CROs Hope for Second Half Research Burst

CROs and CMOs have reported on their second quarter financial performance during July and August. Although revenues and profits were up for most companies reporting, the discussions of market conditions surrounding the financial results had a somewhat unsettled feel. Most contractors expect robust revenues in the second half of 2003 but are clearly nervous about whether the activity will actually materialize.

The major concerns are in the phase 2 to 4 trials business, where the big projects are concentrated. The year got off to a slow start for both new sales and study initiations in phase 2 to 4 trials; although new business signings were up in the April through June quarter, pharmaceutical companies seem to be having trouble getting trials underway.

Companies Build Backlog of Projects

Indicative of this situation is the demand for central laboratory services because sample processing through central labs usually lags behind study initiation by several weeks or months. Covance, the market share leader in central lab services, reported a substantial backlog of signed contracts but disappointing billable sample throughput. PPD, reported the same situation for its MRL International's central laboratory operation.

Table 1. Quarterly results as of 30 June 2003.

PPD raised analyst concerns when its CEO, Fred Eshelman, suggested that several major competitors were aggressively cutting prices to win phase 2 to 4 business. Eshelman implied that two CROs were heavily discounting their services to build their backlog of future projects and increase their attractiveness to investors. Eshelman didn't name names, but industry insiders think he was referring to ICON, which had announced plans for a public offering of shares, and Quintiles Transnational, which was in the midst of a billion-dollar management buyout.

PPD's stock price dropped 17% after the announcement conference call. CROs that reported after PPD, including Icon and Covance, did not concur with PPD's assessment, and their stocks were not heavily affected. This suggests that investors interpreted Eshelman's concerns as more indicative of problems at PPD than in the industry overall.

Pfizer Acquisition Affects Market

It was also clear that the Pfizer acquisition of Pharmacia, completed in April, has weighed heavily on the market. Following the merger, Pfizer's efforts to fully use internal capacity and the cancellation and delay of development programs resulted in clinical and chemistry, manufacturing, and controls (CMC) projects being pulled back in-house and fewer new contracts. This has reduced overall market demand for CRO services; Pfizer now accounts for more than 10% of industry R&D spending. And because Pfizer and Pharmacia were its largest clients, Kendle International was especially hard hit. Kendle's sales dropped 12% for the quarter, and operating income was down 80%.

BioReliance Gets Noticed

The market got another jolt when Pfizer announced that it was backing a new clinical CRO formed by a group of former Pfizer/Pharmacia researchers. The new CRO - Jasper Clinical Research & Development - will offer phases 1 and 2a research services at a facility in Kalamazoo, MI, formerly owned by Pfizer. Pfizer will provide $20 million in support, donate the building and equipment, and guarantee a level of business for three years. The deal suggests that having good personal connections can trump a successful track record when competing for research contracts.

Whereas later-stage research lagged, early-stage activity maintained a relatively strong pace. CROs reported high activity at their phase 1 facilities and reasonable activity in preclinical, although not at the growth rates seen in 2001 to 2002. Covance was awarded a "sole source" contract by a top 10 pharmaceutical company, under which it will be the sole provider of outsourced toxicology services to the company for the next year. My conversations with CMC service providers, many of which do not report their results publicly, indicate their businesses have remained fairly strong.

Rest of 2003 Looks Good

Signs for a successful second half for contractors look positive. Order backlogs are strong, big pharma R&D spending is up 10% so far in 2003, and the funding environment for small pharma and biopharmaceutical companies is improving. Manufacturers of clinical trial materials and clinical packagers reported a big jump in requests for proposals (RFPs) and order activity in June and July, suggesting that pharmaceutical companies are eager to get programs underway.

CROs are also expecting a big boost from government spending, thanks to national security and privatization initiatives by the Bush administration. Covance CEO Chris Kuebler said "strong efforts" by government agencies to outsource to CROs are "at levels never before seen," and a July story in the Washington Post indicated that research positions at the National Institutes of Health are included in the Bush administration's program to outsource more government activities to private firms. BPI