（2183） | Publish:Mon, Jan 06, 2014 IR「BRIDGE REPORT」

BRIDGE REPORT
（2183）

スタンダード

Linical Co., Ltd. (2183)

Kazuhiro Hatano
CEO

Company	Linical Co., Ltd.
Code No.	2183
Exchange	First Section, TSE
Industry	Service
CEO	Kazuhiro Hatano
HQ Address	Shin-Osaka Brick Building, 6-1 Miyahara 1-chome, Yodogawa-ku, Osaka
Year-end	March
URL	http://www.linical.co.jp/english/

Share Price	Shares Outstanding		Market Cap.	ROE (actual)	Trading Unit
¥1,199	11,394,906 shares		¥13.662 billion	46.3%	100 shares
DPS (Est.)	Dividend Yield (Est.)	EPS (Est.)	PER (Est.)	BPS (actual)	PBR (actual)
¥14.00	1.2%	¥60.31	19.9x	¥139.05	8.6x

* Stock price as of closing on November 22, 2013. Number of shares issued at the end of the most recent quarter excluding treasury shares.
ROE, BPS based on previous term's results.

Fiscal Year	Sales	Operating Income	Ordinary Income	Net Income	EPS (¥)	Dividend (¥)
March 2010	2,404	480	473	273	22.16	11.00
March 2011	2,512	288	278	147	12.37	11.00
March 2012	3,110	728	723	424	37.23	11.00
March 2013	3,599	1,003	998	616	54.13	16.50
March 2014 Est.	4,031	1,151	1,144	687	60.31	14.00

* Estimates are those of the Company. An additional ¥2.5 per share was paid, including a commemorative dividend for the listing on the First Section of the TSE during FY3/13.

We present this Bridge Report about Linical Co., Ltd. and details of its first half fiscal year March 2014 earnings.

Key Points

Company Overview

Linical Co., Ltd. provides contract research organization (CRO) related services that include clinical trials of drugs that support the drug development process of pharmaceutical companies, and contract sales organization (CSO: sales and marketing functions for pharmaceutical products on a consigned basis) services. In the CRO business, Linical specializes in the most critical stages of clinical trials of phase II and III studies including major activities such as monitoring. Furthermore, Linical is able to differentiate itself from its competitors by focusing upon schizophrenia, depression, Alzheimer's disease, and other central nervous system (CNS) diseases, oncology, and other highly difficult disease realms(compared with these disease realms, it is more difficult to differentiate services in the highly difficult therapeutic areas associated with adult lifestyle habits where competition is intense.). At the same time, Linical will focus upon specific patient realms in the CSO business and leverage its knowhow established in the CRO business to provide product marketing and post-launch data planning and collection tasks to differentiate its CSO business from that of its competitors, who primarily provide the service of medical representative dispatch.

Linical's main customers include Takeda Pharmaceutical Company Limited, Daiichi Sankyo Company, Limited, Otsuka Pharmaceutical Company, Limited, Shionogi & Company, Limited, Mitsubishi Tanabe Pharma Corporation, ONO PHARMACEUTICAL CO., LTD. and other major Japanese pharmaceutical companies. Moreover, phase II clinical trials are conducted to test the safety, efficacy, usage, and dosage of pharmaceutical products. Phase III clinical trials take these results and confirm them in actual treatments to test their efficacy and safety.

Linical Co., Ltd. was established in June 2005 by nine members who worked at Fujisawa Pharmaceutical Co., Ltd. (currently known as Astellas Pharma Inc.) on the development of immunosuppressant drugs. Established with the objective of becoming the ideal drug development outsourcing (CRO) company from Osaka, Linical focused its efforts in the realms of central nervous system diseases (CNS) and oncology since its founding, and received one of its first orders from Otsuka Pharmaceutical Company shortly after its establishment. Thereafter, the Company fortified its staffing as part of its efforts to strengthen its order taking capabilities. In addition, Linical is benefitting from human resources with bountiful experience in the realm of oncology pharmaceutical product development who formerly worked at foreign pharmaceutical companies and is seeing an expansion in orders near term.

With its advance into the site management organization (SMO, clinical trial facility support organization) business, Aurora Ltd. was turned into a subsidiary in January 2006. However, Linical sold all the shares of Aurora it held in May 2007 in order to focus management resources upon the CRO business. In July 2008, LINICAL USA, INC. was established in California, United States to provide support to Japanese pharmaceutical companies seeking to enter the United States market. Also in October of the same year, Linical listed its shares on the Mothers Market of the Tokyo Stock Exchange, and moved its listing to the First Section of the Tokyo Stock Exchange in March 2013. The two companies, LINICAL TAIWAN CO., LTD. and LINICAL KOREA CO., LTD. were established as 100% owned subsidiaries in Taiwan and Korea respectively during May 2013.

Linical's business can be divided into the two main segments of the CRO and CSO businesses, with each accounting for 95.3% and 4.7% of fiscal year March 2013 sales respectively. The CRO business is focused upon "monitoring services," which include the "quality control" and "consulting" services. At the same time, the CSO business specializes in the provision of outsourced product marketing services and post-launch data planning and collection services as a means of differentiating itself from its competitors, which primarily focus upon medical representative dispatch.

(1) Strengths in CNS, Oncology Monitoring, Highly Difficult Realms with Few Competitors

One of Linical' s strengths is its specialization in monitoring services for highly difficult disease realms of central nervous system and oncology, where there are few competitors. For example, in the realm of oncology evaluating symptoms to determine whether they are the result of side effects of drugs or the cancer itself is very difficult. In the realm of central nervous system diseases evaluating the efficacy of drugs prescribed for patients afflicted with Alzheimer' s disease is also highly difficult. Therefore, high levels of responses and expertise in monitoring are necessary in these difficult realms. In addition, new drug development for patients of acute diseases and intractable diseases (difficult diseases), which are also highly difficult disease realms and, in addition to oncology and CNS realms, is very active (only a few number of CROs that can respond to these situations). Evaluation of the efficacy of drugs for adult lifestyle related diseases is easier because conditions of patients undergoing clinical trials tend to be relatively stable (for example, data gathering of blood sugar levels in diabetes patients).

New drug development trends are shifting from adult lifestyle related diseases towards the realms of oncology and CNS, where treatment satisfaction is low. However as stated above, the safety evaluation of oncology drugs and the efficacy evaluation of CNS drugs are more difficult. Therefore pharmaceutical companies, which had performed these functions internally, have begun to outsource these more difficult tasks to a greater extent in recent years. The CNS realm has been a main field for Linical since its establishment, and it started focusing on the oncology realm two years ago along with the hiring of staff from AstraZeneca. The outstanding balance of orders backlog as of October 25, 2013 stood at ¥4.831 billion, with orders in the realms of oncology and central nervous system amounting to ¥1.673 and ¥1.412 billion, or 34.6% and 29.2% of total order backlog respectively. Consequently, the combined total of oncology and central nervous system realms accounted for over 60% of total order backlog.

(2) High Profitability

In addition to high levels of various task execution capabilities in the clinical work field for efficacy and safety confirmation, high levels of knowledge and technology in the overall CRO operations are also strengths of Linical. The protocol deviation rates on projects undertaken by Linical have been extremely low, and the implementation period, including the period required for case introduction and data collection, for about 80% of all projects has been shortened. Because of its high levels of service quality and quick delivery times in highly difficult disease realms, Linical is able to book orders without having to offer reduced prices and is able to overcome its disadvantage in the economies of scale to achieve a higher profitability compare to its larger competitors.

The source of Linical' s earnings generation capability is its highly skilled and well trained clinical research associates (CRA) as reflected in the good clinical practice (GCP) passport certification examination passage rates. The GCP passport certification examination is designed to help cultivate human resources that can respond to jointly conducted global clinical trials and is conducted by the Japan Society of Clinical Trials and Research. Moreover, all of Linical' s certification holding staff have undergone the testing process and have achieved significantly higher passage rates than its competitors.

Management Strategy

The four main points of Linical' s management strategy include ① the establishment of its brand through continued growth based upon its high quality, short delivery times and fair pricing, ② continued fortification of activities in the oncology and central nervous system realms, and preparations for CRA staff of 270 people and global structure, aiming to strengthening and expansion of the CRO business, ③ fortification and expansion of the CSO business through strengthening of liaison activities, post manufacturing research and survey work, and development of global responses, and ④ cultivating the drug discovery process support business by leveraging planning and application screening responses and subsidies and assistance from funds.

(1) CRO Business

In the CRO business, Linical has focused upon monitoring operations in phase II and III stages of clinical trials and has received high regard from clients for its efforts in the highly difficult disease realms of oncology and CNS. Along with further extending its track record in the realm of difficult diseases, the Company will also increase its CRA staff numbers to expand its business (seeks to achieve 270 clinical research associates at an early stage).

Furthermore, Linical endeavors to create a multiple country clinical trial implementation structure as a response to the Japan led jointly conducted global clinical trials focused upon by the Ministry of Health, Labor and Welfare. As part of these efforts, Linical Taiwan Co., Ltd. (Taipei, Taiwan, Capitalized at 10 million Taiwanese Dollars) and Linical Korea Co., Ltd. (Seoul, Korea, Capitalized at 500 million Korean Won) were established with Linical contributing 100% of the capital for these companies in May 2013. In November, Linical announced Linical Korea Co., Ltd. acquired the stocks of P-pro. Korea CO., Ltd, Korean CRO, as its subsidiary. In the future, Linical will also establish facilities in Europe (Currently conducting research for the CRO business in Europe), and Linical USA Inc. (California, USA) was established in July 2008 as part of a global structure linking Japan, the United States, Europe and Asia.

Along with the global business expansion, Linical is also stepping up its hiring of staff on a global basis with a particular emphasis in Asia, taking on Asian CRAs with Japanese and English language capabilities, in addition to their own mother language, to be trained so that Japanese standard level services can be provided locally. Initially, global study support tasks will be provided, with the goal of educating core staff to be able to provide Asian study services over the intermediate term. Furthermore, monitoring of Asian study and of Japanese led proof of concept trials will be offered in response to customer needs, while newly established subsidiaries in Taiwan and Korea are going to take over these human resources.

(2) CSO Business

Linical differentiates itself from its competitors, which offer primarily MR dispatch services, by focusing upon the consigned service type CSO business. Specifically, the Company seeks to differentiate itself by hiring MRs with bountiful experience in special patient realms and leveraging its bountiful knowhow built up in the CRO business to take on highly specialized tasks. Currently, Linical provides the two main services, namely product marketing and post-launch planning and collection. Along with fortification of these two businesses in the future, the Company will also develop the global clinical research business, which is expected to expand strongly, to become the third cornerstone of this business segment. In addition, the ability to receive work for physician led clinical research was responsible for the turn to profits of this business segment during fiscal year March 2013.

Cover Everything from Development to Post- Launch Services by the CRO and CSO Businesses

(3) Drug Discovery Support Business (New Business Development)

Linical is endeavoring to cultivate new drug discovery support services in order to meet customers' needs such as new drug development schemes that have little impact upon near term earnings, aggressive development of compounds of drug lag in various Asian countries, and one-stop outsourcing services covering everything from development plan creation to approval applications. Therefore, Linical seeks to fortify its experiences in strategic consignment of clinical trial implementation planning creation, data collection, and other related processes, and to leverage subsidies and assistance from drug discovery funds to develop unique compounds at an early stage.

First Half Fiscal Year March 2014 Earnings Results

First Half Sales, Ordinary Income Fall 1.0%, 41.4% Year-Over-Year

Sales and ordinary income fell by 1.0% and 41.4% year-over-year to ¥1.706 billion and ¥306 million respectively during the first half of fiscal year March 2014.
Sales of the CSO business increased on the back of successful efforts to capture consignment of new projects due to strengthened marketing activities. And while fortification of marketing activities allowed sales of the CRO business to rise year-over-year during the second quarter, the year-over-year declines recorded during the first quarter could not be overcome.
With regards to profits, anticipatory hiring of new graduates and midcareer hires in both the CRO and CSO businesses led to increases in personnel costs including hiring expenses at both the cost of sales and sales, general and administrative (SG&A) expenses levels, and caused profits to decline. Gross margin declined by 9.0% points year-over-year to 38.9%, and SG&A rose by ¥55 million, contributing to a 41.3% year-over-year decline in operating income to ¥308 million.
Linical' s estimates announced at the beginning of the term were conservative and took potential for delays in and loss of orders into consideration. Consequently, second quarter earnings results actually exceeded the Company' s estimates.

Consignment contracts for work in both the CRO and CSO businesses usually range from 1 to 3 years and call for sales to be booked on a monthly basis (The total value of consignment contracts is divided by the number of months covered by the contract). Order backlog reflects the unpaid value of orders already booked. Therefore, order backlog also represents sales that will be booked during the coming 1 to 3 years and is one of the assumptions used in determining Linical' s earnings estimates.
Order backlog at the end of the first half fell by 10.0% when compared with backlogs at the end of the previous fiscal year March 2013. However, when the end of the first half is compared to October 25, 2013, order backlog rose by 13.0%. Growing demand for outsourcing and jointly conducted global clinical trials are contributing to a favorable order environment, and high levels of enquiries regarding consigned work indicate that future order trends can be expected to remain strong. In addition, large numbers of enquiries regarding consignment work from both new and existing customers also contributes to the outlook for continued increases in orders. Linical is increasing the number of CRA staff to strengthen its consignment work capabilities.

Total assets declined by ¥188 million from the end of the previous fiscal year to ¥2.453 billion at the end of the first half. This decline is attributed to a fall in cash and equivalent accompanying payment of unpaid taxes. While a decline in net income before taxes and increases in account payables caused free cash flow to turn negative, Linical maintains its position of "0" net debt and a strong equity ratio of 64.6%.

Fiscal Year March 2014 Earnings Estimates

Sales, Ordinary Income Expected to Rise 12.0%, 14.6% Year-Over-Year, Achieve 8th Consecutive Increase in Sales, 3rd Consecutive Term of Record High Profit

Linical has decided to maintain its outstanding earnings estimates for the full fiscal year March 2014.
Estimates call for sales to rise by 12.0% year-over-year to ¥4.031 billion. And while estimates are based on conservative assumptions that include the potential for delays in some orders, any delays are expected to be absorbed by the capture of new orders and increases in staffing for existing projects, allowing sales rise for the eighth consecutive term. With regards to profits, increases in both cost of sales and sales, general and administrative expenses arising from increased staffing of the CRA business and global business deployment, but these higher costs are expected to be absorbed by increases in sales and operating income is expected to rise by 14.7% year-over-year to ¥1.151 billion, marking the third consecutive term of record high profits. Dividend payments are expected to remain in line with projections of ¥14 per share.

Conclusions

The CRO and CSO markets, in which Linical participates, are expected to expand on the back of the growing trend of outsourcing medical product development and sales, and jointly conducted global clinical trials. However, pharmaceutical companies are pursuing more cost effective outsourcing solutions in light of intensifying global competition, increases in the difficulty of new drug development, and government led product price reductions. At the same time, outsourcing targets in the CRO realm are changing due to the lack of in-house experience and knowhow relating to new drug development in the realm of various diseases. Amidst these trends, Linical is expected to be a beneficiary of growth in the number of products developed in the highly difficult realms of oncology and central nervous system diseases that requires the ability to quickly implement high quality clinical trials. In addition, while falsifications of data in clinical research have become big problems, there is a high possibility of further acceleration of the outsourcing trend for post marketing clinical research related services, which Linical will involve in CSO business aftertime. Consequently, the environment surrounding Linical's businesses is positive and the key to capturing strong demand for work is the Company's ability to hire and quickly train highly skilled staff. While anticipatory investments led to weaker first half earnings, increases in profits are expected to be derived from the favorable orders trend during the second half. Earnings during coming terms will depend upon the Company's abilities to balance costs arising from anticipatory investments and to achieve higher sales to offset higher costs. Furthermore, it is a key to mid-and-long term growth for the Company to conduct increasing global clinical trials in the overseas market. Linical is implementing aggressive anticipatory measures including the establishment of overseas subsidiaries, hiring and training of global human resources, and M&A activities. And while more time may be required for the drug discovery process support business, which is supported by new drug discovery funds and is a key part of the Company's medium to long term business strategy, to begin contributing positively to earnings, the founding members will continue to share their knowhow with younger staff to cultivate new business opportunities and establish this business as a cornerstone of Linical's overall earnings.

Disclaimer

This report is intended solely for information purposes, and is not intended as a solicitation to invest in the shares of this company. The information and opinions contained within this report are based on data made publicly available by the Company, and comes from sources that we judge to be reliable. However we cannot guarantee the accuracy or completeness of the data. This report is not a guarantee of the accuracy, completeness or validity of said information and or opinions, nor do we bear any responsibility for the same. All rights pertaining to this report belong to Investment Bridge Co., Ltd., which may change the contents thereof at any time without prior notice. All investment decisions are the responsibility of the individual and should be made only after proper consideration.
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