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  1. 1. Equity Research Healthcare │PharmaceuticalCRO Industry Update Outsourcing Results From Fifth Survey of Pharma and Biotech Sponsors January 11, 2011 Industry Report (11-010) In conjunction with Life Science Strategy Group, we recently conducted Charles River Laboratories Interna- our fifth survey of pharmaceutical and biotechnology sponsors regarding tional, Inc. Ticker: CRL (NYSE) their experience with vendors and general trends affecting the contract re- Price: $36.61 search organization (CRO) industry. We surveyed respondents on outsourcing Stock Rating: Market Perform penetration, the impact of strategic partnerships, and research-and-development Company Profile: Core Growth budgeting trends. In addition, we asked participants to rank their favorite CROs Covance Inc. and indicate the qualities they seek when selecting a vendor. Ticker: CVD (NYSE) Price: $50.31 Covance, Charles River Laboratories, and Quintiles were cited most fre- Stock Rating: Outperform quently as sponsors’ favorite CRO. Covance and Charles River were cited Company Profile: Established Growth most often among preclinical-oriented respondents, while Quintiles and Covance ICON plc were cited most often by respondents focused on clinical development. Notably, Ticker: ICLR (Nasdaq) Quintiles was ranked in the top three in our last survey as well, but other CROs Price: $21.93 that were mentioned in past surveys slipped somewhat. Stock Rating: Market Perform Company Profile: Aggressive Growth Outsourcing market growth should improve and favor larger CROs. Survey PAREXEL International data suggests that market growth should improve over the next few years, based Corporation on expected growth in research-and-development spending and the number of Ticker: PRXL (Nasdaq) Price: $20.60 products in the industry’s pipeline. In addition, outsourcing penetration—particu- Stock Rating: Outperform larly over the longer term—should increase significantly. We believe that strategic Company Profile: Aggressive Growth partnerships will continue to concentrate the benefit from this increased penetra- tion into the hands of fewer CROs. PPD, Inc. Ticker: PPDI (Nasdaq) Price: $27.31 Leading indicators we track are consistent with our survey data and continue Stock Rating: Market Perform to suggest that the pharmaceutical outsourcing environment is growing Company Profile: Core Growth again, but more slowly. Following an analysis of the four leading indicators, we ShangPharma Corporation believe the overall environment for pharmaceutical outsourcing is stable to improv- Ticker: SHP (NYSE) ing in the near term. Recent data suggests that new business and the product Price: $12.35 pipeline are growing (especially in the later stages), R&D spending is stable (but Stock Rating: Outperform well below historical averages), and biotechnology funding is showing signs of Company Profile: Aggressive Growth improvement. We expect some improvement in growth in 2011, particularly after R&D budgets at pharma companies are finalized. We reiterate our Outperform ratings on Parexel, Covance, and ShangPharma, and our Market Perform ratings for ICON, PPD, and Charles River. In our opinion, large pharma’s urgent need to replace revenue that will lose patent pro- tection in the next several years is forcing a focus on late-stage compounds and strategic partnering, which should work to the advantage of larger, global CROs. In this environment, we believe Parexel (with its global footprint, strategic alliance momentum, and later-stage focus) and Covance (which boasts the broadest functional breadth and largest strategic partnerships) are best positioned.John Kreger Liping Cai, CFA Roberto Fatta312.364.8597 +86 21 2327 2260 312.364.8797jkreger@williamblair.com lcai@williamblair.com rfatta@williamblair.com William Blair & Company, L.L.C. 222 West Adams Street Chicago, Illinois 60606Please consult pages 33-34 of this report for all disclosures. 312.236.1600William Blair & Company, L.L.C. receives or seeks to receive compensation for investment banking services from companies www.williamblair.comcovered in this research report. Investors should consider this report as a single factor in making an investment decision.
  2. 2. William Blair & Company, L.L.C.Contents Introduction....................................................................................................................3 Key Conclusions ...........................................................................................................3 CRO Industry Survey ....................................................................................................6 State of the Global Pharmaceutical Outsourcing Industry......................................23 Summary Conclusions From Quality Survey and Leading Indicators ...................29 Global Pharmaceutical Outsourcing Market Model .................................................31 Summary of Valuation Statistics ................................................................................32John Kreger 312.364.8597 -2-
  3. 3. William Blair & Company, L.L.C.Introduction To better understand the broad trends in pharmaceutical outsourcing and spot changing attitudes about the leading vendors, we have conducted several industry surveys over the past six years. For the most recent survey conducted in October, we partnered with Life Science Strategy Group, a leading consultancy specializing in new product planning and commercialization strategy to a variety of life science markets. The 156 respondents were split equally among large ($1 billion or more in annual research-and-development spend), midsize (between $50 million and $1 billion in annual R&D spend), and small (less than $50 million in annual R&D spend) biopharmaceutical companies, the majority of which were from North America. Our questions were generally geared toward the level of outsourcing and the factors affecting outsourcing strategy. We believe our findings are relevant for Covance, Charles River Laboratories, ICON, Par- exel, PPD, Kendle, ShangPharma, and WuXi, as well as a host of privately owned CROs, including Quintiles, PRA, and PharmaNet on the clinical side, and MPI, WIL Research, and Huntingdon on the preclinical side.Key Conclusions After reviewing the data and conducting channel checks with a variety of industry participants, we came away with five primary conclusions regarding the pharmaceutical outsourcing market. I. R&D Spending Is the Critical Variable in Determining the Outlook for Outsourcing in the Coming Few Years, and Could Be Stronger Than Investors Anticipate if the Economy Remains Stable After a slowdown in R&D spending growth in 2009 and 2010, our survey respondents expect spending to ramp up again in 2011 and beyond. As illustrated in figures 4 and 5, on page 9, all three client segments, from large pharma to small biotechs, are reportedly expecting a marked increase in spending growth in 2011. We were particularly surprised that our large pharma respondents are expecting acceleration in growth of three percentage points in 2011. Midsize and small pharmaceutical companies expect R&D spending growth to increase to an even greater degree—by 6 and 14 percentage points, respectively. We are somewhat skeptical of the growth rates expected by our respondents in the coming few years, because their opinions of 2010 spending were well above the flat trend that we have observed year-to-date compared with 2009. We believe this is partly attributable to the fact that our data is dollar weighted. For example, a 10% reduction in spending across Pfizer’s $8 billion-plus R&D budget carries more weight than a 10% increase in spending across Biogen Idec’s $1.2 billion R&D budget. In contrast, our survey respondents with R&D spending greater than $1 billion are counted as “large pharma” and are equally weighted. Despite the discrepancy in absolute growth rates between our survey and our own quarterly data, we are encouraged that trends seem to be moving in the right direction and consider the delta between the 2010 and 2011 projections as a reasonable proxy for the actual rate of growth likely in the coming year. Our CRO model currently anticipates R&D spending growth of 2% in 2011 and 1% in 2012— levels that may prove conservative in light of the three points of improvement anticipated by large pharma respondents in the coming year. Longer term, while the survey data suggests that it is possible that growth returns to historical levels of roughly 9%, we believe that a return to these levels is unlikely, based on declining revenues and cost-cutting measures many companies are expected to undergo over the next several years. Still, responses to our survey suggest that the attitude at many pharma companies (particularly those not involved in mergers) may be more bullish than investors expect.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 -3-
  4. 4. William Blair & Company, L.L.C. II. The Pipeline of New Products Is Robust According to Pharmaprojects, there are roughly 9,600 products in the pipeline at the mo- ment (from preclinical through registration), which is up 6% since last year and up 14% since January 2009. As shown in figures 7 through 10, on pages 11-12, respondents expect the pipeline of products to increase across the development spectrum at companies of all sizes. Seventy-five percent of respondents suggested that the pipeline of clinical products is expected to increase or increase significantly, which is logical given the large number of branded product expirations that must be replaced over the next few years. We view this as bullish for clinical players and believe this trend has already manifested itself in 2010 through the strong bookings recorded by nearly all publicly traded clinical players. Similar to opinions about R&D spending growth noted above, the survey data about pipeline growth was more bullish than the Pharmaprojects data we track monthly. III. Outsourcing Penetration Should Increase Over the Next Few Years We strongly believe the combination of an expanding pipeline and shrinking internal re- sources will result in an increased rate of outsourcing. Our survey suggested that over the next 18 to 24 months, outsourcing penetration should increase across nearly all areas of development. While this does not appear to be the case on a consolidated basis due to the decreases in penetration expected by small pharma respondents, large and midsize play- ers are expecting to increase penetration in nearly all categories (thus the dollar-weighted effects are different from what the simple averages imply). We expect the current outsourcing penetration rate to increase by a few percentage points over the next year or two, and CRO management commentary suggests that over the next five to seven years the outsourcing percentage could increase to more than 60%. Our model currently anticipates roughly a 10-percentage-point increase in penetration from 2010 through 2015. IV. Strategic Deals Will Likely Change the Way Outsourcing Is Conducted In the near term, our respondents indicate that strategic deals should accelerate the rate of outsourcing and concentrate bookings in the hands of fewer CROs. We believe this trend will work in the favor of large, global players with broad therapeutic and functional expertise. While we do not yet know what the full ramifications of strategic deals will be, we believe the trend will ultimately change the way outsourcing is done and drive penetration much higher. We believe the integration of CRO teams into the existing infrastructure of large pharma companies should drive better outcomes and greater efficiency for sponsors. We believe it may take a few years for CROs to optimize the new model, but once they do, we do not see any structural reason why the underlying level of profitability of the business should be reduced. In other words, we expect enhanced visibility and sales-and-marketing efficiencies to offset pricing concessions likely inherent with larger, multiyear deals. V. Spending From Small Sponsors May Be Beginning to Thaw Based on bullish responses to our survey, it appears small companies are becoming more optimistic about the future. Most telling were the responses for R&D spending. While all of the respondents suggested that R&D growth rates should improve, small participants were the most bullish. On average, companies expected growth to remain flat for 2010, but to improve to the midteens beginning in 2011 (see figure 5, on page 9). While outsourcing penetration rates for these companies appear to be less optimistic (coming down in some categories), we believe the strong increase in R&D spending should offset the decline. In addition, numerous channel checks and our leading indicators have begun to suggest that small pharma and biotech companies have reduced their decision-making time and have ramped up spending. We believe this has been driven, at least in part, by an improvement in biotech funding, which was up 51% sequentially, to $3.1 billion in the fourth quarter. In our view, this should bode well for the CRO group in the early part of 2011. We were pleasantly surprised to hear that small sponsors are starting to spend again, given that bookings over the past year appear to have been driven primarily by large pharma. If this trend continues, it could herald improving demand across the development spectrum, but particularly in the early stage, where small sponsors tend to focus their buying power.John Kreger 312.364.8597 -4-
  5. 5. William Blair & Company, L.L.C. Given generally consistent feedback relative to previous surveys, our perception of the highest-quality players in the space has not changed, as the usual suspects are once again at the top end of the quality list in our survey. Interestingly, a large number of early-stage players are at or near the top of the list this time, which we believe is due to a higher per- centage of respondents being responsible for preclinical contracting. Thirty-one percent of respondents said they were early-stage focused, 49% said they were both early- and late- stage focused, and 20% were late-stage focused. Our previous surveys were solely focused on clinical development outsourcing. In addition, while our older surveys were concentrated more in the large and midsize pharma space, our current survey captures a fair number of small biotech customers with products very early in the development process. This would explain the presence of companies such as WuXi and MPI near the top of the list. Still, Covance ranked highest in our survey by a wide margin and scored well among both preclinical- and clinical-oriented respondents. This is likely due to its global reach and unique presence across the development spectrum, which makes it an attractive potential partner, in our view. CROs that have ranked high in our previous surveys (Quintiles and PPD) are again among the top five. However, ICON seems to have dropped a bit and was overtaken by Parexel. To summarize, it appears that sponsors are somewhat more optimistic about the future than investors are, which should bode well for CROs, in our opinion. We believe the stronger- than-expected responses for R&D spending, pipeline growth, and small company spending in particular reinforce our views that the longer-term outlook for the CROs remains strong. In addition, comments on sponsors’ favorite CROs appear to validate our opinions on the best ways to participate in the space. Specifically, we believe that in the short term the clini- cal business seems to have the most momentum, and within that space, Parexel seems to have the best fundamentals at the moment (represented by its leapfrogging of ICON among all respondents). For 2011, therefore, we continue to recommend Parexel as our favorite CRO. While ICON is still one of the top players in the space and a long-term survivor, in our opinion, it might have a more difficult 2011 as it ramps up investment spending on new capabilities, geographies, and technology. Over the longer term, we believe strategic partnerships will be the major driver of stock performance and that the CROs with the broadest capabilities and geographic footprint are best positioned. Therefore, we were not surprised that Covance received the greatest number of total votes as top CRO, based on its strong presence across the development spectrum. We believe Covance represents the best longer-term play in the space, despite a higher-than-average valuation relative to its peers. Over the following pages, we provide a more detailed analysis of the survey data and channel checks that led us to these conclusions. In addition, we provide an update on the pharmaceutical outsourcing environment over the past six months, the changing demand trends, and the implications of industry restructuring on future growth.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 -5-
  6. 6. William Blair & Company, L.L.C.CRO Industry Survey The majority of CRO stock performance, in our opinion, is driven by macro factors that af- fect all industry participants. As a result, we spend the majority of our time tracking the four leading indicators (discussed in more detail below): R&D spending trends, biotechnology industry funding, the product pipeline, and changes in outsourcing—all of which drive in- dustry bookings trends. Yet the current turbulent environment may offer greater-than-normal opportunities for CROs to gain or lose market share, as large pharmaceutical companies urgently seek to reinvent their drug discovery and development models. The key questions, in our view, are: 1) Will the pharmaceutical industry grow or cut R&D spend over the next five years when billions of dollars in revenues are lost to generics? 2) Can outsourcing ramp up quickly enough to compensate for potentially lower R&D spend? 3) Will the rapid shift to strategic partnering ultimately be positive or negative for the CRO industry in terms of growth and profitability? These questions led us to conduct our fifth CRO industry survey. We walk through the results of the survey here. Our seven survey questions are listed in table 1: Table 1 Survey Questions 1. How have your total R&D budgets changed, and how are they expected to change in each of the following years versus the prior year (2010 versus 2009, 2011 versus 2010, 2012 versus 2011, and 2013 onward)? Why? 2. How do you expect your company’s drug pipeline to change over the next two to three years by phase of development? (Answer options included: increase significantly, increase, no change, decrease, decrease significantly, don’t know.) 3. How have your outsourcing strategies changed over the past one to two years in terms of percentage and dollars outsourced? Why? 4. What percentage of your total annual budget is currently outsourced (by phase of development), and how do you think it will change over the next 18 to 24 months? 5. Which CROs are best positioned to capture your outsourced developmental spend over the next two to three years (i.e., vendors to whom you are likely to award more business based on your own internal metrics of perceived value, such as quality, price, on-time delivery, etc.)? Please list your top three CROs in ranked order (No. 1 = best). Please explain why you ranked this company as your top CRO. In addition, please rank your top CROs on the following performance criteria: expertise, price, turnaround time, breadth of services, quality, relationship, and global reach (5 = best/most favorable). 6. How do you envision strategic partnerships will change the nature of your company’s outsourcing to CROs? (Answer options included: closer relationships with fewer CROs, pricing concessions [up to 20%], pricing concessions [20% or more], longer contracts [one to two years], longer contracts [three to five years), more risk-sharing deals, more asset transfers, and no change.) 7. How do you envision strategic partnerships will change the rate of your company’s outsourcing to CROs? (Answer options included accelerate significantly, accelerate somewhat, no change, slow down somewhat, slow down significantly.) Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.John Kreger 312.364.8597 -6-
  7. 7. William Blair & Company, L.L.C. Our survey gathered data from 156 respondents, split roughly equally among large ($1 billion or more in annual R&D spend), midsize (between $50 million and $1 billion in annual R&D spend), and small (less than $50 million in annual R&D spend) biopharmaceutical compa- nies, the majority of which were from North America (figures 1, 2, and 3 provide more detail). Summarizing the vendors that were most often singled out, Covance claimed the position as the most frequently mentioned favorite CRO vendor in this year’s survey, which is up from No. 4 in our prior survey. Charles River Laboratories claimed the No. 2 slot; ICON and PPD tied for this rank in the previous survey. Quintiles took the third slot, down slightly from No. 1 in our prior survey. We are somewhat surprised by the presence of so many early-stage CROs at the top of the list. We attribute this partly to a larger concentration of small biotech respondents with drugs in the early stages of development, as compared with respondents of our previous surveys. Most of the usual suspects remain in the top 10 of most-cited CROs. Breaking down the data by respondent cohort, among those focused on preclinical research and development, Covance and Charles River were mentioned an equal number of times and were far ahead of the rest of the group. Among respondents focused solely on late-stage re- search and development, Quintiles received the most votes, followed by Covance, PPD, ICON, and Parexel. We were surprised by the number of votes Covance received in this category, which suggests it is gaining traction in clinical. Lastly, in the cohort of respondents that deal with both preclinical and clinical R&D, Covance received the most votes, followed by Charles River, Quintiles, and PPD. Consolidating all respondent groups, Covance received the most votes, followed by Charles River, Quintiles, MPI, and PPD. Tables 2 through 5, on pages 17 and 18, provide additional detail. In total, 115 different CROs were mentioned; however, 93 of these received only two total mentions or less. This illustrates the significant fragmentation of this sector, and tells us there remains plenty of market share to win if a company can clearly differentiate itself on quality. As strategic partnerships gain traction, we expect this number of providers to be reduced. Figure 1 Survey Respondent Demographics - Type and Location 30% 26.9% 23.7% 23.7% 25% 20% 15% 9.6% 9.0% 10% 7.1% 5% 0% Large Pharma Midsize Pharma Small Pharma North America Rest of World (ROW) Note: 156 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 -7-
  8. 8. William Blair & Company, L.L.C. Figure 2 Survey Respondent Demographics - Functional Area 20% 49% 31% Clinical R&D ONLY Preclinical R&D ONLY Both Note: 156 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 3 Survey Respondent Demographics - Functional Role 11% 1% 27% 10% 15% 16% 20% Principal Scientist Project Management Senior Management (VP and above) Contracting/Sourcing Clinical Operations Purchasing Other Note: 156 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.John Kreger 312.364.8597 -8-
  9. 9. William Blair & Company, L.L.C. Below we detail that the survey responses often broken down by sponsor size or area of focus within the development spectrum. Question 1: How have your total R&D budgets changed, and how are they expected to change in each of the following years versus the prior year (2010 versus 2009, 2011 versus 2010, 2012 versus 2011, and 2013 onward)? Why? Figure 4 Total R&D Growth 14% 13.2% 13.0% Average Annual Growth 12.1% 12% 10% 8% 5.5% 6% 4% 2% 0% 2010 2011 2012 2013 Note: 156 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 5 Total R&D Growth by Size 20% 17.5% 16.7% Average Annual Growth 15.5% 16% 13.6% 12.0% 12% 10.7% 9.4% 10.5% 9.4% 7.7% 7.3% 8% 4% 1.4% 0% 2010 2011 2012 2013 Large Pharma Midsize Pharma Small Pharma Note: 156 total respondents (Large - 53; Midsize - 52; Small - 51) Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 -9-
  10. 10. William Blair & Company, L.L.C. Figure 6 Total R&D Growth by Phase of Development 18% 15.8% 16% 14% 13.2% 13.2% 13.2% 13.1% 13.0% 12.6% 11.8% 12.1% 12% 11.0% 10.8% 9.9% 10% 7.9% 8% 6% 5.5% 4.2% 4% 2% 1.6% 0% 2010 2011 2012 2013 Total R&D Growth Preclinical Clinical Both Note: 156 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Comments and conclusions According to the data we gathered, it appears as though survey respondents are expecting double-digit growth in their annual R&D budgets in each of the next two to three years on average. From a segment view, we noted that the expected budget growth during this period ranged from 9%-11% for large pharma to 16%-18% for small pharma. While these estimates paint an encouraging picture, we are approaching these growth expectations with a sense of skepticism. If we compare the growth rates expected in 2010 from the survey with those we have observed year-to-date from the sample of companies we track, we notice a fairly large divergence between expectations and reality. Specifically, large pharma respondents suggested that 2010 growth would be in the 8% range, while actual spending according to our numbers is roughly flat. However, we note that our R&D spend data is dollar weighted, while our survey data equally weights each respondent’s estimates, as mentioned previously. Thus, we look more at the change in expectations between 2010 and 2011 as a better proxy for growth in spending. All three respondent cohorts suggest an increase in spending next year, with large pharma expecting an acceleration of 3 percentage points, midsize vendors expecting 6 points of improvement, and smaller clients looking for 14 points of added growth. Our CRO model is expecting growth in the low single digits over the next couple of years. These results bolster our view that it is reasonable to expect in aggregate at least a small increase in R&D spend in 2011. When asked about the factors leading to expected changes in R&D spend over time, re- spondents indicated that pipeline growth and maturation of pipeline, increases in funding and improved access to funding, and increased number of projects and programs were drivers of increased spend. As it relates to those expecting declines in R&D budgets, the main drivers included the economic downturn, pipeline diminution, savings from restricting outside partnerships and collaboration, and termination/completion of projects and programs.John Kreger 312.364.8597 - 10 -
  11. 11. William Blair & Company, L.L.C. Question 2: How do you expect your company’s drug pipeline to change over the next two to three years by phase of development? (Answer options included: increase sig- nificantly, increase, no change, decrease, decrease significantly, don’t know.) Figure 7 Expected Changes in Pipeline Over Next Two to Three Years 80% 74.5% 68.5% Percent of Respondents 70% 60% 50.4% 50% 40% 31.2% 30% 19.9% 15.6% 16.1% 20% 9.6% 10% 2.8% 5.4% 2.1% 4.0% 0% Discovery Preclinical Clinical Increase and/or Increase Significantly No change Decrease and/or Decrease Significantly Dont know Note: 149 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 8 Expected Changes in Pipeline for Large Pharma Over Next Two to Three Years 80% 69.8% 70% Percent of Respondents 60% 54.9% 50% 44.9% 40% 30.6% 29.4% 30% 20.4% 20% 17.0% 13.7% 9.4% 10% 4.1% 3.8% 2.0% 0% Discovery Preclinical Clinical Increase and/or Increase Significantly No change Decrease and/or Decrease Significantly Dont know Note: 53 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 11 -
  12. 12. William Blair & Company, L.L.C. Figure 9 Expected Changes in Pipeline for Midsize Pharma Over Next Two to Three Years 80% 76.1% 71.7% 70% 60% Percent of Respondents 50.0% 50% 43.2% 40% 30% 21.7% 20% 17.4% 10% 4.5% 6.5% 4.3% 2.3% 2.2% 0.0% 0% Discovery Preclinical Clinical Increase and/or Increase Significantly No change Decrease and/or Decrease Significantly Dont know Note: 46 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 10 Expected Changes in Pipeline for Small Pharma Over Next Two to Three Years 90% 79.6% 78.0% 80% Percent of Respondents 70% 60% 56.3% 50% 40% 31.3% 30% 20% 14.0% 10.4% 8.2% 8.2% 10% 4.0% 4.0% 2.1% 4.1% 0% Discovery Preclinical Clinical Increase and/or Increase Significantly No change Decrease and/or Decrease Significantly Dont know Note: 50 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.John Kreger 312.364.8597 - 12 -
  13. 13. William Blair & Company, L.L.C. Comments and conclusions Based on their responses, the majority of respondents in each of the customer segments expect drug pipelines to increase to some extent over the next two to three years in each of the developmental phases, with a particular focus on later-stage/clinical investment. The same general trend is expected in each of the customer segments; however, we noted that roughly 31% of large pharma respondents expect decreases in their discovery pipelines over the next two to three years. Given the impending wave of branded products that are expected to lose patent protection over the next few years, we are not at all surprised that the pipeline appears to be focused on later-stage clinical products, particularly at large pharma companies. Accordingly, the pipeline expectations for discovery compounds at large pharma seems to be a bit lower than other segments. Because drug discovery is critical to the long-term success of the industry, we would expect the pipeline for these products to reaccelerate at some point over the next few years. Pharmaprojects also seems to support this theory, as (see figure 27, on page 28) the number of compounds in the pipeline seems to have improved, particularly in Phases II and III, over the past two years (up 17.1% and 14.4%, respectively). While preclinical and Phase I compounds have also grown (both up 13.6% since January 2009), they have done so at a slower rate. Question 3: How have your outsourcing strategies changed over the past one to two years in terms of percentage and dollar outsourced? Why? Figure 11 Changes in Percentage of R&D Budget Outsourced Over Past Two Years - Large Pharma 70% 61.7% Percent of Responses 60% 50% 40% 30% 14.9% 17.0% 20% 10% 2.1% 4.3% 0% Increase Increase No Change Decrease Decrease Significantly Somewhat Somewhat Significantly Note: 47 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 12 Changes in Percentage of R&D Budget Outsourced Over Past Two Years - Midsize Pharma 40% Percent of Responses 35% 31.3% 31.3% 30% 25% 20.8% 20% 15% 10.4% 10% 6.3% 5% 0% Increase Increase No Change Decrease Decrease Significantly Somewhat Somewhat Significantly Note: 48 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 13 -
  14. 14. William Blair & Company, L.L.C. Figure 13 Changes in Percentage of R&D Budget Outsourced Over Past Two Years - Small Pharma 40% 36.7% 34.7% Percent of Responses 35% 30% 25% 20% 16.3% 15% 10% 6.1% 6.1% 5% 0% Increase Increase No Change Decrease Decrease Significantly Somewhat Somewhat Significantly Note: 49 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Comments and conclusions We were not surprised to find that roughly 60% of survey respondents indicated that over the past one to two years, the percentage of their R&D budget outsourced has increased at some level. Of the 60% that reported an increase, nearly 33% indicated that the percent- age of the R&D budget outsourced has increased 1%-20%, and approximately 27% noted that the percentage outsourced increased 21% or more. The growth was primarily driven by large pharma respondents, where 77% of respondents saw an increase, compared with roughly 50% of midsize and small pharma. Conversely, 12% of the respondents cited decreases in the percentage outsourced. Of these responses, only 6% of large pharma survey respondents indicated decreases in the percentage of developmental spending outsourced. As compared with our model, our current CRO projections assume roughly a 10-percentage- point increase in penetration from 2010 through 2015.John Kreger 312.364.8597 - 14 -
  15. 15. William Blair & Company, L.L.C. Question 4: What percentage of your total annual budget is currently outsourced (by phase of development), and how do you think it will change over the next 18 to 24 months? Figure 14 Percentage of Total Annual Budget Outsourced by Phase 50% 45.3% 45.0% 45.8% 45.1% 44.6% 46.1% 43.2% 44.3% Average Percent Outsourced 40% 38.1% 37.6% 30% 20% 10% 0% Preclinical Phase I Phase II Phase III Phase IV Today Next 18-24 Months Note: 128 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 15 Percentage of Total Annual Budget Outsourced by Phase - Large Pharma 50% 44.5% 43% 39% Average Percent Outsourced 40% 37.6% 32.2% 33% 30% 30.5% 31% 30% 27.7% 20% 10% 0% Preclinical Phase I Phase II Phase III Phase IV Today Next 18-24 Months Note: 41 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 15 -
  16. 16. William Blair & Company, L.L.C. Figure 16 Percentage of Total Annual Budget Outsourced by Phase - Midsize Pharma 60% 52.8% 50.0% 47.6% 49.2% 49.7% Average Percent Outsourced 50% 46.3% 46.3% 43.5% 40% 31.4% 30.8% 30% 20% 10% 0% Preclinical Phase I Phase II Phase III Phase IV Today Next 18-24 Months Note: 41 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Figure 17 Percentage of Total Annual Budget Outsourced by Phase - Small Pharma 70% 61.6% 60% 56.9% 55.6% 56.2% Average Percent Outsourced 52.5% 49.3% 51.4% 51.3% 50% 40.0% 40% 34.7% 30% 20% 10% 0% Preclinical Phase I Phase II Phase III Phase IV Today Next 18-24 Months Note: 46 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Comments and conclusions Based on the survey results, overall outsourcing penetration rates are expected to remain relatively consistent or to slightly increase over the next 12 months in Phases I and III, while slight decreases are expected in preclinical, as well as Phases II and IV. The segment analyses above indicate that large and midsize pharma are expecting modest increases in most categories. We were surprised that small pharma sponsors are expecting to decrease the percentage of R&D outsourced over the next 12 months in each of the phases of de- velopment by an average of 3 points—perhaps illustrating the historical desire of smaller sponsors to add internal infrastructure as they increase in size.John Kreger 312.364.8597 - 16 -
  17. 17. William Blair & Company, L.L.C. Question 5: Which CROs are best positioned to capture your outsourced developmental spend over the next two to three years (i.e., vendors to whom you are likely to award more business based on your own internal metrics of perceived value such as quality, price, on-time delivery, etc.)? Please list your top three CROs in ranked order (No. 1 = best). Please explain why you ranked this company as your top CRO. In addition, please rank your top CROs on the following performance criteria (expertise, price, turnaround time, breadth of services, quality, relationship, and global reach). (Note: 5 = best/most favorable.) Table 2 Preferred CRO Ranking List order based on total mentions Number of respondents assigning rank: Rank in First Second Third Total Previous Place Place Place Mentions Survey Covance 35 24 15 74 4 Charles River 18 22 13 53 NA Quintiles 11 9 12 32 1 MPI Research 5 6 10 21 NA PPDI 8 9 4 21 3 Parexel 4 7 4 15 5 ICON 2 2 7 11 2 WuXi 4 3 2 9 NA Huntington Life Sciences 2 2 5 9 NA INC Research 1 1 3 5 13 WIL 1 1 3 5 NA Kendle 1 1 2 4 9 PRA 1 1 2 4 8 I3 Research 0 2 2 4 14 Aptuit 1 1 1 3 NA Bioreliance 2 0 1 3 NA Biotrial France 1 0 2 3 NA Calvert 1 1 1 3 NA Harlan 2 0 1 3 NA Medspace 1 1 1 3 11 Tandem Labs 2 1 0 3 NA Pharmaron 0 0 3 3 NA Note: 130 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Table 3 Preferred CRO - Respondents Focused on Preclinical Work Only List Order Based on Total Mentions Total Mentions Covance 22 Charles River 22 MPI Research 9 Huntingdon 6 Wuxi 5 PPDI 4 WIL Research 3 Calvert 3 Harlan 2 Bioreliance 2 Pharmaron 2 Note: 48 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 17 -
  18. 18. William Blair & Company, L.L.C. Table 4 Preferred CRO - Respondents Focused on Clinical Work Only List Order Based on Total Mentions Total Mentions Quintiles 13 Covance 11 PPD 6 ICON 6 Parexel 5 Medpace 3 i3 3 INC 3 PRA 3 Kendle 2 Biotrial 2 Note: 31 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Table 5 Preferred CRO - Respondents Focused on Both Preclinical and Clinical Work List Order Based on Total Mentions Total Mentions Covance 41 Charles River 30 Quintiles 18 PPDI 11 MPI 11 Parexel 10 ICON 5 Wuxi 4 Huntington 3 Aptuit 3 Tandem Labs 3 Note: 77 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.John Kreger 312.364.8597 - 18 -
  19. 19. William Blair & Company, L.L.C. Figure 18 Top CRO Performance for Select Criteria – All Respondents 5 4.5 4 3.5 3 2.5 2 1.5 1 0.5 0 Charles River Covance ICON MPI Research Parexel PPDI Quintiles WuXi Expertise Price Turnaround time Breadth of Services Quality Relationship Global Reach Note: 85 total respondents (Charles River - 8; Covance - 33; ICON - 2; MPI Research - 5; Parexel - 4; PPDI - 8; Quintiles - 11; WuXi - 4) Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Comments and conclusions As illustrated in tables 2-5, Covance was mentioned most frequently as a preferred CRO, followed by Charles River Laboratories and Quintiles. In the past six surveys we have conducted, Quintiles has consistently been one of the top three most frequently mentioned CROs. According to the results of the survey, 115 different CROs were mentioned in total; however, only 22 of these received more than two total mentions. This illustrates the signifi- cant fragmentation of this sector and that the opportunity remains to win plenty of market share if a company can differentiate itself. When asked to provide the rationale for CRO rank selection, Covance, Charles River Laboratories, and Quintiles were singled out primarily for high-quality service and strong experience/expertise. Further, as illustrated in figure 18, respondents were asked to score (on a scale of 1-5) their No. 1-ranked CRO in select criteria, including expertise, price, turnaround time, breadth of service, quality, relationship, and global reach. Outside of price, most respondents scored their No. 1 CRO quite favorable in each of the aforementioned categories. We were more surprised by the following: • A large number of early-development-focused companies ranked in the top 10 in terms of total mentions. Five of the top 10 responses are for companies that focus on pre- clinical toxicology or discovery services, many ranking ahead of the clinically focused global CROs like Parexel and ICON. We believe this is possibly due to the fact that there are more small companies participating in this survey than previous surveys we have conducted. Nonetheless, this also suggests that sponsors are focused on quality at the early stages of development to weed out weak candidates early in the development process. When we break respondents into early- versus late-stage focus, the top CRO list changes to the following: Covance and Charles River are still the top two players in early stage, followed by MPI, Huntingdon Life Sciences, and WuXi. On the late-stageLiping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 19 -
  20. 20. William Blair & Company, L.L.C. side, Quintiles, Covance, PPD, ICON, and Parexel were the top five responses. Tables 2-5 list the top CROs when we break the respondents down into preclinical, clinical, or both. • Covance was far and away the most popular response, which we believe is due to its strong presence across all sectors of the development spectrum. This is echoed in Covance’s success in signing strategic deals with large companies like Eli Lilly and Sanofi-Aventis, and suggests that additional strategic deals are likely. • ICON fell from a strong second in our previous survey to seventh in our current survey when considering all responses, and fourth when considering only the clinical cohort. We are somewhat surprised by this given the strong performance in previous surveys and reputation for quality. The modest drop could be attributable in part to the warning letter the company received in 2009 (along with Johnson & Johnson), or perhaps to growing pains following rapid expansion in 2006 through 2008. Longer term, we continue to view ICON as a top-quality player in the space and fully expect it to remain a major competitor for strategic business, based on its global footprint and therapeutic breadth. However, in the short term, we expect the company’s earnings growth may lag its peers as it ramps investment spending on new capabilities, geographies, and technology. • China appears to be a more significant part of the outsourcing process, with WuXi cracking the top 10 (9 total responses) and Pharmaron (3 total responses) making the list of favorite CROs for the first time. Question 6: How do you envision strategic partnerships will change the nature of your company’s outsourcing to CROs? (Answer options included: closer relation- ships with fewer CROs, pricing concessions [up to 20%], pricing concessions [20% or more], longer contracts [one to two years], longer contracts [three to five years], more risk-sharing deals, more asset transfers, and no change.) Figure 19 Impact of Strategic Partnerships on Outsourcing to CROs More asset transfers 6.8% Longer contracts (1-2 years) 12.8% More risk sharing deals 21.1% Pricing concessions (20% or more) 22.6% Longer contracts (3-5 years) 24.8% Pricing concessions (up to 20%) 26.3% No change 26.3% Closer relationships with fewer CROs 52.6% 0 0.1 0.2 0.3 0.4 0.5 0.6 Note: 133 total respondents Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C.John Kreger 312.364.8597 - 20 -
  21. 21. William Blair & Company, L.L.C. Figure 20 Impact of Strategic Partnerships on Outsourcing to CROs by Size 60.0% 60% 50.0% 50% 47.6% 40% 35.7% 33.3% 31.1% 30% 28.9% 26.1% 23.9% 23.8% 22.2% 21.7% 21.4% 20.0% 21.7% 20% 19.6% 16.7% 15.6% 16.7% 14.3% 8.7% 10% 6.7% 8.7% 4.8% 0% Large Pharma Midsize Pharma Small Pharma Closer relationships with fewer CROs No change Pricing concessions (up to 20%) Longer contracts (3-5 years) Pricing concessions (20% or more) More risk sharing deals Longer contracts (1-2 years) More asset transfers Note: 133 total respondents (Large - 45; Midsize - 46; Small - 42) Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Comments and conclusions According to the results of the survey, more than half of all respondents indicated that strategic partnerships will likely promote closer relationships with fewer CROs (see figure 19). Pricing concessions, longer contract terms, and more risk-sharing deals were also mentioned as factors affecting the decision to outsource to CROs. As figure 20 illustrates, response trends were generally consistent across each of the different segments (large, midsize, and small pharma).Liping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 21 -
  22. 22. William Blair & Company, L.L.C. Question 7: How do you envision strategic partnerships will change the rate of your company’s outsourcing to CROs? (Answer options included: accelerate significantly, accelerate somewhat, no change, slowdown somewhat, slowdown significantly.) Figure 21 Impact of Strategic Partnerships on Rate of Outsourcing to CROs 70% 60% 57.8% 50.0% 50% 47.8% 45.9% Percent of Responses 41.3% 42.1% 40% 38.1% 28.9% 30% 20% 11.1% 8.7% 9.0% 10% 7.1% 4.8% 2.2% 2.2% 3.0% 0% Large Pharma Midsize Pharma Small Pharma All Accelerate significantly Accelerate somewhat No Change Slowdown somewhat Slowdown significantly Note: 133 total respondents (Large - 45; Midsize - 46; Small - 42) Sources: Life Science Strategy Group, LLC and William Blair & Company, L.L.C. Comments and conclusions We are encouraged that roughly 55% of all respondents expect strategic partnerships will accelerate the rate of outsourcing to some extent, and of that 9% expect the rate to acceler- ate significantly. Further, only 3% of respondents expect strategic partnerships to slow down the rate of outsourcing. When we look at the survey results from a segment view, 69% of large pharma respondents expect strategic partnerships to increase the rate of outsourcing to CROs at some level.John Kreger 312.364.8597 - 22 -
  23. 23. William Blair & Company, L.L.C.State of the Global Pharmaceutical Outsourcing Industry Shifting gears away from the survey, CRO stocks have appreciated roughly 50% in the last six years, despite a 50% drop in 2008 (see figure 22). CROs have performed well since 2004, as pharmaceutical and biotechnology companies have increasingly used outsourcing providers to run their preclinical programs and clinical trials more efficiently. Since 2005, the top CROs’ revenues have grown 91% (at a 12% compound annual rate). Figure 22 CRO Historical Stock Performance December 2004 – January 11, 2011 350 300 BTK up 137% 250 200 CROs up 51% 150 S&P up 5% 100 50 DRG down 3% 0 12/31/2004 12/31/2005 12/31/2006 12/31/2007 12/31/2008 12/31/2009 12/31/2010 CRO Index S&P 500 BTK DRG CRO index consists of Charles River, Covance, ICON, Kendle, Parexel, PPD, and PRA Source: Thomson Financial Figure 23 CRO Group Net New Business 2500 2000 1500 1000 500 0 Q104 Q204 Q304 Q404 Q105 Q205 Q305 Q405 Q106 Q206 Q306 Q406 Q107 Q207 Q307 Q407 Q108 Q208 Q308 Q408 Q109 Q209 Q309 Q409 Q110 Q210 Q310 CRO companies included: Covance, ICON, Inveresk (when available), Kendle, Parexel, PPD Sources: Company reportsLiping Cai +86 312.364.xxxxAnalyst Name 21 2327 2260 - 23 -

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