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Going Global to Ease Drug Trial Process

Lauren Adams, CFA

Lauren Migliore: Contract research organization, Parexel is a leading provider of outsourced research and development services to pharmaceutical and biotechnology companies. We're pleased to welcome the firm's CFO, Jim Winschel to speak with us today about the competitive dynamics in the drug development industry. Thanks for joining us, Jim.

Jim Winschel: Sure, Lauren. Good to be here.

Migliore: Well, let's start off with an overview of the industry. Can you talk about some of the advantages that CROs offer over traditional in-house development?

Winschel: Sure. Well, over the last several years, what we've seen is that productivity of the pharmaceutical companies themselves have decreased. Spending has substantially increased over that period of time, and the number of approved drugs coming out at the other end has diminished.

What we find is that the CROs have become over the last 10 or 15 years very process-oriented in their effective organizations and experts really in running clinical trials. We give these pharma companies a great efficiency of being able to run the trials on that basis.

Now, when you think about it, if you're running a trial and the drug fails for some reasons, maybe for reasons of efficacy or for drug safety, the pharma company would then have to cancel that trial.

Well, if they are trying to manage their own personnel and their cost, they have to be very nimble to try to replace the work that that particular group was doing with additional work. Whereas in the CROs, since we are doing work for all of the top pharmaceutical companies, all of the top biotechnology companies and hundreds of other companies around the world, we have a lot more flexibility to move the resources around and address the various needs.

Parexel has been following a strategy to be a global company over the last 20 years, and this is really paying off for us right now, because the real important reason for being a global company is access to patients.

If you are trying to run an oncology study, here in the U.S. for example, it's going to take you longer to enroll patients it's going to be much more expensive. But if you are willing to run that trial in Eastern Europe or Asia Pacific or South America or South Africa, you have huge advantage there in terms of being able to rapidly enroll patients in your study. Now, in the Far East there are huge markets for the drugs, when they do get approved and the fact that you've run the trials there, can real be beneficial to you.

Migliore: Kind of going off that thought, the clinical outsourcing industry is still very fragmented with hundreds of providers offering a range of different drug development services. So, what advantages as you were saying do global CROs like Parexel have over their smaller competitors?

Winschel: So, the smaller competitors have a real struggle when they try to bid on a global trial because the way they do it is to partner up with maybe somebody in Europe, somebody else in Asia, maybe somebody else in South America and the pharma companies really dislike this approach.

So, the fact that they can come to us as sort of one-stop-shop, we have responsibility for running the trial for all of the resources. If there is a problem they know exactly who to come to. In the other model, as things start to go wrong, fingers get pointed in a variety of different directions. So, I think it's very beneficial from that standpoint.

I think a large number of the sort of mid-sized CROs right now are really struggling, almost desperate in some ways to try to stay afloat. I wouldn't be surprised if we saw a number of the mid-sized companies merge together to try to be a bigger force as we go forward.

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Migliore: So, it's kind of a scale and reputation story in global CROs?

Winschel: Right.

Migliore: We're also seeing an increasing trend towards long-term strategic arrangements with some of the world's largest drug makers. How will this benefit the top CROs and how do you see it impacting the shape of the industry.

Winschel: Well, it's interesting. All of the strategic relationships are different and somehow they come in all shape, sizes, flavors and those kinds of things. In some cases, we've won strategic partnerships where we are providing clinical research associates in Asia Pacific, for example, for one of the big pharma company.

In other cases, we've been identified as one of two partners to provide all of their outsourced clinical work and so, maybe the pharma company is going to give $200 million to one company and $200 million to the other company. One of the big advantages we have in that particular model is that, we are not required to bid on each of those deals.

In the preferred provider relationship model where pharma company maybe reduce the number of CROs from 10 or 20 or 30 down to five, every one of the five preferred providers had to go out and bid on the work and you've had whatever chance you had to win in that model. Under the strategic relationship model, we don't have to go out and bid on every deal.

The pricing is set up in the master services agreement that's agreed to at the beginning of the arrangement and those pharma company divvies up the work as based maybe on our particular expertise and those kind of thing. So, it's a big advantage to us in that way.

Migliore: As we're talking only a handful of firms occupy the top-tier of CRO industry, and we do see a certain degree of specialization that takes place. For instance, Charles River has a strong presence in research models and Covance is a leading provider of central lab services. How does Parexel differentiate itself from its peers?

Winschel: Well, the strategy that we've been following for number of years now is to, number one, be a global company. So, well over the public CROs we have the largest and most well-established global presence in the world today. And that has – as I said earlier, in terms of enrolling patients and studies, this has been a great thing for us.

Beyond that, we have also focused on expertise, so we have therapeutic – strong therapeutic experts overall, a large number of indications. We have very strong clinical expertise, and we have very strong regulatory expertise. The former Chief Enforcement Officer of the FDA, for example, works for Parexel and this is true not only in the U.S., but really literally around the world. So, that has been a big advantage to us.

The one other, I think, differentiator that we have is that we have a technology business that we started back in 2000 and none of the other CROs have pursued that particular strategy. So this has been a great differentiator for us, given that technology has been used more and more in clinical development these days. For long time the pharmaceutical industry, sort of, resisted these kinds of changes, but that's not true today and we're really seeing – that business has been really going very strong for about 18 months now.

Migliore: Well, despite some of the advantages of the CRO model that we've discussed today, we have seen a steep follow-off in drug development spending over the last two years as drug makers really scrutinize expenses and delay clinical trials. How is the current market affecting Parexel? What challenges are you seeing and when does the company expect demand to stabilize?

Winschel: Well, it's really interesting. Over the last 12 months, Parexel's business has been growing rather dramatically. One of the ratios that we use in the industry is the book-to-bill ratio, which takes the gross number of awards that you've received during the particular quarter, subtracts out the cancellations that occurred in that quarter, and then you take that net result and divide it by the revenue that you generated in the quarter.

The industry generally I think something in the 1.2 to 1.3 range. 1.2 to 1.3 range is doing well. Well, for the last 12 months our average has been about 1.7 book-to-bill ratio, and our backlog in fact has grown 36% on a year-over-year basis, as of September up to $2.9 billion. So what we see is a number of things happening. There is only a small single-digit increase in R&D spending that is occurring right now, but the amount of outsourcing that the pharmaceutical companies are doing, and I'm especially talking about the big pharmaceutical companies, is increasing rather dramatically.

The big CROs themselves because of their broader presence and stronger performance have been able to gain substantial market share over this period. Then in Parexel case, we have very strong presence in the Asia Pacific region, which is growing by leaps and bounds right now.

For example, in our most recent quarter, our service revenue in the Asia Pacific region was up 30% on a year-over-year basis, so all of that makes a difference furthermore in the Asia Pacific region. For example, in Japan, there is about a $10 billion development market opportunity there. Right now, the Japanese pharmaceutical companies have only outsourced about 15% of that work. We understand from our discussions with those companies that they plan to increase the amount of outsourcing that they are doing with the 30% or 40%. So, a very big opportunity to increase work and we are well positioned there to do that.

The other thing that the Japanese regulators have been somewhat frustrated about recently is that they see a drug get introduced for use by patients in the United States, that same drug doesn't get introduced for use in Japan, until about four years later. Part of the problem has been historically that the Japanese only wanted to use Japanese patients and studies to do work and to get drugs approved in Japan. They now said we are willing to include Chinese patients and Korean patients in these studies as well when we are seeking approval in Japan. Perfect, I mean, it couldn't be any more perfect situation for us given our – we have a strong presence in China, strong presence in Korea. And so, we are doing all of that.

Migliore: Well, great. Thank you so much for your thoughts and for being here today.

Winschel: Okay. Thank you.

Migliore: I'm Lauren Migliore for Morningstar. Thanks for joining us.