Covance could cut early development capacity if the unit posts flat sales in the coming fiscal year, its CEO said.
After promising signs over the first nine months of last year weak demand for toxicology services in Europe dragged on early development results in the fourth quarter. Covance is forecasting ‘modest growth’ at the unit this year but failure to hit this target could prompt further cuts to capacity.
“We have plans, and should early development be flat, which would be toward the lower end of the range, then we are prepared to make announcements and decisions”, Joe Herring, CEO of Covance, said in a conference call with investors.
Demand for toxicology services at big CROs (contract research organisations) has slumped since the peaks of 2008 as biopharmaceutical focus has shifted away from preclinical to late phase research.
“At some point in time, that early development volume has to come back or the industry collapses on itself. But calling exactly when that is, is difficult”, Herring said. If the recovery is slower than Covance is predicting it could follow-up the closure of its Virginia, US preclinical site with further capacity cuts.
In the fourth quarter Covance cut headcount at its underperforming European toxicology unit by five per cent. Toxicology “is off to a slow start” in 2012, Herring said, and Covance is “evaluating additional cost and capacity actions should this market softness continue”.
Cuts would be in line with the thinking of some analysts. “Covance still has too much capacity. Retaining excess capacity today so as not to get caught short of capacity if demand returns, is no longer a valid argument”, David Windley, equity analyst at Jefferies & Company, said in October.
Many CROs kept early development capacity in anticipation of a market recovery but made cuts after successive false dawns. “The number of false starts in the industry’s recovery has been remarkable over the past three years”, John Kreger, equity analyst at William Blair, wrote in a note to investors.
Kreger and Herring both said it is inevitable that demand for toxicology will improve eventually. However, the shift in approach to preclinical research means volumes may never hit the historic highs.
“What drove the peaks was a combination of high throughput screening, combinatorial chemistry and investments in genomics. It was more shots on goal the better. And if we hold our batting average, we're going to have a lot more drugs.
“I think the reality is that didn't work”, Herring said.