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Executives

Michael McKelvey - President and Chief Executive Officer

Keith Schneck - Executive Vice President and Chief Financial Officer

Analysts

Eugene Mannheimer - Auriga USA

eResearchTechnology Inc. (ERES) Q1 2009 Earnings Call April 30, 2009 5:00 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the ERT Report First Quarter 2009 Results. My name is Eric. I will be your audio coordinator for today. At this time, all participants are in listen-only mode. We will facilitate a question-and-answer session at the end of the presentation. [Operator instructions]. I would now like to turn your presentation over to Mr. Michael McKelvey, President and CEO. Please proceed.

Michael McKelvey

Thank you Eric. Good afternoon. Thank you for joining us for ERT's first quarter 2009 earnings results conference call. A press release announcing the first quarter of 2009 results was released this afternoon and is available on the ERT and most financial websites.

Joining me today is Keith Schneck, Executive Vice President and Chief Financial Officer.

Prior to beginning the call, I would like to read the forward-looking event statement. When used in this conference call, words such as anticipate, could, estimate, expect, intend, may, will, would, believe, or other similar expressions are intended to identify forward-looking statements. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those expressed or implied in the forward-looking statements.

Factors that might cause such a difference include unfavorable economic conditions; our ability to obtain new contracts and accurately estimate net revenues, variability in size, scope, and duration of projects and internal issues of the sponsoring client; integration of acquisitions, competitive factors, technological development and market demand. There is no guarantee that the amounts in our backlog will ever convert to revenue. Should the current economic conditions continue or deteriorate further, the cancellation rates that we have historically experienced could increase.

Further information on potential factors that could affect the company's financial results can be found in the company's reports on Form 10-K and Form 10-Q filed with the Securities and Exchange Commission. Guidance is based on management's good faith expectations given current market conditions, but that continued or further deterioration of general economic conditions in addition to other factors cited elsewhere could result in the company not achieving the revenue and diluted net income per share guidance provided.

Our forward-looking statements speak only as of the date made. We do not undertake and expressly disclaim any obligations to update forward-looking statements to reflect events or circumstances after the dates of the statements except as required by law. You are cautioned not to place undue reliance on our forward-looking statements.

I will first give highlights for the quarter and details of new bookings and our business lines. Keith will then discuss the detailed financials for the quarter and provide guidance for the second quarter of 2009 and the full year 2009. I will then give some general reflections on our business and then open up the call to questions.

The first quarter of 2009 was in line with our expectations. The quarter continued to show signs of the delayed decision making and push outs in trial starts that we have discussed on previous calls. This a reflection of the current economic and financial environment. Revenues for the first quarter of 2009 were $23.8 million, down 29.4% from the first quarter of 2008. The decline in revenue was largest in Thorough QT area but was also seen in the routine trial area and side support.

As a reminder Thorough QT trails are relatively large and have quick revenue burn off periods. They can be run anywhere after Phase I in the drug development spectrum. Although the timing of when Thorough QT trails are performed is within the discretion of the sponsor, regulatory guidance ultimately requires that they'd be performed prior to the submission of the NDA.

What we have seen over the last months is that some pharmaceuticals and biotechnology companies specially the smaller ones are postponing the signing of Thorough QT contracts and the start dates of some of these trails in order to preserve cash. We saw a similar pattern in the 2005 to 2006 period when Thorough QT trials were delayed to the uncertainty about the ICH E14 guidance and were eventually performed over the next couple of years.

The decline in revenue was all set by significant cost reductions reflecting our focused expense management efforts as well as our reduction in expenses from our shutdown of the Covance Cardiac Safety Services or CCSS operations. Our gross margin percentage was 50.4% in the first quarter of 2009, down slightly from the 52.5% in the first quarter of 2008. We were pleased be able to sustain favorable margins in the face of the significant decline in revenue.

Operating income margin percentage was 14.0% in the quarter, compared to 25.2% a year ago. Diluted net income per share was $0.04, down from $0.11 in the first quarter of 2008. In the quarter we generated 9.1 million in cash flow from operations, with free cash flow of 7.5 million. In the quarter we did a good job in collecting cash and in managing our cost in this challenging environment.

New bookings for the first quarter were 31.2 million. New bookings were down from the 50.1 million in the first quarter of 2008. This decline was driven primarily by the uncertain business environment and delayed decision making that we noted last quarter. The largest percentage drop in new bookings were in Thorough QT bookings. In the first quarter 9% of our bookings were in Thorough QT trials. This compares to 18% in the first quarter of 2008 and 14% in the fourth quarter of 2008.

In the first quarter of 2009 42% of our bookings were in Phase III or Phase IV compared to 51% in the first quarter of 2008 and 59% in the fourth quarter of 2008, 28% of our new bookings were in Phase II compared to 10% in the first quarter of 2008 and 17% in the fourth quarter of 2008. 18% our new bookings and first quarter of 2009 were in Phase I compared to 16% in the first quarter of 2008, and 9% from the fourth quarter of 2008.

Providing further details on bookings, large pharmaceutical and biotech companies continued to dominate the bookings numbers. 69% of the first quarter bookings were from top 30 Pharma compared to 52% a year ago. As usual Phase III bookings accounted for the largest percentage of new bookings. But we did a see a significant uptick in the percentage of new bookings in Phase I and in Phase II. We are not sure if this is a trend or not, bookings by phase have the significant volatility.

However we are somewhat heartened by the increase in Phase I and Phase II booking as this is an indicator of potential increase Thorough QT studies in the future. We saw a slightly increased volume of proposals in the first quarter of 2009, compared with the first quarter of 2008 and also compared to the fourth quarter of 2008. We continue to see no demand from sponsors for using an automated methodology in our bookings numbers.

The pricing environment is a bit mixed. Our average booking prices have been stable over the past few quarters. We do expect to see some downward pressure on prices in the future as price increasingly has become a focus of many of our discussions with clients. However, negotiation of price declines generally come with some anticipated increase in volume. In addition, we continue to see that quality of service is still the number one decision criteria in our sponsor's minds. We feel that we continue to be the market leader in these key criteria.

The gross book-to-bill ratio in the first quarter of 2009 was 1.3 down from 1.5 in the first quarter of 2008. The cancellation rate in the first quarter was an annualized 22.4% as compared to 19.3% in the fourth quarter of 2008 and 15.6% in the first quarter of 2008.

A significant factor in the increased cancellation rate was one large program of multiple studies from a mid-sized pharmaceutical company. This program had to be amended and will be re-submitted to the regulatory authorities. Cancellation rate we report is a fully factor cancellation rate that consist of the actual value of study cancellations, with the value of studies that are completed and amounts under the original contracted value all divided by the beginning period backlog. The majority of our cancellations were in small to medium sized Pharma. Our backlog at the end of the first quarter was a $157.0 million.

In terms of the new business environment we've seeing different trends between large pharmaceutical companies and smaller to mid-sized pharmaceutical and biotech companies. Large pharmaceutical companies are still spending, albeit at a slightly slower pace, while engaging their suppliers in most strategic outsourcing discussions. As we reported on the last call we have engaged several large pharmaceutical companies in strategic outsourcing discussions.

In the first quarter we concluded negotiations on long term partnerships with two additional large pharmaceutical companies. Smaller pharmaceutical companies are sometimes experiencing funding issues that make them more cautious than committing scarce cash to certain compounds. Especially those compounds with less bright future prospects. We find that our reputation for quality and our strong financial position are especially important in these uncertain times.

Companies are focusing on outsourcing their key development programs to companies that will be around for the next couple of years and that are substantial have a substantial accumulated experience in helping get drugs approved through regulatory agencies.

ERTs leadership position in the market, in quality, scientific and medical leadership, project execution and use of advanced technology gives our clients a strong reason to continue to utilize our services. We continue to see increasing revenue contribution from our April business, driven by interest in our Suicidality Monitoring System, reflecting the emphasis of the FDA on prospective assessments for suicidality on products under the osmosis (ph) of the division physiatrist products.

I will now turn the call over to Keith for some more details on our financials for the first quarter of 2009 and guidance for the second quarter and full year of 2009.

Keith Schneck

Thanks, Mike. First quarter revenues were $23.8 million, 29.4% decrease from the $33.7 million in the first quarter of 2008, and a 20.9% sequential drop from the $30.1 million in the fourth quarter of 2008. The year-over-year and sequential revenue decline is due to the following in the order of their significance. One, decline in the Thorough QT revenue, two, a decline in routine revenue, and three runoff of the CCSS acquired backlog.

We also had $800,000 less in equipment sales in the first quarter of 2009 than in the first quarter of 2008. For the first quarter of 2009 our Cardiac Safety Service revenue was 15.6 million compared to 23.8 million a year ago and down from 20.0 million in the fourth quarter of 2008. Site support was 6.3 million compared to 7.8 million a year ago and 7.5 million in the fourth quarter of 2008.

Our eClinical business which includes license technology consulting and training in software maintenance within our EDC and ePRO business units totaled 1.9 million compared to 2.1 million a year ago and 2.6 million in the fourth quarter of 2008. Our eClinical revenue is down primarily because of a change in classification of revenue that was previously included in technology consulting and training category. Our prior classification added about $500,000 per quarter to the eClinical revenue and was not made beginning in 2009 as this revenue is now part of Cardiac Safety revenue.

Gross margin percentage for the first quarter of 2009, was 50.4% compared to 52.5% a year ago and 57.3% in the fourth quarter of 2008.

Gross margin percentage is significantly impacted by volume. The negative impacts of volume on the gross margin percentage compared to the prior year's quarter was partially offset by the elimination of legacy costs associated with processing the CCS backlog that we acquired last year and lower depreciation and amortization.

Operating expenses for the first quarter were $8.7 million, with 36.4% of revenue compared to $9.2 million or 27.3% of revenue a year ago and 8.6 million in the fourth quarter of 2008. Our operating expenses were down year-over-year partially due to the elimination of the transition costs related to CCSS which totaled 1.3 million in the first quarter of 2008, offset by increases in the current quarter for stock option expense, marketing programs, legal an accounting, reserve for uncollectible accounts and other costs.

Our fourth quarter 2008 operating expenses did include some one time items that were not incurred in the first quarter of 2009 such as sales in used tax provision and duplicate facility costs. However, these were offset with the previously mentioned spending increases in the March 2009 quarter.

Let me now move to the balance sheet. ERT ended the quarter with 65.6 million in cash and investments, a slight decrease from the 66.4 million reported at year end 2008. For the first quarter of 2009, net cash provided by operating activities was 9.1 million, which included the impact of reduction of accounts receivable due to the lower revenue levels and focus collection efforts on older items.

During the first quarter, we purchased 1,965,452 shares of ERT common stock at an average price of $5.05 for a total of $10 million under our stock buyback program. 1.8 million of the stock purchase price was settled in April 2009, and is included in accounts payable as of March 31. At this time we have authorization to purchase up to an additional 5.9 million shares.

Accounts receivable were $21.7 million down from $29.2 million on December 31, 2008. DSO's were 82 days down from 87 days in the fourth quarter of 2008. We continued to focus additional resources on improving collection and billing processes with goal of bring down DSO's. We received some major payments on significant older outstanding items just after quarter close.

Given the uncertain economic environment we continued to perform a more detailed review of credit risks and evaluation of the collectibility of individual amounts. We consider our receivable balances to be of good quality and do not have undo concern with collectibility from our customers. We did increase our reserve this quarter on several smaller customers but nothing of significance.

Now for guidance; for the second quarter of 2009 and for the year ending December 31, 2009. As we indicated in the press release and in our call last quarter we continue to see several factors that have negatively impacted our business, continuing into the near future including the cautious and delayed decision making, the decline in Thorough QT bookings and delays in the starts of Thorough QT trials, and a shift to a larger percentage of Phase III bookings, which will take a longer period to turn into revenue.

For the second quarter of 2009 ERT anticipates net revenues of between 23 million and $26 million and diluted net income per share of between $0.03 and $0.06 per share. For the full year ending December 31, 2009 we anticipate net revenues of between $100 million and $115 million, and diluted net income per share of between $0.20 and $0.35 per share. We have reduced our revenue guidance and diluted net income per share guidance due to the lower level of overall bookings in the first quarter and specifically weakness in the Thorough QT bookings.

Additionally we anticipate that Thorough QT bookings will remain soft in the second quarter, resulting in lower revenue expectations for the second half of 2009. As we have said before the primary variable in our guidance is in Thorough QT. The lower end of the guidance assumes continued low levels of bookings in Thorough QT's the upper end of the rage assumes a quicker pick up in bookings over the next several months

Our routine business provides a strong foundation given the present backlog and new customer relationships established in the later half of 2008 and into 2009. We have made spending cuts in selected areas including staffing, where we have not been replacing employees who have resigned. We are consolidating some of our operations within our Philadelphia center. We have negotiated lower costs from service providers and we are reducing the level of outside consultants.

Our effective tax rate is expected to be 40% in 2009, an increase of about two percentage points from 2008. The 2000 rate was impacted by the favorable tax adjustments that reduced the 2008 effective rate by about two percentage points, and such adjustments will not occur in 2009.

I will now turn the call back to Mike.

Michael McKelvey

Thanks, Keith. As we mentioned at the beginning of the call, we are currently operating in an economic and financial environment. This manifests itself in our business in many ways, but three in particular stand out. First, many of our clients are exhibiting caution in making new spending and cash outlay decisions on projects whose timing to both book and to start is somewhat discretionary, such as Thorough QT studies.

Second, clients have been much more focused on funding Phase III trials. Since these trials can take up to four to five years to complete, they take longer to turn into revenue than other types of trials.

Third, the general economic environment makes clients cautious on spending in general. We believe that most of these are timing factors. The confluence of these three factors lead to an anticipated decline in revenues in 2009, relative to 2008. Despite these challenges we are continuing to position ERT for the future. We mentioned in last quarters call our increased expenditures in marketing. One indication of the success to this is that in the first quarter of 2009 we had a ten-fold increase in the number of ERT press clippings generated compared to the first quarter of 2008.

The client reaction to our new seminars on cardiac safety and oncology and the use of ePRO for assessing suicidality in new drugs has been well received. We feel that 2009 could be a good opportunity to increase our market share and increase the market penetration of ECG essentially collected in clinical trials. We have taken some steps in this direction that we believe will bear fruit throughout the year. We feel that in a difficult economic and financial time innovative market leaders can prosper and position themselves for increased growth in the future.

Looking at the bigger picture the four growth drivers that we have discussed in the past. Growth in Pharma and Biotech R&D spending, increased centralization of ECGs, increased focus on cardiac safety and increase in market share are as valid as ever. While two of these growth drivers; growth in Pharma and Biotech R&D spending and increased focus on cardiac safety are out of our direct control, it will continue to be important for our future growth.

We're optimistic that the growth in Pharma and Biotech R&D spending will pick up in 2010 and beyond. In terms of the increased focused on cardiac safety a good example of this is the December 2008 guidance issued by the FDA, that will require sponsors to evaluate the cardiac safety risk on all new anti-diabetic therapies for Type II diabetes.

We've already signed several new contracts associated with this guidance.

Turning to the drivers that we can directly control, we believe that the current environment gives us an opportunity to accelerate the growth in the other two factors. Increased centralization of ECGs and increase in market share. Over the past few months we've been increasingly engaged by a large by large top 30 Pharma companies in strategic outsourcing discussions. This discussions are centered on establishing long-term exclusive or near exclusive enterprise wide relationships with only one or two preferred suppliers and driving increased volumes to these suppliers.

We reported last quarter that we've seen success in these discussions and this continued into the first quarter. We concluded negotiations with two additional long term partnerships with top 20 Pharma clients. We believe that this will position us well for the future. We see an increased movement to large global providers. We are only one of a few firms that have the global capabilities to support large, complex global centralized cardiac safety projects. Last quarter we ran over 500 studies, worked with nearly 25,000 sites and maintained nearly 20,000 ECG devices around the globe. We supported sites (ph) in 89 countries around the world.

In closing we believe that we are well-positioned to work throughout the current economic and financial environment and come out a stronger company. We have a strong debt-free balance sheet, we are the market leader in our industry, we have a reputation enhanced for project management quality, and continue as the thought leaders in the industry. These factors position us well to take advantage of the current regulatory and development climate that seeks to enhance the safety determination of new drugs.

While we may see other delays in the future due to potential funding issues. We believe that the long term fundamentals of our industry and ERT's position in the industry are strong. We find in today's uncertain economic climate that our clients are more determined than ever to work with the established partners who have proven track records of implementing tried and true solutions, with proven substantial experience of submitting data to the regulatory authorities. With that we will now take any questions. Operator.

Question-and-Answer Session

Operator

Thank you (Operator Instructions) Your first question comes from the line of Eugene Mannheimer with Auriga. Please proceed.

Eugene Mannheimer - Auriga USA

Thanks good afternoon. Couple of questions first; Mike as we've kind of gone through this reporting season the number of CRO's that have reported earnings, discussed certainly the difficult environment that more over just increases in cancellation rates from the neighborhood of 20% to as much as 45%. So, goes without saying that you saw your cancellation rates trend up sequentially as well. Can you comment on what type of cancellation factors so to speak you're building into your guidance for '09? Thanks.

Michael McKelvey

Thank you Gene. We normally build in a 20% cancellation rate in our forecasting in the future and we will probably continue to do that and maybe slightly -- maybe you can say higher this year just because of there, as you said the trending up. As we said in the prepared remarks there were one very large customer that they cancelled a series of programs. Hopefully those will comeback online. And then there was another large cancellation from a small Biotech or so also. That's the real color on the cancellations Gene.

Eugene Mannheimer - Auriga USA

Okay Mike. And then as we move to the Thorough QT bookings certainly effecting the quarter and the outlook at 9% of bookings, I believe this is the lowest ever I mean since you've been doing Thorough QTs is that right?

Michael McKelvey

I believe that's true, Gene. Yes.

Eugene Mannheimer - Auriga USA

Okay. So, can -- is it safe to say that we've sort of hit the bottom here and things should resume in the back half or were you kind of expecting this type of pattern for the next couple of quarters?

Michael McKelvey

We believe to the best of ability and as we look at our pipeline from the business perspective that the second half of the year certainly should be a lot stronger than the first half for the year. As you can see in our revenue guidance we're assuming that the second half would be slightly better than the -- second quarter will be slightly better than the first quarter. But we do believe that the delayed decisions making will loosen up a little bit, once when funding specially for smaller to mid-sized Pharma becomes a little more available in the second half of the year, yes.

Eugene Mannheimer - Auriga USA

Okay. So if I'm interpreting it right Mike the flipside of the coin is that the demand is not going away, but you're seeing a delay. So in effect you could see a resurgence or pent up demand for these Thorough's once the market opens up a little bit, is that the right way to look at it?

Michael McKelvey

I think so Gene, that we're tracking as many thorough now as we track well say a year ago. And the business development folks tell me that the number of proposals out there are as strong as they have been in the last two quarters. So I think it really is a question of delays in decision making and hopefully a lot of those proposals will not be cancelled before they are ordered.

Eugene Mannheimer - Auriga USA

Okay and sounds like just deferrals, cautious spending and I shouldn't interpret this as any competitive losses, is that right?

Michael McKelvey

That's right, we do not believe that any the reduction at business development is due to our lack of competitiveness vis-à-vis our competitors now.

Eugene Mannheimer - Auriga USA

Very good and then a financial question and I'll give up the mike here, but certainly you had no demand again for automated methodologies but it sounds like that's something that's sort of a not an if, but a when in terms of when that proliferates. What is your opinion on when automated may go mainstream and how is your cost structure equipped to offer a lower priced service when it comes to fruition? Thanks.

Michael McKelvey

Okay Gene. We believe that if it comes online and main line it would be a number years. I don't want to go out in the limit say the number, but it would certainly be a significant number of years. Not the say that people may -- may not try the automatic method in the next year or two. But we today have seen no interest in any of our sponsors in the automatic method.

As we talked about on previous calls should the automatic method come into play in a number of years we will structure our organization around that. We know the cost structure of our organization extremely well and we know the changes we would need to make -- that would be indicative the change to an automatic algorithm or so. So we're well aware of what we need to do there.

Eugene Mannheimer - Auriga USA

All right good deal. Thanks gentlemen.

Michael McKelvey

Sure.

Operator

(Operator Instructions) It appears we have no audio questions at this time I would like to turn the call over for closing remarks.

Michael McKelvey

Thank you. And thank you all very much for your attention today and your involvement in ERT. We appreciate your vote of confidence throughout the years. Keith and I as well as the other members of ERT's management team and Board are deeply committed to the company and to continuing our momentum in progress and generating results. Have a great evening and a great rest of the week. Thank you.

Operator

And thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.

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