| ERESEARCHTECHNOLOGY INC /DE/ ITEM 1A RISK FACTORS The risk factors identified in the cautionary statements below could cause our actual results to differ materially from those suggested in the forward-looking statements appearing elsewhere in this Form 10-K However, these risk factors are not exhaustive, as new risks emerge from time to time, and it is not possible for management to predict all such risk factors or to assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements |
| Accordingly, forward-looking statements should not be relied upon as a prediction of actual results |
| Extensive governmental regulation of the clinical trial process could require costly modifications to our products, adversely affect prospective clients’ willingness to use our products and services and increase competition and reduce our market share |
| We may incur increased expenses or suffer a reduction in revenues if our products and services do not comply with applicable government regulations or if regulations allow more competition in the market place |
| The FDA has published regulations and guidelines addressing a broad range of matters relating to the use of computerized systems to collect, manage and analyze data from clinical trials |
| Moreover, electronic data entry, management and analysis of medical information pertaining to subjects in clinical trials will be subject to state and federal government regulations that are not yet finalized |
| Conforming our products and services to these guidelines or to future changes in regulation could substantially increase our expenses |
| In the United States and in foreign countries, regulatory authorities have also established other standards for conducting clinical trials leading to the approval of new products with which we must comply |
| We are subject to these regulations because our products and services assist sponsors and CROs in conducting trials and preparing new drug or device applications |
| If a regulatory authority concludes that trials were not conducted in accordance with established requirements, it may take a variety of enforcement actions depending upon the nature of the violation and the applicable country |
| In the United States, these measures may range from issuing a warning letter or seeking injunctive relief or civil penalties to recommending criminal prosecution, which could result in a prohibition of our continued participation in future clinical trials |
| In November 2001, the FDA held a public meeting at which it proposed requiring sponsors of new drugs to submit ECG raw data in digital format and annotated digital ECG waveforms |
| Annotated waveforms include definition of measurement points that are used to create ECG analysis data |
| A subsequent meeting held in January 2003, which was supported by a preliminary concept paper issued in November 2002, further discussed the trial design, ECG acquisition, analysis and reporting for digital ECGs |
| Following a meeting in June 2004, the International Conference on Harmonization (ICH) released to the public in September 2004 the following guidelines at Step 3, S7B: Safety Pharmacology Studies for Assessing the Potential for Delayed Ventricular Repolarization (QT Interval Prolongation) by Human Pharmaceuticals and E14: The Clinical Evaluation of QT/ 10 ______________________________________________________________________ [130]Back to Contents QTc Interval Prolongation and Proarrhythmic Potential for Non-Antiarrhythmic Drugs (ICH E14) |
| The objective of these guidelines is to recommend the design and timing of studies in the clinical development process and provide general recommendations on available non-clinical methodologies to assess the potential risk of QT interval prolongation of a pharmaceutical product |
| On May 12, 2005, the ICH ratified and recommended for implementation the cardiac safety monitoring guidance provided in ICH E14 (step 4) |
| The guidance confirms previous guidance reinforcing the need for routine cardiac safety testing as well as Thorough QTc testing for all compounds entering the blood stream commencing early in clinical development to provide maximum guidance for later trials, as well as testing for all compounds in Phase III prior to submission for approval |
| Our clients and prospective clients will be less likely to use our products and services if the products and services do not comply with regulatory requirements in all countries where clinical trials are expected to take place or if we are precluded from participating in clinical trials in countries where trials will be conducted |
| In addition, changing regulatory requirements could provide an advantage to our competitors if our competitors are able to meet the requirements more rapidly or at lower cost |
| For example, in the May 12, 2005 ICH release, it was suggested that semi-automated processing of electrocardiograms may be found acceptable in certain instances |
| Semi-automated processing uses software algorithm-placed measurements that are later adjudicated by a cardiac specialist or physician |
| While we are positioned to provide semi-automated processing, we have historically been a leader in the industry in manual processing |
| Our manual processing includes manually derived measurements, using our on screen, high resolution caliper placement system, which are later interpreted by a cardiologist |
| Drug sponsors have begun to shift towards semi-automated processing, allowing more competitors to compete with us in offering this service and, as a result, we are forced to reduce pricing to maintain our market share |
| The effect of such actions reduces our revenue and gross profit per transaction |
| Our results of operations for fiscal 2004 and 2005 were adversely affected by the uncertainty in the clinical research and drug development industry that is due in part to this evolving regulatory guidance, and our results of operations in the future may also be adversely affected if this uncertainty continues |
| Our failure to maintain revenue and gross profit per transaction may affect our ability to achieve growth in cardiac safety revenues from year to year |
| If we fail to show growth in cardiac safety revenues, we may not meet the expectations of securities analysts and investors, which would likely cause the market price of our common stock to decline |
| We have several large clients from whom we derive substantial revenue and therefore the loss of even a few of our clients could significantly reduce our revenues |
| We have one client representing more than 10prca of our total revenues for 2005 |
| The Franchise Agreement in place for this client expires in 2006 |
| This means we will revert to contract pricing on a per trial basis consistent with our typical master service agreements |
| If we lose this client or other significant clients and do not replace them with new clients, our revenues will decrease and may not be sufficient to cover our costs |
| We currently derive and expect to continue to derive a significant portion of our revenues from a limited number of clients |
| Consolidation among our clients could cause us to lose clients, decrease the market for our products and result in a reduction of our revenues |
| Our client base could decline because of consolidation, and we may not be able to expand sales of our products and services to new clients |
| Consolidation in the pharmaceutical, biotechnology and medical device industries and among CROs has accelerated in recent years, and we expect this trend to continue |
| In addition, our profitability will suffer if we reduce our prices in response to competitive pressures without achieving corresponding reductions in our expenses |
| In addition, new companies or organizations that result from such consolidation may decide that our products and services are no longer needed because of their own internal processes or the use of alternative systems |
| As these industries consolidate, competition to provide products and services to industry participants will become more intense and the importance of establishing relationships with large industry participants will become greater |
| These industry participants may try to use their market power to negotiate price reductions for our products and services |
| Also, if consolidation of larger clients occurs, the combined organization may represent a larger percentage of business for us and, as a result, we are likely to rely more significantly on the combined organization’s revenues to continue to achieve growth |
| 11 ______________________________________________________________________ [131]Back to Contents If clinical trial sponsors and CROs do not shift from their existing paper-based methods of collecting and managing clinical trial data to an electronic system, we may not achieve the market penetration necessary to grow the business at expected levels |
| If participants conducting clinical trials are unwilling to adopt our technology solutions and new ways of conducting business, our revenues may not be sufficient to achieve the expected growth rate of securities analysts and investors |
| Our efforts to establish a standardized, electronic process to collect, manage and analyze clinical trial and cardiac safety data are a significant departure from the traditional clinical research process |
| We estimate that the majority of clinical trials today use manual, paper-based data entry, management and analysis tools |
| Each clinical trial can involve a multitude of participants, including the sponsor, a CRO, regional site managers, investigators and patients |
| With so many participants involved in a clinical trial, it may be difficult to convince a sponsor or CRO to accept new methods of conducting a clinical trial |
| We may not be successful in persuading these participants to change the manner in which they have traditionally operated and to accept our products and services |
| While we saw some willingness from drug developers to shift from paper-based methods during 2004 and 2005, the adoption is slow |
| If general economic conditions worsen, potential clients may be unwilling to make large capital software purchases or commitments, which could affect our ability to maintain and/or increase license revenues |
| We have seen some resistance by potential clients in making the necessary large capital expenditure to license our software through our traditional perpetual license offering |
| Despite our efforts to market an annual or otherwise recurring term license, our failure to continue selling perpetual software licenses in the near term may affect our ability to achieve growth in license revenues from year to year |
| If we fail to show growth in license revenues, we may not meet the expectations of securities analysts and investors, which would likely cause the market price of our common stock to decline |
| In addition, if we are not successful in selling recurring term licenses, we will not generate the volume of recurring revenues in the future that we are expecting |
| We may fail to maintain revenue and income growth |
| If we do not maintain revenue and income growth, our stock price is likely to decline and we may not be able to continue to operate |
| Failure to maintain expected growth in profitability could cause the market price of our common stock to decline, affect our ability to raise capital, reduce our cash reserves, limit our capital spending and ultimately cause us to discontinue operating our business |
| Our future operating results are uncertain and may fluctuate |
| If we fail to meet the expectations of securities analysts and investors, our stock price would likely decline |
| If our operating results in any future period fluctuate significantly, we may not meet the expectations of securities analysts and investors, which would likely cause the market price of our common stock to decline |
| It is difficult to predict the timing or amount of our revenues because: • we generate a significant percentage of our revenues from a limited number of clients • our sales cycles can be lengthy and variable • Thorough QTc studies are typically of large volume and of short duration • sponsors and CROs may unexpectedly cancel, postpone or reduce the size of clinical trials We make decisions on operating expenses based on anticipated revenue trends and available resources |
| We also incur expenses educating and providing information to our client base, including through consultations, without any obligation by our client to purchase our products and services |
| Because many of our expenses are fixed and we are committed to making a significant investment in our organization and in marketing our products and services, delays in recognizing revenues could cause our operating results to fluctuate from period to period |
| If we fail to generate the contract signings that we expect, we may fail to meet financial guidance that we have provided, or may provide in the future, to the public |
| 12 ______________________________________________________________________ [132]Back to Contents We depend entirely on the clinical trial market and a downturn in this market could cause our revenues to decrease |
| Our business depends entirely on the clinical trials that pharmaceutical, biotechnology and medical device companies conduct |
| Our revenues will decline if there is less competition in the pharmaceutical, biotechnology or medical device industries, which would result in fewer products under development and decreased pressure to accelerate a product approval |
| Our revenues will also decline if the FDA or similar agencies in foreign countries loosen their requirements, thereby decreasing the complexity of conducting clinical trials |
| Any other developments that adversely affect the pharmaceutical, biotechnology or medical device industries generally, including product liability claims, new technologies or products or general business conditions, could also decrease the volume of our business |
| During 2005, three studies for which we contracted to provide Cardiac Safety services were delayed or postponed, resulting in lower than expected revenues and earnings |
| We could experience this again in the future if there are developments in the clinical trial market that causes a delay in studies |
| Our failure to expand our business or manage growth successfully could disrupt our business operations, increase our costs and delay implementation of our business strategies |
| Difficulties in managing our future growth could disrupt our business operations, increase our costs and delay achievement of our business goals, making it more difficult for us to maintain profitability |
| Our growth strategy depends on our ability to expand and improve our field sales, marketing and services organization, our operations and our corporate and administrative organizations, both in the United States and throughout the world |
| In order to grow, we will need to hire additional personnel |
| There are a limited number of experienced personnel with an adequate knowledge of our industry, and competition for their services is intense |
| In addition, we may not be able to project the rate or timing of increases in the use of products and services accurately or to expand and upgrade our systems and infrastructure to accommodate the increases |
| The expansion of our foreign operations also will require us to assimilate differences in foreign business practices, overcome language barriers and hire and retain qualified personnel abroad |
| Our failure to establish and maintain strategic alliances may delay the development of our products and services, cause us to lose clients and prevent us from growing our business, any of which could cause our stock price to decline |
| We have relationships with providers of clinical pharmacology services, hardware and software systems, telecommunications, web-hosting and development, systems integration and website content that support our sales and marketing efforts by satisfying other needs of our existing clients that our solutions do not address and by providing us access to their clients as potential sources of new business |
| We do not generally have long-term contracts with our strategic partners, so they may cease doing business with us on relatively short notice |
| We have also built strategic alliances with three of our customers in the form of Digital ECG Franchise agreements |
| These agreements expire in August 2006, December 2006 and May 2007, respectively |
| There is no assurance that we will extend these agreements beyond their existing terms |
| This would mean that we would revert to contract pricing on a per trial basis consistent with our typical master service agreements and potentially lose business from these clients that may affect our future growth |
| We may not be successful in competing against others providing similar products and services, which could reduce our revenues and market share |
| If our products and services do not achieve widespread acceptance by our clients, our revenues and market share will likely decline |
| Our competitors include other centralized cardiac safety laboratories, CROs, software vendors, and clinical trial data service companies |
| Our targeted clients, sponsors and CROs may decide to choose other technology-based products and services generated internally by them or from another source |
| Many of our competitors have substantially greater financial and other resources, greater name recognition and more extensive client bases than we do |
| In addition, many competitors focus their efforts on providing software or services for discrete aspects of the clinical trial process and may compare favorably to us on those discrete aspects |
| Further, certain drug development organizations may decide not to outsource all or a significant portion of the cardiac 13 ______________________________________________________________________ [133]Back to Contents safety activities associated with their clinical research programs, which could reduce our revenues and market share |
| We may incur liability as a result of providing Cardiac Safety analysis and interpretation services |
| We provide centralized analysis and interpretation of ECGs in connection with our clients’ clinical trials |
| It is possible that liability may be asserted against us and the physicians who interpret the ECGs for us for failing to accurately diagnose a medical problem indicated by the ECG or for failing to disclose a medical problem to the investigator responsible for the subject being tested |
| If we are found liable, we may be forced to pay fines and damages and to discontinue a portion of our operations |
| The contractual protections included in our client contracts and our insurance coverage may not be sufficient to protect us against such liability |
| If the protections are not adequate, we may be unable to achieve or maintain profitability and our stock price would likely fall |
| The cardiac safety equipment that we own and lease could become obsolete due to technological advances or we may not be able to provide the quantity of equipment needed to service our clients |
| We own and lease equipment, which we provide to our clients to perform cardiac safety procedures |
| This equipment may become obsolete due to advances in technology and the introduction of newer equipment models prior to the time that we have fully depreciated the asset or fulfilled our lease obligations |
| This could result in us recording additional expense to write-off the book value or the remaining lease value of the equipment |
| We are also dependent on a limited number of suppliers to provide the equipment necessary to service our clients and if adequate equipment is not available we may lose clinical clients, resulting in reduced revenues |
| Capacity constraint or system failures could result in the loss of or liability to clients, which could reduce our revenues and increase our expenses |
| In the past, we have been able to staff for increasing workload demands in an expeditious manner |
| However, there may not be a sufficient and suitable group of potential employees available if rapid growth occurs in a short period of time |
| If we are unable to hire suitable employees to adequately meet market demand for QTc studies, it could affect our ability to bid on this business or to meet existing contractual turnaround times |
| If our clients experience any significant level of problems with our technology, we may become liable to those clients, we may be unable to persuade our clients to change from a manual, paper-based process and we may lose clients |
| The success of our products and services depends on the ability to protect against: • software or hardware malfunctions that interrupt operation of our applications or cause loss of data integrity • power loss or telecommunications failures • overloaded systems • human error • natural disasters In addition, when we offer our software products as an application service provider, our network infrastructure may be vulnerable to computer viruses, break-ins and similar disruptive problems caused by our clients or other Internet users |
| This could also lead to delays, loss of data, interruptions or cessation of service to our clients for which we may be liable |
| There is no current technology that provides absolute protection against these events |
| In addition, we may find that the cost to develop or incorporate technology into our products that provides the maximum protection against these problems outweighs the incremental benefits of providing such enhanced protection |
| 14 ______________________________________________________________________ [134]Back to Contents Our software products are complex and may contain undetected software errors, which could lead to an increase in our costs or a reduction in our revenues |
| The occurrence of hardware and software errors, whether caused by our solutions or another vendor’s products, could: • cause sales of our solutions to decrease and our revenues to decline • cause us to incur significant warranty and repair costs • divert the attention of our technical personnel away from product development efforts • cause significant client relations problems Complex software products such as those included in our technology solutions frequently contain undetected errors when first introduced or as new versions are released |
| In addition, we combine our solutions with software and hardware products from other vendors |
| As a result, we may experience difficulty in identifying the source of an error |
| Rapidly changing technology may impair our ability to develop and market our solutions and cause us to become less competitive |
| The marketplace for our software products is increasingly driven by demands for ease of use and effective performance for end users of the system |
| We depend on continued focus on product improvements in this area in order to remain competitive |
| Our failure to continuously offer competitive products and services could cause us to lose clients and prevent us from successfully marketing our solutions to prospective clients |
| Because our business relies on technology, we are susceptible to: • rapid technological change • changing client needs • frequent new product introductions • evolving industry standards As the Internet, computer and software industries continue to experience rapid technological change, we must quickly modify our solutions to adapt to such changes |
| Currently, the EDC industry is reevaluating its technology needs for the future |
| The demands of operating in such an environment may delay or prevent our development and introduction of new or enhanced products and services that continually meet changing market demands and that keep pace with evolving industry standards |
| We have experienced development delays in the past and may experience similar or more significant delays in the future |
| In addition, competitors may develop products superior to our solutions, which could make our products obsolete |
| We depend on certain key executives |
| If we lose the services of any of these executives, our operations could be disrupted, we could incur additional expenses and our ability to expand our operations could be impeded, particularly if we are not able to recruit a suitable replacement in a timely manner |
| The loss of the services of one or more of our key executives could negatively affect our ability to achieve our business goals |
| In December 2005 and February 2006, we announced the pending retirements of our Executive Vice President and Chief Financial Officer and our President and Chief Executive Officer, respectively |
| Our future performance will depend significantly on our ability to replace these two positions with talented individuals and the continued service and performance of all of our remaining executives, particularly Dr |
| Joel Morganroth, our Chairman of the Board of Directors |
| We also depend on our key technical, client support, sales and other managerial employees |
| We believe that it would be costly and time consuming to find suitable replacements for all these employees, including the replacements for our Executive Vice President and Chief Financial Officer and our President and Chief Executive Officer |
| 15 ______________________________________________________________________ [135]Back to Contents If we are unable to protect our proprietary technology or maintain our technological advantages, we may lose our intellectual property rights and become less competitive |
| If we fail to protect our intellectual property from infringement, other companies may use our intellectual property to offer competitive products at lower prices |
| If we fail to compete effectively against these companies, we could lose clients and experience a decline in sales of our solutions |
| To protect our intellectual property rights, we rely on a combination of copyright and trade secret laws and restrictions on disclosure |
| In addition, in 2004 we were issued a US Patent on over 50 claims directed to various features of eRT’s EXPeRT^® workflow enabled data handling technology |
| Despite our efforts to protect our proprietary rights, unauthorized parties may copy or otherwise obtain and use our products and technology |
| In addition, our US Patent could be successfully challenged as invalid |
| Monitoring unauthorized use of our solutions is difficult and the steps we have taken may not prevent unauthorized use of our technology, particularly in foreign countries where the laws may not protect our proprietary rights as fully as in the United States |
| Third parties may claim that we infringe upon their intellectual property rights, which could result in the loss of our rights, subject us to liability and divert management attention |
| Although we are not currently involved in any intellectual property litigation, we may be a party to litigation in the future either to protect our intellectual property or as a result of an alleged infringement by us of the intellectual property of others |
| These claims and any resulting litigation could subject us to significant liability or invalidate our ownership rights in the technology used in our solutions |
| Litigation, regardless of the merits of the claim or outcome, could consume a great deal of our time and money and would divert management time and attention away from our core business |
| Any potential intellectual property litigation also could force us to do one or more of the following: • stop using the challenged intellectual property or selling our products or services that incorporate it • obtain a license to use the challenged intellectual property or to sell products or services that incorporate it, which could be costly or unavailable • redesign those products or services that are based on or incorporate the challenged intellectual property, which could be costly and time consuming or could adversely affect the functionality and market acceptance of our products If we must take any of the foregoing actions, we may be unable to sell our solutions, which would substantially reduce our revenues |
| Third parties have made claims for damages against the Company and may continue to do so, which could result in an unfavorable settlement or judgment against us |
| We are currently named as a defendant in anaction for damages |
| Although we believe the claim against us is without merit and we intend to vigorously defend ourselves, we may be unsuccessful in our defense efforts, which would result in unfavorable settlement costs or monetary judgments against us |
| Litigation, regardless of the merits of the claim or outcome, consumes a great deal of our time and money and often diverts management time and attention away from our core business |
| In addition, unsuccessful litigation could reduce our cash reserves, cause the market price of our common stock to decline and ultimately cause us to discontinue operating our business |
| Our international operations expose us to additional risks |
| A key element of our business strategy is to expand our international operations |
| We face a number of risks and expenses that are inherent in operating in foreign countries and, accordingly, our international operations may not achieve profitability consistently each year |
| The risks to us from our international operations include: • Government regulations • Trade restrictions • Burdensome foreign taxes 16 ______________________________________________________________________ [136]Back to Contents • Exchange rate controls and currency exchange rate fluctuations • Political and economic instability • Varying technology standards • Difficulties in staffing and managing foreign operations We are subject to a variety of government regulations in the countries where we market our products and services |
| We currently operate in the United Kingdom through a foreign subsidiary and may operate in the future in other countries through additional foreign subsidiaries |
| If we form foreign subsidiaries outside of the United Kingdom, we may need to withhold taxes on earnings or other payments they distribute to us |
| Generally, we can claim a foreign tax credit against our federal income tax expense for these taxes |
| However, the United States tax laws have a number of limitations on our ability to claim that credit or to use any foreign tax losses, which could result in higher payment by us of taxes in the United States |
| We may also need to include our share of our foreign subsidiaries’ earnings in our income even if the subsidiaries do not distribute money to us |
| As a result, less cash would be available to us in the United States |
| Our global operations may involve transactions in a variety of currencies |
| Fluctuations in currency exchange rates could reduce our reported revenues or increase our reported expenses |
| We currently do not utilize hedging instruments |
| The agreements that we sign with clients outside the United States may be governed by the laws of the countries where we provide our products and services |
| We may also need to resolve any disputes under these agreements in the courts or other dispute resolution forums in those countries |
| This could be expensive or could distract management’s attention away from our core business |