those inexcess of one year) generally include an inflation or cost of living adjustmentfor the portion of the services to be performed beyond one year from thecontract date. As a result, Covance believes that the effects of inflationgenerally do not have a material adverse effect on its operations or financialcondition.

**RecentlyIssued Accounting Standards**

In September 2006, theFinancial Accounting Standards Board (the “FASB”) issued Statement of FinancialAccounting Standards No. 158, *Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106 and 132(R),* (“SFAS 158”).As of December 31, 2006, Covance adopted the recognition and disclosureprovisions of SFAS 158, which require an employer to recognize the over fundedor under funded status of its defined benefit postretirement plans – measuredas the difference between the fair value of plan assets and the projectedbenefit obligation - as an asset or liability, respectively, in its balancesheet and to recognize changes in the funded status of the plan in the year inwhich such changes occur through other comprehensive income. SFAS 158 alsorequires, effective for fiscal years ending after December 15, 2008, that themeasurement of the over funded or under funded status of a plan be made as ofthe employer’s fiscal year end and not as of an earlier measurement date.  Covance will be required to conform themeasurement dates of its plans to December 31st for its fiscal year ending December 31, 2008.Covance does not expect this change in measurement dates to have a materialimpact on its consolidated results of operations or financial position.

In September 2006, theFASB issued Statement of Financial Accounting Standards No. 157, *Fair Value Measurements,* (“SFAS 157”).SFAS 157, which applies whenever other standards require (or permit) fair valuemeasurement, defines fair value and provides guidance for using fair value tomeasure assets and liabilities.  SFAS 157also requires expanded disclosures about the extent to which companies measureassets and liabilities at fair value, the information used in thosemeasurements and the effect of fair value measurements on earnings. Covancewill be required to adopt SFAS 157, which is effective for fiscal yearsbeginning after November 15, 2007, no later than the quarter beginning January1, 2008. Covance is currently in the process of evaluating SFAS 157, and hasnot yet determined the impact, if any, SFAS 157 will have on its consolidatedresults of operations or financial position.

***ForwardLooking Statements.****Statements in thisManagement’s Discussion and Analysis of Financial Condition and Results ofOperations, as well as in certain other parts of this Quarterly Report on Form10-Q that look forward in time, are forward looking statements made pursuant tothe safe harbor provisions of the Private Securities Litigation Reform Act of1995. Forward looking statements include statements concerning plans,objectives, goals, strategies, future events or performance, expectations,predictions, and assumptions and other statements which are other thanstatements of historical facts. All such forward looking statements are basedon the current expectations of management and are subject to, and are qualifiedby, risks and uncertainties that could cause actual results to differmaterially from those expressed or implied by those statements. These risks anduncertainties include, without limitation, competitive factors, outsourcingtrends in the pharmaceutical industry, levels of industry research anddevelopment spending, the Company’s ability to continue to attract and retainqualified personnel, the fixed price nature of contracts or the loss of largecontracts, risks associated with acquisitions and investments, the Company’sability to increase order volume, the pace of translation of orders intorevenue in late-stage development services, difficulties or delays inintegrating the business of Radiant and achieving anticipated efficiencies andsynergies, and other factors described in Covance’s filings with the Securitiesand Exchange Commission, including its Annual Report on Form 10-K.*

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

For thesix months ended June 30, 2007, approximately 37% of our net revenues werederived from our operations outside the United States.  We do not engage in derivative or hedgingactivities related to our potential foreign exchange exposures.  See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Foreign Currency Risks” for amore detailed discussion of our foreign currency risks and exposures.

**Item 4. Controls and Procedures**

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

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**Part II. Other Information**

**Item 1a.  Risk Factors**

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

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

Governmentalagencies throughout the world, but particularly in the United States, strictlyregulate the drug development process. Our business involves helping pharmaceutical and biotechnology companiesnavigate the regulatory drug approval process. Changes in regulation, such as a relaxation in regulatory requirementsor the introduction of simplified drug approval procedures, or an increase inregulatory requirements that we have difficulty satisfying, or that make ourservices less competitive, could eliminate or substantially reduce the demandfor 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 to reimbursementsfor pharmaceutical products, our customers may spend less, or reduce theirgrowth in spending on research and development.

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

Any failure on ourpart to comply with applicable regulations could result in the termination ofon-going research or the disqualification of data for submission to regulatoryauthorities.  For example, if we were tofail to properly monitor compliance by clinical trial investigators with studyprotocols, the data collected from that trial could be disqualified.  If this were to happen, we could becontractually required to repeat the trial at no further cost to our customer,but at substantial cost to us.

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

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

·                  the failure of products to satisfysafety requirements;

·                  unexpected or undesired results ofthe products;

·                  insufficient patient enrollment;

·                  insufficient investigatorrecruitment;

·                  the client’s decision to terminatethe development of a product or to end a particular study; and

·                  ourfailure to perform properly our duties under the contract.

The loss, reduction in scope or delay of a largecontract or the loss or delay of multiple contracts could materially adverselyaffect our business, although our contracts frequently entitle us to receivethe costs of winding down the terminated projects, as well as all fees earnedby us up to the time of termination. Some contracts also entitle us to a termination fee.

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

Since our contracts are often structured as fixedprice or fee-for-service with a cap, we bear the financial risk if we initiallyunder price our contracts or otherwise 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.

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

We may seek to develop and market new services thatcomplement or expand our existing business or expand our service offeringsthrough acquisition. If we are unable to develop new services and/or createdemand for those newly developed services, or expand our service offeringsthrough acquisition, our future business, results of operations, financialcondition, and cash flows could be adversely affected.

**Our quarterly operating resultsmay vary.**

Our operating results mayvary significantly from quarter to quarter and are influenced by factors overwhich we have little control such as:

·                  exchange rate fluctuations;

·                  the commencement, completion or cancellationof large contracts;

·                  the progress of ongoing contracts;

·                  the timing of and charges associatedwith completed acquisitions or other events; and

·                  changesin the mix of our services.

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

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

Our revenues dependgreatly on the expenditures made by the pharmaceutical and biotechnologyindustries in research and development. Accordingly, economic factors and industry trends that affect ourclients in these industries also affect our business.  If companies in these industries were toreduce the number of research and development projects they outsource, ourbusiness could be materially adversely affected.

**We operate in a highlycompetitive industry.**

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

·                  reputation for on-time quality performance andregulatory compliance;

·                  expertise and experience in specific areas;

·                  scope of service offerings;

·                  strengths in various geographic markets;

·                  price;

·                  technological expertise and efficient drugdevelopment processes;

·                  quality of facilities;

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

·                  ability to manage large-scale clinicaltrials both domestically and internationally;

·                  expertise and experience in market accessservices; 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.

There is competitionamong the larger contract research organizations for both clients and potentialacquisition candidates.  Additionally,small, limited-service entities considering entering the contract researchorganization industry will find few barriers to entry, thus further increasingpossible competition.  These competitivepressures may affect the attractiveness of our services and could adverselyaffect our financial results.

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**We may expand our businessthrough acquisitions.**

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

·                  difficulties 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

·                  lossof key employees of the acquired companies.

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

In recent years the United States Congress and statelegislatures have considered various types of health care reform in order tocontrol growing health care costs.  Weare unable to predict what legislative proposals will be adopted in the future,if any.  Similar reform movements haveoccurred in Europe and Asia.

Implementation of health care reform legislation thatcontain costs could limit the profits that can be made from the development ofnew 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 serviceofferings.

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

We depend on third parties to provide us with servicescritical to our business.  For instance,we have entered into an agreement with IBM to manage certain aspects of ourinformation technology infrastructure. The failure of any of these third parties to adequately provide theneeded services could have a material adverse effect on our business.

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

We derive a large portionof our net revenues from international operations.  For the six month period ended June 30, 2007,we derived approximately 37% of our net revenues from outside the UnitedStates.  Our financial statements aredenominated in U.S. dollars.  Inaddition, in certain circumstances, we may incur costs in one currency relatedto our services or products for which we are paid in a different currency. As aresult, factors associated with international operations, including changes inforeign currency exchange rates, could significantly affect our results ofoperations, financial condition and cash flows.

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

Our success depends to asignificant extent upon the efforts of our senior management team and other keypersonnel. The loss of the services of such personnel could adversely affectour business.  Also, because of thenature of our business, our success is dependent upon our ability to attractand retain technologically qualified personnel. There is substantial competition for qualified personnel, and aninability to recruit or retain qualified personnel may impact our ability togrow our business and compete effectively in our industry.

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

In contracting to work ondrug development trials, we face a range of potential 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

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

We also contract withphysicians, also referred to as investigators, to conduct the clinical trialsto test new drugs on human volunteers. These tests can create a risk of liability for personal injury or deathto volunteers, resulting from negative reactions to the drugs administered orfrom professional malpractice by third party investigators.  We believe that our risks in this area aregenerally reduced by the following:

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

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

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

Contractual indemnifications generally do not protectus against liability arising from certain of our own actions, such asnegligence 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 beno assurance that we will be able to maintain such insurance coverage on termsacceptable to us.

**Reliance on air transportation**.

Our central laboratoriesand certain of our other businesses are heavily reliant on air travel fortransport of clinical trial kits and other material, products and people, and asignificant disruption to the air travel system, or our access to it, couldhave a material adverse effect on our business.

**Certain service offerings and research products are dependenton limited sources of supply of services or products which if interrupted couldaffect our business.**

We depend on a limited number ofsuppliers for certain services and for certain animal populations. Disruptionsto the continued supply of these services or products may arise from exportimport restrictions or embargoes, foreign political or economic instability, orotherwise. Disruption of supply could have a material adverse effect on ourbusiness.

**Actionsof animal rights extremists may affect our business**.

Our early development services utilize animals inpreclinical testing of the safety and efficacy of drugs and also breed and sellanimals for biomedical research.  Suchactivities 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 otheracts by animal rights extremists who object to the use of animals in drugdevelopment could have a material adverse effect on our business.

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

Itis important that our research products be free of diseases, includinginfectious diseases.  The presence ofdiseases can distort or compromise the quality of research results, can causeloss of animals in our inventory, can result in harm to humans or outsideanimal populations if the disease is not contained to animals in inventory, orcan result in other losses.  Such resultscould harm our reputation or have a material adverse effect on our financialcondition, results of operations, and cash flows.

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**Item 2.  Unregistered Sales of Equity Securities andUse of Proceeds**

Repurchases of equitysecurities as reported on a settlement date basis during the quarter ended June30, 2007 were as follows:

**IssuerPurchases of Equity Securities:**
| **Period**                           | ** ** | **Total # of  Shares  Purchased** | ** ** | **Average Price  Paid Per  Share** | ** ** | **Total # of  Shares  Purchased as  Part of  Currently  Authorized  Programs** | ** ** | **Maximum # of  Shares that May  Yet Be Purchased  Under Currently  Authorized  Programs** | ** ** |
|--------------------------------------|------------|---------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| April 1, 2007 –  April 30, 2007 |       | 3⁄4                                      |       | 3⁄4                                       |       | 3,521,500                                                                                          |       | 2,478,500                                                                                                                     |       |
| May 1, 2007 –  May 31, 2007     |       | 3⁄4                                      |       | 3⁄4                                       |       | 3,521,500                                                                                          |       | 2,478,500                                                                                                                     |       |
| June 1, 2007 – June 30,  2007   |       | 196,200                                     | ** ** | $                                            | 67.238     |                                                                                               | 3,717,700  |                                                                                                                          | 2,282,300  |   |
|                                      |            |                                             |            |                                              |            |                                                                                                    |            |                                                                                                                               |            |  |

 

**Item 4.  Submissionof Matters to a Vote of Security Holders**

The Annual Meeting ofStockholders of Covance was held on May 3, 2007, pursuant to notice.

Two directors werereelected to the Board of Directors with the following votes cast: JosephHerring received******59,258,469******votes for and******1,273,030******votes were withheld;Irwin Lerner received******58,803,111******votes for and******1,728,388******votes werewithheld.  The following directors’ termsof office as a director continued after the meeting: Kathleen G. Bang, RobertBarchi, Sandra L. Helton, J. Randall MacDonald and William C. Ughetta.

The shareholders approvedthe 2007 Employee Equity Participation Plan (the “2007 EEPP).  The 2007 EEPP received 46,879,261 votes for,7,578,122 votes against, 123,057 votes abstained and there were 5,951,059broker non-votes.

The shareholders ratifiedthe appointment of Ernst & Young LLP as the Company’s independent auditorswith the following votes cast: 60,343,959 votes for, 121,527 votes against and66,013 votes abstained.
| **Item 6. Exhibits** |
|----------------------|
|                 |   |   |
|                      | 31.1 | Certification – Joseph L. Herring. ***Filed herewith***. |
|                 |   |   |
|                 | 31.2 | Certification – William E. Klitgaard. ***Filed herewith.*** |
|                 |   |   |
|                 | 32.1 | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 – Joseph L. Herring. ***Filed  herewith***. |
|                 |   |   |
|                 | 32.2 | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002 – William E. Klitgaard. ***Filed  herewith***. |

 

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.
|                      |   | **     COVANCE INC.**           |
|----------------------|--------|----------------------------------------------------------|
| ** **           |   | ** **                                               |
| ** **           |   | ** **                                               |
| Dated: July 31, 2007 | By:    | /s/ Joseph L. Herring                                    |   |
|                 |   |      Joseph L. Herring          |
|                 |   |      Chairman of the Board  and |
|                 |   |      Chief Executive  Officer   |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the Registrant and in thecapacities and on the dates indicated.
| Signature                 | ** ** | **Title**                                | ** ** | **Date**      |
|---------------------------|------------|------------------------------------------|------------|---------------|
| ** **                | ** ** | ** **                               | ** ** | ** **    |
| /s/ Joseph L.  Herring    |       |                                     |       |          |   |
| Joseph L. Herring         |       | Chairman of the Board and                |       | July 31, 2007 |
|                      |       | Chief Executive Officer                  |       |          |
|                      |       | (Principal Executive Officer)            |       |          |
|                      |       |                                     |       |          |
| /s/ William E.  Klitgaard |       |                                     |       |          |   |
| William E. Klitgaard      |       | Corporate Senior Vice President and      |       | July 31, 2007 |
|                      |       | Chief Financial Officer                  |       |          |
|                      |       | (Principal Financial Officer)            |       |          |
|                      |       |                                     |       |          |
| /s/ Michele A.  Kennedy   |       |                                     |       |          |   |
| Michele A. Kennedy        |       | Corporate Vice President, Controller and |       | July 31, 2007 |
|                      |       | Chief Accounting Officer                 |       |          |
|                      |       | (Principal Accounting Officer)           |       |          |

 

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**EXHIBITINDEX**
| Exhibit  Number | ** ** | **Description**                                                                                                                                                             |
|-----------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1            |       | Certification – Joseph L. Herring. ***Filed herewith.***                                                                                                               |
|            |       |                                                                                                                                                                        |
| 31.2            |       | Certification – William E. Klitgaard. ***Filed herewith***.                                                                                                            |
|            |       |                                                                                                                                                                        |
| 32.1            |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – Joseph L.  Herring. ***Filed herewith***.    |
|            |       |                                                                                                                                                                        |
| 32.2            |       | Certification Pursuant to 18 U.S.C. Section 1350, as  Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 – William  E. Klitgaard. ***Filed herewith.*** |

 

30

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