Outsourcing Outlook

The annual meeting of the American Association of Pharmaceutical Scientists (AAPS) is one of the best windows on the state of the contract services industry. This year's meeting in Salt Lake City, UT was no exception.

The mood of most vendors was strongly positive. CRO and CMO staffers at AAPS confirmed that product development activity and spending are picking up. Most said that they are seeing the upturn in RFP activity that the public CROs are reporting in their quarterly earnings conference calls. One CMO that finishes active pharmaceutical ingredients (APIs) reported that it had worked on almost 90 new chemical entities this year, most in preclinical development.

Most small, privately-held providers of laboratory and clinical trials materials (CTM) services reported good results for 2003; according to the representatives with whom I spoke, revenues were up 15% or more at most companies. This is encouraging news, as some of the large public CROs have reported disappointing results in their lab services business this year. The smaller labs have a fairly diversified client base, so they have been less exposed to big pharma mergers and the financing problems of biopharmaceutical companies (contract labs that focus on biopharmaceutical companies reported having an off-year). In addition, smaller labs are usually willing to do more in order to meet a client's needs than larger CROs, and that flexibility has helped them retain business in this slow market.

Table 1. September 30, 2003 Quarterly Results; Source: PharmSource

One focus for service providers is the expansion of CTM formulation manufacturing capacity, especially for sterile products. Both DSM Pharmaceuticals and Quintiles Transnational (at its facility in Kansas City, MO) will bring on new clinical-scale sterile manufacturing operations in 2004. Just before the meeting, Baxter announced a strategic alliance between its Baxter Pharmaceutical Solutions unit and Althea Technologies; Althea will provide phase 1 and 2 CTM services to clients, and Baxter will handle phase 3 and commercial manufacturing. Patheon is expanding its offerings of development services at its Cincinnati, OH facility, which it acquired from Aventis last year.

Drug delivery technology was the hot topic at AAPS once again, with many of the presentations and poster sessions dedicated to related scientific and technical issues. Some 75 exhibitors were highlighting their proprietary drug delivery technologies and expertise. While dosing convenience and product differentiation are important, formulation challenges may be the biggest incentive of all - by some estimates, as many as 50% of all new drug candidates involve poorly soluble APIs.

Strong Quarterly Results

Publicly traded contract services providers reported good results for the July through September quarter, but the big news was the strength of their new business activity. After a slow first half, proposal and contract activity has really picked up, and contractors expect 2004 to be an especially strong year.

Overall, revenues for the third quarter were up an average of 15% over the same quarter in 2002, with profits growing at a slightly higher rate. The strongest results were in phase 1 clinical research, where most CROs reported very high utilization rates, and preclinical toxicology, especially in Europe. Phase 2 and 3 research was slowed by weak business development activity in the first half of the year and by patient recruitment problems in the startup of new studies.

CRO executives were especially optimistic about 2004. All experienced a substantial increase in RFPs in the third quarter, and several experienced record quarters for new business signings. There was a general sense that big pharma is finally getting its pipeline moving, while biopharmaceutical companies are somewhat more willing to spend now that the financial markets are more conducive to fundraising. The strong performance in preclinical and phase 1 have increased optimism about future phase 2 and 3 activity, which account for 60% of total R&D spending. Executives at Charles River Laboratories see R&D funding continuing to favor development over research (target and lead identification and optimization), which has hurt their discovery services business.

Cardinal Health Makes More Waves

Cardinal Health once again got the industry's attention with an acquisition, this time of UK-based Intercare. Intercare is a manufacturer and wholesaler of generic pharmaceuticals in the UK, as well as a leading contract sterile products manufacturer. Its sterile manufacturing operations include Martindale, located in the UK, and Federa, with sites in Brussels, Belgium and Limoges, France. It also owns L.C.O. Sante, a contract manufacturer of hormonal products. According to George Fotiades, president of Cardinal Health's Pharmaceutical Technologies and Services business unit, Intercare's sterile manufacturing operations are a "strategic platform" for expansion of Cardinal Health's business in Europe.

The acquisition heats up the rivalry in sterile manufacturing on several fronts. Cardinal Health will now compete more directly with Patheon for FDA-compliant sterile manufacturing in Europe. Federa is building a new manufacturing facility in Brussels that is intended to be FDA-compliant, while Patheon has two FDA-compliant sites in Italy. In addition, it will intensify competition between Cardinal Health and Baxter Pharmaceutical Solutions by increasing Cardinal Health's capabilities in pre-filled syringes. Cardinal Health is already installing a 60-million-unit syringe manufacturing operation in Puerto Rico, and Federa's new facility will have complementary capabilities.

Cardinal Health is paying $530 million in cash and assumption of debt for publicly-traded Intercare, whose annual sales are about $550 million. The sale is pending approval by Intercare stockholders. Fotiades says that Cardinal Health has a strategic interest in Intercare's generic products business, which is focused on niche products used in hospitals, but has yet to decide what it will do with the distribution business, which accounts for just 25% of Intercare's operating profits.