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Healthcare │Pharmaceutical
CRO 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 Fatta
312.364.8597 +86 21 2327 2260 312.364.8797
jkreger@williamblair.com lcai@williamblair.com rfatta@williamblair.com William Blair & Company, L.L.C.
222 West Adams Street
Chicago, Illinois 60606
Please consult pages 33-34 of this report for all disclosures. 312.236.1600
William Blair & Company, L.L.C. receives or seeks to receive compensation for investment banking services from companies www.williamblair.com
covered in this research report. Investors should consider this report as a single factor in making an investment decision.

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 ................................................................................32

John Kreger 312.364.8597 -2-


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.xxxx
Analyst Name 21 2327 2260 -3-


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-


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.

Analyst Name 21 2327 2260 -5-


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-


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

Analyst Name 21 2327 2260 -7-


Figure 2
Survey Respondent Demographics - Functional Area

20%

49%

31%

Clinical R&D ONLY Preclinical R&D ONLY Both

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


John Kreger 312.364.8597 -8-


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

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
Note: 156 total respondents (Large - 53; Midsize - 52; Small - 51)

Analyst Name 21 2327 2260 -9-


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


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 -


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
Don't know

Figure 8
Expected Changes in Pipeline for Large Pharma Over Next Two to Three Years

80%
69.8%
70%

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%

Increase and/or Increase Significantly No change

Decrease and/or Decrease Significantly Don't know


Analyst Name 21 2327 2260 - 11 -


Figure 9
Expected Changes in Pipeline for Midsize Pharma Over Next Two to Three Years

80% 76.1%
71.7%
70%

60%

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%

Increase and/or Increase Significantly No change

Decrease and/or Decrease Significantly Don't know


Figure 10
Expected Changes in Pipeline for Small Pharma Over Next Two to Three Years

90%
79.6% 78.0%
80%

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%

Increase and/or Increase Significantly
No change
Decrease and/or Decrease Significantly
Don't know

John Kreger 312.364.8597 - 12 -


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

Figure 12
Over Past Two Years - Midsize Pharma

40%

35% 31.3% 31.3%
30%
25% 20.8%
20%
15% 10.4%
10% 6.3%
5%
0%

Analyst Name 21 2327 2260 - 13 -


Figure 13
Over Past Two Years - Small Pharma

40% 36.7%
34.7%

35%
30%
25%
20% 16.3%
15%
10% 6.1% 6.1%
5%
0%


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 -


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


Figure 15
Percentage of Total Annual Budget Outsourced by Phase - Large Pharma

50%
44.5% 43%
39%

40% 37.6%

32.2% 33%
30% 30.5% 31%
30% 27.7%

20%

10%

0%


Analyst Name 21 2327 2260 - 15 -


Figure 16
Percentage of Total Annual Budget Outsourced by Phase - Midsize Pharma

60%
52.8%
50.0%
47.6% 49.2% 49.7%

50% 46.3% 46.3%
43.5%

40%
31.4%
30.8%
30%

20%

10%

0%


Figure 17
Percentage of Total Annual Budget Outsourced by Phase - Small Pharma
70%
61.6%
60% 56.9% 55.6% 56.2%

52.5%
49.3% 51.4% 51.3%
50%
40.0%
40% 34.7%

30%

20%

10%

0%



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 -


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

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

Analyst Name 21 2327 2260 - 17 -


Table 4
Preferred CRO - Respondents Focused on Clinical Work Only
Total Mentions
Quintiles 13
Covance 11
PPD 6
ICON 6
Parexel 5
Medpace 3
i3 3
INC 3
PRA 3
Kendle 2
Biotrial 2

Table 5
Preferred CRO - Respondents Focused on
Both Preclinical and Clinical Work
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

John Kreger 312.364.8597 - 18 -


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)

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-stage

Analyst Name 21 2327 2260 - 19 -


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


John Kreger 312.364.8597 - 20 -


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%

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


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).

Analyst Name 21 2327 2260 - 21 -


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%

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


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 -


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
Q1'04
Q2'04
Q3'04
Q4'04
Q1'05
Q2'05
Q3'05
Q4'05
Q1'06
Q2'06
Q3'06
Q4'06
Q1'07
Q2'07
Q3'07
Q4'07
Q1'08
Q2'08
Q3'08
Q4'08
Q1'09
Q2'09
Q3'09
Q4'09
Q1'10
Q2'10
Q3'10

CRO companies included: Covance, ICON, Inveresk (when available), Kendle, Parexel, PPD
Sources: Company reports

Analyst Name 21 2327 2260 - 23 -

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