** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

**FORM 10-Q**

** **
| ý                                                      | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934** |                                                                                                               |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------|
|                                                        | ** ** | ** **                                                                                                             | ** **                                                                                                         |
| **For the quarterly period ended September 30,  2005** |       |
| ** **                                                  | ** ** | ** **                                                                                                             |                                                                                                               |
| **OR**                                                      |       |
| ** **                                                  | ** ** | ** **                                                                                                             |                                                                                                               |
|                                                        | o          | ** **                                                                                                             | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF  1934** |
|                                                             |            |                                                                                                                        |                                                                                                                    |  |  |  |

** **

**Commission File Number: 000-50839**

** **

**PhaseForward Incorporated**

(Exact name of registrant as specified in its charter)

 
| **Delaware**                                                    | ** ** | **04-3386549**                        |
|-----------------------------------------------------------------|------------|---------------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
|                                                            |       |                                  |
| **880 Winter Street  Waltham, Massachusetts**                   | ** ** | **02451**                             |
| (Address of principal executive offices)                        |       | (Zip Code)                            |

 

**(888) 703-1122**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.

 

Yes  ý  No  o

 

Indicate by check mark whether theregistrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).

 

Yes  o  No  ý

 

Indicate by check mark whether theregistrant is a shell company (as defined in Rule 12b-2 of the ExchangeAct).

 

Yes  o  No  ý

 

Asof November 2, 2005, the registrant had 33,430,611 shares of Common Stockoutstanding.

 

 

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**PHASEFORWARD INCORPORATEDQUARTERLY REPORT ON FORM 10-QFor the quarterly period ended September 30, 2005Table of Contents**

** **
| **Part I—Financial Information** | 3                                                                                                                      |
|--------------------------------------------|------------------------------------------------------------------------------------------------------------------------|
| Item  1.                                   | Condensed Consolidated Financial  Statements (unaudited)                                                               | 3 |
|                                       | Condensed Consolidated  Balance Sheets as of December 31, 2004 and September 30, 2005                        | 3 |
|                                       | Condensed Consolidated  Statements of Operations for the three and nine months ended  September 30, 2004 and 2005 | 4 |
|                                       | Condensed Consolidated Statements  of Cash Flows for the nine months ended September 30, 2004 and 2005            | 5 |
|                                       | Notes to Condensed  Consolidated Financial Statements                                                                  | 6 |
| Item 2.                                    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                            | 20 |
| Item 3.                                    | Quantitative  and Qualitative Disclosures about Market Risk                                                            | 49 |
| Item 4.                                    | Controls and Procedures                                                                                                | 50 |
| **Part II—Other Information**    | 51                                                                                                                     |
| Item 2.                                    | Unregistered  Sales of Equity Securities and Use of Proceeds                                                           | 51 |
| Item 4.                                    | Submission  of Matters to a Vote of Security Holders                                                                   | 51 |
| Item  5.                                   | Other  Information                                                                                                     | 51 |
| Item  6.                                   | Exhibits                                                                                                               | 52 |
| Signatures                                 | 53                                                                                                                     |
| Exhibit Index                         | 54                                                                                                                     |

 

2

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**Part I—FinancialInformation**

** **

**Item 1.****                         ****Condensed Consolidated Financial Statements (unaudited)**

** **

**PhaseForward Incorporated and Subsidiaries**

** **

**Condensed ConsolidatedBalance Sheets**

** **

**(unaudited)**

** **

**(inthousands, except per share amounts)**

 
| ** **                                                                                          | ** ** | **As of   December 31,  2004** | ** ** | **As of  September 30,  2005** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|-----------------------------------------------|------------|------------------------------------------|------------|
| **Assets**                                                                                          |       |                                          |       |                                     |       |
| Current assets:                                                                                     |       |                                          |       |                                     |       |
| Cash and cash  equivalents                                                                          |       | $                                             | 53,485     |                                     | $          | 44,605 |   |
| Short-term  investments                                                                             |       | 4,735                                         |       | 10,592                                   |       |
| Accounts  receivable, net of allowance of $391 and $323 in 2004 and 2005, respectively              |       | 19,682                                        |       | 18,817                                   |       |
| Deferred set up  costs, current portion                                                             |       | 783                                           |       | 1,076                                    |       |
| Prepaid  commissions and royalties, current portion                                                 |       | 3,035                                         |       | 3,528                                    |       |
| Prepaid expenses  and other current assets                                                          |       | 2,335                                         |       | 2,694                                    |       |
| Total current assets                                                                                |       | 84,055                                        |       | 81,312                                   |       |
| Property and equipment, net                                                                         |       | 5,717                                         |       | 6,234                                    |       |
| Deferred set up costs, net of current  portion                                                      |       | 665                                           |       | 941                                      |       |
| Prepaid commissions and royalties, net of  current portion                                          |       | 2,756                                         |       | 2,614                                    |       |
| Goodwill                                                                                            |       | 21,817                                        |       | 27,177                                   |       |
| Intangible assets, net of accumulated  amortization of $89 in 2005                                  |       | —                                        |       | 3,811                                    |       |
| Other assets                                                                                        |       | 240                                           |       | 182                                      |       |
| Total assets                                                                                        |       | $                                             | 115,250    |                                     | $          | 122,271 |   |
|                                                                                                |       |                                          |       |                                     |       |   |   |
| **Liabilities and Stockholders’ Equity**                                                       |       |                                          |       |                                     |       |
| Current Liabilities:                                                                                |       |                                          |       |                                     |       |
| Current portion  of notes payable                                                                   |       | $                                             | 2,558      |                                     | $          | — |   |
| Accounts payable                                                                                    |       | 1,619                                         |       | 1,322                                    |       |
| Accrued expenses                                                                                    |       | 11,658                                        |       | 12,983                                   |       |
| Restructuring  accrual                                                                              |       | 344                                           |       | —                                   |       |
| Deferred revenue,  current portion                                                                  |       | 35,350                                        |       | 36,567                                   |       |
| Deferred rent,  current portion                                                                     |       | 142                                           |       | 363                                      |       |
| Total current liabilities                                                                           |       | 51,671                                        |       | 51,235                                   |       |
| Notes payable, net of current portion                                                               |       | 1,849                                         |       | —                                   |       |
| Deferred revenue, net of current portion                                                            |       | 1,002                                         |       | 2,252                                    |       |
| Deferred rent, net of current portion                                                               |       | 1,481                                         |       | 1,079                                    |       |
| Total liabilities                                                                                   |       | 56,003                                        |       | 54,566                                   |       |
| Contingencies (Note 14)                                                                             |       |                                          |       |                                     |       |
| Stockholders’ equity:                                                                          |       |                                          |       |                                     |       |
| Preferred stock,  $0.01 par value:                                                                  |       |                                          |       |                                     |       |
| Authorized—5,000  shares Issued—0 shares                                                  |       | —                                        |       | —                                   |       |
| Common stock,  $0.01 par value:                                                                     |       |                                          |       |                                     |       |
| Authorized—100,000  shares Issued—32,399 and 33,387 shares in 2004 and 2005, respectively |       | 324                                           |       | 334                                      |       |
| Additional  paid-in capital                                                                         |       | 165,462                                       |       | 167,874                                  |       |
| Subscription  receivable                                                                            |       | (127                                          | )          | —                                   |       |
| Deferred  stock-based compensation                                                                  |       | (1,755                                        | )          | (802                                     | )          |
| Treasury stock,  37 shares at cost                                                                  |       | (111                                          | )          | (111                                     | )          |
| Accumulated other  comprehensive loss                                                               |       | (160                                          | )          | (680                                     | )          |
| Accumulated  deficit                                                                                |       | (104,386                                      | )          | (98,910                                  | )          |
| Total stockholders’ equity                                                                     |       | 59,247                                        |       | 67,705                                   |       |
| Total liabilities  and stockholders’ equity                                                    |       | $                                             | 115,250    |                                     | $          | 122,271 |   |

 

See accompanying notes.

 

3

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**Phase ForwardIncorporated and SubsidiariesCondensed Consolidated Statements of Operations(unaudited)(in thousands, except per share amounts)**

 
| ** **                                                                                  | ** ** | **Three Months  Ended  September 30,** | ** ** | **Nine  Months   Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2004**                                         | ** ** | **2005**                                          | ** ** | **2004** | ** ** | **2005** | ** ** |
| Revenues:                                                                                   |       |                                             |       |                                              |       |   |   |   |   |
| License                                                                                     |       | $                                                | 7,352      |                                              | $          | 8,637 |   | $ | 19,875 |   | $ | 26,088 |   |
| Service                                                                                     |       | 11,657                                           |       | 13,605                                            |       | 33,789 |   | 37,414 |   |
| Total revenues                                                                              |       | 19,009                                           |       | 22,242                                            |       | 53,664 |   | 63,502 |   |
| Costs of revenues:                                                                          |       |                                             |       |                                              |       |   |   |   |   |
| License                                                                                     |       | 501                                              |       | 722                                               |       | 1,371 |   | 1,759 |   |
| Service(1)                                                                                  |       | 6,890                                            |       | 7,799                                             |       | 20,513 |   | 22,475 |   |
| Total costs of revenues                                                                     |       | 7,391                                            |       | 8,521                                             |       | 21,884 |   | 24,234 |   |
| Gross margin:                                                                               |       |                                             |       |                                              |       |   |   |   |   |
| License                                                                                     |       | 6,851                                            |       | 7,915                                             |       | 18,504 |   | 24,329 |   |
| Service                                                                                     |       | 4,767                                            |       | 5,806                                             |       | 13,276 |   | 14,939 |   |
| Total gross margin                                                                          |       | 11,618                                           |       | 13,721                                            |       | 31,780 |   | 39,268 |   |
| Operating expenses:                                                                         |       |                                             |       |                                              |       |   |   |   |   |
| Sales and  marketing(1)                                                                     |       | 3,509                                            |       | 3,897                                             |       | 10,350 |   | 11,808 |   |
| Research and  development(1)                                                                |       | 3,170                                            |       | 3,653                                             |       | 9,124 |   | 10,423 |   |
| General and  administrative(1)                                                              |       | 3,963                                            |       | 3,937                                             |       | 9,509 |   | 10,959 |   |
| Restructuring                                                                               |       | —                                           |       | —                                            |       | — |   | (92 | ) |
| Total operating expenses                                                                    |       | 10,642                                           |       | 11,487                                            |       | 28,983 |   | 33,098 |   |
| Income from operations                                                                      |       | 976                                              |       | 2,234                                             |       | 2,797 |   | 6,170 |   |
| Other income (expense):                                                                     |       |                                             |       |                                              |       |   |   |   |   |
| Interest income                                                                             |       | 138                                              |       | 449                                               |       | 310 |   | 1,236 |   |
| Interest expense                                                                            |       | (45                                              | )          | —                                            |       | (255 | ) | (144 | ) |
| Other, net                                                                                  |       | (143                                             | )          | (79                                               | )          | (72 | ) | (220 | ) |
| Total other income (expense)                                                                |       | (50                                              | )          | 370                                               |       | (17 | ) | 872 |   |
| Income before provision for income taxes                                                    |       | 926                                              |       | 2,604                                             |       | 2,780 |   | 7,042 |   |
| Provision for income taxes                                                                  |       | 604                                              |       | 434                                               |       | 1,645 |   | 1,566 |   |
| Net income                                                                                  |       | 322                                              |       | 2,170                                             |       | 1,135 |   | 5,476 |   |
| Accretion of preferred stock and dividend  declared                                         |       | 417                                              |       | —                                            |       | 8,953 |   | — |   |
| Net income (loss) applicable to common  stockholders                                        |       | $                                                | (95        | )                                                 | $          | 2,170 |   | $ | (7,818 | ) | $ | 5,476 |   |
| Net income (loss) per share applicable to  common stockholders:                             |       |                                             |       |                                              |       |   |   |   |   |
| Basic                                                                                       |       | $                                                | —     |                                              | $          | 0.07 |   | $ | (0.70 | ) | $ | 0.17 |   |
| Diluted                                                                                     |       | $                                                | —     |                                              | $          | 0.06 |   | $ | (0.70 | ) | $ | 0.16 |   |
| Weighted average  number of common shares used in net income (loss) per share calculations: |       |                                             |       |                                              |       |   |   |   |   |
| Basic                                                                                       |       | 26,249                                           |       | 32,241                                            |       | 11,149 |   | 32,856 |   |
| Diluted                                                                                     |       | 26,249                                           |       | 35,307                                            |       | 11,149 |   | 34,827 |   |

 

----

| (1)   Amounts include stock-based expenses, as  follows: |   |   |   |   |   |   |   |   |   |
|--------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                                               |   |   |   |   |   |   |   |   |   |
| Costs of service  revenues                                         |   | $      | 26     |   | $      | 11     |   | $      | 76     |   | $ | 48 |   |
| Sales and  marketing                                               |   | 31     |   | 28     |   | 111    |   | 24     |   |
| Research and  development                                          |   | 69     |   | 36     |   | 248    |   | 131    |   |
| General and  administrative                                        |   | 558    |   | (2     | )      | 1,168  |   | 227    |   |
| Total stock-based  expenses                                        |   | $      | 684    |   | $      | 73     |   | $      | 1,603  |   | $ | 430 |   |

 

See accompanying notes.

 

4

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**Phase ForwardIncorporated and SubsidiariesCondensed Consolidated Statements of Cash Flows(unaudited)(in thousands)**

 
| ** **                                                                                       | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                                            | ** ** | **2005** | ** ** |
| **Operating activities**                                                                         |       |                                                |       |   |   |
| Net income                                                                                       |       | $                                                   | 1,135      |   | $ | 5,476 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities:               |       |                                                |       |   |   |
| Depreciation and  amortization                                                                   |       | 2,270                                               |       | 2,510 |   |
| Stock-based  expenses                                                                            |       | 1,603                                               |       | 430 |   |
| Loss on disposal  of fixed assets                                                                |       | —                                              |       | 53 |   |
| Foreign currency  exchange loss                                                                  |       | 65                                                  |       | 160 |   |
| Provision for  allowance for doubtful accounts                                                   |       | 165                                                 |       | (1 | ) |
| Non-cash income  tax expense                                                                     |       | 1,652                                               |       | 1,040 |   |
| Amortization of  premiums or discounts on short-term investments                                 |       | —                                              |       | (48 | ) |
| Changes in assets  and liabilities:                                                              |       |                                                |       |   |   |
| Accounts  receivable                                                                             |       | 8,394                                               |       | 1,312 |   |
| Deferred costs                                                                                   |       | (1,502                                              | )          | (1,025 | ) |
| Prepaid expenses  and other current assets                                                       |       | (902                                                | )          | (350 | ) |
| Accounts payable                                                                                 |       | 667                                                 |       | (377 | ) |
| Accrued expenses                                                                                 |       | (698                                                | )          | 621 |   |
| Deferred revenue                                                                                 |       | (3,831                                              | )          | 2,585 |   |
| Deferred rent                                                                                    |       | 976                                                 |       | (179 | ) |
| Net cash provided by operating activities                                                        |       | 9,994                                               |       | 12,207 |   |
|                                                                                             |       |                                                |       |   |   |
| **Investing activities**                                                                         |       |                                                |       |   |   |
| Proceeds from maturities of short-term  investments                                              |       | —                                              |       | 3,848 |   |
| Purchase of short-term investments                                                               |       | (1,279                                              | )          | (9,626 | ) |
| Purchase of property and equipment                                                               |       | (2,385                                              | )          | (2,805 | ) |
| Decrease in restricted cash, net                                                                 |       | 1,611                                               |       | — |   |
| Decrease (increase) in other assets                                                              |       | (10                                                 | )          | 9 |   |
| Cash paid for acquisition of Lincoln  Technologies, Inc., net of cash acquired(1)           |       | —                                              |       | (10,598 | ) |
| Net cash used in investing activities                                                            |       | (2,063                                              | )          | (19,172 | ) |
|                                                                                             |       |                                                |       |   |   |
| **Financing activities**                                                                         |       |                                                |       |   |   |
| Proceeds from issuance of notes payable and  borrowings under lines of credit                    |       | 2,928                                               |       | — |   |
| Payments on lines of credit and notes  payable                                                   |       | (4,428                                              | )          | (4,407 | ) |
| Payment of dividend payable                                                                      |       | (4,700                                              | )          | — |   |
| Stock issuance costs                                                                             |       | (5,215                                              | )          | — |   |
| Proceeds from issuance of common stock                                                           |       | 42,815                                              |       | 2,899 |   |
| Proceeds from repayment of subscriptions  receivable                                             |       | 514                                                 |       | 127 |   |
| Net cash provided by (used in) financing  activities                                             |       | 31,914                                              |       | (1,381 | ) |
| Effect of exchange rate changes on cash and  cash equivalents                                    |       | (30                                                 | )          | (534 | ) |
| Net change in cash and cash equivalents                                                          |       | 39,815                                              |       | (8,880 | ) |
| Cash and cash equivalents at beginning of  year                                                  |       | 19,046                                              |       | 53,485 |   |
| Cash and cash equivalents at end of period                                                       |       | 58,861                                              |       | 44,605 |   |
| Short-term investments at end of period                                                          |       | 1,279                                               |       | 10,592 |   |
| Total cash, cash equivalents and short-term  investments at end of period                        |       | $                                                   | 60,140     |   | $ | 55,197 |   |
|                                                                                             |       |                                                |       |   |   |
| **Non-cash financing activities**                                                                |       |                                                |       |   |   |
| Accretion of Series B, C, and D  redeemable convertible preferred stock to redemption value |       | $                                                   | 4,253      |   | $ | — |   |
|                                                                                             |       |
|                                                                                                  |
| (1) Cash paid for acquisition of  Lincoln Technologies, Inc.                           |       |                                                |       |   |   |
|                                                                                             |       |                                                |       |   |   |
| Fair value of  assets acquired                                                                   |       | $                                                   | —     |   | $ | 1,742 |   |
| Liabilities  assumed, including acquisition costs paid                                           |       | —                                              |       | (898 | ) |
| Acquired  intangible assets                                                                      |       | —                                              |       | 3,900 |   |
| Cost in excess of  net assets acquired                                                           |       | —                                              |       | 6,400 |   |
| Cash paid                                                                                        |       | —                                              |       | 11,144 |   |
| Less cash  acquired                                                                              |       | —                                              |       | 546 |   |
| Cash paid for  acquisition                                                                       |       | $                                                   | —     |   | $ | 10,598 |   |

 

See accompanying notes.

 

5

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**Phase ForwardIncorporated and SubsidiariesNotes to Condensed Consolidated Financial Statements(unaudited)(in thousands, except share and per share amounts)**

** **

**1.****             ****Basis of Presentation**

** **

The accompanying unauditedcondensed consolidated financial statements included herein have been preparedby Phase Forward Incorporated (the “Company”) pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”). Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles in theUnited States have been condensed or omitted pursuant to such SECrules and regulations. Management of the Company believes that thedisclosures herein are adequate to make the information presented notmisleading. In the opinion of management, the unaudited condensed consolidatedfinancial statements have been prepared on the same basis as the auditedconsolidated financial statements and reflect all material adjustments(consisting only of those of a normal and recurring nature) which are necessaryto present fairly the consolidated financial position of the Company as ofSeptember 30, 2005, the results of its operations for the three and ninemonths ended September 30, 2004 and 2005 and its cash flows for the ninemonths ended September 30, 2004 and 2005. These unaudited condensed consolidatedfinancial statements and notes thereto should be read in conjunction with theaudited consolidated financial statements and notes thereto included in theCompany’s 2004 Annual Report on Form 10-K filed with the SEC onMarch 9, 2005. The results of operations for the interim periods are notnecessarily indicative of the results of operations to be expected for the yearending December 31, 2005.

 

On August 25, 2005, theCompany acquired 100% of the outstanding common shares of LincolnTechnologies, Inc. (“Lincoln”), a provider of products and services forclinical trial safety signal detection and applied data standards.  The results of Lincoln have been included inthe unaudited condensed consolidated financial statements since the date ofacquisition (see Note 5).

 

**2.****             ****Revenue Recognition and Deferred Set up Costs**

** **

The Company derives revenues fromsoftware licenses and services. License revenue is derived principally from thesale of multi-year software term licenses of the Company’s *InFormTM, ClintrialTM* and *ClintraceTM* software products. Servicerevenue is derived from the Company’s delivery of the hosted solution of its *InForm *software product, consultingservices and customer support, including training.

 

The components of revenue are asfollows:

 
| ** **                   | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| License                      |       | $                                                    | 7,352      |                                                | $          | 8,637 |   | $ | 19,875 |   | $ | 26,088 |   |
| Application hosting services |       | 7,238                                                |       | 7,998                                               |       | 19,840 |   | 22,105 |   |
| Consulting services          |       | 1,192                                                |       | 2,679                                               |       | 3,971 |   | 5,696 |   |
| Customer support             |       | 3,227                                                |       | 2,928                                               |       | 9,978 |   | 9,613 |   |
| Total                        |       | $                                                    | 19,009     |                                                | $          | 22,242 |   | $ | 53,664 |   | $ | 63,502 |   |
|                              |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

The Company recognizes softwarelicense revenue in accordance with Statement of Position (“SOP”) No. 97-2,*Software Revenue Recognition,* asamended, issued by the American Institute of Certified Public Accountants,while revenue resulting from application hosting services are recognized inaccordance with

 

6

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Emerging Issues Task Force(“EITF”) Issue No. 00-03, *Applicationof AICPA Statement of Position 97-2 to Arrangements that include the Right toUse Software Stored on Another Entity’s Hardware*, SEC StaffAccounting Bulletin (“SAB”) Nos. 101 and 104, *RevenueRecognition*, and EITF Issue No. 00-21, *Revenue Arrangements with Multiple Deliverables.*

 

Customers generally have theability to terminate application hosting, consulting and training serviceagreements upon 30 days notice to the Company. License agreements,multiple element arrangements, including license and services agreements, andcertain application hosting services can generally be terminated by eitherparty for material breach of obligations not corrected within 30 daysafter notice of the breach.

 

The Company recognizes revenue whenall of the following conditions are satisfied: (1) there is persuasiveevidence of an arrangement; (2) the product or service has been providedto the customer; (3) the collection of fees is probable; and (4) theamount of fees to be paid by the customer is fixed or determinable.

 

The Company generally enters intosoftware term licenses with its customers for three to five year periods. Thesearrangements typically include multiple elements: a software license,consulting services and customer support. The Company bills its customers inaccordance with the terms of the underlying contract. Generally, the Companybills the annual license fee for the first year of a multi-year contract inadvance and bills the license fees for the subsequent years in advance on theanniversary date. The Company’s payment terms are generally net 30 days.

 

The Company’s software licenserevenue is earned from the sale of off-the-shelf software requiring nosignificant modification or customization subsequent to delivery to thecustomer. Consulting services, which can also be performed by third-partyconsultants, are deemed to be non-essential to the functionality of thesoftware and typically are for trial configuration, implementation planning,loading of software, building simple interfaces and running test data anddocumentation of procedures.

 

The Company generally bundlescustomer support with the software license for the entire term of the license.As a result, the Company generally recognizes revenue for all elements,including consulting services, ratably over the term of the software licenseand support arrangement. The Company allocates the revenue recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For its term-based licenses, the Companyallocates to consulting services the anticipated service effort and valuethroughout the term of the arrangement at an amount that would have beenallocated had those services been sold separately to the customer. The remainingvalue is allocated to license and support services, with 10% of this amountallocated to support services. The Company has allocated the estimated fairvalue to its multiple element arrangements to provide meaningful disclosuresabout each of its revenue streams. The costs associated with the consulting andcustomer support services are expensed as incurred. There are instances inwhich the Company sells software licenses based on usage levels. These softwarelicenses can be based on estimated usage, in which case the license fee chargedto the customer is fixed based on this estimate. When the fee is fixed, therevenue is recognized ratably over the contractual term of the arrangement. Ifthe fee is based on actual usage, and therefore variable, the revenue isrecognized in the period of use. Revenue from certain follow-on consultingservices, which are sold separately to customers with existing softwarelicenses and are not considered part of a multiple element arrangement, arerecognized as the services are performed.

 

The Company continues to sell the *Clintrial* and *Clintrace* software products to certain existing customers asperpetual software licenses with the option to purchase customer support. TheCompany generally does not sell perpetual licenses to new customers. TheCompany has established vendor specific objective evidence of fair value forthe customer support in these arrangements. Accordingly, the license revenue isrecognized upon delivery of the software and when all other revenue recognitioncriteria are met. The customer support is recognized ratably over the term ofthe underlying support arrangement. The

 

7

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Company continues togenerate customer support and maintenance revenue from its perpetual licensecustomer base. Training revenue is recognized as earned.

 

In addition to making its softwareproducts available to customers through licenses, the Company offers its *InForm *electronic data capturesoftware product through a fully-hosted, turnkey deployment. Revenue resultingfrom application hosting services consists of three stages for each clinicaltrial. The first stage includes trial and application set up, including designof electronic case report forms and edit checks, implementation of the systemand server configuration. The second stage consists of application hosting andrelated support services. The third stage, database lock, consists of servicesrequired to close out, or lock, the database for the clinical trial. Servicesprovided for the first and third stages are provided on a fixed fee basisdepending upon the complexity of the trial and system requirements. Servicesfor the second stage are charged separately as a fixed monthly fee. The Companygenerally recognizes revenue from application hosting and related servicesratably over the hosting period. Fees charged and costs incurred for the trialsystem design, set up and implementation are deferred and capitalized, asapplicable, until the start of the hosting period. These revenues and costs arerecognized and amortized, as applicable, ratably over the estimated hostingperiod. The capitalized costs include incremental direct costs with thirdparties and certain internal direct costs of the trial and application set up,as defined under Statement of Financial Accounting Standards (SFAS)No. 91, *Accounting for NonrefundableFees and Costs Associated with Originating or Acquiring Loans and IndirectCosts of Leases*. These costs include salary and benefits associatedwith direct labor costs incurred during trial set up, as well as third-partysubcontract fees and other contract labor costs. Work performed outside theoriginal scope of work is contracted for separately as an additional fee and isgenerally recognized ratably over the remaining term of the hosting period.

 

In the event that an applicationhosting customer cancels a clinical trial and its related statement of work,all deferred revenue is recognized, all deferred set up costs are expensed andcertain termination-related fees may be charged.

 

The Company capitalized $482 and$666 of deferred set up costs and amortized $500 and $425 in the three monthsended September 30, 2004 and 2005, respectively, and capitalized $1,331and $1,841 of deferred set up costs and amortized $1,380 and $1,272 in the ninemonths ended September 30, 2004 and 2005, respectively. The amortizationof deferred set up costs is a component of cost of services.

 

Deferred revenue represents amountsbilled or cash received in advance of revenue recognition.

 

Provisions for estimated losses onuncompleted contracts are made on a contract-by-contract basis and arerecognized in the period in which such losses become probable and can bereasonably estimated. To date, the Company has not experienced any material losseson uncompleted application hosting contracts.

 

In accordance with EITF IssueNo. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred,* the Company included $190 and $162 of out-of-pocketexpenses in service revenue and cost of service revenue in the three monthsended September 30, 2004 and 2005, respectively, and included $614 and$552 of out-of-pocket expenses in service revenue and cost of service revenuein the nine months ended September 30, 2004 and 2005, respectively.

 

**3.****             ****Prepaid Sales Commissions and Royalties**

** **

For arrangements where revenue isrecognized over the relevant contract period, the Company capitalizes relatedcommissions paid to sales people and royalties paid to third parties, andrecognizes these expenses over the period that the related revenue isrecognized. Commission payments are nonrefundable unless amounts due from acustomer are determined to be uncollectible or if the customer subsequentlychanges or terminates the level of service, in which case commissions paid arerecoverable by the Company. The Company capitalized $1,240 and $989 ofcommissions and amortized to sales and

 

8

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marketing expense $753 and$1,003 in the three months ended September 30, 2004 and 2005,respectively, and capitalized $2,820 and $2,312 of commissions and amortized tosales and marketing expense $2,002 and $2,738 in the nine months endedSeptember 30, 2004 and 2005, respectively.

 

The Company’s royalty obligation isbased upon the license and customer support revenue earned for certain productsin an arrangement. The Company has the right to recover the royalties in theevent the arrangement is cancelled. The Company capitalized $367 and $645 ofroyalties and amortized to costs of revenues $652 and $803 in the three monthsended September 30, 2004 and 2005, respectively, and capitalized $2,568and $2,879 of royalties and amortized to costs of revenues $1,841 and $2,102 inthe nine months ended September 30, 2004 and 2005, respectively.

 

**4.****             ****Warranties and Indemnification**

** **

The Company’s software licensearrangements and hosting services are typically warranted to perform in amanner consistent with general industry standards that are reasonablyapplicable and substantially in accordance with the Company’s productdocumentation under normal use and circumstances. The Company’s arrangementsalso include certain provisions for indemnifying customers against liabilitiesif its products or services infringe a third party’s intellectual propertyrights. See the discussion of possible indemnification obligations inNote 14.

 

The Company has entered intoservice level agreements with some of its hosted application customerswarranting certain levels of uptime reliability and permitting those customersto receive credits against monthly hosting fees or terminate their agreementsin the event that the Company fails to meet those levels.

 

To date, the Company has notincurred any material costs as a result of such indemnifications and has notaccrued any liabilities related to such obligations in the accompanyingconsolidated financial statements.

 

**5.****             ****Acquisition of Lincoln Technologies, Inc.**

** **

On August 25, 2005, theCompany acquired 100% of the outstanding common shares of Lincoln, a providerof products and services for clinical trial safety signal detection, andapplied data standards.  The acquiredtechnology and products of Lincoln provide the Company with an expanded drugsafety offering and enhance the Company’s ability to offer innovative softwareand services in the drug safety market. The Company paid a premium for Lincoln to enable it to become a leadingprovider in the drug safety market and to obtain a valuable workforce.

 

The aggregate purchase price paid incash was approximately $11,200.  Theacquisition agreement calls for additional cash consideration, to be paidsubject to achievement of certain financial targets in 2005 and 2006, of up to$2,000 and $4,000 in 2005 and 2006, respectively.  The acquisition of Lincoln was accounted foras a purchase under SFAS No. 141, *BusinessCombinations*.  Accordingly,the results of Lincoln have been included in the unaudited condensedconsolidated financial statements since the date of acquisition.

 

The components of the considerationpaid are as follows:

 
| Cash paid                                                                       |   | $   | 11,000 |   |
|---------------------------------------------------------------------------------|--------|-----|--------|--------|
| Acquisition costs                                                               |   | 165 |   |
| Total purchase price to be allocated to  acquired asset subject to amortization |   | $   | 11,165 |   |

 

The following table summarizes theallocation of the initial purchase price to the fair value of the assetsacquired and liabilities assumed at the date of acquisition:

 

9

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| Current assets                                          |   |   |   | $      | 1,479  |   |
|---------------------------------------------------------|--------|--------|--------|--------|--------|--------|
| Property, plant and equipment                           |   |   |   | 263    |   |
| Intangible assets subject to amortization:              |   |   |   |   |   |
| Developed  technology (five year useful life)           |   | $      | 1,800  |   |   |   |
| Customer base  (five year useful life)                  |   | 1,600  |   |   |   |
| Other intangible  assets (two to five year useful life) |   | 500    |   |   |   |
|                                                    |   |   |   | 3,900  |   |
| Goodwill                                                |   |   |   | 6,400  |   |
| Total assets acquired                                   |   |   |   | 12,042 |   |
| Current liabilities                                     |   |   |   | (877   | )      |
| Net assets acquired                                     |   |   |   | $      | 11,165 |   |
|                                                         |        |        |        |        |        |        |  |

 

Included in liabilities assumed isa provision for lease abandonment costs of approximately $270 relating to theleased facilities of Lincoln.  From thedate of acquisition through September 30, 2005, $9 of the lease obligationhas been paid.

 

The following table presentsselected unaudited financial information of the Company and Lincoln as if theacquisition had occurred on January 1, 2004.  The unaudited pro forma results are notnecessarily indicative of the results that would have occurred had theacquisition been consummated on January 1, 2004.

 
| ** **                                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Pro forma revenues                                                        |       | $                                                    | 20,038     |                                                | $          | 22,711 |   | $ | 56,361 |   | $ | 66,443 |   |
| Pro forma income  from operations                                         |       | 1,128                                                |       | 1,606                                               |       | 2,697 |   | 5,312 |   |
| Pro forma net  income (loss) applicable to common stockholders            |       | —                                               |       | 1,685                                               |       | (7,880 | ) | 4,821 |   |
| Pro froma net  income (loss) per share applicable to common stockholders: |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                     |       | $                                                    | —     |                                                | $          | 0.05 |   | $ | (0.71 | ) | $ | 0.15 |   |
| Diluted                                                                   |       | $                                                    | —     |                                                | $          | 0.05 |   | $ | (0.71 | ) | $ | 0.14 |   |

 

**6.****             ****Net Income (Loss) Per Share**

 

Basic and diluted net income (loss)per share is presented in conformity with SFAS No. 128, *Earnings Per Share*. Basic net income (loss)per common share was determined by dividing net income (loss) applicable tocommon stockholders by the weighted average number of common shares outstandingduring the period. Weighted average shares outstanding exclude unvestedrestricted common stock. The Company’s potentially dilutive shares, whichinclude outstanding common stock options, redeemable convertible preferredstock for the three and nine month periods ending September 30, 2004, andwarrants for the three and nine month periods ending September 30, 2004and the nine month period ending September 30, 2005 also have not beenincluded in the computation of diluted net income (loss) per share for allperiods in which the Company was in a loss position as the result would beanti-dilutive.

 

10

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The following table reconciles theweighted average shares outstanding used to calculate basic and diluted netincome (loss) per share:

 
| ** **                                                               | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                               | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Numerator:                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Net income (loss)  applicable to common stockholders                     |       | $                                                    | (95        | )                                                   | $          | 2,170 |   | $ | (7,818 | ) | $ | 5,476 |   |
| Denominator:                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted average  common shares outstanding                              |       | 26,268,826                                           |       | 33,241,245                                          |       | 11,178,874 |   | 32,855,642 |   |
| Less: Weighted  average unvested restricted common shares outstanding    |       | (19,670                                              | )          | —                                              |       | (30,399 | ) | — |   |
| Basic net income  (loss) per share—weighted average common shares   |       | 26,249,156                                           |       | 32,241,245                                          |       | 11,148,475 |   | 32,855,642 |   |
| Dilutive effect  of common stock options                                 |       | —                                               |       | 2,065,700                                           |       | — |   | 1,971,780 |   |
| Diluted net  income (loss) per share—weighted average common shares |       | 26,249,156                                           |       | 35,306,945                                          |       | 11,148,475 |   | 34,827,422 |   |
| Net income (loss)  per share applicable to common stockholders:          |       |                                                 |       |                                                |       |   |   |   |   |
|                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                    |       | $                                                    | —     |                                                | $          | 0.07 |   | $ | (0.70 | ) | $ | 0.17 |   |
|                                                                     |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted                                                                  |       | $                                                    | —     |                                                | $          | 0.06 |   | $ | (0.70 | ) | $ | 0.16 |   |
|                                                                          |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |  |  |

 

The following common shareequivalents and unvested restricted shares have been excluded from thecomputation of diluted weighted average shares outstanding because suchsecurities were anti-dilutive during the periods presented.

 
| ** **                 | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                 | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Options outstanding        |       | 4,204,423                                            |       | —                                              |       | 4,423,900 |   | 321,000 |   |
| Unvested restricted shares |       | 14,305                                               |       | —                                              |       | 25,035 |   | — |   |
| Warrant                    |       | 34,330                                               |       | —                                              |       | 34,330 |   | — |   |
| Redeemable Preferred Stock |       | 4,717,195                                            |       | —                                              |       | 16,799,836 |   | — |   |

 

**7.****             ****Foreign Currency Translation**

 

The financial statements of theCompany’s foreign subsidiaries are translated in accordance with SFASNo. 52, *Foreign Currency Translation.*The reporting currency for the Company is the U.S. dollar. The functionalcurrency of the Company’s subsidiaries in the United Kingdom, France, Germany,Belgium, Japan and Australia are the local currencies of those countries.Accordingly, the assets and liabilities of the Company’s foreign subsidiariesare translated into U.S. dollars using the exchange rate in effect at eachbalance sheet date. Revenue and expense accounts are generally translated usingan average rate of exchange during the period. Foreign currency translationadjustments are accumulated as a component of other comprehensive loss as aseparate component of stockholders’ equity. Gains and losses arising from

 

11

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transactions denominated inforeign currencies are primarily related to intercompany accounts that havebeen determined to be temporary in nature and cash and accounts receivabledenominated in non-functional currencies. The Company has recorded foreigncurrency losses of $103 and $38 for the three months ended September 30,2004 and 2005, respectively, and approximately $65 and $169 for the nine monthsended September 30, 2004 and 2005, respectively. Such gains and (losses)are included in other income (expense) in the accompanying unaudited condensedconsolidated statements of operations.

 

**8.****             ****Cash, Cash Equivalents and Short-Term Investments**

 

The Company accounts for itsinvestments in accordance with SFAS No. 115, *Accounting for Certain Investments in Debt and Equity Securities*.Under SFAS No. 115, securities that the Company has the intent and abilityto hold to maturity are reported at amortized cost, which approximates marketvalue, and are classified as held-to-maturity. The Company considers all highlyliquid investments with original maturities of 90 days or less at the timeof purchase to be cash equivalents and investments with original maturities ofbetween 91 days and one year to be short term investments. The Companyinvests in high quality corporate debentures rated at least A2 by Moody’sInvestors Service or A by Standard & Poors. At September 30, 2005cash equivalents primarily consisted of money market funds that were readilyconvertible to cash. At September 30, 2005, short-term investmentsprimarily consisted of U.S. agency notes and corporate debentures.

 

Cash, cash equivalents andshort-term investments as of December 31, 2004 and September 30, 2005were as follows:

 
| ** **                                | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------|------------|---------------------------------|------------|
| **Description**                           | ** ** | **Contracted  Maturity**        | ** ** | **Amortized  Cost** | ** ** | **Fair Market  Value** | ** ** |
| Cash and cash equivalents                 |       | Demand                          |       | $ | 13,138 |   | $ | 13,138 |   |
| U.S. agency notes and U.S. treasury bills |       | Less than 90 days               |       | 3,390 |   | 3,390 |   |
| Money market funds                        |       | Demand                          |       | 35,014 |   | 35,014 |   |
| Certificate of deposit                    |       | 30 days                         |       | 1,943 |   | 1,943 |   |
| Total cash and cash equivalents           |       |                            |       | $ | 53,485 |   | $ | 53,485 |   |
| Short-term investments                    |       | 147-356 days               |       | $ | 4,735 |   | $ | 4,728 |   |

 
| ** **                                | ** ** | **September 30, 2005** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| **Description**                           | ** ** | **Contracted  Maturity**         | ** ** | **Amortized  Cost** | ** ** | **Fair Market  Value** | ** ** |
| Cash and cash equivalents                 |       | Demand                           |       | $ | 15,098 |   | $ | 15,098 |   |
| U.S. agency notes and U.S. treasury bills |       | Less than 90 days                |       | 3,164 |   | 3,164 |   |
| Money market funds                        |       | Demand                           |       | 26,343 |   | 26,343 |   |
| Total cash and cash equivalents           |       |                             |       | $ | 44,605 |   | $ | 44,605 |   |
| Short-term investments                    |       | 131-359 days                     |       | $ | 10,592 |   | $ | 10,579 |   |

 

The Company has had no realized orunrealized gains or losses to date on the sale of money market funds orshort-term investments.

 

**9.****             ****Stock-Based Compensation**

 

In January 2003, the FASBissued SFAS No. 148, *Accounting forStock-Based Compensation-Transition and Disclosure,* which providesalternative methods of transition for a voluntary change to a fair-value-basedmethod of accounting for stock-based employee compensation. In addition, SFASNo. 148 amends the disclosure requirements of SFAS No. 123, *Accounting for Stock-Based Compensation,*to require prominent disclosures in annual financial statements about themethod of accounting for stock-based employee compensation and the effect ofthe method used on reported results. The Company accounts for

 

12

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options granted under itsstock-based compensation plans for employees under Accounting Principles Board(APB) Opinion No. 25, *Accounting forStock Issued to Employee*s, and has elected the disclosure-onlyalternative under SFAS No. 123 and the enhanced disclosures as required bySFAS No. 148. Under APB Opinion No. 25, when the exercise price ofoptions granted under these plans equals or exceeds the market price of the underlyingstock on the date of grant, no compensation expense is required.

 

The following tables illustrate theassumptions used and the effect on net income (loss) if the Company had appliedthe fair value recognition provisions of SFAS No. 123 to stock-basedemployee compensation. The Company has computed the pro forma disclosuresrequired under SFAS No. 123 for all employee stock options granted usingthe Black-Scholes option pricing model prescribed by SFAS No. 123.

 

The assumptions used and weightedaverage information are as follows:

 
| ** **                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Average risk-free interest rate           |       | —                                               |       | 4.15                                                | %          | 3.61 | % | 4.04 | % |
| Expected dividend yield                   |       | —                                               |       | —                                              |       | — |   | — |   |
| Expected life                             |       | —                                               |       | 4 years                                             |       | 7 years |   | 4 years |   |
| Expected volatility                       |       | —                                               |       | 60                                                  | %          | 0-90 | % | 60-90 | % |
| Weighted average fair value at grant date |       | —                                               |       | $                                                   | 7.70       |   | $ | 6.00 |   | $ | 6.72 |   |
|                                           |            |                                                      |            |                                                     |            |  |  |  |  |  |  |  |

 

There were no stock option grantsduring the three month period ending September 30, 2004.

 

The Company offers the 2004 EmployeeStock Purchase Plan. Accordingly, the Company has calculated the SFASNo. 123 pro forma expense for shares purchased under the 2004 EmployeeStock Purchase Plan using the following assumptions:

 
| ** **                      | ** ** | **Three Months Ended  September 30, 2005** | ** ** | **Nine Months Ended  September, 30 2005** | ** ** |
|---------------------------------|------------|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| Average risk-free interest rate |       | 3.12                                                           | %          | 2.74                                                          | %          |
| Expected dividend yield         |       | —                                                         |       | —                                                        |       |
| Expected life                   |       | 0.50 years                                                |       | 0.50 years                                               |       |
| Expected volatility             |       | 60                                                             | %          | 60                                                            | %          |

 

Had compensation costs beendetermined consistent with SFAS No. 123, the Company’s net income (loss)would have been the following pro forma amounts:

 
| ** **                                                                                                           | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                           | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income (loss)  applicable to common stockholders, as reported                                                    |       | $                                                    | (95        | )                                                   | $          | 2,170 |   | $ | (7,818 | ) | $ | 5,476 |   |
| Add: Stock-based  compensation expense included in reported net income (loss)                                        |       | 684                                                  |       | 73                                                  |       | 1,603 |   | 430 |   |
| Less: Total  stock-based employee compensation expense determined  under fair-value-based method for all awards |       | (881                                                 | )          | (778                                                | )          | (2,084 | ) | (2,158 | ) |
| Pro forma net  income (loss)                                                                                         |       | $                                                    | (292       | )                                                   | $          | 1,465 |   | $ | (8,299 | ) | $ | 3,748 |   |
| Pro forma net  income (loss) per share applicable to common stockholders:                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                                                                |       | $                                                    | (0.01      | )                                                   | $          | 0.05 |   | $ | (0.74 | ) | $ | 0.11 |   |
| Diluted                                                                                                              |       | $                                                    | (0.01      | )                                                   | $          | 0.04 |   | $ | (0.74 | ) | $ | 0.11 |   |

 

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**10.****           ****Goodwill and Intangible Assets**

** **

A rollforward of the net carryingamount of goodwill is as follows:

 
| Balance as of  December 31, 2004                                                          |   | $      | 21,817 |   |
|------------------------------------------------------------------------------------------------|--------|--------|--------|--------|
| Increase associated with the acquisition of  Lincoln (see Note 5)                              |   | 6,400  |   |
| Utilization of acquired net operating  losses in the nine months ended September 30, 2005 |   | (1,040 | )      |
| Balance as of September 30, 2005                                                          |   | $      | 27,177 |   |

 

The Company acquired ClinsoftCorporation, which developed and sold the *Clintrial*and *Clintrace*products, onAugust 14, 2001. The goodwill resulting from the acquisition is reviewedfor impairment on an annual basis in accordance with SFAS No. 142,*Goodwill and Other Intangible Assets.*TheCompany performed its annual impairment test for the year endedDecember 31, 2004 as of October 1, 2004 and determined that noimpairment of goodwill existed.

 

The utilization of acquired netoperating losses reflects a reduction in cash payments to local taxingauthorities for income taxes that are not reflected as a benefit in the incometax provision for financial statement purposes but rather as a reduction togoodwill.

 

The following is a summary ofidentifiable intangible assets:

 
| **Description**                   | ** ** | **Estimated  Useful Life** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
|-----------------------------------|------------|----------------------------|------------|----------------------------|------------|-------------------------------|------------|
| Developed technology and know-how |       | 5 years                    |       | $                          | 1,800      |                          | $          | 37 |   |
| Customer relationships            |       | 5 years                    |       | 1,600                      |       | 33                            |       |
| Employment/non-compete agreements |       | 2 years                    |       | 300                        |       | 15                            |       |
| Tradename                         |       | 5 years                    |       | 200                        |       | 4                             |       |
| Total                             |       |                       |       | $                          | 3,900      |                          | $          | 89 |   |

 

The estimated remainingamortization expense for each of the five succeeding fiscal years:

 
| **Year  ended December 31,** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-----------|------------|
| 2005                                   |       | $         | 218        |   |
| 2006                                   |       | 870       |       |
| 2007                                   |       | 817       |       |
| 2008                                   |       | 720       |       |
| 2009                                   |       | 720       |       |
| Total                                  |       | $         | 3,345      |   |

 

14

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**11.****           ****Accrued Expenses**

 

Accrued expenses consist of thefollowing:

 
| ** **                           | ** ** | **As of  December 31,  2004** | ** ** | **As of  September 30,  2005** | ** ** |
|--------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| Accrued payroll and related benefits |       | $                                       | 4,791      |                                     | $          | 5,489 |   |
| Accrued royalties                    |       | 2,378                                   |       | 2,237                                    |       |
| Accrued income taxes                 |       | 1,289                                   |       | 1,067                                    |       |
| Accrued other expenses               |       | 3,200                                   |       | 4,190                                    |       |
|                                 |       | $                                       | 11,658     |                                     | $          | 12,983 |   |

 

**12.****           ****Restructuring**

** **

The Company recorded a $4,503restructuring charge for the year ended December 31, 2003 that related tothe relocation of the Company’s corporate headquarters in December 2003.Of this amount, $2,486 represented the loss on a facilities lease and $2,017related to the abandonment of the related fixed assets and leaseholdimprovements. The facility lease loss represented 15 months of rentremaining under an existing lease and related operating expenses. As ofMarch 31, 2005, payment of all charge related expenses had occurred and asa result the Company recorded a benefit of $92 representing the elimination ofaccrued expenses associated with the restructuring charge.

 

The rollforward of therestructuring charge is as follows:

 
| ** **                                                                                    | ** ** | **Lease  Loss** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------|------------|
| Balance as of December 31, 2003                                                          |       | $               | 2,486      |   |
| Payments made in the twelve months ended  December 31, 2004                              |       | (1,974          | )          |
| Reduction to provision for lease loss in  the twelve months ended December 31, 2004 |       | (168            | )          |
| Balance as of December 31, 2004                                                          |       | $               | 344        |   |
| Payments made in the nine months ended  September 30, 2005                               |       | (252            | )          |
| Reduction to provision for lease loss in  the nine months ended September 30, 2005       |       | (92             | )          |
| Balance as of September 30, 2005                                                         |       | $               | —     |   |

 

**13.****           ****Debt**

 

Between April 2000 andSeptember 2004, the Company had entered into several equipment lines ofcredit with a bank. All advances under these equipment lines of credit werepayable in 30 to 36 equal monthly installments of principal, plus accruedinterest. The interest that accrued under these notes ranged from prime rate(5.25% and 5.75% at December 31, 2004 and March 31, 2005,respectively) to prime rate plus 1.0%. As of December 31, 2004, there wasa total of $4,407 outstanding under all of the Company’s equipment lines ofcredit. In March 2005, the Company paid in full all outstandingdebt-related to its equipment lines of credit. The equipment line of creditexpired on March 31, 2005 and was not renewed.

 

Effective March 31, 2004, theCompany renewed its working capital line of credit with a bank and increasedthe amount under which it can borrow to $5,000. Interest accrues at prime rate.All advances made under the working capital line are due and payable onMarch 31, 2006. As of December 31, 2004 and September 30, 2005,$0 was outstanding under the working capital line of credit. AtSeptember 30, 2005, there was $3,700 available under the line of credit,and $1,300 reserved under a letter of credit associated with the Company’s leasedfacilities.

 

15

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Borrowings under the workingcapital line of credit were secured by substantially all assets of the Company,excluding intellectual property. The Company had entered into a negative pledgeagreement that, subject to certain exceptions, generally prohibited the Companyfrom pledging its intellectual property to others. Under the working capitalline of credit, as amended in March 2004, the Company is required tocomply with certain financial covenants. At September 30, 2005, theCompany was in compliance with all financial covenants. In August of 2005,the working capital line of credit was amended to eliminate the securityinterest in the Company’s assets and the negative pledge on the Company’s intellectualproperty. The amendment also removed or modified the financial covenants.

 

**14.****           ****Contingencies**

 

From time to time and in theordinary course of business, the Company may be subject to various claims,charges and litigation.

 

Since 2004, the Company has beeninvolved in a lawsuit filed against it and one of its customers, QuintilesInc., by Datasci, LLC (“Datasci”) and Dr. Mark L. Kozam, doing businessunder the name MLK Software. The lawsuit alleges that the Company’s *InForm, Clintrial* and *Clintrial Integration Solution* productsand its services, and the products and services of Quintiles, infringe a UnitedStates patent claimed to be owned by Datasci and Dr. Kozam. The Companyhas asserted numerous defenses and has filed counterclaims against Datasci andDr. Kozam. This action is ongoing and the Company is prepared tovigorously defend the claims and pursue its counterclaims and any otherremedies available to the Company. The Company is unable to predict the outcomeof this action and is therefore unable to assess whether its outcome will havea material adverse effect on its results of operations.

 

The Company accepts standardindemnification provisions in the ordinary course of business, whereby it maybe required to indemnify its customers for certain costs and damages arisingfrom third party claims in connection with alleged or actual infringement ofintellectual property, including the claim described above. The term of theseindemnification provisions generally coincides with the customer’s use of theCompany’s products. To date, the Company has not incurred any costs to settleclaims related to these indemnification provisions. As a result, the Companybelieves the estimated fair value of these provisions is minimal.

 

**15.****           ****Stockholders’ Equity**

** **

During the nine months endedSeptember 30, 2005, the Company issued 898,840 shares of common stock inconnection with the exercise of stock options resulting in proceeds of $2,497,and 79,836 shares of common stock under the Company’s 2004 Employee Stock PurchasePlan resulting in proceeds of $447. During this period, the Company also issued9,802 shares in connection with the cashless exercise of a warrant to purchasecommon stock.

 

During November andDecember 2001, the Company executed full recourse notes receivable inconsideration for the payment of the exercise of options. The notes arereflected as subscriptions receivable, a component of stockholders’ equity.There was $127 and $0 of these notes receivable outstanding atDecember 31, 2004 and September 30, 2005, respectively. InFebruary 2005, all outstanding notes were paid in full.

 

**16.****           ****Deferred Compensation**

** **

The Company records deferredstock-based compensation in the amount by which the exercise price of an optionis less than the deemed fair value of its common stock at the date of grant.Because there had been no public market for the Company’s stock prior to theJuly 2004 initial public offering of its common stock (the “IPO”), theCompany’s Board of Directors had determined the fair value of the common stockon the date of grant based upon several factors, including, but not limited to,the Company’s operating and

 

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financial performance, theissuances of convertible preferred stock, the rights and preferences of allsecurities senior to common stock and the anticipated offering price of thecommon stock in connection with the Company’s IPO. During 2003, all stockoptions were granted with an exercise price of $3.00 per share, while theestimated per share fair value of the Company’s common stock ranged from $3.00to $4.00 in the first quarter of 2003, $4.00 to $5.00 in the second quarter of2003, $5.00 to $7.50 in the third quarter of 2003 and $7.50 to $9.00 in thefourth quarter of 2003. During the nine months ended September 30, 2004,options were granted at exercise prices ranging from $4.50 to $6.00 per sharewhile the estimated fair value of the Company’s common stock was $10 per share.During the six months ended December 31, 2004 options were granted at aprice of $7.55 per share, which was the fair market value of the Company’scommon stock at the date of grant. During the nine months endedSeptember 30, 2005, options to purchase 1,170,500 shares of common stockwere granted at exercise prices ranging from $6.30 to $7.81 per share, whichwas the fair market value of the common stock at the dates of the grant. As aresult of the stock option grants prior to its initial public offering, theCompany recorded stock-based compensation of $1,603 and $430 in the nine monthsended September 30, 2004 and 2005, respectively.  As of September 30, 2005, there was anaggregate of $802 of deferred stock-based compensation remaining to beamortized, of which approximately $150 will be amortized in the remainingquarter of 2005.  The Company amortizesthe deferred compensation charges over the vesting period of the underlyingoption awards in accordance with Financial Interpretation No. 28. OnJanuary 1, 2006, the Company is required to adopt SFASNo. 123(R) which requires fair value accounting for stock-basedawards. See Note 19.

 

**17.****           ****Comprehensive Income**

 

The Company’s other comprehensiveincome relates to foreign currency translation adjustments and is presentedseparately on the balance sheet as required.

 

Comprehensive income consisted ofthe following:

 
| ** **                        | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                        | ** ** | **2004**                                             | ** ** | **2005**                                            | ** ** | **2004** | ** ** | **2005** | ** ** |
| Net income                        |       | $                                                    | 322        |                                                | $          | 2,170 |   | $ | 1,135 |   | $ | 5,476 |   |
| Cumulative translation adjustment |       | 64                                                   |       | 14                                                  |       | (45 | ) | (520 | ) |
| Comprehensive income              |       | $                                                    | 386        |                                                | $          | 2,184 |   | $ | 1,090 |   | $ | 4,956 |   |

 

**18.****           ****Forward Foreign Exchange Contracts**

 

The Company enters intotransactions in currencies other than the U.S. dollar and holds cash in foreigncurrencies which expose the Company to transaction gains and losses as foreigncurrency exchange rates fluctuate against the U.S. dollar. The Company fromtime to time enters into forward foreign exchange contracts to hedge theforeign currency exposure of non-U.S. dollar denominated third-party and intercompanyreceivables and cash balances. The contracts, which relate to the Britishpound, Euro, and the Japanese yen, generally have terms of one month. Thesehedges are deemed fair value hedges and have not been designated for hedge accounting.The gains or losses on the forward foreign exchange contracts along with theassociated losses and gains on the revaluation and settlement of theintercompany balances, accounts receivable and cash balances are recorded incurrent operations.

 

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The following table summarizes theoutstanding forward foreign exchange contracts held by the Company atSeptember 30, 2005:

 
| ** **    | ** ** | **As of September 30, 2005** | ** ** |
|---------------|------------|--------------------------------------------------|------------|
| ** **    | ** ** | **Local  Currency  Amount**                      | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** |
| British pound |       | 1,800                                            |       | $ | 3,185 |   |
| Euro          |       | 800                                              |       | 966 |   |
| Japanese yen  |       | 48,000                                           |       | 424 |   |
|          |       |                                             |       | $ | 4,575 |   |

 

The forward foreign exchangecontracts are short-term and mature within 35 days of origination.

 

Due to the short period of timebetween entering into the forward foreign exchange contracts andSeptember 30, 2005, the forward foreign exchange contract rateapproximates the exchange rate as of the end of the reporting period.

 

Realized and unrealized gains(losses), net of hedging are accounted for in other income (expense). Losses,net of hedging, were $103 and $38 for the three months ended September 30,2004 and 2005, respectively and $65 and $169 for the nine months endedSeptember 30, 2004 and 2005, respectively. The Company settles foreignexchange contracts in cash.

 

**19.****           ****Recently Issued Accounting Pronouncements**

** **

On December 16, 2004, the FASBissued SFAS No. 123 (revised 2004), *Share-BasedPayment*, which is a revision of SFAS No. 123, *Accounting for Stock-Based Compensation*.SFAS No. 123(R) supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees*,and amends SFAS No. 95, *Statement ofCash Flows*. Generally, the approach in SFAS No. 123(R) issimilar to the approach described in Statement 123. However, SFASNo. 123(R) requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the income statementbased on their fair values. Pro forma disclosure is no longer an alternative.

 

SFAS No. 123(R) must beadopted no later than January 1, 2006 for calendar year-end companies.Early adoption will be permitted in periods in which financial statements havenot yet been issued.

 

SFAS No. 123(R) permitspublic companies to adopt its requirements using one of two methods:

 

•       A “modified prospective”method in which compensation cost is recognized beginning with the effectivedate (a) based on the requirements of SFAS No. 123(R) for allshare-based payments granted after the effective date and (b) based on therequirements of SFAS No. 123 for all awards granted to employees prior tothe effective date of SFAS No. 123(R) that remain unvested on theeffective date.

 

•       A “modified retrospective”method which includes the requirements of the modified prospective methoddescribed above, but also permits entities to restate based on the amountspreviously recognized under SFAS No. 123 for purposes of pro formadisclosures either (a) all prior periods presented or (b) priorinterim periods of the year of adoption.

 

The Company is continuing to reviewthe two alternative adoption methods and the resulting impact of fair valuingawards in its financial statements. The Company is also reviewing variousoption valuation techniques and may use a valuation method other than theBlack-Scholes model for new awards upon adoption of SFAS No. 123(R).

 

The adoption of SFASNo. 123(R)’s fair value method will likely have a significant impact onthe Company’s results of operations, although it will have no impact on itsoverall financial position. The

 

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impact of adoption of SFASNo. 123(R) cannot be predicted at this time because it will depend inpart on levels of share-based payments granted in the future.

 

In June 2005, the FASB issuedSFAS No. 154, *Accounting Changes andError Corrections*, which will require entities that voluntarily makea change in accounting principle to apply that change retrospectively to priorperiods’ financial statements, unless this would be impracticable. SFASNo. 154 supersedes APB Opinion No. 20, *Accounting Changes*, which previously required that mostvoluntary changes in accounting principles be recognized by including in thecurrent period’s net income the cumulative effect of changing to the newaccounting principle. SFAS No. 154 also makes a distinction between“retrospective application” of an accounting principle and the “restatement” offinancial statements to reflect the correction of an error. Another significantchange in practice under SFAS No. 154 will be that if an entity changesits method of depreciation, amortization, or depletion for long-lived,non-financial assets, the change must be accounted for as a change inaccounting estimate. Under APB No. 20, such a change would have beenreported as a change in accounting principle. SFAS No. 154 applies toaccounting changes and error corrections that are made in fiscal yearsbeginning after December 15, 2005.

 

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**Item 2.****                         ****Management’s Discussion and Analysis of Financial Conditionand Results of Operations.**

** **

*The followingdiscussion and analysis of our financial condition and results of operationsshould be read in conjunction with our unaudited condensed consolidatedfinancial statements and related notes that appear elsewhere in this QuarterlyReport on Form 10-Q. In addition to historical consolidated financialinformation, the following discussion contains forward-looking statements thatreflect our plans, estimates and beliefs. Our actual results could differmaterially from those discussed in the forward-looking statements. Factors thatcould cause or contribute to these differences include those discussed belowand elsewhere in this Quarterly Report on Form 10-Q.*

* *

**Overview**

** **

Phase Forward Incorporated is aprovider of integrated enterprise-level electronic data capture, management andsafety software solutions for use in the clinical trial component of itscustomers’ global research and development initiatives. We offer softwareproducts, services and hosted solutions to pharmaceutical, biotechnology andmedical device companies, as well as academic institutions, clinical researchorganizations and other entities engaged in clinical trials. By automatingessential elements of the clinical trial process, we believe our products allowour customers to accelerate the market introduction of new medical therapiesand corresponding revenue, reduce overall research and developmentexpenditures, enhance existing data quality control efforts and reduce clinicaland economic risk.

 

**LincolnAcquisition**

** **

 On August 25, 2005, we acquired 100% of the outstanding commonshares of Lincoln Technologies, Inc. (“Lincoln”), a provider of productsand services for clinical trial safety signal detection and applied datastandards.  The aggregate purchase pricepaid in cash was approximately $11.2 million. The acquisition agreement calls for additional cash consideration, to bepaid subject to achievement of certain financial targets in 2005 and 2006, ofup to $2.0 million and $4.0 million in 2005 and 2006, respectively.  The acquisition of Lincoln was accounted foras a purchase under Statement of Financial Accounting Standards (SFAS)No. 141, *Business Combinations*.   Accordingly, the results of Lincoln havebeen included in the unaudited condensed consolidated financial statementssince the date of acquisition.

 

**Sources ofRevenues**

** **

We derive our revenues fromsoftware licenses and services. License revenue is derived principally from thesale of multi-year software term licenses for our *InForm, Clintrial* and *Clintrace*software products. Service revenue is derived from our delivery of the hostedsolution of our *InForm *softwareproduct, consulting services and customer support, including training. Wegenerally recognize revenue ratably over the life of a license or servicecontract. This allows us to maintain a backlog that provides multi-yearvisibility in revenue. As our backlog grows, we believe that the predictabilityof our future revenues will increase. Two customers, including Eli Lilly and Company, the holder of record ofapproximately 1% of our common stock, accounted for approximately 21% and 26%of our total revenues for the nine months ended September 30, 2004 and2005, respectively. Our top 20 customers accounted for approximately 71% and67% of our total revenues in the quarters ended September 30, 2004 and2005, respectively, net of reimbursable out-of-pocket expenses.

 

Revenues for Lincoln for the periodfrom the August 25, 2005 acquisition date to September 30, 2005consisted primarily of consulting services revenue.

 

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*LicenseRevenue*

* *

We derive our license revenue fromour three major software products: *InForm*,our Internet based electronic data capture solution; *Clintrial*, our clinical data management solution; and *Clintrace*, our adverse event reportingsolution. Although each of our *InForm,Clintrial* and *Clintrace*software solutions are available as stand-alone enterprise applications, wealso offer integrated enterprise solutions incorporating certain of ourelectronic data capture, data management and safety products.

 

License revenue for our *InForm *electronic data capturesoftware solution, either on a stand-alone or integrated basis, is determinedprimarily by the number, complexity and duration of the clinical trials and thenumber of participants in each clinical trial. License revenue for our *Clintrial* and *Clintrace* software solutions is determined primarily by thenumber of users accessing the software solution. Except as discussed below, weenter into software license agreements with terms generally of three to fiveyears with payment terms generally annually in advance. License revenue isrecognized ratably over the duration of the software term license agreement, tothe extent that amounts are fixed or determinable and collectable.

 

Following our acquisition ofClinsoft in August of 2001, we began converting holders of Clinsoftperpetual software licenses to our software term license agreements. In certainsituations we continue to sell perpetual licenses of our *Clintrial*and*Clintrace*software products to our existing customers. Werecognize revenue on the perpetual licenses upon delivery of the software.Perpetual license revenue represented less than 1% of total revenue for thenine months ended September 30, 2004 and 2005. We continue to provide andcharge for maintenance and support on our products to those customers who donot convert to our software term license arrangements. We generally charge 18%of the perpetual license fee for customer support. We intend to continue ourefforts to convert the remaining former Clinsoft customer base to software termlicense arrangements.

 

*ServiceRevenue*

* *

*Application HostingServices.*In addition to making our software products available tocustomers through licenses, we offer our *InForm *electronicdata capture software as a hosted application solution delivered through astandard web-browser, with customer support and training services. Revenueresulting from this hosting service consists of three stages for each clinicaltrial:

 

•       *Firststage—*trial and application set up, including design ofelectronic case report forms and edit checks, installation and serverconfiguration of the system;

 

•       *Secondstage—*application hosting and related support services; and

 

•       *Thirdstage—*services required to close out, or lock, the database forthe clinical trial.

 

Services provided for the first andthird stages are provided on a fixed fee basis depending upon the complexity ofthe trial and system requirements. Services for the second stage are chargedseparately as a fixed monthly fee. We recognize revenue from all stages of thehosting service ratably over the hosting period. Fees charged and costsincurred for the trial system design, set up and implementation are deferreduntil the start of the second stage and then amortized ratably over theestimated hosting period. The deferred costs include direct costs related tothe trial and application set up. Fees for the first and third stages of theservices are billed based upon milestones. Fees for application hosting andrelated services in the second stage are billed quarterly in advance. Bundledinto this revenue element is the revenue attributable to the software licenseused by the customer. In addition, application hosting services revenueincludes reimbursable out-of-pocket expenses.

 

In the event that an applicationhosting customer cancels a clinical trial and its related statement of work,all deferred revenue is recognized and all deferred set up costs are expensedand certain

 

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termination-related fees maybe charged. In addition, application hosting services revenue includes hostingservices associated with term license arrangements and reimbursableout-of-pocket expenses.

 

*ConsultingServices.*Consulting services include the design and documentation ofthe processes related to our customers’ use of our products and services in theirclinical trials. Consulting services also include project planning andmanagement services, guidance on best practices in using our software products,as well as implementation services consisting of application architecturedesign, systems integration, installation and validation. Revenue fromconsulting services included in a multiple element software license agreementor in a hosted solution are recognized ratably over the term of thearrangement. The associated costs are expensed as incurred. Revenue fromconsulting services that are not included in a multiple element softwarelicense arrangement are recognized as services are performed. Fixed pricedarrangements are billed based upon contractual milestones, andtime-and-materials arrangements are billed monthly.

 

*Customer Support.*We have a multinational services organization to supportour software products and hosted solutions worldwide. Customer support includestelephone support, software maintenance and training. We bundle customersupport in our software term licenses and allocate 10% of the value of thelicense to customer support revenue. Our customer support revenue also consistsof customer support fees paid by the*Clintrial* and *Clintrace*perpetual license customers. Customer support revenue is recognized ratablyover the period of the customer support or term license agreement, with paymentterms generally annually in advance.

 

**Costs ofRevenues and Operating Expenses**

** **

We allocate overhead expenses suchas rent and occupancy charges and employee benefit costs to all departmentsbased on headcount. As such, general overhead expenses are reflected in cost ofservice revenue and in the sales and marketing, research and development andgeneral and administrative expense categories.

 

*Costs of Revenues.*Cost of license revenue consists primarily of theamortization of royalties paid for certain modules within our *Clintrial* software product and our *InForm *software product.  The cost of license revenue varies based uponthe mix of revenue from software licenses for our products. We operate ourservice organization on a global basis as one distinct unit, and do not segmentcosts for our various service revenue elements. These services includeperforming application hosting, consulting and customer support services, andcosts consist primarily of employee-related costs associated with theseservices, amortization of the deferred clinical trial set up costs, allocatedoverhead, outside contractors, royalties associated with providing customersupport for third-party modules licensed to our customers for use with the *Clintrial* software product andreimbursable out-of-pocket expenses. Cost of services also includes hostingcosts that primarily consist of hosting facility fees and server depreciation.The cost of service revenue varies based upon employee utilization levels inthe service organization and royalties associated with revenue derived fromproviding customer support, as well as costs associated with the flexible useof outside contractors to support internal resources. We supplement the trialdesign and set up activity for application hosting services through the use ofoutside contractors. This allows us to utilize outside contractors in thoseperiods where trial design and set up activity is highest while reducing theuse of outside contractors in those periods where trial activity lessens,allowing for a more flexible delivery model. The percentage of the servicesworkforce represented by outside contractors varies from period to perioddepending on the volume of specific support required. The cost of services issignificantly higher as a percentage of revenue as compared to our cost oflicense revenue primarily due to the employee-related and outside contractorexpenses associated with providing services.

 

*Gross Margin.*Ourgross margin on license revenue varies based on the mix of royalty- andnonroyalty-bearing license revenue. Our gross margin on service revenue variesprimarily due to variations

 

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in the utilization levels ofthe professional service team and the timing of expense and revenue recognitionunder our service arrangements. In situations where the service revenue isrecognized ratably over the software license term, typically three to fiveyears, our costs associated with delivery of the services are recognized as theservices are performed, which is typically during the first 9 to 12 monthsof the contract period. Accordingly, our gross margin on service revenue willvary significantly over the life of a contract due to the timing, amount andtype of service required in delivering certain projects. In addition,consolidated gross margin will vary depending upon the mix of license andservice revenue.

 

*Sales andMarketing.*Sales and marketing expenses consist primarily ofemployee-related expenses, including travel, marketing programs (which includeproduct marketing expenses such as trade shows, workshops and seminars,corporate communications, other brand building and advertising), allocatedoverhead and the amortization of commissions. We expect that sales and marketing expenses will increase in absolutedollars as we expand and further penetrate our customer base, expand ourdomestic and international selling and marketing activities associated withexisting and new product and service offerings, build brand awareness andsponsor additional marketing events.

 

*Research andDevelopment.*Research and development expensesconsist primarily of employee-related expenses, allocated overhead and outsidecontractors. We have historically focused our research and development effortson increasing the functionality, performance and integration of our softwareproducts. We expect that in the future, research and development expenses willincrease in absolute dollars as we introduce additional integrated softwaresolutions to our product suite.

 

*General andAdministrative.*General and administrative expensesconsist primarily of employee-related expenses, professional fees, primarilyconsisting of expenses for accounting, compliance and legal services, and othercorporate expenses and allocated overhead. We expect that in the future,general and administrative expenses will fluctuate quarter by quarter due tothe timing of outside contractor and professional fees associated withcompliance, as well as legal services.

 

*Restructuring.*Werecorded a $4.5 million restructuring charge in 2003 which related to therelocation of our corporate headquarters. This charge included approximately$2.5 million relating to the estimated future obligation under thenon-cancelable lease and an approximate $2.0 million write-off of therelated abandoned leasehold improvements and fixed assets. As of March 31,2005, the payment of all charge-related expenses had occurred and, as a result,we recorded a restructuring benefit of $92,000 in the nine months endedSeptember 30, 2005 representing the elimination of accrued expensesassociated with the restructuring charge.

 

*Stock-BasedExpenses.*Our cost of service revenue and operating expenses,excluding our restructuring charges, include stock-based expenses related tothe fair value of options issued to non-employees and option grants toemployees in situations where the exercise price is determined to be less thanthe deemed fair value of our common stock at the date of grant.

 

**ForeignCurrency Translation**

** **

With regard to our internationaloperations, we frequently enter into transactions in currencies other than theU.S. dollar. As a result, our revenues, expenses and cash flows are subject tofluctuations due to changes in foreign currency exchange rates, particularlychanges in the Euro, British pound sterling, Australian dollar and Japaneseyen. In the three months ended September 30, 2004 and 2005, approximately44% and 45%, respectively, of our revenues were generated in locations outsidethe United States. In the nine months ended September 30, 2004 and 2005,approximately 41% and 47%, respectively, of our revenues were generated inlocations outside the United States. The majority of these revenues were incurrencies other than the U.S. dollar. In periods when the U.S. dollar declinesor increases in value as compared to the foreign currencies in which we conductbusiness, our foreign currency-based revenues and expenses increase ordecrease, as the case may be, when translated into U.S. dollars.

 

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**CriticalAccounting Policies and Estimates**

** **

Our unaudited condensedconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesefinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets, liabilities, revenues, costs and expenses andrelated disclosures. On an ongoing basis, we evaluate our estimates andassumptions with our audit committee. There have been no material changes tothese estimates for the periods presented in this Quarterly Report onForm 10-Q. Our actual results may differ from these estimates.

 

We believe that of our significantaccounting policies, which are described in the Notes to our unauditedcondensed consolidated financial statements included in this Quarterly Reporton Form 10-Q, the following accounting policies involve a greater degreeof judgment and complexity. Accordingly, these are the policies we believe arethe most critical to aid in fully understanding and evaluating our consolidatedfinancial condition and results of operations.

 

*RevenueRecognition and Deferred Set Up Costs.*Werecognize software license revenue in accordance with Statement of Position(“SOP”) No. 97-2, *Software RevenueRecognition,* as amended, issued by the American Institute ofCertified Public Accountants, while revenue resulting from application servicesare recognized in accordance with Emerging Issues Task Force (“EITF”) IssueNo. 00-03, *Application of AICPAStatement of Position 97-2 to Arrangements that Include the Right to UseSoftware Stored on Another Entity’s Hardware* and SEC StaffAccounting Bulletin (SAB) Nos. 101 and 104, *RevenueRecognition*. On August 1, 2003, we adopted EITF IssueNo. 00-21, *Revenue Arrangements withMultiple Deliverables.* The adoption of EITF Issue No. 00-21 didnot have a material impact on our financial position or results of operations.

 

Customers generally have theability to terminate application hosting, consulting and training serviceagreements upon 30 days notice to us. License agreements, multiple elementarrangements, including license and services agreements, and certainapplication hosting services can generally be terminated by either party formaterial breach of obligations not corrected within 30 days after noticeof the breach.

 

We recognize revenue when all ofthe following conditions are satisfied: (1) there is persuasive evidenceof an arrangement; (2) the product or service has been provided to thecustomer;  (3) the collection offees is probable; and (4) the amount of fees to be paid by the customer isfixed or determinable.

 

We generally enter into softwareterm licenses with our customers for three to five year periods. Thesearrangements typically include multiple elements: software license, consultingservices and customer support. We bill our customers in accordance with the termsof the underlying contract. Generally, we bill the annual license fee for thefirst year of the multi-year contract in advance and bill license fees forsubsequent years on the anniversary date. Our payment terms are generally net30 days.

 

Our software license revenue isearned from the sale of off-the-shelf software requiring no significantmodification or customization subsequent to delivery to the customer.Consulting services, which can also be performed by third-party consultants,are deemed to be non-essential to the functionality of the software andtypically are for trial configuration, implementation planning, loading ofsoftware, building simple interfaces and running test data and documentation ofprocedures.

 

We generally bundle customer supportwith the software license for the entire term of the arrangement. As a result,we generally recognize revenue for all elements ratably over the term of themultiple element arrangement. We allocate the revenue for these arrangements tothe different elements based on management’s estimate of the relative fairvalue of each element. For our contracts accounted for ratably under SOPNo. 97-2, we allocate to consulting services the anticipated service levelthroughout the term of the arrangement at an amount equal to what it would havebeen had those services been sold

 

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separately to the customer.The remaining value is allocated to license and support services, with a 10%value allocated to support services. The costs associated with the consultingand customer support services are expensed as incurred. There are instances inwhich we sell software licenses based on usage levels. These software licensescan be based on estimated usage, in which case the license fee charged to thecustomer is fixed based on this estimate. When the fee is fixed, the revenue isrecognized over the contractual term of the arrangement. If the fee is based onactual usage, and therefore variable, the revenue is recognized in the periodof use. Revenue from certain follow-on consulting services, which are soldseparately to customers with existing software licenses and are not consideredpart of a multiple element arrangement, is generally recognized as the servicesare performed.

 

Revenue from perpetual softwarelicenses represented less than 1% of total revenues for the nine months endedSeptember 30, 2004 and 2005. We continue to sell perpetual licenses forthe *Clintrial* and *Clintrace* software products in certainsituations to our existing customers with the option to purchase customersupport. We have established vendor specific objective evidence of fair valuefor the customer support. Accordingly the perpetual license revenue isrecognized upon delivery of the software and when all other revenue recognitioncriteria are met. Customer support revenue is recognized ratably over the termof the underlying support arrangement.

 

In addition to making our softwareproducts available to customers through licenses, we offer our *InForm *electronic data capturesoftware solution through a hosted application solution delivered through astandard web-browser. Revenue resulting from application hosting servicesconsist of three stages for each clinical trial: the first stage involvesapplication set up, including design of electronic case report forms and editchecks, implementation of the system and server configuration; the second stageinvolves application hosting and related support services; and the third stageinvolves services required to close out, or lock, the database for the clinicaltrial. Services provided for the first and third stages are provided on a fixedfee basis based upon the complexity of the trial and system requirements.Services for the second stage are charged separately as a fixed monthly fee. Werecognize revenue from all stages of the hosting service over the hostingperiod. Fees charged and costs incurred for the trial system design, set up andimplementation are deferred and capitalized as applicable, until the start ofthe second stage and then amortized and recognized, as applicable, ratably overthe estimated hosting period. The capitalized costs include incremental directcosts with third parties and certain internal direct costs related to the trialand application set up, as defined under SFAS No. 91, *Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Indirect Costs of Leases*.These costs include salary and benefits associated with direct labor costsincurred during trial set up, as well as third-party subcontract fees and othercontract labor costs. Work performed outside the original scope of work iscontracted for separately as an additional fee and is generally recognized overthe remaining term of the hosting period. Fees for the first and third stagesof the services are billed based upon milestones. Fees for application hostingand related services in the second stage are billed quarterly in advance.Bundled into this revenue element is the revenue attributable to the softwarelicense used by the customer.

 

We capitalized $482,000 and$666,000 of deferred set up costs and amortized $500,000 and $425,000 in thethree months ended September 30, 2004 and 2005, respectively, andcapitalized $1.3 million and $1.8 million of deferred set up costs andamortized $1.4 million and $1.3 million in the nine months endedSeptember 30, 2004 and 2005, respectively. The amortization of deferredset up costs is a component of cost of services.

 

Deferred revenue represents amountsbilled or cash received in advance of revenue recognition.

 

*Accounting forCommission Payments and Royalties.*For arrangements where werecognize revenue over the relevant contract period, we defer relatedcommission payments to our direct sales force and software license royaltiespaid to third parties and amortize these amounts over the same period that therelated revenue are recognized. This is done to better match commission androyalty expenses with the

 

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related revenue. Wecapitalized $1.2 million and $989,000 of commissions and amortized to sales andmarketing expense $753,000 and $1.0 million in the three months endedSeptember 30, 2004 and 2005, respectively, and capitalized $2.8 millionand $2.3 million of commissions and amortized to sales and marketing expense$2.0 million and $2.7 million in the nine months ended September 30, 2004and 2005, respectively.

 

Royalties are paid on a percentageof billings basis for certain of our products. We capitalized $367,000 and$645,000 of royalties and amortized to costs of revenues $652,000 and $803,000in the three months ended September 30, 2004 and 2005, respectively, andcapitalized $2.6 million and $2.9 million of royalties and amortized to costsof revenues $1.8 million and $2.1 million in the nine months endedSeptember 30, 2004 and 2005, respectively.

 

*AccountsReceivable Reserves.*We maintain allowances for doubtfulaccounts for estimated losses resulting from the inability of our customers tomake required payments. We regularly evaluate the collectibility of our tradereceivables based on a combination of factors, which may include dialogue withthe customer to determine the cause of non-payment, the use of collectionagencies, and/or the use of litigation. In the event it is determined that thecustomer may not be able to meet its full obligation to us, we record aspecific allowance to reduce the related receivable to the amount that weexpect to recover given all information available to us. We monitor collectionsfrom our customers and maintain a provision for estimated credit losses basedupon our historical experience and any specific customer collection issues thatwe have identified. While such credit losses have historically been within our expectationsand the provisions established, we cannot guarantee that credit loss rates willnot increase in the future. If the financial condition of our customers were todeteriorate, resulting in an impairment of their ability to make payments,additional allowances may be required. Our accounts receivable reserves were$391,000 and $323,000 as of December 31, 2004 and September 30, 2005,respectively.

 

*Accounting forIncome Taxes.*In connection with the preparationof our financial statements, we are required to estimate our income taxes ineach of the jurisdictions in which we operate. This process involves theassessment of our net operating loss carryforwards and credits, as well asestimating the actual current tax liability together with assessing temporarydifferences resulting from differing treatment of items, such as reserves andaccrued liabilities, for tax and accounting purposes. We then assess thelikelihood that deferred tax assets will be recovered from future taxableincome, and to the extent we believe that recovery is not likely, we mustestablish a valuation allowance. As of September 30, 2005, we haveincurred a three year cumulative loss from operations. Once we are no longer ina three year cumulative loss position, we would expect to recognize some or allof our deferred tax assets based principally on our ability to forecast futureoperating income. Currently, we believe that it is more likely than not that wewill not realize the value of our deferred tax assets and therefore have provideda full valuation allowance against our net deferred tax assets. We willcontinue to evaluate the realizability of our deferred tax assets quarterly. Ifin future periods our assessment deems it more likely than not the deferred taxassets will be recognized, we would record an adjustment to our valuationallowance at that time, which would result in a reduction to income taxexpense, and such reduction could be significant in the period in which suchdetermination is made.

 

The American Jobs Creation Act of2004 (the “Act”), which was enacted on October 22, 2004, introduced aspecial one-time dividends received deduction on the repatriation of certainforeign earnings to a U.S. taxpayer (repatriation provision), provided certaincriteria are met. Even in light of the Act, our current intention is toreinvest the total amount of our unremitted earnings in the local jurisdictionor to repatriate the earnings only when doing so would be tax-effective. Assuch, we have not provided U.S. tax expense on the unremitted earnings of ourforeign subsidiaries.

 

*Accounting forStock-Based Awards.*We record deferred stock-basedcompensation charges in the amount by which the exercise price of an option isless than the deemed fair value of our common stock at

 

26

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the date of grant. Becausethere had been no public market for our stock prior to the July 2004initial public offering of our common stock (the “IPO”), our board of directorshad determined the fair value of our common stock based upon several factors,including, but not limited to, our operating and financial performance, salesof convertible preferred stock to third parties, the rights and preferences ofsecurities senior to common stock and the anticipated offering price of ourcommon stock in connection with the IPO.

 

We have not historically engagedunrelated third parties to prepare valuations of our common stock. Inconnection with the IPO, management and the board of directors retroactivelyassessed the fair value of our common stock during 2003 and through the date ofthe IPO.

 

During 2003, all stock options weregranted with an exercise price of $3.00 per share, while the estimated pershare fair value of our common stock was subsequently determined to range from$3.00 to $4.00 in the first quarter of 2003, $4.00 to $5.00 in the secondquarter of 2003, $5.00 to $7.50 in the third quarter of 2003 and $7.50 to $9.00in the fourth quarter of 2003.

 

At the beginning of 2003, wedetermined the value of our common stock based principally on the per shareamounts that would have been distributed to the common stockholders, after allrequired distributions to the preferred stockholders, in the event of a sale ofthe Company at the value established in our January 2002 preferred stockfinancing. We chose this valuation methodology based on our operatingperformance during 2002 and the limited, if any, access we had to the publicequity markets at the time.

 

The increase in our estimated pershare fair value of common stock since the beginning of 2003 reflects a numberof significant factors, including an improvement in our operating results,especially in the second half of the year, changes to our management teamthroughout 2003, additions to our board of directors in the second half of 2003and an overall improvement in stock market indices and increasing volume ofinitial public offerings of common stock throughout 2003.

 

In the first, second and thirdquarters of 2003, we incurred operating losses of $1.4 million,$1.1 million and $31,000, respectively. In the fourth quarter, we had anoperating profit of $432,000, excluding a restructuring charge in the fourthquarter. Our increasing per share fair value of common stock throughout 2003reflects this positive trend in operating results. In addition, in the secondhalf of 2003, because of our improved operating performance and the improvingequity markets, we began to contemplate an initial public offering of ourcommon stock.

 

During 2004, prior to our IPO,options were granted at exercise prices ranging from $4.50 to $6.00 per sharewhile the estimated fair value of our common stock was $10.00 per share. Thefair value of our common stock during 2004, prior to our IPO, was based on thehigh end of the range of estimated offering prices of common stock ascontemplated in the preliminary prospectus for our initial public offering thatwas filed with the Securities and Exchange Commission. All options grantedsince the IPO were priced at the fair market value of the common stock at thedate of grant.

 

As of September 30, 2005,there was an aggregate of $802,000 of deferred stock-based compensationremaining to be amortized. Historically, we have elected not to record employeestock-based awards at fair value. The impact of recording employee stock-basedawards at fair value, using the Black-Scholes option-pricing model, is furtherdescribed in Note 9 of the notes to our unaudited condensed consolidatedfinancial statements contained in this Quarterly Report on Form 10-Q.Effective January 1, 2006, we will be required to adopt a fair valueapproach to valuing stock-based awards. See Note 19 in the notes to ourunaudited condensed consolidated financial statements.

 

In the past, we have awarded alimited number of stock options to non-employees. For these options, werecognize the stock-based compensation over the vesting periods of theunderlying awards, based on an estimate of their fair value on the vestingdates using the Black-Scholes option-pricing model.

 

27

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*GoodwillImpairment*. We review the carrying value of goodwill periodicallybased upon the expected future discounted operating cash flows of our business.Our cash flow estimates are based on historical results adjusted to reflect ourbest estimate of future markets and operating conditions. Actual results maydiffer materially from these estimates. The timing and size of impairmentcharges, if any, involves the application of management’s judgment regardingthe estimates and could significantly affect our operating results.

 

**Overview ofResults of Operations for the Three Months Ended September 30, 2004 and2005**

** **

License revenue increased 17% inthe three months ended September 30, 2005 as compared to the three monthsended September 30, 2004. Service revenue increased 17% in the threemonths ended September 30, 2005 as compared to the three months endedSeptember 30, 2004.

 

Our gross margin increased 18%, or$2.1 million, in the three months ended September 30, 2005 to$13.7 million, compared to $11.6 million for the same period in 2004,due to an increase in license revenue which generates a higher gross margin andincreased utilization of our services personnel, which led to higher servicemargins.

 

Operating income increased $1.3million from $976,000 in the three months ended September 30, 2004 to $2.2million for the three months ended September 30, 2005. The operatingincome in the three months ended September 30, 2004 and 2005 included$684,000 and $73,000 of stock-based compensation, respectively. As ofSeptember 30, 2005, we had $55.2 million of cash, cash equivalentsand short-term investments, a decrease of $3.0 million from$58.2 million at December 31, 2004.

 

The results for the three monthsended September 30, 2005 were impacted by foreign exchange rates.  Revenues and expenses increased approximately1% and 0%, respectively, as a result of fluctuations in foreign exchange rates.

 

*Revenues*

 
| ** **                   | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                   | ** ** | **2004**                                                                   | ** ** | **2005** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues**                 | ** ** | **Amount**                                                                 | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Change** | ** ** |
| **Amount**                   | ** ** | **%**                                                                      |
| ** **                   | ** ** | **(in thousands)**                                                    | ** ** |
| License                      |       | $                                                                          | 7,352      |   | 39 | % | $ | 8,637 |   | 39 | % | $ | 1,285 |   | 17 | % |
| Application hosting services |       | 7,238                                                                      |       | 38 |   | 7,998 |   | 36 |   | 760 |   | 10 | % |
| Professional services        |       | 1,192                                                                      |       | 6 |   | 2,679 |   | 12 |   | 1,487 |   | 125 | % |
| Customer support             |       | 3,227                                                                      |       | 17 |   | 2,928 |   | 13 |   | (299 | ) | (9 | )% |
| Total                        |       | $                                                                          | 19,009     |   | 100 | % | $ | 22,242 |   | 100 | % | $ | 3,233 |   | 17 | % |

 

Total revenues increased in thethree months ended September 30, 2005 as compared to the same period in2004 due to increases in professional services revenue and license revenueacross all products, as well as an increase in**application hosting services. The increase in professional servicesrevenue for the three months ended September 30, 2005 was primarilyrelated to the increase in consulting services associated with our existingcustomer base, primarily related to *InForm*,and the addition of new consulting engagements related to our acquisition ofLincoln. The increase in license revenue in the three months endedSeptember 30, 2005 was primarily due to an increase in sales of *InForm*, and to a lesser extent an increasein sales of both *Clintrial* and *Clintrace* products. This increase was aresult of our continued strategy to expand the usage of our software productswithin our existing customer base by cross selling the *InForm*, *Clintrial*and *Clintrace* products to thesecustomers, and through sales to new customers. The increase in revenueassociated with the hosted-application version of our *InForm *product in the three monthsended September 30, 2005 was due to an increase in clinical trials undermanagement, which include both application hosting services trials as well astrials hosted for our *InForm *licensecustomers.

 

28

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Customer support revenue forthe three months ended September 30, 2005 decreased compared to the sameperiod in 2004 due to the reduction in the *Clintrial*renewal base as a**resultof the conversion of the former Clinsoft customers to term-based licenses thathave a lower customer support fee, as well as a decrease in *InForm *support revenue associatedwith the timing of support activities.

 
| ** **                          | ** ** | **For the Three Months Ended September 30,** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **2004**                                                                   | ** ** | **2005** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                                                 | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Change** | ** ** |
| **Amount**                          | ** ** | **%**                                                                      |
| ** **                          | ** ** | **(in thousands)**                                                    | ** ** |
| United States                       |       | $                                                                          | 10,564     |   | 56 | % | $ | 12,225 |   | 55 | % | $ | 1,661 |   | 16 | % |
| United Kingdom                      |       | 5,210                                                                      |       | 27 |   | 6,271 |   | 28 |   | 1,061 |   | 20 | % |
| France                              |       | 2,067                                                                      |       | 11 |   | 2,179 |   | 10 |   | 112 |   | 5 | % |
| Asia-Pacific                        |       | 1,168                                                                      |       | 6 |   | 1,567 |   | 7 |   | 399 |   | 34 | % |
| International  subtotal             |       | 8,445                                                                      |       | 44 |   | 10,017 |   | 45 |   | 1,572 |   | 19 | % |
| Total                               |       | $                                                                          | 19,009     |   | 100 | % | $ | 22,242 |   | 100 | % | $ | 3,233 |   | 17 | % |

 

The increase in revenues worldwidewas due primarily to the increase in *InForm* revenuein the United States and United Kingdom resulting from additionalenterprise-wide license and service agreements. In addition, the Asia-Pacific license and services revenue increasedacross all products.

* *

*Costs of Revenues*

 
| ** **                      | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|---------------------------------|------------|----------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                      | ** ** | **2004**                                                                   | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                                                 | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                                                 | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | **Change** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                                                                 | ** ** | **Revenue**         | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                      | ** ** | **(in thousands)**                                                    | ** ** |
| License                         |       | $                                                                          | 501        |                | 7          | %          | $          | 722 |   | 8 | % | $ | 221 |   | 44 | % |
| Services                        |       | 6,890                                                                      |       | 59                  |       | 7,799      |       | 57 |   | 909 |   | 13 | % |
| Total                           |       | $                                                                          | 7,391      |                | 39         | %          | $          | 8,521 |   | 38 | % | $ | 1,130 |   | 15 | % |

 

The cost of license revenueincreased in the three months ended September 30, 2005 due to an increasein royalty expense associated with certain modules of our *Clintrial* software product as well as our *InForm *software products. Cost ofservices for the three months ended September 30, 2005 increased by$909,000 as we incurred $418,000 of additional employee-related expenses, ofwhich $81,000 relates to our recent acquisition of Lincoln and $419,000incremental outside contractor expense which was necessary to deliver increasedservices.  In addition, there were alsoexpense increases in computer and related and depreciation of $109,000 and$106,000, respectively. These expense increases were partially offset by anincreased benefit of labor capitalization (net of amortization) of $260,000associated with the trial build or set up phase for application hosting servicearrangements, due to an increase in trials in the set up phase.

 

*GrossMargin*

 
| ** **            | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------|------------|----------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|
| ** **            | ** ** | **2004**                                                                   | ** ** | **2005**               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                                                 | ** ** | **Percentage of** | ** ** | ** ** | ** ** | **Percentage of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                                                 | ** ** | **Related**            | ** ** | ** ** | ** ** | **Related** | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                                                 | ** ** | **Revenue**            | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                                                    | ** ** |
| License               |       | $                                                                          | 6,851      |                   | 93         | %          | $          | 7,915 |   | 92 | % | $ | 1,064 |   | 16 | % |
| Services              |       | 4,767                                                                      |       | 41                     |       | 5,806      |       | 43 |   | 1,039 |   | 22 | % |
| Total                 |       | $                                                                          | 11,618     |                   | 61         | %          | $          | 13,721 |   | 62 | % | $ | 2,103 |   | 18 | % |

 

29

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The license gross margin percentagedeclined in the three months ended September 30, 2005 due to an increasein royalty expense relating to *InForm *andcertain modules of the *Clintrial*software.  The services gross margin percentageincreased for the three months ended September 30, 2005 due to an increasein consulting services revenue performed on a time and material basis for someof our enterprise customers, rather than services performed under bundledarrangements, where the revenue is recognized ratably over the license period,while the expenses are recognized as incurred. In addition, an application hosting services trial cancellation resultedin the acceleration of revenue recognition for amounts previously deferredassociated with the trial set up and other work performed up until the time ofcancellation.  The increased utilizationof our services personnel also contributed to higher services margins.  These increases more than offset the decreasein license gross margin.  It is likelythat gross margin, as a percentage of revenues, will fluctuate quarter byquarter due to the timing and mix of license and service revenues, and the type,amount and timing of service required in delivering certain projects.

 

*Operating Expenses*

 
| ** **                  | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-----------------------------|------------|----------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                  | ** ** | **2004**                                                                   | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                                                 | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                                                 | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                                    | ** ** |
| Sales and marketing         |       | $                                                                          | 3,509      |                | 18         | %          | $          | 3,897 |   | 18 | % | $ | 388 |   | 11 | % |
| Research and development    |       | 3,170                                                                      |       | 17                  |       | 3,653      |       | 16 |   | 483 |   | 15 | % |
| General and administrative  |       | 3,963                                                                      |       | 21                  |       | 3,937      |       | 18 |   | (26 | ) | (1 | )% |
| Total                       |       | $                                                                          | 10,642     |                | 56         | %          | $          | 11,487 |   | 52 | % | $ | 845 |   | 8 | % |
|                             |            |                                                                            |            |                     |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

*Sales andMarketing.*Sales and marketing expenses increased for the three monthsended September 30, 2005 primarily due to a $251,000 increase incommission expense resulting from an increase in revenues and the effectivecommission rate, and an increase in outside contractor expense of $90,000, ofwhich $29,000 relates to our recent acquisition of Lincoln. We expect that oursales and marketing expenses will continue to increase in absolute dollars ascommission expense increases with our revenues and we continue to build ourbrand awareness through what we believe are the most cost-effective channelsavailable. However, sales and marketing expenses may fluctuate quarter byquarter due to the timing of marketing programs.

 

*Research andDevelopment.*Research and development expensesincreased in the three months ended September 30, 2005 primarily due to anincrease in employee-related expenses of $461,000, of which $110,000 relates toour recent acquisition of Lincoln.  Wealso hired additional people to improve our quality assurance and productdevelopment team. We expect that our research and development costs willcontinue to increase in absolute dollars as we continue to introduce additionalintegrated software solutions and add features and functionality to ourproducts.

 

*General andAdministrative.*General and administrative expensesdecreased slightly in the three months ended September 30, 2005.  We incurred increases in employee-relatedexpenses of $344,000, of which $96,000 relates to our recent acquisition ofLincoln, and outside contractors of $238,000 primarily related to preparationfor compliance with the Sarbanes-Oxley Act of 2002.  These expense increases were offset by a$560,000 decrease in stock-based compensation and a $203,000 decrease inprofessional fees associated with defending ongoing litigation related to ourintellectual property.  We expect that inthe future, general and administrative expenses will fluctuate quarter byquarter due to the timing of outside contractor and professional feesassociated with compliance, as well as legal services.

 

30

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*OperatingIncome, Other Income (Expense)*

 
| ** **                 | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                 | ** ** | **2004**                                                                   | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | ** **                                                                 | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                                                 | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                                    | ** ** |
| **Operating income**       |       | $                                                                          | 976        |                | 5          | %          | $          | 2,234 |   | 10 | % | $ | 1,258 |   | 129 | % |
| **Other income (expense)** | ** ** | ** **                                                                 | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income            |       | $                                                                          | 138        |                | 1          | %          | $          | 449 |   | 2 | % | $ | 311 |   | 225 | % |
| Interest expense           |       | (45                                                                        | )          | —              |       | —     |       | — |   | 45 |   | (100 | )% |
| Other, net                 |       | (143                                                                       | )          | (1                  | )          | (79        | )          | — |   | 64 |   | (45 | )% |
| Total                      |       | $                                                                          | (50        | )                   | 0          | %          | $          | 370 |   | 2 | % | $ | 420 |   | (840 | )% |

 

*OperatingIncome.*The increase in operating income in the three months endedSeptember 30, 2005 was primarily due to an increase in gross margin,partially offset by increased operating expenses resulting from increases inemployee-related expenses, commission expense and outside contractor fees,principally related to services and general and administrative. It is likelythat operating income, as a percentage of revenues, will fluctuate quarter byquarter due to the timing and mix of license and services revenues, and theamount and type of service required in delivering certain projects, as well asthe timing of operating expense activities.

 

*Other Income(Expense).*The increase in interest income in the three months endedSeptember 30, 2005 was primarily due to an increase in average cash andcash equivalents available for investment and short-term investments and highermarket rates of return. The decrease in interest expense in the three monthsended September 30, 2005 was due to the payoff of all outstanding debtduring the quarter ended March 31, 2005. Other, net expense primarilydecreased due to a reduction in foreign exchange losses in the three monthsended September 30, 2005 compared to the foreign exchange losses in thethree months ended September 30, 2004, which relate to unfavorableexchange rate movements on non-U.S. dollar denominated accounts receivable andintercompany balances.

 

*Provisionfor Income Taxes*

 
| ** **                 | ** ** | **For the Three Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|----------------------------|------------|----------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                 | ** ** | **2004**                                                                   | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | ** **                                                                 | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                                                 | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                                    | ** ** |
| Provision for income taxes |       | $                                                                          | 604        |                | 3          | %          | $          | 434 |   | 2 | % | $ | (170 | ) | (28 | )% |
|                            |            |                                                                            |            |                     |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The provision for income taxes for2004 represents foreign withholding taxes and income taxes payable that cannotbe offset through loss carryforwards. The provision for income taxes for 2005represents income taxes payable that cannot be offset through losscarryforwards. The effective tax rate for 2005 decreased to 16.7% compared toan effective tax rate of 65.2% for 2004. The decrease in our effective tax rateis primarily due to the decrease in stock-based expenses of $611,000, which isnot deductible for tax purposes, but is included in the calculation of theeffective rate, and to a reduction in foreign withholding taxes and U.S. incometaxes payable.  The decrease in theforeign withholding taxes related to the elimination of withholding tax due tochanges in legislation between the U.S. and Japan effective in the secondquarter of 2004. The decrease in U.S. income taxes payable related to therecording of a one time benefit associated with adjustments required toprevious estimates compared to our tax return for the year endedDecember 31, 2004 filed in the third quarter of 2005, and to the change inthe mix and timing of the

 

31

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use of net operating losscarryforwards to offset taxable income. In utilizing our net operating losscarryforwards, we are required to use our oldest net operating losses first. Asa result, we have first used the net operating losses acquired in the Clinsoftacquisition. The utilization of the acquired net operating losses reduces theamount of income taxes payable to local tax authorities. This benefit has beenreflected as a reduction of goodwill. The benefit of utilization of the netoperating loss carryforwards that were not acquired has been reflected as areduction to the income tax provision.

 

**Overview ofResults of Operations for the Nine Months Ended September 30, 2004 and2005**

 

License revenue increased 31% inthe nine months ended September 30, 2005 as compared to the nine monthsended September 30, 2004. Service revenue increased 11% in the nine monthsended September 30, 2005 as compared to the nine months endedSeptember 30, 2004.

 

Our gross margin increased 24%, or$7.5 million, in the nine months ended September 30, 2005 to$39.3 million, compared to $31.8 million for the same period in 2004,primarily due to the increase in license revenue.

 

Operating income increased by$3.4 million from $2.8 million in the nine months ended September 30,2004 to an operating income of $6.2 million for the nine months endedSeptember 30, 2005. The operating income in the nine months ended September 30,2004 and 2005 included $1.6 million and $430,000 of stock-based compensation,respectively. As of September 30, 2005, we had $55.2 million of cash,cash equivalents and short-term investments securities, a decrease of$3 million from $58.2 million at December 31, 2004.

 

The results for the nine monthsended September 30, 2005, were impacted by foreign exchange. Revenues andexpenses increased approximately 3% and 1%, respectively, as a result offluctuations in foreign exchange rates.

 

*Revenues*

 
| ** **                   | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                   | ** ** | **2004**                                                                  | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                                                                | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Revenues**                 | ** ** | **Amount**                                                                | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                   | ** ** | **(in thousands)**                                                   | ** ** |
| License                      |       | $                                                                         | 19,875     |                | 37         | %          | $          | 26,088 |   | 41 | % | $ | 6,213 |   | 31 | % |
| Application hosting services |       | 19,840                                                                    |       | 37                  |       | 22,105     |       | 35 |   | 2,265 |   | 11 | % |
| Professional services        |       | 3,971                                                                     |       | 7                   |       | 5,696      |       | 9 |   | 1,725 |   | 43 | % |
| Customer support             |       | 9,978                                                                     |       | 19                  |       | 9,613      |       | 15 |   | (365 | ) | (4 | )% |
| Total                        |       | $                                                                         | 53,664     |                | 100        | %          | $          | 63,502 |   | 100 | % | $ | 9,838 |   | 18 | % |

 

Total revenues increased in thenine months ended September 30, 2005 as compared to the same period in2004 due to an increase in license revenue across all products, as well as anincrease in *InForm *applicationhosting services. The increase in license revenue in the nine months endedSeptember 30, 2005 was primarily due to an increase in sales of *InForm *and, to a lesser extent, anincrease in sales of both *Clintrial*and *Clintrace* products. Thisincrease was a result of our continued strategy to expand the usage of oursoftware products by cross selling the *InForm*,*Clintrial* and *Clintrace* products to our existingcustomer base, additional utilization of our products within our customer baseand sales to new customers. The increase in revenue associated with thehosted-application version of our *InForm *productin the nine months ended September 30, 2005 was due to an increase inclinical trials under management. Professional services revenue for the ninemonths ended September 30, 2005 increased compared to the same period in2004 due to the increase in consulting services associated with our existingenterprise customers. The small decrease in the customer support revenue forthe nine months

 

32

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ended September 30,2005 was primarily due to a decrease in the *Clintrial*renewal base as a result of the conversion of the former Clinsoft customers toterm based licenses that have a lower customer support fee, offset partially byan increase in *InForm *supportrevenue associated with an increase in license and training revenue associatedwith our *InForm *product.

 
| ** **                          | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                          | ** ** | **2004**                                                                  | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                          | ** ** | ** **                                                                | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                                                | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                                   | ** ** |
| United States                       |       | $                                                                         | 31,523     |                | 59         | %          | $          | 33,750 |   | 53 | % | $ | 2,227 |   | 7 | % |
| United Kingdom                      |       | 12,489                                                                    |       | 23                  |       | 18,747     |       | 30 |   | 6,258 |   | 50 | % |
| France                              |       | 6,264                                                                     |       | 12                  |       | 6,396      |       | 10 |   | 132 |   | 2 | % |
| Asia-Pacific                        |       | 3,388                                                                     |       | 6                   |       | 4,609      |       | 7 |   | 1,221 |   | 36 | % |
| International  subtotal             |       | 22,141                                                                    |       | 41                  |       | 29,752     |       | 47 |   | 7,611 |   | 34 | % |
| Total                               |       | $                                                                         | 53,664     |                | 100        | %          | $          | 63,502 |   | 100 | % | $ | 9,838 |   | 18 | % |

 

The increase in revenues worldwidewas due primarily to the increase in *InForm *revenuein the United Kingdom, resulting from additional enterprise-wide license and serviceagreements, with one customer accounting for approximately 50% of the increase.In addition, the Asia-Pacific license and services revenue increased across allproducts.

 

*Costs of Revenues*

* *
| ** **                      | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------------------------------------------------|------------|-------------------|------------|------------|------------|
| ** **                      | ** ** | **2004**                                                                  | ** ** | **2005**          | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                                                | ** ** | **Percentage of** | ** ** | ** ** | ** ** | **Percentage of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                      | ** ** | ** **                                                                | ** ** | **Related**       | ** ** | ** ** | ** ** | **Related** | ** ** | **Change** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                                                                | ** ** | **Revenue**       | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                      | ** ** | **(in thousands)**                                                   | ** ** |
| License                         |       | $                                                                         | 1,371      |              | 7          | %          | $          | 1,759 |   | 7 | % | $ | 388 |   | 28 | % |
| Services                        |       | 20,513                                                                    |       | 61                |       | 22,475     |       | 60 |   | 1,962 |   | 10 | % |
| Total                           |       | $                                                                         | 21,884     |              | 41         | %          | $          | 24,234 |   | 38 | % | $ | 2,350 |   | 11 | % |

 

 

The cost of license revenueincreased in the nine months ended September 30, 2005 due to a $397,000increase in royalty expense associated with our *InForm *software product as well as certain modules ofour *Clintrial* software product.Cost of services for the nine months ended September 30, 2005 increased by$2.0 million as we incurred $849,000 of additional employee-related expensesand $924,000 incremental outside contractor expense to deliver increasedservices. In addition, we incurred expense increases in computer-relatedexpenses, occupancy and depreciation of $340,000, $153,000 and $222,000,respectively. These expense increases were partially offset by an increasedbenefit of labor capitalization (net of amortization) of $618,000 associatedwith the trial build or setup phase for application hosting servicearrangements, due to an increase in trials in the set up phase.

 

*GrossMargin*

* *
| ** **            | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **             | ** ** | ** ** | ** ** |
|-----------------------|------------|---------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|
| ** **            | ** ** | **2004**                                                                  | ** ** | **2005**               | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                                                | ** ** | **Percentage of** | ** ** | ** ** | ** ** | **Percentage of** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                                                                | ** ** | **Related**            | ** ** | ** ** | ** ** | **Related** | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                                                | ** ** | **Revenue**            | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                                                   | ** ** |
| License               |       | $                                                                         | 18,504     |                   | 93         | %          | $          | 24,329 |   | 93 | % | $ | 5,825 |   | 31 | % |
| Services              |       | 13,276                                                                    |       | 39                     |       | 14,939     |       | 40 |   | 1,663 |   | 13 | % |
| Total                 |       | $                                                                         | 31,780     |                   | 59         | %          | $          | 39,268 |   | 62 | % | $ | 7,488 |   | 24 | % |

 

33

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The license gross margin percentagewas unchanged for the nine months ended September 30, 2005. The servicesgross margin percentage increased for the nine months ended September 30,2005 due to increased utilization of our services personnel.

 

*OperatingExpenses*

* *
| ** **                  | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                  | ** ** | **2004**                                                                  | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                                                | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                                                | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                                   | ** ** |
| Sales and marketing         |       | $                                                                         | 10,350     |                | 19         | %          | $          | 11,808 |   | 19 | % | $ | 1,458 |   | 14 | % |
| Research and development    |       | 9,124                                                                     |       | 17                  |       | 10,423     |       | 16 |   | 1,299 |   | 14 | % |
| General and administrative  |       | 9,509                                                                     |       | 18                  |       | 10,959     |       | 17 |   | 1,450 |   | 15 | % |
| Restructuring               |       | —                                                                    |       | —              |       | (92        | )          | — |   | (92 | ) | — |   |
| Total                       |       | $                                                                         | 28,983     |                | 54         | %          | $          | 33,098 |   | 52 | % | $ | 4,115 |   | 14 | % |

 

*Sales andMarketing.*Sales and marketing expenses increased for the nine monthsended September 30, 2005 primarily due to a $472,000 increase inemployee-related expenses, which included one-time charges associated withchanges in management, and a $736,000 increase in commission expense resultingfrom an increase in revenues and an increase in the effective commission rate.In addition, travel expense increased by $115,000.

 

*Researchand Development.*Research and development expensesincreased in the nine months ended September 30, 2005 primarily due to anincrease in employee-related expenses of $1.5 million as we hired additionalpeople to improve our quality assurance and product development team. This waspartially offset by a $292,000 decrease in outside consultant expense as webrought certain research and development activities in-house

 

*General andAdministrative.*General and administrative expensesincreased in the nine months ended September 30, 2005 primarily due to a$754,000 increase in professional fees primarily associated with defendingongoing litigation related to our intellectual property and increased accountingfees due to the requirements of being a public company, as well as $701,000 ofincreased employee-related expenses. In addition, outside contractor expensesincreased $453,000 primarily related to preparation for compliance withSection 404 of the Sarbanes-Oxley Act, additional insurance expense of$171,000, and an increase of $136,000 for investor relations.  These expense increases were partially offsetby a $941,000 decrease in stock-based compensation.

 

*OperatingIncome, Other Income (Expense)*

 
| ** **                 | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|----------------------------|------------|---------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                 | ** ** | **2004**                                                                  | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                 | ** ** | ** **                                                                | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                 | ** ** | **Amount**                                                                | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                 | ** ** | **(in thousands)**                                                   | ** ** |
| **Operating income**       |       | $                                                                         | 2,797      |                | 5          | %          | $          | 6,170 |   | 10 | % | $ | 3,373 |   | 121 | % |
| **Other income (expense)** | ** ** | ** **                                                                | ** ** | ** **          | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income            |       | $                                                                         | 310        |                | —     | %          | $          | 1,236 |   | 2 | % | $ | 926 |   | 299 | % |
| Interest expense           |       | (255                                                                      | )          | —              |       | (144       | )          | — |   | 111 |   | 44 | % |
| Other, net                 |       | (72                                                                       | )          | —              |       | (220       | )          | — |   | (148 | ) | (206 | )% |
| Total                      |       | $                                                                         | (17        | )                   | —     | %          | $          | 872 |   | 1 | % | $ | 889 |   | 5,229 | % |
|                            |            |                                                                           |            |                     |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

*Operating Income.  *The increasein operating income in the nine months ended September 30, 2005 wasprimarily due to an increase in gross margins, partially offset by increasedoperating expenses resulting from increases in employee-related expenses,commission expense, outside contractor expense and

 

34

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professional fees. It is likely thatoperating income, as a percentage of revenues, will fluctuate quarter byquarter due to the timing and mix of license and services revenues, and theamount and type of service required in delivering certain projects, as well asthe timing of operating expense activities.

 

*Other Income (Expense).  *The increasein interest income in the nine months ended September 30, 2005 wasprimarily due to an increase in cash and cash equivalents available forinvestment and short-term investments. The decrease in interest expense in thenine months ended September 30, 2005 was primarily due to the pay off ofour debt in the quarter ended March 31, 2005. Other, net expense increasedprimarily due to foreign exchange losses in the nine months ended September 30,2005 compared to foreign exchange gains in the nine months ended September 30,2004, related to unfavorable exchange rate movements on non-U.S. dollar denominatedaccounts receivable and intercompany balances.

 

*Provision for Income Taxes*

 
| ** **                  | ** ** | **For the Nine Months Ended September 30,** | ** ** | ** **          | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------------------------------------------|------------|---------------------|------------|------------|------------|
| ** **                  | ** ** | **2004**                                                                  | ** ** | **2005**            | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                                                                | ** ** | **Percentage**      | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **Amount**                                                                | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                                   | ** ** |
| Provision  for income taxes |       | $                                                                         | 1,645      |                | 3          | %          | $          | 1,566 |   | 2 | % | $ | (79 | ) | (5 | )% |
|                             |            |                                                                           |            |                     |            |            |            |  |  |  |  |  |  |  |  |  |

 

Theprovision for income taxes for 2004 represents foreign withholding taxes andincome taxes payable that cannot be offset through loss carryforwards. Theprovision for income taxes for 2005 represents income taxes payable that cannotbe offset through loss carryforwards. The effective tax rate for 2005 decreasedto 22.2% compared to an effective tax rate of 59.2% for 2004. The decrease inour effective tax rate is primarily due to the decrease in stock-based expenseof $1.2 million, which is not deductible for tax purposes, but is included inthe calculation of the effective rate, and to a reduction in foreignwithholding taxes and U.S. income taxes payable.  The decrease in the foreign withholding taxesrelated to the elimination of withholding tax due to changes in legislationbetween the U.S. and Japan effective in the second quarter of 2004. Thedecrease in U.S. income taxes payable related to the recording of a one timebenefit associated with adjustments required to previous estimates compared toour tax return for the year ended December 31, 2004 filed in the thirdquarter of 2005, and to the change in the mix and timing of the use of netoperating loss carryforwards to offset taxable income. In utilizing our netoperating loss carryforwards, we are required to use our oldest net operatinglosses first. As a result we have first used the net operating losses acquiredin the Clinsoft acquisition. The utilization of the acquired net operatinglosses reduces the amount of income taxes payable to local tax authorities.This benefit has been reflected as a reduction of goodwill. The benefit ofutilization of the net operating loss carryforwards that were not acquired hasbeen reflected as a reduction to the income tax provision.

 

**Liquidityand Capital Resources**

 

AtDecember 31, 2004 and September 30, 2005, our principal sources ofliquidity were cash, cash equivalents and short-term investments totaling$58.2 million and $55.2 million, respectively, and accountsreceivable of $19.7 million and $18.8 million, respectively.

 

Fromour inception, we funded our operations primarily through issuances ofconvertible preferred stock for aggregate net cash proceeds of$79.7 million, including net cash acquired in the Clinsoft acquisition,the proceeds from the initial public offering and exercise of theover-allotment option resulting in net proceeds of $36.6 million, and theissuance of notes payable for an aggregate of $17.3 million.

 

Cashprovided by (used in) operating activities has historically been affected bychanges in working capital accounts, primarily deferred revenue, accountsreceivable and accrued expenses, and add-backs of non-cash expense items suchas depreciation and amortization, non-cash income tax expense and 

 

35

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stock-basedcompensation. Fluctuations within accounts receivable and deferred revenue areprimarily related to the timing of billings of our term license customers andthe associated revenue recognition. Movements in deferred costs are related tothe volume and stages of hosted clinical trials and movements in accruedexpenses and accounts payable are due to the timing of certain transactions.

 

Netcash provided by operating activities was $12.2 million for the ninemonths ended September 30, 2005, which was greater than net income of$5.5 million. The difference is primarily due to $2.5 million of non-cashdepreciation and amortization, $1.0 million of non-cash income tax expense andchanges in working capital, which consisted primarily of a $1.3 milliondecrease in accounts receivable and an increase in deferred revenue of $2.6million, partially offset by an increase in deferred costs of $1.0 million.

 

Netcash used in investing activities was $19.2 million for the nine months ended September 30,2005, which was primarily due to $10.6 million used in the acquisition ofLincoln, purchase of short-term investments of $9.6 million and capitalexpenditures of $2.8 million, partially offset by $3.8 million of proceedsfrom maturities of short-term investments.

 

Netcash used in financing activities was $1.4 million for the nine monthsended September 30, 2005, consisting primarily of $4.4 million of debtrepayments as we paid all of our outstanding bank debt, partially offset by$2.9 million of proceeds from the exercise of common stock options and sales ofcommon stock under the employee stock purchase plan.

 

AtDecember 31, 2004 and September 30, 2005, respectively, we had$1.6 million and $1.3 million of outstanding letters of credit related toour facilities. The letters of credit are reflected as a reduction in theamount available under the line of credit.

 

Substantiallyall of our long-lived assets as of December 31, 2004 and September 30,2005 are located in the United States.

 

Wedo not have any special purpose entities or any off-balance sheet financingarrangements.

 

Wegenerally do not enter into binding purchase commitments. Our principalcommitments consist of leases for office space. At September 30, 2005, thefuture minimum payments under these leases were as follows:

 
| **Year  ended December 31,** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-----------|------------|
| 2005                                   |       | $         | 704        |   |
| 2006                                   |       | 2,734     |       |
| 2007                                   |       | 2,363     |       |
| 2008                                   |       | 2,047     |       |
| 2009                                   |       | 346       |       |
| Total  minimum payments                |       | $         | 8,194      |   |

 

BetweenApril 2000 and September 2004, we had entered into several equipmentlines of credit with a bank. All advances under these equipment lines of creditwere payable in 30 to 36 equal monthly installments of principal, plus accruedinterest. The interest that accrued under these notes ranged from prime rate(5.25% and 5.75% at December 31, 2004 and March 31, 2005,respectively) to prime rate plus 1.0%. As of December 31, 2004 there was atotal of $4.4 million outstanding and $3.2 million available under all of ourequipment lines of credit. In March 2005, we paid in full all outstandingdebt related to our equipment lines of credit. The equipment lines of creditexpired on March 31, 2005 and were not renewed.

 

EffectiveMarch 31, 2004, we renewed our working capital line of credit with a bankand increased the amount under which we can borrow to $5.0 million. Interestaccrues at prime rate. All advances made

 

36

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under the workingcapital line are due and payable on March 31, 2006. As of December 31,2004 and September 30, 2005, $0 was outstanding under the working capitalline of credit. At September 30, 2005, there was $3.7 million availableunder the line of credit, and $1.3 million reserved under a letter of creditassociated with our leased facilities.

 

Borrowingsunder our working capital line of credit were secured by substantially all ofour assets other than our intellectual property. We also entered into anegative pledge agreement that, subject to certain exceptions, generallyprohibited us from pledging our intellectual property to others. Under theterms of this credit line, we are required to comply with certain financialcovenants. At September 30, 2005, we were in compliance with all financialcovenants. In August of 2005, the working capital line of credit wasamended to eliminate the security interest in our assets and the negativepledge on our intellectual property. The amendment also removed or modified thefinancial covenants.

 

AtDecember 31, 2004, we had net operating loss carryforwards ofapproximately $88.4 million, which may be used to offset future U.S.federal taxable income, if any, and $4.8 million of federal research anddevelopment tax credit carryforwards. In addition, we have $5.6 million ofnet operating losses relating to our non-U.S. jurisdictions. Of these amounts,approximately $26.9 million and $3.0 million of net operating losscarryforwards and tax credit carryforwards, respectively, relate to amountsacquired as part of the Clinsoft acquisition. These tax carryforwards mayreduce our future cash payments to the taxing authorities. The realizedbenefits of the acquired carryforwards will be reflected as an adjustmentthrough goodwill and not a reduction in the effective tax rate. Thecarryforwards expire beginning in 2008 through 2023 and are subject to reviewand possible adjustment by the taxing authorities. The Internal Revenue Codecontains provisions that may limit the net operating loss and tax creditcarryforwards available to be used in any given year in the event of certainchanges in the ownership interests of significant stockholders.

 

Webelieve our existing cash, cash equivalents, short-term investments and cashprovided by operating activities and our working capital line of credit will besufficient to meet our working capital and capital expenditure needs over thenext twelve months. Our future capital requirements will depend on manyfactors, including our rate of revenue growth, the expansion of our marketing andsales activities, the timing and extent of spending to support productdevelopment efforts, the timing of introductions of new services andenhancements to existing services, and the continuing market acceptance of ourservices. To the extent that existing cash and securities and cash fromoperations are insufficient to fund our future activities, we may need to raiseadditional funds through public or private equity or debt financing. From timeto time, we may also enter into agreements with respect to potentialinvestments in, or acquisitions of, businesses, services or technologies, whichcould also require us to seek additional equity or debt financing. Additionalfunds for those purposes may not be available on terms favorable to us or atall.

 

**CertainFactors Which May Affect Future Results**

 

*Our operating results and financial conditionhave varied in the past and may in the future vary significantly depending on anumber of factors. Except for the historical information in this report, thematters contained in this report include forward-looking statements thatinvolve risks and uncertainties. The following factors, among others, couldcause actual results to differ materially from those contained inforward-looking statements made in this report and presented elsewhere bymanagement from time to time. Such factors, among others, may have a materialadverse effect upon our business, results of operations and financialcondition.*

* *

**RisksRelated to Our Industry**

** **

***Wedepend primarily on the pharmaceutical, biotechnology and medical deviceindustries and are therefore subject to risks relating to changes in theseindustries.***

*** ***

Ourbusiness depends on the clinical trials conducted or sponsored bypharmaceutical, biotechnology and medical device companies and other entitiesconducting clinical research. General economic

 

37

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downturns, increasedconsolidation or decreased competition in the industries in which thesecompanies operate could result in fewer products under development or decreasedpressure to accelerate product approval which, in turn, could materiallyadversely impact our revenues. Our operating results may also be adverselyimpacted by other developments that affect these industries generally, including:

 

•       theintroduction or adoption of new technologies or products;

 

•*      *thediscovery of safety issues with approved products or products in clinicaldevelopment;

 

•       theassertion of product liability claims;

 

•       changes inthird-partyreimbursement practices;

 

•       changes ingovernment regulation or governmental price controls;

 

•       changes inmedical practices;

 

•       changes inthe purchasing patterns of entities conducting clinical research; and

 

•       changes ingeneral business conditions.

 

Anydecrease in research and development expenditures or in the size, scope orfrequency of clinical trials conducted or sponsored by pharmaceutical,biotechnology or medical device companies or other entities as a result of theforegoing or other factors could materially adversely affect our operations orfinancial condition.

 

***Ifentities engaged in clinical trials do not shift from traditional paper-basedmethods of collecting clinical trial data to electronic systems, we may notachieve the market penetration necessary to maintain profitability.***

*** ***

Ifentities engaged in clinical trials are unwilling to use our electronic datacapture solutions or to change the way of collecting clinical trial data, ourfuture growth and market share may be limited. Most clinical trials today relyon pre-printed, three-part paper case report forms for data collection. Ourefforts to establish an electronic process to capture clinical trial data are asignificant departure from the traditional paper-based methods of collectingclinical trial data. As is typical for new and rapidly evolving industries,customer demand for recently introduced technology is highly uncertain. We maynot be successful in persuading entities engaged in clinical trials to changethe manner in which they have traditionally collected clinical trial data andto accept our software products, services and hosted solutions. If we fail toconvince entities engaged in clinical trials to use our methods of capturingclinical trial data, our revenues may be limited and we may fail to maintainprofitability.

 

***Weoperate in a highly competitive industry and if we are not able to competeeffectively, our business and operating results will be harmed.***

 

Themarket for our software products, services and hosted solutions ischaracterized by rapidly changing technologies, evolving industry standards andfrequent new product and service introductions and enhancements that may renderexisting products and services obsolete. Accordingly, we are susceptible torapid and significant declines in market share due to unforeseen changes in thefeatures, functions or pricing of competing products. Barriers to entry arerelatively low and, with the introduction of new technologies and new marketentrants, we expect that competition will increase. Increased competition islikely to result in pricing pressures, which could negatively impact our sales,gross margins or market share. Our failure to compete effectively couldmaterially adversely affect our business, financial condition or results ofoperations.

 

Someof our current competitors, as well as many of our potential competitors, havegreater name recognition, longer operating histories and significantly greaterresources. As a result, our competitors may be able to respond more quickly andeffectively than we can to new or changing opportunities,

 

38

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technologies, standardsor customer requirements. In addition, current and potential competitors haveestablished, and may in the future establish, cooperative relationships withvendors of complementary products, technologies or services to increase theavailability of their products to the marketplace. Accordingly, new competitorsor alliances may emerge that have greater market share, larger customer bases,more widely adopted proprietary technologies, greater marketing expertise andlarger sales forces than we have, which could put us at a competitivedisadvantage. Further, in light of these advantages, even if our products andservices are more effective than the product or service offerings of ourcompetitors, current or potential customers might accept competitive productsand services in lieu of purchasing our software products, services and hostedsolutions. We cannot assure you that we can maintain or enhance our competitiveposition against current and future competitors.

 

***Changingcustomer or prospective customer requirements could decrease the demand for ourproducts and services, which would adversely affect our revenues and operatingresults.***

*** ***

Ourfuture success will depend in large part on our ability to enhance and broadenour software products, services and hosted solutions to meet the evolving needsof our customers and prospective customers. To achieve our goals, we need toeffectively respond to our customers’ and prospective customers’ needs,technological changes and new industry standards and developments in a timelymanner. If we are unable to enhance our existing product and service offeringsor develop new products and services to meet changing requirements, demand forour software products, services and hosted solutions could suffer and ourrevenues and operating results could be materially adversely affected. We couldalso incur substantial costs if we need to modify our products or services, orinformation technology infrastructure, to adapt to technological changes or newindustry standards or developments.

 

***Changesin regulations and regulatory guidance applicable to our customers or potentialcustomers and the approval process for their products may result in ourinability to continue to do business.***

*** ***

Demandfor our software products, services and hosted solutions is largely a functionof regulation and regulatory guidance associated with the approval of newdrugs, biological products and medical devices imposed upon the clinical trialprocess by the U.S. federal government and related regulatory authorities suchas the U.S. Food and Drug Administration, or FDA, and by foreign governments.In recent years, efforts have been made to streamline the FDA approval processand coordinate U.S. standards with those of other developed countries. Anychange in the scope of applicable regulations and regulatory guidance couldalter the type or amount of clinical trial spending or negatively impactinterest in our software products, services and hosted solutions. Anyregulatory reform that limits or reduces the research and development spendingof entities conducting clinical research upon which our business depends couldhave a material adverse effect on our revenues or gross margins.

 

Inaddition, any failure to conform our software products, services and hostedsolutions to domestic or international changes in regulations and regulatoryguidance applicable to our customers or potential customers and the approvalprocess for their products may result in our inability to continue to dobusiness. Changing our software products, services and hosted solutions toallow our customers to comply with future changes in regulation or regulatoryguidance, either domestically or internationally, could cause us to incursubstantial costs. We cannot assure you that our product and service offeringswill allow our customers and potential customers to stay in compliance withregulations and regulatory guidance as they develop. If our product and serviceofferings fail to allow our customers and potential customers to operate in amanner that is compliant with applicable regulations and regulatory guidance,clinical trial sponsors and other entities conducting clinical research may beunwilling to use our software products, services and hosted solutions.

 

39

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**Risks Related to Our Company**

 

***Weoperate in an emerging market, which makes it difficult to evaluate our businessand future prospects.***

*** ***

Wewere incorporated in September 1997 and operate in an emerging market.Accordingly, our business and future prospects are difficult to evaluate. Youshould consider the challenges, risks and uncertainties frequently encounteredby companies using new and unproven business models in rapidly evolvingmarkets. These challenges include our ability to:

 

•       generatesufficient revenues to maintain profitability;

 

•       managegrowth in our operations;

 

•       attract andretain customers;

 

•       attract andretain key personnel;

 

•       develop andrenew strategic relationships; and

 

•       accessadditional capital when required and on reasonable terms.

 

Wecannot be certain that we will successfully address these and other challenges,risks and uncertainties or that our business model will be successful. Failureto do so could adversely affect our business, results of operations orfinancial condition.

 

***Oursoftware products and hosted solutions are at varying stages of marketacceptance and the failure of any of our products to achieve wide acceptancewould harm our operating results.***

*** ***

Webegan offering our *InForm *electronicdata capture software solution for clinical trials in December 1998.Although the *Clintrial* and *Clintrace* products were introduced over10 years ago, we did not begin offering these products until after ouracquisition of Clinsoft Corporation in 2001, and we did not begin offering theproducts of Lincoln until after its August 25, 2005 acquisition by us.Continued use of our *Clintrial*and *Clintrace* software products,and broad and timely acceptance of our *InForm *productand the Lincoln products, as well as integrated solutions combining one or moreof our software products, is critical to our future success and is subject to anumber of significant risks, some of which are outside our control. These risksinclude:

 

•       ourcustomers’ and prospective customers’ desire for and acceptance of ourelectronic data capture, management and safety software solutions;

 

•       our softwareproducts and hosted solutions’ ability to support large numbers of users andmanage vast amounts of data;

 

•       ourcustomers’ ability to use our software products and hosted solutions, traintheir employees and successfully deploy our technology in their clinicaltrials;

 

•       our abilityto meet product development and release schedules; and

 

•       our abilityto significantly expand our internal resources and increase our capital andoperating expenses to support the anticipated growth and continued integrationof our software products, services and hosted solutions.

 

Ourfailure to address, mitigate or manage these risks would seriously harm ourbusiness, particularly if the failure of any or all of our software products orhosted solutions to achieve market acceptance negatively affects our sales ofour other products and services.

 

***Claimsthat we or our technologies infringe upon the intellectual property or otherproprietary rights of a third party may require us to incur significant costs,to enter into royalty or licensing agreements or to develop or licensesubstitute technology.***

 

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Weare, and may in the future be, subject to claims that our technologies infringeupon the intellectual property or other proprietary rights of a third party.For instance, Dr. Mark L. Kozam, doing business under the name MLKSoftware and Datasci, LLC have filed a complaint against us and one of ourcustomers alleging that we infringe a patent claimed to be owned by them. Wehave incurred and may continue to incur substantial professional fees inconnection with this claim. In addition, the vendors who provide us withtechnology that we use in our technology could become subject to similarinfringement claims. Although we believe that our software solutions do notinfringe the patents of any third party, we cannot assure you that ourtechnology does not infringe patents held by others or that they will not inthe future. The claim referenced above and any future claims of infringementcould cause us to incur substantial costs defending against the claim, even ifthe claim is without merit, and could distract our management from ourbusiness. Moreover, any settlement or adverse judgment resulting from the claimcould require us to pay substantial amounts or obtain a license to continue touse the technology that is the subject of the claim, or otherwise restrict orprohibit our use of the technology. There can be no assurance that we would beable to obtain a license from the third party asserting the claim oncommercially reasonable terms, if at all, that we would be able to successfullydevelop alternative technology on a timely basis, if at all, or that we wouldbe able to obtain a license from another provider of suitable alternativetechnology to permit us to continue offering, and our customers to continueusing, the applicable technology. In addition, we generally provide in ourcustomer agreements, including our agreement with the customer that is thesubject of the claim referenced above, that we will indemnify our customersagainst third-party infringement claims relating to our technology provided tothe customer, which could obligate us to fund significant amounts. Infringementclaims asserted against us or our vendors may have a material adverse effect onour business, results of operations or financial condition.

 

***Asa result of long sales cycles and our business model, we may be required tospend substantial time and expense before we recognize a significant portion ofthe revenues, if any, attributable to our customer contracts.***

*** ***

Thesales cycle for some of our software solutions frequently takes in excess ofnine months from initial customer contact to contract execution. During thistime, we may expend substantial time, effort and financial resources withoutrealizing any revenue with respect to the potential sale. In addition, while webegin recognizing revenue upon the execution of our agreements for softwareterm licenses and related services, it may be difficult for us to rapidlyincrease our revenue through additional sales in any period, as license revenueand, when applicable, related services revenue, from new customers isrecognized over the applicable license term, typically three to five years. Asa result, we may not recognize significant revenues, if any, from somecustomers despite incurring considerable expense related to our sales,implementation, and service delivery processes. Even if we do realize revenuesfrom a contract, our term license pricing model may keep us from recognizing asignificant portion of these revenues (including revenues for related services)during the same period in which sales, implementation, and service deliveryexpenses were incurred. For example, pursuant to our contract withGlaxoSmithKline, we have incurred significant up-front implementation and otherservice expenses associated with delivery of services under the contract,whereas the revenue under the contract will be recognized ratably over anapproximately 5-year period which began in July 2004. Timing differencesof this nature could cause our service gross margins and profitability tofluctuate significantly from quarter to quarter. Similarly, a decline in new orrenewed software term licenses in any one quarter will not necessarily be fullyreflected in the revenue in that quarter and may negatively affect our revenuein future quarters. This could also cause our operating results to fluctuatefrom quarter to quarter.

 

***Wemay be unable to adequately protect, and we may incur significant costs indefending, our intellectual property and other proprietary rights.***

*** ***

Oursuccess depends on our ability to protect our intellectual property and otherproprietary rights. We rely upon a combination of trademark, trade secret,copyright, patent and unfair competition laws, as

 

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well as licenseagreements and other contractual provisions, to protect our intellectualproperty and other proprietary rights. In addition, we attempt to protect ourintellectual property and proprietary information by requiring our employeesand consultants to enter into confidentiality, noncompetition and assignment ofinventions agreements. To the extent that our intellectual property and otherproprietary rights are not adequately protected, third parties might gainaccess to our proprietary information, develop and market products or servicessimilar to ours, or use trademarks similar to ours, each of which couldmaterially harm our business. Existing U.S. federal and state intellectualproperty laws offer only limited protection. Moreover, the laws of othercountries in which we market our software products, services and hostedsolutions may afford little or no effective protection of our intellectualproperty. If we resort to legal proceedings to enforce our intellectualproperty rights or to determine the validity and scope of the intellectualproperty or other proprietary rights of others, the proceedings could beburdensome and expensive, even if we were to prevail. The failure to adequatelyprotect our intellectual property and other proprietary rights may have amaterial adverse effect on our business, results of operations or financialcondition.

 

***Ifwe are unable to retain our personnel and hire additional skilled personnel, wemay be unable to achieve our goals.***

*** ***

Ourfuture success depends upon our ability to attract, train and retain highlyskilled employees and contract workers, particularly our management team, salesand marketing personnel, professional services personnel and softwareengineers. Each of our executive officers and other employees could terminatehis or her relationship with us at any time. The loss of any member of ourmanagement team might significantly delay or prevent the achievement of ourbusiness or development objectives and could materially harm our business. Inaddition, because of the technical nature of our software products, servicesand hosted solutions and the dynamic market in which we compete, any failure toattract and retain qualified direct sales, professional services and productdevelopment personnel, as well as our contract workers, could have a materialadverse affect on our ability to generate sales, successfully develop newsoftware products, services and hosted solutions or software enhancements ordeliver services and solutions as requested by our customers.

 

***Ouroperating results may fluctuate and could cause the market price of our commonstock to fall rapidly and without notice.***

*** ***

Ourrevenues and operating results are difficult to predict and may fluctuate fromquarter to quarter, particularly because of the rapidly evolving market inwhich we operate and our term license model. Our results of operations in anygiven quarter will be based on a number of factors, including:

 

•       the timingof our product sales and the length of our sales and implementation cycles;

 

•       the timingand mix of license and services revenues, and the amount and type of servicerequired in delivering certain projects;

 

•       changes inand timing of our operating expenses;

 

•       the extentto which our software products, services and hosted solutions achieve ormaintain market acceptance;

 

•       our abilityto introduce new products and services and enhancements to our existingproducts and services on a timely basis;

 

•       thecompetitive environment in which we operate;

 

•       our abilityto hire and retain qualified personnel;

 

•       changes inthe regulatory environment related to the clinical trial market;

 

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•       changes inour customers’ purchasing patterns;

 

•       thefinancial condition of our current and potential customers; and

 

•       the timing,size and integration success of potential future acquisitions.

 

Asignificant portion of our operating expense is relatively fixed in nature andplanned expenditures are based in part on expectations regarding futurerevenues. Accordingly, unexpected revenue shortfalls or operating expenses maydecrease our gross margins and could cause significant changes in our operatingresults from quarter to quarter. Results of operations in any quarterly periodshould not be considered indicative of the results to be expected for anyfuture period. In addition, our future quarterly operating results mayfluctuate and may not meet the expectations of securities analysts orinvestors. If this occurs, the trading price of our common stock could fallsubstantially either suddenly or over time.

 

***Wemay acquire or make investments in companies or technologies that could causedisruption of our business and loss of value or dilution to our stockholders.***

*** ***

Fromtime to time, we evaluate potential investments in, and acquisitions of,complimentary technologies, services and businesses. We have made in the past,and may make in the future, acquisitions or significant investments in otherbusinesses. Entering into an acquisition entails many risks, any of which couldharm our business, including:

 

•       difficultiesin integrating the operations, technologies, products, existing contracts andpersonnel of the target company and realizing the anticipated synergies of thecombined businesses;

 

•       the price wepay or other resources that we devote may exceed the value we eventuallyrealize or the value we could have realized if we had allocated the purchaseprice or other resources to another opportunity;

 

•       potentialloss of key employees, customers and strategic alliances from either ourcurrent business or the target company’s business;

 

•       managing therisks of entering markets or types of businesses in which we have limited or nodirect experience;

 

•       thediversion of management’s attention from other business concerns; and

 

•       assumptionof unanticipated problems or latent liabilities, such as problems with thequality of the target company’s products.

 

Inaddition, if we finance any future acquisitions by issuing equity securities orconvertible debt, our existing stockholders may be diluted or the market priceof our stock may be adversely affected. The failure to successfully evaluateand execute acquisitions or investments or otherwise adequately address theserisks could materially harm our business and financial results.

 

***Interruptionsor delays in service from our third-party providers could impair the deliveryof our hosted InForm electronic data capture solution and harm ourbusiness.***

*** ***

Wehost our*InForm *electronicdata capture software solution at third-party facilities. Consequently, theoccurrence of a natural disaster, technical or service lapses, or otherunanticipated problems at the facilities of our third-party providers couldresult in unanticipated interruptions in our customers’ access to our *InForm *electronic data capturesoftware solution. Our hosted services may also be subject to sabotage,intentional acts of malfeasance and similar misconduct due to the nature of theInternet. In the past, Internet users have occasionally experienceddifficulties with Internet and online services due to system or securityfailures. We cannot assure you that our business interruption insurance willadequately compensate our customers or us for losses that may occur. Even ifcovered by insurance, any failure or

 

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breach of security ofour systems could damage our reputation and cause us to lose customers.Further, certain of our hosted*InForm *electronic datacapture solutions are subject to service level agreements that guarantee 95% to99% server availability. In the event that we fail to meet those levels,whether resulting from an interruption in service caused by our technology orthat of a third-party provider, we could be subject to customer credits ortermination of these customer contracts.

 

***Failureof our technology and products could harm our business and operating results.***

*** ***

Thetechnology underlying our software products and hosted solutions processes vastamounts of clinical trial data. Customers relying on our products to collect,manage and report clinical trial information may have a greater sensitivity toproduct errors and security vulnerabilities than customers of software productsin general. In the past, failures of our technology and human error havenegatively impacted the data capture, management or reporting capabilities ofour products, and new errors may be detected in the future. Any delay orfailure of our technology may result in the disruption of the clinical trialprocess and could harm our business and operating results. Product or serviceerrors could materially and adversely affect our reputation, result insignificant costs to us and impair our ability to sell our products andservices in the future. The costs incurred in correcting any defects or errorsmay be substantial and could adversely affect our operating margins. Inaddition, security breaches, whether intentional or accidental, could expose usto a risk of loss of data, litigation and possible liability.

 

***Theloss of one or more major customers could materially and adversely affect ourresults of operations and financial condition.***

*** ***

Ourtop five customers accounted for approximately 35% of our revenues during thenine months ended September 30, 2005. Two customers, Eli Lilly and Companyand GlaxoSmithKline, accounted for approximately 26% of our total revenues forthe nine months ended September 30, 2005. The loss of any of our majorcustomers could have a material adverse effect on our results of operations orfinancial condition. We may not be able to maintain our customer relationships,and our customers may not renew their agreements with us, which could adverselyaffect our results of operations or financial condition. A significant changein the liquidity or financial position of any of these customers could alsohave a material adverse effect on the collectibility of our accountsreceivables, our liquidity and our future operating results.

 

***Wehave incurred substantial losses in the past and may not continue to beprofitable in the future.***

*** ***

Weincurred significant losses in each fiscal year from our inception in September 1997through 2003, and we may incur significant operating losses in the future. As aresult of our operating losses and accretion of preferred dividends, we had anaccumulated deficit of $98.9 million at September 30, 2005. Youshould not consider recent revenue growth as indicative of our futureperformance as our operating results may fluctuate significantly from quarterto quarter. In addition, we expect our development, sales and other operatingexpenses to increase in the future. If our revenue does not grow to offsetthese expected increased expenses, we may not continue to be profitable. Infact, in future quarters we may not have any revenue growth and our revenuecould decline. Furthermore, if our operating expenses exceed our expectations,our financial performance will be adversely affected.

 

***Theglobal nature of our business exposes us to multiple risks.***

*** ***

Forthe quarter ended September 30, 2005, approximately 45% of our revenueswere derived from international operations. We expect that our internationaloperations will continue to account for a significant portion of our revenues.As a result of our international operations, we are exposed to many risks anduncertainties, including:

 

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•                    difficultiesin staffing, managing and supporting operations in multiple countries;

 

•                    tariff andinternational trade barriers;

 

•                    fewer legalprotections for intellectual property and contract rights abroad;

 

•                    differentand changing legal and regulatory requirements in the jurisdictions in which wecurrently operate or may operate in the future;

 

•                    governmentcurrency control and restrictions on repatriation of earnings;

 

•                    fluctuationsin foreign currency exchange and interest rates; and

 

•                    politicaland economic changes, hostilities and other disruptions in regions where we currentlyoperate or may operate in the future.

 

Negativedevelopments in any of these areas in one or more countries could result in areduction in demand for our software products, services and hosted solutions,the cancellation or delay of orders already placed, threats to our intellectualproperty, difficulty in collecting receivables, and a higher cost of doingbusiness, any of which could adversely affect our business, results ofoperations or financial condition. Moreover, with regard to our internationaloperations, we frequently enter into transactions in currencies other than theU.S. dollar and we incur operating expenses in currencies other than the U.S.dollar. This creates a foreign currency exchange risk for us that could have amaterial adverse effect on our results of operations and financial condition.

 

***Wemay lose or delay revenues related to our hosted solutions if our customersterminate or delay their contracts with us.***

*** ***

Certainof our hosted electronic data capture and other service and consultingcontracts are subject to cancellation by our customers at any time with limitednotice. Entities engaged in clinical trials may terminate or delay a clinicaltrial for various reasons including the failure of the tested product tosatisfy safety or efficacy requirements, unexpected or undesired clinicalresults, decisions to de-emphasize a particular product or forego a particularclinical trial, decisions to downsize clinical development programs,insufficient patient enrollment or investigator recruitment and productionproblems resulting in shortages of required clinical supplies. In the case ofour hosted solutions, any termination or delay in the clinical trials wouldlikely result in a consequential delay or termination in those customers’ servicecontracts. We have experienced terminations and delays of our customer servicecontracts in the past and expect to experience additional terminations anddelays in the future. Because we do not recognize any portion of a hostedservice contract’s revenue until the implementation cycle is complete, thetermination or delay of our customers’ clinical trials could result indecreased or delayed revenues under these contracts which could materially harmour business.

 

***Failureto manage our rapid growth effectively could harm our business.***

*** ***

Werecently experienced a period of rapid growth that placed a significant strainon our operational and financial resources and our personnel. From January 1,1999 to March 31, 2005, the number of our employees increased from 35 toapproximately 361.  To manage ouranticipated future growth effectively, we must continue to maintain and mayneed to enhance our information technology infrastructure, financial andaccounting systems and controls and manage expanded operations ingeographically distributed locations. We will also be required to attract,integrate, train and retain a significant number of qualified sales andmarketing personnel, professional services personnel, software engineers andother management personnel. Our failure to manage our rapid growth effectivelycould have a material adverse effect on our business, operating results orfinancial condition.

 

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***Wecould incur substantial costs resulting from product liability claims relatingto our products or services or our customers’ use of our products or services.***

*** ***

Anyfailure or errors in a customer’s clinical trial or adverse event reportingobligations caused or allegedly caused by our products or services could resultin a claim for substantial damages against us by our customers or the clinicaltrial participants, regardless of our responsibility for the failure. Althoughwe are generally entitled to indemnification under our customer contractsagainst claims brought against us by third parties arising out of our customers’use of our products, we might find ourselves entangled in lawsuits against usthat, even if unsuccessful, divert our resources and energy and adverselyaffect our business. Further, in the event we seek indemnification from acustomer, we cannot assure you that a court will enforce our indemnificationright if challenged by the customer obligated to indemnify us or that thecustomer will be able to fund any amounts for indemnification owed to us. Wealso cannot assure you that our existing general liability insurance coveragewill continue to be available on reasonable terms or will be available inamounts sufficient to cover one or more large claims, or that the insurer willnot disclaim coverage as to any future claim.

 

***Weand our products and services could be subjected to governmental regulation,requiring us to incur significant compliance costs or to cease offering ourproducts and services.***

*** ***

Theclinical trial process is subject to extensive and strict regulation by theFDA, as well as other regulatory authorities worldwide. Our electronic datacapture, management and safety products and services could be subjected tostate, federal and foreign regulations. We cannot assure you that our productsand service offerings will comply with applicable regulations and regulatoryguidelines as they develop. If our products or services fail to comply with anyapplicable government regulations or guidelines, we could incur significantliability or be forced to cease offering our applicable products or services.Also, conforming our products and services to any applicable regulations andguidelines could substantially increase our operating expenses.

 

***Ourbusiness could be seriously harmed by our dependence on a limited number ofsuppliers.***

*** ***

Wedepend upon a limited number of suppliers for specific components of oursoftware products and hosted solutions. We may increase our dependence oncertain suppliers as we continue to develop and enhance our software andservice solutions. Our dependence on a limited number of suppliers leaves usvulnerable to having an inadequate supply of required components, priceincreases, delayed supplier performance and poor component quality. Forinstance, we rely on Oracle Corporation to supply the database component of oursoftware solutions and on Equinix, Inc. to provide the server facilitiesfor our hosting services. Oracle Corporation also offers a software packagethat is competitive with our products and services. If we are unable to obtaincomponents for our software solutions from third-party suppliers in thequantities and of the quality that we need, on a timely basis or at acceptableprices, we may not be able to deliver our software products, services and hostedsolutions on a timely or cost-effective basis to our customers, and ourbusiness, results of operations and financial condition could be seriouslyharmed. Moreover, delays or interruptions in our service, including withoutlimitation delays or interruptions resulting from a change in suppliers, mayreduce our revenue, cause customers to terminate their contracts and adverselyaffect our customer renewals.

 

***Wemay not be able to obtain capital when desired on favorable terms, if at all,or without dilution to our stockholders.***

*** ***

Weanticipate that our current cash and cash equivalents will be sufficient tomeet our current needs for general corporate purposes. However, we may needadditional financing to execute on our current or future business strategies,including to:

 

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•                    hireadditional personnel;

 

•                    develop newor enhance existing software products, services and hosted solutions;

 

•                    enhance ouroperating infrastructure;

 

•                    acquirebusinesses or technologies; or

 

•                    otherwiserespond to competitive pressures.

 

Ifwe raise additional funds through the issuance of equity or convertible debtsecurities, the percentage ownership of our stockholders could be significantlydiluted, and these newly issued securities may have rights, preferences orprivileges senior to those of existing stockholders. We cannot assure you thatadditional financing will be available on terms favorable to us, or at all. Ifadequate funds are not available or are not available on acceptable terms, whenwe desire them, our ability to fund our operations, take advantage ofunanticipated opportunities, develop or enhance our software products, servicesand hosted solutions, or otherwise respond to competitive pressures would besignificantly limited.

 

***Inthe course of conducting our business, we possess or could be deemed to possesspersonal medical information in connection with the conduct of clinical trials,which if we fail to keep properly protected, could subject us to significant liability.***

*** ***

Oursoftware solutions are used to collect, manage and report information inconnection with the conduct of clinical trails. This information is or could beconsidered to be personal medical information of the clinical trialparticipants. Regulation of the use and disclosure of personal medicalinformation is complex and growing. Increased focus on individuals’ rights toconfidentiality of their personal information, including personal medicalinformation, could lead to an increase of existing and future legislative orregulatory initiatives giving direct legal remedies to individuals, includingrights to damages, against entities deemed responsible for not adequatelysecuring such personal information. In addition, courts may look to regulatory standardsin identifying or applying a common law theory of liability, whether or notthat law affords a private right of action. Since we receive and processpersonal information of clinical trial participants from our customers, thereis a risk that we could be liable if there were a breach of any obligation to aprotected person under contract, standard of practice or regulatoryrequirement. If we fail to properly protect this personal information that isin our possession or deemed to be in our possession, we could be subjected tosignificant liability.

 

**RisksRelated to our Common Stock**

** **

***Themarket price of our common stock may be volatile, which could result insubstantial losses for investors purchasing shares in the public markets andsubject us to securities class action litigation. The current market price ofour common stock may not be indicative of future market prices and we may beunable to sustain or increase the value of an investment in our common stock.***

*** ***

Wecompleted our initial public offering last year. An active public market forour common stock may not continue to develop or be sustained. Market prices forsecurities of software, technology and health care companies have beenparticularly volatile. The trading price of our common stock may fluctuatesignificantly and, accordingly, may not be indicative of future trading pricesand we may be unable to sustain or increase the value of an investment in ourcommon stock. Some of the factors that may cause the market price of our commonstock to fluctuate include:

 

•                    changes inestimates of our financial results or recommendations by securities analysts;

 

•                    financialresults that are below estimate of such results;

 

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•                    period-to-periodfluctuations in our financial results or those of companies that are perceivedto be similar to us;

 

•                    changes inmarket valuations of similar companies;

 

•                    announcementsby us or our competitors of significant products, contracts, acquisitions orstrategic alliances;

 

•                    sales ortransfers of large blocks of stock by existing investors;

 

•                    the failureof any of our software products, services and hosted solutions to achieve ormaintain commercial success;

 

•                    success ofcompetitive products and technologies;

 

•                    litigationinvolving our company or our general industry or both;

 

•                    futureissuances of securities or the incurrence of debt by us, or other changes inour capital structure;

 

•                    regulatorydevelopments in the United States and foreign countries;

 

•                    additions ordepartures of key personnel;

 

•                    investors’general perception of us; and

 

•                    changes ingeneral economic, industry and market conditions.

 

Inaddition, if the market for software, technology or health care stocks or thestock market in general experiences a loss of investor confidence, the tradingprice of our common stock could decline for reasons unrelated to our business,operating results or financial condition. If any of the foregoing occurs, itcould cause our stock price to fall and may expose us to class action lawsuitsthat, even if unsuccessful, could be costly to defend and a distraction tomanagement.

 

***Ownershipof our common stock is concentrated among a small number of stockholders andsales of a large block of which could cause the market price of our commonstock to drop significantly, even if our business is doing well.***

*** ***

Arelatively small number of our stockholders own large blocks of shares. Wecannot predict the effect, if any, that public sales of these shares or theavailability of these shares for sale will have on the market price of ourcommon stock. If our stockholders, and particularly our directors and officers,sell substantial amounts of our common stock in the public market, or if thepublic perceives that such sales could occur, this could have an adverse impacton the market price of our common stock, even if there is no relationshipbetween such sales and the performance of our business.

 

***Ourdirectors and management exercise significant control over our company.***

*** ***

AtSeptember 30, 2005, our directors and executive officers and theiraffiliates beneficially control approximately 31% of our outstanding commonstock. As a result, these stockholders, if they act together, are able toinfluence our management and affairs and all matters requiring stockholderapproval, including the election of directors and approval of significantcorporate transactions. This concentration of ownership may have the effect ofdelaying or preventing a change in control of our company and might affect themarket price of our common stock.

 

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***Delawarelaw and our corporate documents may prevent or frustrate a change in control ora change in management that stockholders believe is desirable.***

*** ***

Provisionsof our certificate of incorporation and bylaws and Delaware law may discourage,delay or prevent a merger, acquisition or other change in control thatstockholders may consider favorable, including transactions in which you mightotherwise receive a premium for your shares. These provisions may also preventor frustrate attempts by our stockholders to replace or remove our management.These provisions include:

 

•                    limitationson the removal of directors;

 

•                    advancenotice requirements for stockholder proposals and nominations;

 

•                    theinability of stockholders to act by written consent or to call specialmeetings; and

 

•                    the abilityof our board of directors to designate the terms of and issue new series ofpreferred stock without stockholder approval, which could be used to institutea rights plan, or a poison pill, that would work to dilute the stock ownershipof a potential hostile acquirer, likely preventing acquisitions that have notbeen approved by our board of directors.

 

Theaffirmative vote of the holders of at least 75% of our shares of capital stockentitled to vote is necessary to amend or repeal the above provisions of ourcertificate of incorporation. In addition, absent approval of our board ofdirectors, our bylaws may only be amended or repealed by the affirmative voteof the holders of at least 75% of our shares of capital stock entitled to vote.

 

Inaddition, Section 203 of the Delaware General Corporation Law prohibits apublicly held Delaware corporation from engaging in a business combination withan interested stockholder, generally a person which together with itsaffiliates owns, or within the last three years has owned, 15% of our votingstock, for a period of three years after the date of the transaction in whichthe person became an interested stockholder, unless the business combination isapproved in a prescribed manner.

 

Theexistence of the foregoing provisions could limit the price that investorsmight be willing to pay in the future for shares of our common stock.

 

**Item 3.**                          Quantitativeand Qualitative Disclosures about Market Risk

** **

*ForeignCurrency Exchange Risk*

* *

Ourresults of operations and cash flows are subject to fluctuations due to changesin foreign currency exchange rates, particularly changes in the Euro, Britishpound sterling, Australian dollar and Japanese yen. In the nine months ended September 30,2004 and 2005, 41% and 47%, respectively, of our revenues were generated inlocations outside the United States. The majority of these revenues aredenominated in currencies other than the U.S. dollar, as are many of theassociated expenses. Except for revenue transactions in Japan, we enter intotransactions directly with substantially all of our foreign customers. Thiscreates a foreign currency exchange risk for us.

 

Asof September 30, 2005, we had $7.4 million of receivables denominated incurrencies other than the U.S. dollar. If the foreign exchange rates fluctuatedby 10% as of September 30, 2005, our foreign exchange receivable exposurewould have fluctuated by approximately $740,000. In addition, although ourforeign subsidiaries have intercompany accounts that eliminate uponconsolidation such accounts expose us to foreign currency rate movements.Exchange rate fluctuations on short-term intercompany accounts are recorded inour consolidated statements of operations under “other income (expense)”, whileexchange rate fluctuations on long-term intercompany accounts are recorded inour consolidated balance sheets under “accumulated other comprehensive loss” instockholders’ equity. We also maintain cash accounts denominated in currenciesother than the local currency which expose us to foreign exchange rate

 

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movements. We haveimplemented a risk management program under which we measure foreign currencyexchange risk monthly and manage those exposures through the use of variousinternal controls and the use of forward foreign exchange contracts. Thisprocess is designed to minimize foreign currency translation exposures thatcould otherwise affect consolidated results of operations. As of September 30,2005 we hedged approximately $4.6 million of receivables, intercompanyaccounts and cash balances denominated in currencies other than the U.S.dollar.

 

*InterestRate Sensitivity*

* *

Wehad unrestricted cash, cash equivalents and short term investments totaling$55.2 million at September 30, 2005. Investments in securities areinvested primarily in high quality securities of a short duration and are notmaterially affected by fluctuations in interest rates. The cash and cashequivalents are held for working capital purposes. We do not enter intoinvestments for trading or speculative purposes. Due to the short-term natureof these investments, we believe that we do not have any material exposure tochanges in the fair value of our investment portfolio as a result of changes ininterest rates. Declines in interest rates, however, would reduce futureinvestment income.

 

Wehave a working capital line of credit which bears interest based upon the primerate. At December 31, 2004 and September 30, 2005 there were noamounts outstanding under our working capital line of credit.

 

**Item 4.**                          Controls andProcedures

** **

Wemaintain disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed in our Securities Exchange Act reports isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms, and that such information is accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure. In designing and evaluating the disclosure controls and procedures,management recognized that any controls and procedures, no matter how welldesigned and operated, can provide only reasonable assurance of achieving thedesired control objectives, as ours are designed to do, and managementnecessarily was required to apply its judgment in evaluating the cost-benefitrelationship of possible controls and procedures.

 

Asof September 30, 2005, we carried out an evaluation, under the supervisionand with the participation of our management, including our Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended. Basedupon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that, as of September 30, 2005, our disclosure controls andprocedures were effective in enabling us to record, process, summarize andreport information required to be included in our periodic SEC filings withinthe required time period.

 

Therehave been no changes in our internal control over financial reporting thatoccurred during the period covered by this report that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

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**Part II—OtherInformation**

** **

**Item2.****                        ****Unregistered Sales of Equity Securities and Use of Proceeds.**

 

OnJanuary 7, 2005, we issued 9,802 shares of common stock to Silicon ValleyBank in connection with the exercise of a warrant to purchase commonstock.  The warrant was issued to SiliconValley Bank in connection with our entry into a loan agreement with the bank inAugust 2000.  We issued the commonstock to Silicon Valley Bank, an existing securityholder, by means of acashless exercise with no commission or other remuneration paid directly orindirectly for soliciting the warrant exercise. The issuance of this commonstock was exempt under Section 3(a)(9) and/or Section 4(2) ofthe Securities Act of 1933, as amended.

 

**Item4.****                        ****Submission of Matters to a Vote of Security Holders**

 

At the annual meeting of our stockholders held May 12,2005, our stockholders took the following actions:

 

Our stockholders elected Axel Bichara, Paul A.Bleicher, Richard D’Amore, James I. Cash, Jr., Franklyn A. Caine, PeterBarton Hutt, and Robert K. Weiler, each to serve for a one-year term and untiltheir successors have been duly elected and qualified or until their earlierdeath, resignation or removal. The directors were elected by a plurality of thevotes cast at the 2005 annual meeting, as follows:

 
| **Nominee**             | ** ** | **Votes  For** | ** ** | **Shares  Withheld** | ** ** |
|-------------------------|------------|----------------|------------|----------------------|------------|
|                    |       |           |       |                 |       |
| Axel Bichara            |       | 25,691,466     |       | 3,396                |       |
| Paul A.  Bleicher       |       | 25,687,555     |       | 7,307                |       |
| Richard  D’Amore   |       | 25,691,466     |       | 3,396                |       |
| James I. Cash, Jr. |       | 25,098,910     |       | 595,952              |       |
| Franklyn A.  Caine      |       | 25,452,311     |       | 242,511              |       |
| Peter Barton  Hutt      |       | 25,685,466     |       | 9,396                |       |
| Robert K.  Weiler       |       | 25,413,237     |       | 281,625              |       |

 

No other persons were nominated, nor received votes,for election as a director at the 2005 annual meeting.

 

Our stockholders approved the selection of Ernst &Young LLP as our independent registered public accounting firm for the fiscalyear ending December 31, 2005. The votes cast at the 2005 annual meetingwere as follows: 25,614,113 shares voted for, 80,739 shares voted against and10 shares abstained from voting.

 

**Item 5.**                          OtherInformation.

 

Ourpolicy governing transactions in our securities by directors, officers andemployees permits our officers, directors and certain other persons to enter intotrading plans complying with Rule 10b5-1 under the Securities Exchange Actof 1934, as amended. As permitted by Rule 10b5-1 and our policy governingtransactions in our securities, some of our officers have established tradingplans, and we anticipate that some or all of our officers, directors andemployees may establish trading plans in the future. We have disclosed andintend to continue to disclose the names of executive officers and directorswho have adopted 10b5-1 trading plans in our periodic filings.   However, we undertakeno obligation to update or revise theinformation provided in such filings, including for revision or termination ofan established trading plan. We have been advised that at the time of thefiling of this Quarterly Report, 10b5-1 plans were in effect for our Presidentand Chief Executive Officer, Robert K. Weiler, our Chairman and Chief StrategyOfficer, Paul A. Bleicher, and our Vice President, Development, StevenRosenberg.

 

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**Item6.**                          Exhibits.

 

(a)      List of exhibits

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                  |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|
| 2.1(1)#          |       | Agreement  and Plan of Merger by and among Phase Forward, Merger Sub, Lincoln and  Lincoln SR dated as of August 16, 2005.                       |
| 10.1(2)          |       | Termination  Agreement and Sixth Loan Modification Agreement to the Loan Agreement between  the Registrant and Silicon Valley Bank, as modified. |
| 31.1             |       | Certification  of CEO pursuant to Rule 13a-14(a) and 15d-14(s) under the Securities Exchange  Act of 1934.                                       |
| 31.2             |       | Certification  of CFO pursuant to rules 13a-14(a) and 15d-14(s) under the Securities  Exchange Act of 1934.                                      |
| 32.1             |       | Certification  of CEO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                         |
| 32.2             |       | Certification  of CFO pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                         |

 

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| #   | Confidential treatment  requested for portions of this document.                                                                                             |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (1) | Incorporated by reference  herein to Exhibit 2.1 of the Company’s Current Report on Form 8-K  filed with the SEC on August 31, 2005.     |
| (2) | Incorporated by reference  herein to Exhibit 10.2 of the Company’s Quarterly Report on Form 10-Q  filed with the SEC on August 10, 2005. |

 

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**Signatures**

** **

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
| ** **                    | **PHASE  FORWARD INCORPORATED** |
|-------------------------------|---------------------------------|
| ** **                    | ** **                      |
|                          | By:                             | /s/ ROBERT K. WEILER |   |
|                          |                            | Robert K. Weiler |
|                          |                            | *Chief  Executive Officer* |
|                          |                            | *(Principal  executive officer)* |
|                          |                            |   |
|                          | By:                             | /s/ RODGER WEISMANN |   |
|                          |                            | Rodger Weismann |
|                          |                            | *Chief  Financial Officer* |
|                          |                            | *(Principal  financial and accounting officer)* |
|                          |                            |   |
| Date: November 14,  2005 |                            |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit  No.** | ** ** | **Description**                                                                                                                 |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|
| ** **       | ** ** | ** **                                                                                                                      |
| 2.1(1)#          |       | Agreement and Plan of  Merger by and among Phase Forward, Merger Sub, Lincoln and Lincoln SR dated  as of August 16, 2005. |
|             |       |                                                                                                                            |   |
|             | 10.1(2)    |                                                                                                                            | Termination Agreement and  Sixth Loan Modification Agreement to the Loan Agreement between the  Registrant and Silicon Valley Bank, as modified. |
|             |       |                                                                                                                            |   |
|             | 31.1       |                                                                                                                            | Certification of CEO  pursuant to Rule 13a-14(a) and 15d-14(s) under the Securities  Exchange Act of 1934. |
|             |       |                                                                                                                            |   |
|             | 31.2       |                                                                                                                            | Certification of CFO  pursuant to rules 13a-14(a) and 15d-14(s) under the Securities  Exchange Act of 1934. |
|             |       |                                                                                                                            |   |
|             | 32.1       |                                                                                                                            | Certification of CEO  pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|             |       |                                                                                                                            |   |
|             | 32.2       |                                                                                                                            | Certification of CFO  pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |
|                  |            |                                                                                                                                 |  |

 

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| #   | Confidential  treatment requested for portions of this document.                                                                         |
|-----|------------------------------------------------------------------------------------------------------------------------------------------|
| (1) | Incorporated  by reference herein to Exhibit 2.1 of the Company's Current Report on Form  8-K filed with the SEC on August 31, 2005.     |
| (2) | Incorporated  by reference herein to Exhibit 10.2 of the Company's Quarterly Report on Form  10-Q filed with the SEC on August 10, 2005. |

 

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