| EMBREX INC /NC/ ITEM 1A RISK FACTORS If any of the following risks occur, our business, financial condition or results of operations could be materially adversely affected |
| OUR FUTURE GROWTH DEPENDS ON EXPANSION OF INTERNATIONAL REVENUES AND WE WILL BE SUBJECT TO INCREASED RISKS IN THE INTERNATIONAL MARKETPLACE We estimate that our Inovoject® system inoculates approximately 85prca of all eggs produced for the US and Canadian broiler poultry markets |
| Given this market penetration, we expect only limited growth in the number of system installations and only minor system revenue growth in this market |
| Additionally, due to our market penetration and the significance of the US and Canadian poultry markets to our revenue, any adverse conditions in these markets could have a material and adverse effect on our revenues |
| For this reason, we must expand our device installations and product sales in markets outside the United States and Canada in order to realize revenue growth |
| In 2005, international sales accounted for 37prca of our consolidated revenues |
| In 2004 and 2003, international sales accounted for 34prca and 32prca of our consolidated revenues, respectively |
| Revenue growth outside the United States and Canada depends on gaining and preserving market acceptance of our devices and in ovo administration of vaccine products in markets outside the United States and Canada to treat prevailing poultry diseases in those markets |
| Lack of market acceptance of our devices and in ovo products in these markets would materially adversely affect our revenue growth |
| Our operating expenses associated with operations outside the United States and Canada historically have been relatively higher as a percentage of revenues than similar costs for operations inside the United States and Canada |
| Accordingly, we believe that international sales may result in decreased gross margins for Embrex |
| International sales are also subject to a variety of risks, including risks arising from the following: • exchange rate risks (including risk associated with the translation of our subsidiaries’ financial results into US Dollars and transaction risk), tariffs, trade barriers and taxes; • adverse changes in local investment or exchange control regulations, potential restrictions on the flow of international capital and the possibility of confiscatory taxation, price controls or the taking or modification of our property rights by a country in the exercise of its sovereignty; • economic and political conditions beyond our control, including country-specific conditions such as political instability, government corruption and civil unrest; • the risk that we may not be granted a renewal license due to regulatory changes or other reasons with respect to current product registrations in certain foreign countries that are subject to periodic re-registration; and • trade restrictions and economic embargoes imposed by the United States and other countries |
| OUR FUTURE GROWTH ALSO DEPENDS ON THE DEVELOPMENT AND MARKET ACCEPTANCE OF NEW PRODUCTS In addition to international expansion, we need to develop and market new products to continue to generate increased revenues and growth of our business |
| We currently are developing, both independently and in collaboration with others, various products that address poultry health and performance needs |
| These products are being designed to be delivered in ovo through the Inovoject® system or in conjunction with the Inovoject® system and are in various stages of development |
| We may increase, decrease or eliminate funding for any product under development at any time depending on our assessment of our priorities, available funding, the probability that the product can be successfully commercialized, potential return on investment and other factors |
| There is no guarantee that any new products will be successfully developed and marketed |
| In addition, we have not initiated the regulatory approval process for some of these potential products, and we cannot assure you that regulatory approval will be obtained |
| Our inability to develop new products or any delay in our development of these products may materially adversely affect our revenue growth |
| Because of a number of factors, a new product may not reach the market 10 ______________________________________________________________________ [34]Table of Contents without lengthy delays, if at all |
| Some of the factors that may affect our development and marketing of new products include the following: • our research and evaluations of compounds and new technologies may not yield product opportunities; • potential products may involve extensive and time-consuming clinical trials to demonstrate safety and effectiveness, and the results of such trials are uncertain; • potential products may require collaborative partners and we may be unable to identify partners or enter into arrangements on terms acceptable to us; • we may not be able to produce or contract for the manufacture of new products at a cost or in quality or quantities necessary to make them commercially viable; • domestic and international regulatory approval of these products may not be obtained or may be obtained only with lengthy delays; • we may not be able to secure additional financing that may be needed to bring a potential product to market; • we may experience unexpected safety, regulatory or efficacy concerns with respect to marketed products, whether or not scientifically justified, leading to adverse public reaction, product recalls, withdrawals or declining sales; • marketing products developed jointly with other parties may require royalty payments or other payments by us to our co-developers, which may materially adversely affect our profitability; • we may be unable to accurately predict market requirements and evolving standards; and • we may not be able to attract and retain sufficient numbers of qualified development personnel |
| We have developed and commercialized two devices that work with the Inovoject® system: the Egg Remover® and Vaccine Saver® |
| The Egg Remover® can also be used without an Inovoject® system in specific situations where customers do not need injection services |
| These two devices have had initial success; however, there is no guarantee that acceptance of these devices will continue to grow |
| In December 2005, we filed for USDA regulatory approval with respect to our in ovo coccidiosis vaccine, Inovocox^™ |
| Although this product is in the regulatory review process, there is no assurance that USDA approval will be obtained |
| Marketing this product in non-US countries will require us to pursue separate approvals from foreign regulatory agencies |
| We completed construction of a vaccine manufacturing facility, Embrex Poultry Health, in the first quarter of 2004 to commercially produce the Inovocox^™ vaccine |
| Construction costs for Embrex Poultry Health to date are approximately dlra14dtta7 million |
| In addition to USDA approval for Inovocox^™, our coccidiosis vaccine manufacturing facility must receive a separate USDA approval to manufacture the Inovocox^™ vaccine |
| We cannot assure you that the facility will receive USDA approval to manufacture Inovocox^™ |
| Delays in obtaining either product or manufacturing facility approvals may materially adversely affect our marketing of, and our ability to receive revenues from, Inovocox^™ |
| Additionally, even if we receive USDA product and facility approvals, we cannot assure you that Inovocox^™ supplies will be available, that Inovocox^™ will be sold in commercial quantities or that product sales will be sufficient to offset our investment in development of the product and construction of the Inovocox^™ vaccine manufacturing facility |
| We have developed and commercialized AAC, which is technology that we use in our Bursaplex® vaccine |
| Bursaplex® has been sold in commercial quantities during the past six years, and we currently have approval to sell it in 33 countries |
| However, there is no assurance that supplies will continue to be available or that the product will continue to be sold in commercial quantities |
| In May 2003, the USDA provided regulatory approval of Newplex^™, our in ovo Newcastle Disease vaccine, within the United States |
| Newplex^™ vaccine is also based on AAC technology |
| We are now seeking regulatory approval for Newplex^™ in key markets worldwide |
| Although we have received approval to sell Newplex™ in nine countries, there is no assurance that approvals in other markets will be granted, that supplies will be available or that Newplex^™ will be sold in commercial quantities in the United States or in any of the other countries where approval has been obtained |
| There can be no assurance that we will successfully complete the development and commercialization of any new products, or that any of these new products will meet revenue and profit expectations if developed and commercialized |
| 11 ______________________________________________________________________ [35]Table of Contents ECONOMIC FACTORS AFFECTING OUR CUSTOMERS MAY ADVERSELY AFFECT OUR FINANCIAL RESULTS Our revenues principally come from leases and sales to the poultry industry |
| If there is a general economic decline in that industry, our operations and financial condition could be materially and adversely affected |
| Also, domestic and global economic factors beyond our control may adversely impact our customers and, as a result, our revenues and earnings |
| Examples of these factors include the following: • fluctuations in the prices of energy and poultry feed; • disease outbreaks that adversely affect poultry production, including avian influenza; • market demand for poultry products, including the supply and pricing of alternative proteins; • costs to comply with applicable laws and regulations, including those relating to environmental protection, food safety, market regulation and genetically modified organisms or ingredients; • product recalls and related adverse publicity and consumer reaction; • access to foreign markets together with foreign economic conditions, including currency fluctuations and trade restrictions; and • the extent to which our cost of products and operating expenses increase faster than contractual price adjustments with our customers |
| For example, if rising poultry feed prices increase the production costs of commercial poultry producers or a foreign government bans the importation of US chicken, these producers may reduce poultry production |
| This decreased production could adversely impact our revenues, since a principal component of our revenues are fees charged to customers for the number of eggs injected or processed by Embrex devices |
| WE FACE RISKS OF COMPETITION AND CHANGING TECHNOLOGY The Inovoject® system uses a process that was patented in the United States by the USDA in 1984 |
| We held the exclusive license to the Sharma Patent until June 2002, when the Sharma Patent expired |
| With the expiration of the Sharma Patent, competitive in ovo delivery systems are being developed and marketed |
| Embrex is aware of four companies that are marketing in ovo injection systems to poultry companies |
| Although there has not been widespread commercial acceptance of any of these competing systems, we are aware of direct competition for customers and limited commercial placements by some of these companies, including with some of our customers |
| Increased competition could result in lower prices for our products, reduced demand for our products and a corresponding reduction in our ability to recover development, engineering, manufacturing and service costs |
| Also, a significant portion of our revenues comes from a relatively small number of customers |
| If we lose one or more large customers due to competition, our revenues could be significantly lower |
| Any of these developments could have a material adverse effect on our business, results of operations and financial condition |
| The poultry vaccine business is especially competitive and dominated by a few large companies with an established global presence |
| In order for us to expand our sales of in ovo vaccines, these products must be commercially accepted worldwide and compete effectively against the vaccines of these other companies |
| Our inability to compete successfully in the poultry vaccine sector could materially adversely affect our revenue growth |
| Our competitors and potential competitors include independent companies that specialize in biotechnology, as well as major agricultural or animal health companies, pharmaceutical companies, chemical companies, universities and public and private research organizations |
| Many of these competitors are well established and have substantially greater marketing, financial, technological and other resources than we have |
| Competitors may succeed in developing technologies and products that are more effective than any that have been or are being developed by us or that could render our technology and products obsolete or non-competitive |
| THE LOSS OF KEY CUSTOMERS COULD ADVERSELY AFFECT OUR FINANCIAL RESULTS Historically, a significant portion of our revenues has come from a relatively small number of customers |
| The only other customer representing greater than 10prca of total consolidated revenues is Pilgrim’s, representing 11prca and 12prca of consolidated 2005 and 2004 revenues, respectively |
| As with many of our customers, we have short-term contracts with Tyson and Pilgrim’s |
| Our top three customers, including Tyson and Pilgrim’s, accounted for approximately 33prca and 36prca of our consolidated 2005 and 2004 revenues, respectively |
| We expect a similar level 12 ______________________________________________________________________ [36]Table of Contents of customer concentration to continue in future years |
| The poultry market is highly concentrated, with the largest poultry producers dominating the market |
| For example, in 2005, Tyson and Pilgrim’s supplied approximately 23prca and 15prca of all broilers grown in the United States, respectively |
| The concentration of our revenues with these large customers means factors affecting those customers also will impact our revenues and earnings |
| If we lose a large customer and fail to add new customers to replace lost revenues, our operating results will be materially and adversely affected |
| Also, if these customers reduce the number of eggs they incubate at hatcheries, we will receive lower device revenues since our fees are based on the number of eggs injected |
| IF WE LOSE THE PROTECTION OF OUR PATENTS AND PROPRIETARY RIGHTS, OUR FINANCIAL RESULTS COULD SUFFER Importance and Limitations of Patent and Proprietary Rights Protections Some of our products and processes used to produce our products involve proprietary rights, including patents |
| We own some of the technologies employed in these processes, and some are owned by others and licensed to us |
| The Inovoject® system utilizes a process that was patented by the USDA in the United States |
| We held an exclusive license to the Sharma Patent until it expired in June 2002 |
| We have supplemented the Sharma Patent with additional US and foreign patents and have submitted additional patent applications covering specific design features of the Inovoject® system, as well as Embrex’s Egg Remover® system and Vaccine Saver® option |
| Our competitors or potential competitors may have filed for or received United States and foreign patents and may obtain additional patents and proprietary rights relating to in ovo technology, vaccines, uses and/or processes which may compete with our existing products and our products under development |
| Accordingly, we cannot assure you that our patent applications will result in patents being issued or that, if issued, the claims under our patents will afford protection against competitors with similar technology |
| We cannot be sure that others will not obtain patents of different technology that we would need to license or circumvent in order to practice our inventions |
| Even though we strive to take appropriate action to protect our intellectual property, there is a risk that competitive systems currently being developed and marketed could gain acceptance in the United States or elsewhere |
| We believe that patent protection of materials or processes we develop and any products that may result from the research and development efforts of our licensors and us are important to the commercial success of our products |
| The loss of the protection of these patents and proprietary rights could materially adversely affect our business and our competitive position in the market |
| The patent position of companies such as ours generally is highly uncertain and involves complex legal and factual questions |
| Some of the reasons for this uncertainty include the following: • To date, no consistent regulatory policy has emerged regarding the breadth of claims allowed in biotechnology patents |
| Consequently, there can be no assurance that patent applications relating to our products or technology will result in patents being issued or that, if issued, the patents will afford protection against competitors with similar technology; • Some patent licenses held by us may be terminated upon the occurrence of specified events or become non-exclusive after a specified period; • Companies that obtain patents claiming products or processes that are necessary for or useful to the development of our products could bring legal actions against us claiming infringement (though we currently are not the subject of any patent infringement claim); • Issuance of a valid patent does not prevent other companies from using alternative, non-infringing technology, so we cannot be sure that any of our patents (or patents issued to others and licensed to us) will provide significant commercial protection; • We may not have the financial resources necessary to obtain patent protection in some countries or to enforce any patent rights we may hold; • The laws of some foreign countries may not protect proprietary rights to the same extent as the laws of the United States, and many companies have encountered significant problems in protecting their proprietary rights in these foreign countries; • We may be required to obtain licenses from others to develop, manufacture or market our products |
| We may not be able to obtain these licenses on commercially reasonable terms, and we cannot be sure that the patents underlying the licenses will be valid and enforceable; and • We also rely upon unpatented, proprietary technology, which we may not be able to protect fully if others independently develop substantially equivalent proprietary information or techniques, improperly gain access to our proprietary technology or disclose this technology to others |
| 13 ______________________________________________________________________ [37]Table of Contents We attempt to protect our proprietary materials and processes by relying on trade secret laws and non-disclosure and confidentiality agreements with our employees and other persons with access to our proprietary materials or processes or who have licensing or research arrangements with us |
| We plan to continue to use these protections in the future, but we cannot be sure that these agreements will not be breached or that we would have adequate remedies for any breach |
| Even with these protections, others may independently develop or obtain access to these materials or processes, which may materially adversely affect our competitive position |
| If we are sued for infringing the patent or other proprietary rights of a third party, we could incur substantial costs and diversion of management and technical personnel, whether or not the litigation is ultimately determined in our favor |
| For a description of the patent litigations in which we have been involved, |