| EP MEDSYSTEMS INC Item 1A Risk Factors In addition to the other information set forth in this annual report, you should carefully consider the following factors that could materially affect our business, financial condition or future results |
| The risks and uncertainties described below are not the only risks and uncertainties that we face |
| Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also impair our business, financial condition and results of operations |
| We were incorporated in January 1993 and completed the initial public offering of our common stock in June 1996 |
| We have incurred substantial operating losses in each year since our incorporation |
| At December 31, 2005, we had an accumulated deficit of approximately dlra48dtta3 million |
| Our net sales revenue of dlra16dtta7 million, less cost of sales, did not cover our operating expenses of approximately dlra16dtta2 million for the year ended December 31, 2005 |
| At December 31, 2004, we had an accumulated deficit of approximately dlra42dtta6 million |
| Our net sales revenue of dlra16dtta4 million, less cost of sales, did not cover our operating expenses of approximately dlra13dtta9 million for the year ended December 31, 2004 |
| We expect that our operating expenses will continue to exceed our revenues, and as such, we will likely continue to incur operating losses unless and until revenue from newer products covers our costs |
| We may need additional funds to support our operations and we may need to reduce our operations, sell stock or assets, or merge with another entity to continue our operations |
| Our operations to date have consumed substantial capital resources, and we will continue to expend substantial and increasing amounts of capital for research, product development and testing to establish commercial-scale manufacturing capabilities, and to market potential and approved products |
| Our future capital requirements will depend on many factors, including: • continued scientific progress in our research and development programs; • the size and complexity of our research and development programs; • the scope and results of testing and trials of our products; • the time and costs involved in applying for regulatory approvals; 13 ______________________________________________________________________ [40]Table of Contents • the costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims; • competing technological and market developments; • our ability to establish and maintain collaborative research and development arrangements; • the cost of manufacturing scale-up and product commercialization; • our ability to create an effective sales channel for our products; and • the costs of being a public company |
| We may need to raise additional funds in order to satisfy these and other future capital requirements |
| If we are not able to do so, we may not be able to fund our future operations |
| We expect that our existing capital resources, including the capital previously raised through the sale of common stock and the issuance of convertible notes under our existing revolving credit facility, will be sufficient to fund our activities as currently planned through the end of the first quarter of 2007 |
| However, in the event our sales do not meet budgeted amounts, our capital expenditures increase over our estimates, we are unable to convert our outstanding notes into shares of our common stock and/or we are unable to borrow additional funds under our existing revolving credit facility, it is likely that we will need additional financing sooner than currently expected |
| In the future, it is possible that we will not have adequate resources to support our business activities |
| We may seek additional funding, including public and private financings |
| Our choice of financing alternatives may vary from time to time depending upon various factors, including the market price of our securities, conditions in the financial markets, and the interest of other entities in strategic transactions with us |
| There can be no guarantee that additional financing will be available on acceptable terms, whether through borrowings, collaborative arrangement, issuance of securities, or otherwise |
| If adequate funds are not available, we may be required to delay, scale back or eliminate one or more of our research and development programs or other initiatives |
| We may also need to obtain funds through arrangements with collaborative partners or others that require us to relinquish rights to certain technologies or potential products |
| Any such delay, scale back, partnership or similar arrangement could have a negative impact on our ability to develop products, or to achieve profitability if our products are brought to market |
| If additional financing is not available to us on acceptable terms, or at all, it would have a material adverse effect on our business, financial condition, prospects and results of operations |
| We may need to establish collaborative agreements, and this could have a negative effect on our freedom to operate our business, fund new product development or profit fully from sales of our products |
| We may seek to collaborate with other medical device companies to gain access to their research and development, manufacturing, marketing, distribution capabilities and financial resources |
| However, we may not be able to negotiate arrangements with any collaborative partners on acceptable terms |
| Any collaborative relationships that we enter into may include restrictions on our freedom to operate our business or to profit fully from the sales of our products |
| Once a collaborative arrangement is established, our partner may discontinue its funding of any particular program or may, either alone or with others, pursue alternative technologies for the medical conditions our products are intended to treat |
| If a partner were to develop, or to establish an economic interest in, a competing product, such partner may withdraw financial or technological resources from the development of our collaborative product or technology |
| Without collaborative arrangements, we must fund our own research and development activities, accelerating the depletion of our capital and requiring us to develop our own marketing capabilities |
| Therefore, if we are unable to establish and maintain collaborative arrangements on acceptable terms, we could experience a material adverse effect on our ability to develop products and, once developed, to market them successfully |
| Our success will depend on continued market acceptance of the EP-WorkMate^^®^ and market acceptance of our EP-WorkMate^^®^ integrated with RPM™, the EP-4™ Stimulator, the ALERT^^®^ System and ViewMate^^®^ and other product offerings |
| Our ability to increase revenues over the next several years will depend on the continued market acceptance by electrophysiologists of our EP-WorkMate^^®^ computerized monitoring and analysis workstation integrated with RPM™, and market acceptance of our ALERT^^®^ System and ViewMate^^®^ product offerings |
| Sales of our EP-WorkMate^^®^, 14 ______________________________________________________________________ [41]Table of Contents its integrated EP-4™ stimulator, and Boston Scientific Corporation’s RPM™ RealTime Position Management™ system accounted for 85prca, 89prca, and 86prca of our sales in the year ended December 31, 2005, 2004, and 2003, respectively |
| Because the EP-WorkMate^^®^ has a list price of approximately dlra175cmam000 with an integrated EP-4™ Stimulator, each sale of an EP-WorkMate^^®^ represents a relatively large percentage of our net sales |
| Acceptance and use of our products by physicians and other clinicians is critical to our success |
| Physician and clinician acceptance will depend upon, among other things, substantial favorable clinical experience, advantages over alternative treatments, cost effectiveness and favorable reimbursement policies of third-party payors, such as insurance companies, Medicare and other governmental programs |
| Decreased or flat sales or low market acceptance of our EP-WorkMate^^®^ products or low market acceptance of our recently approved products could have a material adverse effect on our business, results of operations and financial condition |
| We are primarily engaged in the sale of capital equipment, which is sensitive to fluctuations in our customers’ budgets |
| We are primarily engaged in the sale of capital goods and, as a result, are subject to the budgetary cycles of our customers |
| These cycles can cause fluctuations in our quarterly revenue as our customers manage their capital budgets based on available cash to pay for equipment |
| We have limited manufacturing experience and manufacturing capacity, which may affect our ability to produce commercially viable products economically and in sufficient quantities |
| Our profitability will depend on our ability to manufacture our products efficiently and economically |
| We have limited manufacturing experience, particularly with respect to our catheter products |
| Our failure to obtain efficiency in our manufacturing processes will affect our profitability and could have a material adverse effect on our business, results of operations and financial condition |
| We have limited experience in manufacturing any of our products in volumes necessary for us to achieve commercial profitability |
| We may not be able to establish or maintain reliable, high-volume, cost-effective manufacturing capacity, which is critical to our future profitability |
| We cannot assure you that we will be able to maintain or establish outsourcing arrangements on acceptable terms |
| We also cannot assure you that we will be able to successfully manufacture our products in volumes sufficient for us to be profitable or that we can successfully increase our manufacturing capacity |
| We depend on third-party sources to manufacture certain of our products and critical components for our products |
| We rely on third-party sources to manufacture critical components for the EP-4™ Stimulators, ViewMate^^®^ and its ViewFlex™ catheter, ALERT^^®^ Companion, EP-WorkMate^^®^ and RPM™ Navigation System |
| Any interruption by 15 ______________________________________________________________________ [42]Table of Contents these third-party sources in the supply of such products or components would have a material adverse effect on our ability to deliver those products or the products in which such components are used and could materially adversely impact our sales and gross margins |
| If any interruption were to occur, we may not be able to reach an acceptable arrangement with an alternative source of supply on a timely basis or on acceptable terms |
| Our failure to find alternative manufacturing sources could have a material adverse effect on our business, results of operations and financial condition |
| During the first quarter of 2006, we discovered non-conforming material from a supplier of a critical component for our ViewFlex™ catheter |
| We expect to resolve this issue in the second quarter of 2006 |
| Our success depends in part on our ability to keep pace with technological developments and marketplace changes |
| The electrophysiology market is characterized by rapidly changing technology, new products and dynamic industry standards |
| Accordingly, our ability to compete depends on our ability to develop new products and improve existing products to keep pace with technological and marketplace changes |
| The research and development necessary for new products and for product refinements can take longer and require greater expenditures than we expect, and our efforts may not be successful |
| Moreover, any new products or refinements to existing products may not be accepted by physicians or patients |
| If we are unable to successfully respond to technological developments or changes in the marketplace in which we compete, our business, financial condition and prospects may be materially adversely affected |
| Our patents and proprietary rights might not provide sufficient intellectual property protection for our products |
| Our success and ability to compete effectively in the electrophysiology marketplace depends on our ability to protect our patents, proprietary technology and other intellectual property |
| We have acquired, and will seek to acquire, patents in the United States and certain foreign countries |
| We also have entered into license agreements to obtain rights, including patent rights, of third parties that we consider important to our business |
| We cannot assure you that patents will be issued on our patent applications and applications for which we have acquired licenses |
| Further, if pending or future patents are issued, they may not be sufficient to provide us with meaningful protection or a commercial advantage |
| Additionally, patents we hold or may hold in the future may be challenged, invalidated or circumvented |
| Moreover, our competitors, many of whom have substantial resources and have made substantial investments in competing technologies, may presently have or may seek patents that will prevent, limit or interfere with our ability to make, use or sell our products in the United States and other countries |
| In addition to patents, we rely on a combination of trade secrets, copyrights and trademarks to protect our intellectual property rights |
| For example, our software (which is an integrated component in the EP-WorkMate^^®^ and EP-4™ Stimulator) is copyrighted; however, existing copyright laws offer only limited practical protection from misappropriation |
| As a result, our competitors may independently develop substantially equivalent proprietary technology |
| If we are unable to pay royalties, we may lose our rights to use certain important technology |
| We have entered into several technology and licensing agreements which require us to pay royalties, including, in some cases, minimum annual royalties |
| If we do not pay these royalties, we may be in breach of our technology agreements and could lose the rights granted to us under these agreements |
| The loss of these rights would affect our ability to make, market and sell the ALERT^^®^ product line and the RPM™ product line, which could have a material adverse affect on our business, results of operations, financial condition and prospects |
| Intellectual property litigation could harm our business |
| We operate in an industry that is susceptible to significant patent and intellectual property litigation and, in recent years, it has been common for companies in the medical device field to aggressively challenge the rights of other companies to prevent the marketing of new devices |
| We may have to defend against third party intellectual property claims or initiate litigation against third parties that are infringing on our patents or other intellectual property rights |
| The result of such litigation could cause us to cancel or delay shipments of any products found to be employing another party’s intellectual property rights, require us to develop alternative technology or require us to enter into costly royalty or licensing agreements |
| Further, if necessary licenses are not available to us on satisfactory terms, we may not be able to redesign our products or processes to avoid any alleged infringement of a third party’s intellectual property rights |
| Accordingly, we could be prevented from manufacturing and selling some of our products |
| Any litigation, with or without merit, to defend against third party patents and other intellectual property claims and litigation initiated by us to protect our patents and other intellectual property rights may be costly for us and time consuming to our management |
| Such costs may be prohibitive and may affect our ability to defend against or initiate patent and other intellectual property 16 ______________________________________________________________________ [43]Table of Contents claims |
| In addition, any litigation of this type might require our management to focus on matters outside of the day-to-day operations of our business |
| Our inability to defend against any type of intellectual property claim or protect our own intellectual property may have a material adverse effect on our business, results of operations and financial condition |
| We face significant competition, and many of our competitors have greater financial, marketing and other resources than we do, which may affect our future success |
| The medical device market, particularly in the area of electrophysiology products, is highly competitive and is characterized by rapid product development and technological change |
| Many of our competitors have access to significantly greater financial, marketing and other resources than we do |
| The greater resources of our competitors could enable them to develop competing products more quickly so as to make it difficult for us to develop a share of the market for these products |
| By having greater resources, our competitors may also be able to respond more quickly to technology changes in the marketplace may be able to better market their products and may be able to obtain regulatory approval for products more quickly than we can |
| Our future success will depend on our ability to remain competitive with other developers of medical devices and therapies |
| Third-party reimbursement might be denied, might ultimately be at levels which effectively reduce our prices, or might be unavailable for some of our products, resulting in a reduction in revenue from the sale of our products |
| Our products are generally purchased by physicians or medical institutions |
| In the United States, third-party payors, such as Medicare, Medicaid and private insurers, are billed for the healthcare services provided to patients using those products |
| Similar reimbursement arrangements exist in several European countries |
| Third-party payors are increasingly challenging the prices charged for medical products and services and are putting pressure on medical equipment suppliers to reduce prices |
| Initiatives to limit the growth of healthcare costs, including price regulation, are also underway in several countries in which we do business |
| Implementation of healthcare reforms in the United States and other countries may limit the price of, or the level at which, reimbursement is provided for our products and adversely affect both our pricing flexibility and the demand for our products |
| Certain procedures involving the EP-WorkMate^^®^, our EP-3™ Stimulator, our EP-4™ Stimulator, our integrated RPM™ Navigation technology, our ALERT^^®^ System product line and our ViewFlex™ catheters currently are eligible for reimbursement at varying levels, some of which will need to increase for us to continue to increase revenues |
| Maintaining and increasing levels of third-party payor reimbursement will likely be tied to economic benefits realized through use of our products and patient outcomes and resulting market acceptance of those products |
| We cannot assure you that significant economic benefits from the use of our products can or will be realized or that patient outcomes from the use of our products will be significantly improved |
| In addition, changes in FDA regulations or in third-party payor policies could limit or reduce reimbursement or make reimbursement unavailable for procedures using our products |
| In any of those events, or if third-party reimbursement does not become available for products we may develop in the future, our business, results of operations and financial condition could be materially adversely affected |
| The success of our business is dependent on our key personnel and the loss of any of these personnel could have a material adverse effect on our business, results of operations and financial condition |
| The success of our business is dependent, to a significant extent, upon the abilities and continued efforts of our senior management team, including David A Jenkins, our President, Chief Executive Officer, Chief Operating Officer and Chairman of our Board of Directors and C Bryan Byrd, our Vice President of Engineering and Manufacturing |
| Our success also depends upon certain of our research and development and other scientific personnel |
| None of our other executive officers or key scientific personnel currently has an employment agreement with us |
| We currently maintain key-man life insurance on Mr |
| Byrd, but there can be no assurance that this policy will be maintained or renewed |
| The loss of any of these persons and the inability to quickly attract replacements for these key personnel could have a material adverse effect on our business, results of operations and financial condition |
| We believe our future success will depend substantially upon our ability to attract and retain highly qualified technical and management personnel |
| We believe that there is and will continue to be intense competition for qualified personnel in this industry |
| We might not be able to attract, manage and retain our sales force and third-party distributors, which may affect our ability to promote and sell our products |
| We utilize our own direct sales and marketing force to sell and promote our products in the United States and France |
| We may not be able to continue to attract, manage and retain a qualified sales and marketing force that can successfully promote our products, which could materially adversely affect our business, results of operations and financial condition |
| We generate sales throughout the rest of the world through a network of independent third-party distributors |
| While we do not consider any single distributor to be material to our business, we might not be able to replace existing distributors on a timely basis, or do so on terms which are commercially reasonable if present relationships are terminated |
| Further, we might not be able to make arrangements with new distributors to access new international markets |
| If our current or future distributors are not successful in actively and effectively marketing our products, it could have a material 17 ______________________________________________________________________ [44]Table of Contents adverse effect on our business and prospects |
| In the fourth quarter of 2005, we terminated our agreements with our Armenian and German distributors and our relationship with our European sales manager |
| The German distributor is contesting the termination, and while we believe its claim is without merit, we cannot, at this time, estimate the costs we may incur in enforcing this termination or the impact on our revenue |
| Our sales in Europe may have been impacted in the fourth quarter of 2005 by the termination of our European sales manager and the termination of these distributor relationships |
| We believe this decrease in sales in Europe may continue until we are able to replace our European manager and distributors |
| Our business could be subject to product liability claims, which, if successful, could have a material adverse effect on our business and financial condition |
| We face an inherent business risk of exposure to product liability and other claims and lawsuits in the event that our technologies or products are alleged to have resulted in adverse effects |
| We may not be able to avoid significant liability exposure as our products are highly complex and some are or will be used in relatively new medical procedures and in situations where there is a potential risk of serious injury, adverse side effects or death |
| In addition, misuse of these products, including the misuse or reuse of our catheters, may increase the risk of a patient experiencing adverse effects and, as a result, the risk of product liability claims |
| We may not have sufficient insurance coverage, and we may not be able to obtain sufficient coverage at a reasonable cost |
| We currently maintain product liability insurance with coverage limits of dlra5cmam000cmam000 per occurrence and dlra5cmam000cmam000 in the aggregate per year |
| We cannot assure you that this coverage is or will be adequate to cover future claims |
| This insurance is expensive and may not be available to us in the future |
| An inability to obtain or maintain product liability insurance at acceptable costs or to otherwise protect against potential product liability claims could prevent or inhibit the commercialization of some or all of our products |
| A successful claim against us or settlement by us in excess of our insurance coverage or our inability to maintain insurance, could have a material adverse effect on our business, results of operations and financial condition |
| We are subject to risks associated with sales in multiple countries |
| We derive a significant portion of our revenues from sources outside the United States |
| In 2005, 2004, and 2003, approximately 23prca, 22prca, and 41prca, respectively, of our net sales were derived from sales outside the United States |
| We expect international sales will continue to represent a significant percentage of our total sales |
| We sell our products in Europe, Japan, Turkey, Saudi Arabia and China, among others |
| While we attempt to mitigate risks associated with international sales, as a result of the significant portion of our revenues derived from such international sales, we are subject to associated risks, including: • United States export license requirements and unauthorized re-export of our products to non-United States approved jurisdictions, non-compliance with which, or the occurrence of which can result in fines, injunctions, civil penalties, recall or seizure of products, total or partial suspension of foreign sales and criminal prosecution, among other things; • currency devaluations and fluctuations in currency exchange rates, particularly in Europe in connection with the euro and pounds sterling; • imposition of, or increases in, customs duties and other tariffs; • inability to definitively determine or satisfy legal requirements; • foreign tax laws and potential increased costs associated with overlapping tax structures; • inability to effectively enforce contract or legal rights; • inability to obtain complete financial, end-user and other information under local legal, judicial, regulatory, disclosure and other systems or from foreign distributors; • unexpected changes in regulatory requirements; • nationalization and other risks, which could result from a change in government or other political, social or economic instability; 18 ______________________________________________________________________ [45]Table of Contents • extended collection periods for accounts receivable; • potentially inadequate protections of intellectual property rights; • restrictions on repatriation of earnings; and • the effects of terrorism, wars or other geopolitical events which, directly or indirectly, impact the demands for products manufactured or sold by United States companies or the global economy generally |
| These risks could have a material adverse effect on our ability to maintain and expand foreign sales |
| Our failure to maintain and expand foreign sales would have a material adverse effect on our business, results of operations and financial condition |
| Our export controls may not be adequate to ensure compliance with United States export laws, especially when we sell our products to distributors over which we have limited control |
| The United States government has declared an embargo that restricts the export of products and services to a number of countries, including Iran, Syria, Sudan and Cuba, for a variety of reasons, including the support by these countries of terrorism |
| We sell our products through distributors in Europe, Asia and the Middle East, and in such circumstances, the distributor is responsible for interacting with the end user of our products, including to assist in the set up of any products purchased by such end user |
| In order to comply with United States export laws, we have instituted export controls including training for our personnel in export restrictions and requirements, appointing an export control officer to oversee our export procedures, executing agreements with our distributors that include defining their territory for sale and requirements pertaining to United States export laws, obtaining end user information from our distributors and screening it to restricted party lists maintained by the United States government |
| While we believe that these procedures are adequate to prevent the export or re-export of our products into countries under embargo by the United States government, we cannot assure you that our products will not be exported or re-exported by our distributors into such restricted countries |
| In particular, our control over what our distributors do with our products is necessarily limited, and we cannot assure you that they will not sell our products to an end user in a country in violation of United States export laws |
| Any violation of United States export regulations could result in substantial legal, consulting and accounting costs, and significant fines and/or criminal penalties |
| In the event that our products are exported to countries under a United States trade embargo in violation of applicable United States export laws and regulations, such violations, costs and penalties or other actions that could be taken against us could adversely affect our reputation and/or have an adverse effect on our business, financial condition, prospects or results of operations |
| We have sold and may continue to sell, with a license, our products into countries that are under embargo by the United States and as a result have incurred and may continue to incur significant legal, consulting and accounting fees and may place our Company’s reputation at risk |
| United States export laws permit the sale of medical products to certain countries under embargo by the United States government if the seller of such products obtains a license to do so, which requirements are in place because the United States has designated such countries as state sponsors of terrorism |
| Certain of our products have been sold in Syria under license through a distribution agreement with an independent distributor |
| In addition, certain of our products were distributed in Iran without United States governmental authorization |
| The aggregate revenue generated by sales of our products into Syria and Iran have been immaterial to our business and results of operations |
| We may continue to supply medical devices to Syria and other countries that are under embargo by the United States government upon obtaining all necessary licenses |
| We do not believe, however, that our sales into such countries will be material to our business or results of operations |
| There are risks we face in selling to countries under United States embargo, including, but not limited to, possible damage to our reputation for sales to countries that are deemed to support terrorism, and failure of our export controls to limit sales strictly to the terms of the relevant license, which failure may result in civil and criminal penalties |
| In addition, we may incur significant legal, consulting and accounting costs in ensuring compliance with our export licenses to countries under embargo |
| Any damage to our reputation from such sales, failure to comply with the terms of our export licenses or the additional costs we incur in making such sales could have a material adverse impact on our business, financial condition, prospects or results of operations |
| 19 ______________________________________________________________________ [46]Table of Contents Sales of our products into Iran are under investigation by the United States Department of Commerce, and we cannot assure you that such investigation will not result in significant fines or penalties that could have a material adverse effect on the Company’s business, financial condition, prospects, or results of operations |
| The United States Department of Commerce has requested certain information relating to, and is conducting an investigation into, certain sales of our products into Iran |
| In addition, the Commission is conducting an informal inquiry to determine whether there have been violations of certain provisions of the federal securities laws in connection with the Company’s financial and accounting reporting, including relating to disclosures the Company made in its Form 8-K filed with the Commission on August 12, 2005 regarding the ongoing government investigation of sales by the Company of its products into Iran |
| We are cooperating fully with the federal government in connection with these matters |
| In addition, the United States Department of Justice, through the United States Attorney’s Office for the District of New Jersey, had also requested certain information and had initiated an investigation into the sales of our products into Iran |
| In March 2006, the United States Attorney’s Office for the District of New Jersey informed the Company that it will not prosecute the Company in connection with this matter |
| Based on the Company’s investigation of these matters to date, management believes that a limited number of the Company’s heart monitor systems were distributed to medical facilities in Iran without United States governmental authorization |
| We believe the aggregate revenues generated by these transactions were not material to the Company’s cumulative financial results during the period in which the transactions occurred |
| At this time, we do not have a license to sell products in Iran and have not entered into any agreements with distributors to distribute our products in Iran |
| We have incurred legal, consulting and accounting expenses associated with the investigations by the United States Department of Justice, Department of Commerce and the Commission, amounting to dlra911cmam000 in the third quarter of 2005 and dlra519cmam000 in the fourth quarter of 2005 |
| We cannot assure you that the ongoing investigations by the Department of Commerce and the Commission will not result in significant costs, fines or penalties that could have a material adverse effect on our business, financial condition, prospects, or |