Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

x**      ****QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For the quarterly period ended March 31, 2009**

 

**OR**

 

o          **TRANSITION REPORT PURSUANT TOSECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thetransition period from                                 to                               **

 

**CommissionFile Number: 000-50839**

 

**PhaseForward Incorporated**

(Exact name ofregistrant as specified in its charter)

 

| **Delaware**                                                     | ** ** | **04-3386549**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) | ** ** | (I.R.S. Employer  Identification No.) |

 

| **77  Fourth Avenue  Waltham, Massachusetts** | ** ** | **02451**  |
|-----------------------------------------------|------------|------------|
| (Address of  principal executive offices)     | ** ** | (Zip Code) |

 

**(888) 703-1122**

(Registrant’stelephone number, including area code)

 

Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.  Yes  xNo o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  o Yes o No

 

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

| Large accelerated filer x                     |   | Accelerated filer o         |
|-----------------------------------------------|--------|-----------------------------|
|                                          |   |                        |
| Non-accelerated filero                        |   | Smaller reporting company o |
| (Do not check if a smaller reporting company) |   |                        |

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act).  Yes o No x

 

As of May 1, 2009,the registrant had 43,129,043 shares of common stock outstanding.

 

 

 

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Tableof Contents

 

**PHASE FORWARD INCORPORATED**

** **

**QUARTERLY REPORT ON FORM 10-Q**

** **

**For the quarterly period ended March 31,2009**

** **

**Table of Contents**

 
|                                             | ** **                                                                                                                                       | **Page  Number** |
|---------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------------|
| ** **                                  |                                                                                                                                             |
| **Part I—Financial  Information** |                                                                                                                                             |
| Item 1.                                     | Condensed Consolidated  Balance Sheets as of December 31, 2008 (unaudited) and  March 31, 2009 (unaudited)                             | 3                |
|                                        | Condensed  Consolidated Statements of Income for the three months ended  March 31, 2008 (unaudited) and March 31, 2009 (unaudited)     | 4                |
|                                        | Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2008 (unaudited) and March 31, 2009 (unaudited) | 5                |
|                                        | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                                | 6                |
| Item 2.                                     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                      | 19               |
| Item 3.                                     | Quantitative  and Qualitative Disclosures about Market Risk                                                                                      | 33               |
| Item 4.                                     | Controls and  Procedures                                                                                                                         | 34               |
| **Part II—Other  Information**    |                                                                                                                                             |
| Item 1.                                     | Legal Proceedings                                                                                                                                | 35               |
| Item 1A.                                    | Risk Factors                                                                                                                                     | 35               |
| Item 2.                                     | Unregistered  Sale of Equity Securities and Use of Proceeds                                                                                      | 35               |
| Item 5.                                     | Other Information                                                                                                                                | 35               |
| Item 6.                                     | Exhibits                                                                                                                                         | 36               |
| Signatures                                  |                                                                                                                                             | 37               |
| Exhibit Index                          |                                                                                                                                             | 38               |

 

2

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**Part I—Financial Information**

 

**Item 1. *CondensedConsolidated Financial Statements (unaudited)***

** **

**Phase Forward Incorporated**

**Condensed Consolidated BalanceSheets**

**(unaudited)**

**(in thousands, except per share amounts)**

 
| ** **                                                                             | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------|------------|
| ** **                                                                             | ** ** | **2008**                    | ** ** | **2009**                 | ** ** |
| **Assets**                                                                             |       |                        |       |                     |       |
| Current assets:                                                                        |       |                        |       |                     |       |
| Cash and cash  equivalents                                                             |       | $                           | 131,550    |                     | $          | 134,209 |   |
| Restricted cash,  current portion                                                      |       | 500                         |       | 500                      |       |
| Short-term  investments                                                                |       | 27,893                      |       | 22,101                   |       |
| Accounts  receivable, net of allowance of $578 and $562, respectively                  |       | 39,999                      |       | 42,457                   |       |
| Acquired future  billings, current portion                                             |       | 1,129                       |       | 902                      |       |
| Deferred set up  costs, current portion                                                |       | 2,393                       |       | 2,627                    |       |
| Prepaid  commissions and royalties, current portion                                    |       | 4,524                       |       | 5,094                    |       |
| Prepaid expenses  and other current assets                                             |       | 4,773                       |       | 5,448                    |       |
| Deferred income  taxes, current portion                                                |       | 12,895                      |       | 12,641                   |       |
|                                                                                   |       |                        |       |                     |       |
| Total current  assets                                                                  |       | 225,656                     |       | 225,979                  |       |
|                                                                                   |       |                        |       |                     |       |
| Acquired future  billings, net of current portion                                      |       | 962                         |       | 650                      |       |
| Property and  equipment, net                                                           |       | 36,615                      |       | 38,808                   |       |
| Deferred set up  costs, net of current portion                                         |       | 1,630                       |       | 1,774                    |       |
| Prepaid  commissions and royalties, net of current portion                             |       | 4,277                       |       | 4,375                    |       |
| Intangible  assets, net of accumulated amortization of $3,624 and $4,385, respectively |       | 27,586                      |       | 26,825                   |       |
| Goodwill                                                                               |       | 39,125                      |       | 39,269                   |       |
| Deferred income  taxes, net of current portion                                         |       | 7,107                       |       | 4,917                    |       |
| Restricted cash,  net of current portion                                               |       | 962                         |       | 962                      |       |
| Long-term  investments                                                                 |       | 18,022                      |       | 21,790                   |       |
| Securities  settlement agreement                                                       |       | 5,322                       |       | 5,137                    |       |
| Other assets                                                                           |       | 626                         |       | 621                      |       |
|                                                                                   |       |                        |       |                     |       |
| Total assets                                                                           |       | $                           | 367,890    |                     | $          | 371,107 |   |
|                                                                                   |       |                        |       |                     |       |
| **Liabilities  and Stockholders’ Equity**                                         |       |                        |       |                     |       |
| Current liabilities:                                                                   |       |                        |       |                     |       |
| Accounts payable                                                                       |       | $                           | 8,895      |                     | $          | 4,726 |   |
| Accrued expenses                                                                       |       | 22,686                      |       | 15,799                   |       |
| Leasehold  incentive obligation, current portion                                       |       | 791                         |       | 791                      |       |
| Deferred  revenues, current portion                                                    |       | 79,918                      |       | 85,843                   |       |
|                                                                                   |       |                        |       |                     |       |
| Total current  liabilities                                                             |       | 112,290                     |       | 107,159                  |       |
|                                                                                   |       |                        |       |                     |       |
| Deferred rent,  net of current portion                                                 |       | 564                         |       | 1,699                    |       |
| Leasehold  incentive obligation, net of current portion                                |       | 7,248                       |       | 7,050                    |       |
| Deferred  revenues, net of current portion                                             |       | 8,600                       |       | 9,918                    |       |
| Other long-term  liabilities                                                           |       | 1,515                       |       | 1,451                    |       |
|                                                                                   |       |                        |       |                     |       |
| Total  liabilities                                                                     |       | 130,217                     |       | 127,277                  |       |
|                                                                                   |       |                        |       |                     |       |
| Commitments and  contingencies (Note 12)                                               |       |                        |       |                     |       |
|                                                                                   |       |                        |       |                     |       |
| Stockholders’  equity:                                                            |       |                        |       |                     |       |
| Preferred stock,  $.01 par value:                                                      |       |                        |       |                     |       |
| Authorized—5,000  shares                                                          |       |                        |       |                     |       |
| Issued—0 shares                                                                   |       | —                      |       | —                   |       |
| Common stock,  $.01 par value:                                                         |       |                        |       |                     |       |
| Authorized—100,000  shares                                                        |       |                        |       |                     |       |
| Issued—42,986  and 43,145 shares, respectively                                    |       | 430                         |       | 431                      |       |
| Additional  paid-in capital                                                            |       | 283,676                     |       | 286,127                  |       |
| Treasury stock,  37 shares at cost                                                     |       | (111                        | )          | (111                     | )          |
| Accumulated  other comprehensive loss                                                  |       | (672                        | )          | (1,045                   | )          |
| Accumulated  deficit                                                                   |       | (45,650                     | )          | (41,572                  | )          |
|                                                                                   |       |                        |       |                     |       |
| Total  stockholders’ equity                                                       |       | 237,673                     |       | 243,830                  |       |
|                                                                                   |       |                        |       |                     |       |
| Total  liabilities and stockholders’ equity                                       |       | $                           | 367,890    |                     | $          | 371,107 |   |

 

See accompanying notes.

 

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**PhaseForward Incorporated**

**Condensed Consolidated Statements of Income**

**(unaudited)**

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

 
| ** **                                                                           | ** ** | **Three Months Ended  March 31****,** | ** ** |
|--------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                           | ** ** | **2008**                                   | ** ** | **2009** | ** ** |
| Revenues:                                                                            |       |                                       |       |   |   |
| License                                                                              |       | $                                          | 12,614     |   | $ | 14,116 |   |
| Service                                                                              |       | 25,406                                     |       | 34,700 |   |
|                                                                                 |       |                                       |       |   |   |
| Total revenues                                                                       |       | 38,020                                     |       | 48,816 |   |
| Costs of  revenues:                                                                  |       |                                       |       |   |   |
| License (2)                                                                          |       | 655                                        |       | 566 |   |
| Service (1), (2)                                                                     |       | 15,528                                     |       | 19,899 |   |
|                                                                                 |       |                                       |       |   |   |
| Total cost of  revenues                                                              |       | 16,183                                     |       | 20,465 |   |
| Gross margin:                                                                        |       |                                       |       |   |   |
| License                                                                              |       | 11,959                                     |       | 13,550 |   |
| Service                                                                              |       | 9,878                                      |       | 14,801 |   |
|                                                                                 |       |                                       |       |   |   |
| Total gross  margin                                                                  |       | 21,837                                     |       | 28,351 |   |
| Operating  expenses:                                                                 |       |                                       |       |   |   |
| Sales and  marketing(1), (2)                                                         |       | 6,151                                      |       | 7,206 |   |
| Research and  development(1)                                                         |       | 5,558                                      |       | 8,180 |   |
| General and  administrative(1), (2)                                                  |       | 5,700                                      |       | 7,804 |   |
|                                                                                 |       |                                       |       |   |   |
| Total operating  expenses                                                            |       | 17,409                                     |       | 23,190 |   |
|                                                                                 |       |                                       |       |   |   |
| Income from  operations                                                              |       | 4,428                                      |       | 5,161 |   |
| Other income:                                                                        |       |                                       |       |   |   |
| Interest income                                                                      |       | 1,901                                      |       | 640 |   |
| Other income                                                                         |       | 134                                        |       | 409 |   |
|                                                                                 |       |                                       |       |   |   |
| Total other  income                                                                  |       | 2,035                                      |       | 1,049 |   |
|                                                                                 |       |                                       |       |   |   |
| Income before  provision for income taxes                                            |       | 6,463                                      |       | 6,210 |   |
| Provision for  income taxes                                                          |       | 2,461                                      |       | 2,132 |   |
|                                                                                 |       |                                       |       |   |   |
| Net income                                                                           |       | $                                          | 4,002      |   | $ | 4,078 |   |
|                                                                                 |       |                                       |       |   |   |
| Net income per  share applicable to common stockholders:                             |       |                                       |       |   |   |
| Basic                                                                                |       | $                                          | 0.10       |   | $ | 0.10 |   |
|                                                                                 |       |                                       |       |   |   |
| Diluted                                                                              |       | $                                          | 0.09       |   | $ | 0.09 |   |
|                                                                                 |       |                                       |       |   |   |
| Weighted average  number of common shares used in net income per share calculations: |       |                                       |       |   |   |
| Basic                                                                                |       | 41,859                                     |       | 42,430 |   |
|                                                                                 |       |                                       |       |   |   |
| Diluted                                                                              |       | 43,738                                     |       | 43,998 |   |

 

----

(1)          Amountsinclude stock-based compensation expense, as follows:

 
| Costs of service  revenues  |   | $   | 393    |   | $      | 476 |   |
|-----------------------------|--------|-----|--------|--------|--------|-----|--------|
| Sales and  marketing        |   | 314 |   | 415    |   |
| Research and  development   |   | 279 |   | 621    |   |
| General and  administrative |   | 760 |   | 1,057  |   |

 

(2)          Amounts include amortization expense of acquiredintangible assets, as follows:

 
| Costs of license  revenues  |   | $      | 155    |   | $      | 155 |   |
|-----------------------------|--------|--------|--------|--------|--------|-----|--------|
| Costs of service  revenues  |   | 100    |   | 261    |   |
| Sales and marketing         |   | — |   | 320    |   |
| General and  administrative |   | — |   | 25     |   |

 

See accompanying notes.

 

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**PhaseForward Incorporated**

**Condensed Consolidated Statements of Cash Flows**

**(unaudited)**

**(inthousands)**

 
| ** **                                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                              | ** ** | **2008**                               | ** ** | **2009** | ** ** |
| **Operating  activities**                                                               |       |                                   |       |   |   |
| Net income                                                                              |       | $                                      | 4,002      |   | $ | 4,078 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:      |       |                                   |       |   |   |
| Depreciation and  amortization                                                          |       | 2,160                                  |       | 3,713 |   |
| Stock-based  compensation expense                                                       |       | 1,746                                  |       | 2,569 |   |
| Loss on disposal  of fixed assets                                                       |       | 316                                    |       | — |   |
| Amortization of  leasehold incentive obligation                                         |       | —                                 |       | (198 | ) |
| Provision for  allowance for doubtful accounts                                          |       | 46                                     |       | 13 |   |
| Deferred income  taxes                                                                  |       | 2,272                                  |       | 2,444 |   |
| Amortization of  premiums or discounts on investments                                   |       | (88                                    | )          | (3 | ) |
| Change in fair  value of long-term investments                                          |       | —                                 |       | (437 | ) |
| Change in fair  value of securities settlement agreement                                |       | —                                 |       | 185 |   |
| Changes in  assets and liabilities:                                                     |       |                                   |       |   |   |
| Accounts  receivable and acquired future billings                                       |       | (4,664                                 | )          | (2,210 | ) |
| Deferred costs                                                                          |       | (865                                   | )          | (1,155 | ) |
| Prepaid expenses  and other current assets                                              |       | 609                                    |       | (726 | ) |
| Accounts payable                                                                        |       | 1,705                                  |       | (4,125 | ) |
| Accrued expenses                                                                        |       | (4,900                                 | )          | (6,715 | ) |
| Deferred revenue                                                                        |       | 16,366                                 |       | 7,465 |   |
| Deferred rent                                                                           |       | (149                                   | )          | 1,135 |   |
|                                                                                    |       |                                   |       |   |   |
| Net cash  provided by operating activities                                              |       | 18,556                                 |       | 6,033 |   |
|                                                                                    |       |                                   |       |   |   |
| **Investing  activities**                                                               |       |                                   |       |   |   |
| Proceeds from  maturities of short-term and long-term investments                       |       | 28,325                                 |       | 12,000 |   |
| Purchase of short-term  and long-term investments                                       |       | (25,625                                | )          | (9,536 | ) |
| Purchase of  property and equipment                                                     |       | (1,403                                 | )          | (5,174 | ) |
|                                                                                    |       |                                   |       |   |   |
| Net cash  provided by (used in) investing activities                                    |       | 1,297                                  |       | (2,710 | ) |
|                                                                                    |       |                                   |       |   |   |
| **Financing  activities**                                                               |       |                                   |       |   |   |
| Proceeds from  issuance of common stock                                                 |       | 446                                    |       | 342 |   |
| Withholding  taxes in connection with vesting of restricted stock awards                |       | —                                 |       | (459 | ) |
|                                                                                    |       |                                   |       |   |   |
| Net cash  provided by (used in) financing activities                                    |       | 446                                    |       | (117 | ) |
|                                                                                    |       |                                   |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                           |       | 90                                     |       | (547 | ) |
|                                                                                    |       |                                   |       |   |   |
| Net increase in  cash and cash equivalents                                              |       | 20,389                                 |       | 2,659 |   |
| Cash and cash  equivalents at beginning of period                                       |       | 133,401                                |       | 131,550 |   |
|                                                                                    |       |                                   |       |   |   |
| Cash and cash  equivalents at end of period                                             |       | 153,790                                |       | 134,209 |   |
| Short-term and  long-term investments at end of period                                  |       | 45,472                                 |       | 43,891 |   |
| Total cash, cash  equivalents and short-term and long-term investments at end of period |       | $                                      | 199,262    |   | $ | 178,100 |   |

 

See accompanying notes.

 

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**Phase Forward Incorporated Notes to Condensed Consolidated Financial Statements**

**(unaudited)(in thousands, except share and per share amounts)**

 

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

 

The accompanyingunaudited condensed consolidated financial statements included herein have beenprepared by 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 SEC rules andregulations. Management of the Company believes that the disclosures herein areadequate to make the information presented not misleading. In the opinion ofmanagement, the unaudited condensed consolidated financial statements have beenprepared on the same basis as the audited consolidated financial statements andreflect all material adjustments (consisting only of those of a normal andrecurring nature) which are necessary to present fairly the consolidatedfinancial position of the Company as of March 31, 2009, the results of itsoperations for the three months ended March 31, 2008 and 2009 and its cashflows for the three months ended March 31, 2008 and 2009. These unauditedcondensed consolidated financial statements and notes thereto should be read inconjunction with the audited consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2008. The results of operations for the interim periodsare not necessarily indicative of the results of operations to be expected forthe year ending December 31, 2009.

 

As of March 31,2009, the Company’s significant accounting policies and estimates, which aredetailed in the Company’s Annual Report on Form 10-K for the year ended December 31,2008, have not changed except for the adoption of Statement of FinancialAccounting Standards (“SFAS”) No. 141 (R), *BusinessCombinations*, SFAS No. 160, **Noncontrolling Interests in ConsolidatedFinancial Statements—an amendment of ARB No. 51,**SFAS No. 161, **Disclosures about Derivative Instruments and Hedging Activities—anamendment of FASB Statement No. 133,** and SFAS 162, **The Hierarchy ofGenerally Accepted Accounting Principles**.  See Note 19 for additional informationregarding the Company’s adoption of these pronouncements.

 

**2.****   Revenue Recognition andDeferred Set Up Costs**

 

The Company derives revenues from software licenses andservices. License revenues are derived principally from the sale of termlicenses for the following software products offered by the Company: *InFormTM, ClintrialTM,**WebSDM*TM, *Empirica*TM*Trace*, *EmpiricaTM Signal**and**CTSDTM.*Servicerevenues are derived principally from the Company’s delivery of the hostedsolutions of its *InFormTM,**ClarixTM, Empirica Signal,**CTSD* and *WebSDM*software products, and consulting services and customer support, includingtraining, for all of the Company’s products.

 

The components ofrevenue are as follows:

 
| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|----------------------------------------|------------|
| ** **                    | ** ** | **2008**                               | ** ** | **2009** | ** ** |
| License                       |       | $                                      | 12,614     |   | $ | 14,116 |   |
| Application  hosting services |       | 19,185                                 |       | 26,626 |   |
| Consulting  services          |       | 3,099                                  |       | 4,861 |   |
| Customer support              |       | 3,122                                  |       | 3,213 |   |
|                          |       |                                   |       |   |   |
| Total                         |       | $                                      | 38,020     |   | $ | 48,816 |   |

 

The Company recognizessoftware license revenues in accordance with the American Institute ofCertified Public Accountants (“AICPA”) Statement of Position (“SOP”) No. 97-2,*Software Revenue Recognition,* asamended, while revenues resulting from application hosting services arerecognized in accordance with Emerging Issues Task Force (“EITF”) Issue No. 00-3,*Application of AICPA Statement of Position97-2 to Arrangements that include the Right to Use Software Stored on AnotherEntity’s Hardware*, SEC Staff Accounting Bulletin (“SAB”) No. 104,*Revenue Recognition,* and EITFIssue No. 00-21, *Revenue Arrangements with MultipleDeliverables.*

 

Customers generally havethe ability to terminate application hosting, consulting and training serviceagreements upon 30 days notice to the Company. License agreements,multiple element arrangements, including license and service 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 recognizesrevenues when all of the following conditions are satisfied: (1) there ispersuasive evidence of an arrangement; (2) the product or service has beenprovided to the customer; (3) the collection of fees is probable; and (4) theamount of fees to be paid by the customer is fixed or determinable.

 

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The Company generallyenters into software term licenses for its *InForm*,*Clintrial* and *Empirica Trace*products with its customersfor 3 to 5-year periods. License agreements for other**licensed products are generally forannual or multi-year terms.  Thesearrangements typically include multiple elements: software license, consultingservices and customer support. The Company bills its customers in accordancewith the terms of the underlying contract. Generally, the Company bills licensefees annually in advance for each year of the license term. Payment terms aregenerally net 30 days.

 

The Company’s softwarelicense revenues are earned from the sale of off-the-shelf software requiringno significant 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.

 

Customer support includestraining services, telephone support and software maintenance.  The Company generally bundles customersupport with the software license for the entire term of the arrangement. As aresult, the Company generally recognizes revenues for all elements, includingconsulting services, ratably over the term of the software license and supportarrangement. The Company allocates the revenues 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 value ofthe Company’s consulting services sold within a bundled arrangement is equal tothe value of consulting services sold on a stand-alone basis, as the activitiesperformed under both types of arrangements are similar in nature.  The remaining value is allocated to licenseand support services, with 10% of this amount allocated to support services.The customer support services rate of 10% for multi-year term-based licensesreflects a significant discount from the rate for customer support servicesassociated with perpetual licenses due to the reduction in the time periodduring which the customer can utilize the upgrades and enhancements.  The Company believes this rate is substantiveand represents an amount it believes reasonable to be allocated.  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, therevenues are generally recognized ratably over the contractual term of thearrangement. If the fee is based on actual usage, and therefore variable, therevenues are recognized in the period of use. Revenues from certain follow-onconsulting services, 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 tosell additional perpetual licenses for the *Clintrial* and *Empirica Trace* software products incertain situations to its existing customers with the option to purchasecustomer support. The Company has established vendor specific objectiveevidence of fair value for the customer support. Accordingly, license revenuesare recognized upon delivery of the software and when all other revenuerecognition criteria are met. Customer support revenues are recognized ratablyover the term of the underlying support arrangement. The Company generatescustomer support and maintenance revenues from its perpetual license customerbase. Training revenues are recognized as earned.

 

In addition to making itssoftware products available to customers through licenses, the Company offersits *InForm*, *EmpiricaSignal*, *CTSD* and *WebSDM* software solutions through a hosted application solutiondelivered through a standard Web-browser. The Company’s *Clarix* solutionis presently available only on a hosted application basis.

 

Revenues resulting from *InForm *and *Clarix*applicationhosting services consist of three stages for each clinical trial: the firststage involves application set up, including design, implementation of thesystem and server configuration; the second stage involves application hostingand related support services; and the third stage involves services required toclose out, or lock, the database for the clinical trial. Services provided forthe first and third stages are provided on a fixed fee basis based upon thecomplexity of the trial and system requirements. Services for the second stageare charged separately as a fixed monthly fee. The Company recognizes revenuesfrom all stages of the *InForm *and *Clarix*hosting service ratably over the hosting period. Fees chargedand costs incurred for the trial system design, set up and implementation aredeferred until the start of the hosting period and are amortized and recognizedratably over the estimated hosting period. The deferred costs includeincremental direct costs with third parties and certain internal direct costsrelated to the trial and 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 recognizedratably over the remaining term of the hosting period. Fees for the first andthird stages of the service are billed based upon milestones. Fees forapplication hosting and related services in the second stage are generallybilled quarterly in advance. Bundled into this revenue element are revenuesattributable to the software license used by the customer.

 

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Revenues resulting fromhosting services for the *Empirica Signal*,*CTSD* and *WebSDM* products consist of installationand server configuration, application hosting and related supportservices.  Services for this offering aregenerally charged a monthly fixed fee. Revenues are recognized ratably over the period of the service.

 

In the event that anapplication hosting customer cancels a clinical trial and its related statementof work, all deferred revenues are recognized and all deferred set up costs areexpensed.  In addition, certain terminationrelated fees may be charged and if so, such fees are recognized in the periodof termination.

 

Provisions for estimatedlosses on uncompleted contracts are made on a contract-by-contract basis andare recognized in the period in which such losses become probable and can bereasonably estimated. To date, the Company has not experienced any materiallosses on uncompleted application hosting or consulting contracts.

 

One customer,GlaxoSmithKline, accounted for approximately 13% of the Company’s totalrevenues in the three months ended March 31, 2008, and $863 of accountsreceivable outstanding as of December 31, 2008.  In the three months ended March 31,2009, no customer accounted for 10% or more of the Company’s total revenues forthe period.

 

The Company deferred$1,205 and $1,295 of set up costs and amortized $805 and $917 during the threemonths ended March 31, 2008 and 2009, respectively. The amortization ofdeferred set up costs is a component of cost of service revenues.

 

The Company may alsoenter into arrangements to provide consulting services separate from a licensearrangement. In these situations, revenue is recognized in accordance with SOP81-1, *Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts,*on either atime and materials basis or using the proportional performance method. If theCompany is not able to produce reasonably dependable estimates, revenue isrecognized upon completion of the project and final acceptance from thecustomer. If significant uncertainties exist about project completion orreceipt of payment, the revenue is deferred until the uncertainty is resolved.Provisions for estimated losses on contracts are recorded during the period inwhich they are identified.

 

Deferred revenuerepresents amounts billed or cash received in advance of revenue recognition.

 

In accordance with EITFIssue No. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred,* the Company included $156 and $121 of reimbursableout-of-pocket expenses in service revenues and cost of service revenues in thethree months ended March 31, 2008 and 2009, respectively.

 

**Internal Use Software and Website Development Costs**

 

The Company follows the guidance of EITF Issue No. 00-2,*Accounting for Web Site Development Costs,*which sets forth the accounting for website development costs based on thewebsite development activity. The Company follows the guidance set forth in SOPNo. 98-1, *Accounting for the Cost of Computer SoftwareDeveloped or Obtained for Internal Use*, in accounting for thedevelopment of its on demand use systems. SOP No. 98-1 requires companiesto capitalize qualifying computer software costs which are incurred during theapplication development stage, and to amortize them over the software’sestimated useful life. The Company capitalized $0 and $206 during the threemonths ended March 31, 2008 and March 31, 2009, respectively, relatedto Company-wide financial systems, and has included these amounts in purchasedcomputer software in the accompanying unaudited condensed consolidatedfinancial statements.  The Companyamortizes such costs when the systems or software becomes operational. Costsare amortized over the estimated useful life of the respective system or software.  Amortization expense was $25 and $9 duringthe three months ended March 31, 2008 and 2009, respectively.

 

**Computer Software Development Costs and Research andDevelopment Expenses**

 

The Company has evaluated the establishment oftechnological feasibility of its products in accordance with SFAS No. 86, *Accounting for the Costs of Computer Software to Be Sold, Leased orOtherwise Marketed*. The Company sells products in a market that issubject to rapid technological change, new product development and changingcustomer needs; accordingly, the Company has concluded that technologicalfeasibility is not established until the development stage of the product isnearly complete. The Company defines technological feasibility as thecompletion of a working model. The time period during which costs could becapitalized, from the point of reaching technological feasibility until thetime of general product release, is very short, and consequently, the amountsthat could be capitalized are not material to the Company’s financial positionor results of operations. Therefore, the Company has charged all such costs toresearch and development expense in the period incurred.

 

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**3.   Prepaid SalesCommissions and Royalties**

 

For arrangements where revenues are recognized over therelevant contract period, the Company defers related commissions paid to itsdirect sales force and software license royalties paid to third parties, andamortizes these expenses over the period in which the related revenues arerecognized.

 

Commission payments are nonrefundable unless the salesrepresentatives do not achieve their specific quota, 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 deferred $2,020 and $1,984 ofcommissions and amortized to sales and marketing expense $1,784 and $1,744during the three months ended March 31, 2008 and 2009, respectively.

 

The Company’s royaltyobligation is based upon the license and customer support revenues earned forcertain products in an arrangement. The Company has the right to recover theroyalties in the event the arrangement is cancelled. The Company deferred$1,047 and $1,089 of royalties and amortized to cost of revenues $691 and $661during the three months ended March 31, 2008 and 2009, respectively.

 

**4.   Warranties andIndemnification**

 

The Company’s softwarelicense arrangements and hosting services are typically warranted to perform ina manner 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 property rights.

 

The Company has entered into service level agreementswith some of its hosted application customers warranting certain levels ofuptime reliability and permitting those customers to receive credits againstmonthly hosting fees or terminate their agreements in the event that theCompany fails to meet those levels.

 

To date, the Company has not incurred any material costsas a result of such indemnifications and has not accrued any liabilitiesrelated to such obligations in the accompanying consolidated financialstatements.

 

**5.    Acquisitions**

 

*WabanSoftware, Inc.**(Subsequent event)*

 

On April 22, 2009,the Company acquired all of the outstanding common stock of Waban Software, Inc.(“Waban”), a provider of platform solutions for the automation and complianceof clinical data analysis.  Waban’sStatistical Computing Environment and Clinical Data Repository (SCE/CDR)solutions provide automation, traceability and control of the key activitiesinvolved in the integration, analysis and reporting on clinical trial data.  The aggregate purchase price was $14,000 incash, as adjusted by working capital adjustments, and minus any transactionfees or indebtedness of Waban.  TheCompany acquired the technology of Waban to allow it to penetrate the marketfor statistical computing and clinical data repository solutions.  The acquisition of Waban will be accountedfor as a purchase under SFAS No. 141 (R), *BusinessCombinations*.  Accordingly,the results of Waban will be included in the consolidated financial statementsof the Company from the date of acquisition.

 

*Clarix LLC*

 

On September 5, 2008, the Company acquired all of theoutstanding membership interests of Clarix LLC (“Clarix”), a provider ofWeb-integrated interactive response technology (“IRT”) for clinical trialmanagement. Clarix’s Web-integrated IRT is used for subject randomization,predictive medication inventory management, and operational management inreporting clinical trials. The aggregate purchase price was $41,283 in cash.The Company acquired the technology of Clarix to allow it to penetrate the IRTmarket and extend its electronic data capture solution. There were no earn-outprovisions as a result of the acquisition. The acquisition of Clarix wasaccounted for as a purchase under SFAS No. 141, *BusinessCombinations*. Accordingly, the results of Clarix have been includedin the consolidated financial statements of the Company since the date ofacquisition.

 

**6.   Net Income Per Share**

 

Basic and diluted net income per share is presented inconformity with SFAS No. 128, *Earnings Per Share*.Basic net income per common share for all periods presented was determined bydividing net income applicable to common stockholders by the weighted averagenumber of common shares outstanding during the period. Weighted average sharesoutstanding exclude unvested restricted common stock. Diluted net income pershare includes the effects of all dilutive, potentially issuable common sharesusing the treasury stock method.

 

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The calculation of basic and diluted net income pershare is as follows:

 
| ** **                                                            | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                            | ** ** | **2008**                              | ** ** | **2009** | ** ** |
| Numerator:                                                            |       |                                  |       |   |   |
| Net income                                                            |       | $                                     | 4,002      |   | $ | 4,078 |   |
|                                                                  |       |                                  |       |   |   |
| Denominator:                                                          |       |                                  |       |   |   |
| Weighted average  common shares outstanding                           |       | 42,718,775                            |       | 43,022,458 |   |
| Less weighted  average unvested restricted common shares outstanding  |       | (860,087                              | )          | (592,150 | ) |
|                                                                  |       |                                  |       |   |   |
| Basic weighted  average common shares outstanding                     |       | 41,858,688                            |       | 42,430,308 |   |
| Dilutive effect  of common stock options                              |       | 1,363,374                             |       | 1,071,713 |   |
| Dilutive effect  of unvested restricted common stock awards and units |       | 516,117                               |       | 495,665 |   |
| Diluted weighted  average common shares outstanding                   |       | 43,738,179                            |       | 43,997,686 |   |
|                                                                  |       |                                  |       |   |   |
| Net income per  share applicable to common stockholders:              |       |                                  |       |   |   |
| Basic                                                                 |       | $                                     | 0.10       |   | $ | 0.10 |   |
|                                                                  |       |                                  |       |   |   |
| Diluted                                                               |       | $                                     | 0.09       |   | $ | 0.09 |   |

 

Diluted weighted averagecommon shares outstanding do not include options and awards outstanding topurchase 350,876 and 350,011 common equivalent shares for the three monthsended March 31, 2008 and 2009, respectively, as their effect would havebeen anti-dilutive.

 

**7.   Foreign Currency Translation**

 

The financial statements of the Company’s foreignsubsidiaries are translated in accordance with SFAS No. 52, *Foreign Currency Translation.* The reporting currency for theCompany is the U.S. dollar. The functional currency of the Company’ssubsidiaries in Australia, Belgium, France, India, Japan, Romania and theUnited Kingdom are the local currencies of those countries. Accordingly, theassets and liabilities of the Company’s foreign subsidiaries are translatedinto U.S. dollars using the exchange rate in effect at each balance sheet date.Revenue and expense accounts are translated using an average rate of exchangeduring the period. Gains and losses arising from transactions denominated inforeign currencies are primarily related to intercompany accounts that havebeen determined to be temporary in nature and cash accounts and accountsreceivable denominated in non-functional currencies. There were noforeign currency gains or losses for the three months ended March 31,2008.  The Company recorded a foreigncurrency gain of $147 for the three months ended March 31, 2009, which isincluded in other income in the accompanying unaudited condensed consolidatedstatements of income.

 

Foreign currencytranslation adjustments are accumulated as a component of other comprehensiveincome as a separate component of stockholders’ equity.

 

**8.   Cash, Cash Equivalents, Short-term and Long-term Investments**

 

TheCompany accounts for its investments 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. Securities for which it is notthe Company’s intent to hold to maturity are classified as eitheravailable-for-sale securities or trading securities. Available-for-salesecurities are reported at fair value, with temporary unrealized gains (losses)excluded from earnings and reported in a separate component of stockholders’equity and other than temporary unrealized losses included in earnings. Tradingsecurities are reported at fair value, with unrealized gains (losses) includedin earnings. The Company considers all highly liquid investments with originalmaturities of 90 days or less at the time of purchase to be cash equivalents andinvestments with original maturities of between 91 days and one year to beshort-term investments. The Company considers investments with maturitiesgreater than one year to be long-term investments.  All securities, with the exception of auctionrate securities (“ARS”), are classified as held-to-maturity securities. Theauction rate securities are debt instruments issued by various municipalitiesthroughout the United States.  Inprior periods and up through the execution of the signed settlement agreementwith UBS in November 2008 as further discussed below, the ARS were classified as available-for-sale because it wasthe Company’s intent not to hold them to maturity. Upon the execution of the settlement agreementwith UBS, the Company elected to make a one-time transfer of the ARS fromavailable-for-sale securities to trading securities. 

 

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Accordingly,on a prospective basis, all unrealized gains (losses) for these tradingsecurities have been included in earnings.

 

Cash, cash equivalents,short-term and long-term investments as of December 31, 2008 and March 31,2009 consist of the following:

 
| ** **                      | ** ** | **December 31, 2008** | ** ** |
|---------------------------------|------------|----------------------------|------------|
| ** **                      | ** ** | **Contracted**             | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per** | ** ** |
| **Description**                 | ** ** | **Maturity**               | ** ** | **Cost** | ** ** | **Value** | ** ** | **Balance Sheet** | ** ** |
| Cash                            |       | Demand                     |       | $ | 22,487 |   | $ | 22,487 |   | $ | 22,487 |   |
| Money market funds              |       | Demand                     |       | 109,063 |   | 109,063 |   | 109,063 |   |
| Total cash and cash equivalents |       |                       |       | $ | 131,550 |   | $ | 131,550 |   | $ | 131,550 |   |
|                            |       |                       |       |   |   |   |   |   |   |
| U.S. agency notes               |       | 236 days                   |       | $ | 2,000 |   | $ | 2,000 |   | $ | 2,000 |   |
| Municipal bonds                 |       | 1  day                     |       | 1,000 |   | 1,000 |   | 1,000 |   |
| Corporate bonds                 |       | 127 days                   |       | 24,893 |   | 24,884 |   | 24,893 |   |
| Total short-term investments    |       |                       |       | $ | 27,893 |   | $ | 27,884 |   | $ | 27,893 |   |
|                            |       |                       |       |   |   |   |   |   |   |
| Auction rate securities         |       | 26 years                   |       | $ | 24,050 |   | $ | 18,022 |   | $ | 18,022 |   |
| Total long-term investments     |       |                       |       | $ | 24,050 |   | $ | 18,022 |   | $ | 18,022 |   |

 
| ** **                      | ** ** | **March 31, 2009** | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **Contracted**          | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per** | ** ** |
| **Description**                 | ** ** | **Maturity**            | ** ** | **Cost** | ** ** | **Value** | ** ** | **Balance Sheet** | ** ** |
| Cash                            |       | Demand                  |       | $ | 22,793 |   | $ | 22,793 |   | $ | 22,793 |   |
| Money market funds              |       | Demand                  |       | 111,416 |   | 111,416 |   | 111,416 |   |
| Total cash and cash equivalents |       |                    |       | $ | 134,209 |   | $ | 134,209 |   | $ | 134,209 |   |
|                            |       |                    |       |   |   |   |   |   |   |
| Corporate bonds                 |       | 158 days                |       | $ | 22,101 |   | $ | 22,091 |   | $ | 22,101 |   |
| Total short-term investments    |       |                    |       | $ | 22,101 |   | $ | 22,091 |   | $ | 22,101 |   |
|                            |       |                    |       |   |   |   |   |   |   |
| Corporate bonds                 |       | 619 days                |       | $ | 3,331 |   | $ | 3,341 |   | $ | 3,331 |   |
| Auction rate securities         |       | 26 years                |       | 24,050 |   | 18,459 |   | 18,459 |   |
| Total long-term investments     |       |                    |       | $ | 27,381 |   | $ | 21,800 |   | $ | 21,790 |   |

 

The Company has had norealized gains or losses from the sale of cash equivalents or short-terminvestments.

 

As of December 31,2008 and March 31, 2009, the Company held ARS totaling $24,050 at parvalue, which were classified as long-term investments in the accompanying unauditedcondensed consolidated balance sheets, and which are recorded at fair value.These ARS are debt instruments issued by various states throughout the UnitedStates to finance student loans.  The types of ARS that the Company ownsare backed by student loans, 95% of which are guaranteed under the FederalFamily Education Loan Program, and all have credit ratings of AAA (orequivalent) from a recognized rating agency.  Historically, the carryingvalue of ARS approximated fair value due to the frequent resetting of theinterest rates. With the liquidity issues experienced in the global credit andcapital markets, the Company’s ARS have experienced multiple failed auctions.While the Company continues to earn and receive interest on these investmentsat the maximum contractual rate, the estimated fair value of these ARS nolonger approximates par value.

 

In November 2008,the Company accepted an offer from and entered into an agreement (the “Agreement”)with UBS AG (“UBS”) with respect to all of the Company’s ARS held at thattime.  As a UBS client who holds ARS, the Company will receive certainrights, which will entitle the Company to sell ARS to UBS affiliates during theperiod from June 30, 2010 to July 2, 2012 for a price equal to parvalue.  In accepting the Agreement, the Company granted UBS the authorityto sell or auction the ARS at par at any time up until the expiration date ofthe Agreement and released UBS from any claims relating to the marketing andsale of ARS.  UBS obligations under theAgreement are not secured by its assets and do not require UBS to obtain anyfinancing to support its performance obligations under the Agreement.  UBS has disclaimed any assurance that it willhave sufficient financial resources to satisfy its obligations under theAgreement.  If UBS has insufficientfunding to buy back the ARS and the auction process continues to fail, theCompany may incur further losses on the carrying value of the ARS.

 

The Company performed afair value calculation of these ARS as of December 31, 2008 and March 31,2009.  Fair value was determined using asecondary market indications method (direct discounts) and a discounted cashflow method as recent auctions of these securities were not successful,resulting in the Company continuing to hold these securities and issuers payinginterest at the maximum contractual rate. This valuation technique considersthe following: time left to maturity, the rate of interest paid on thesecurities, the amount of principal to be repaid to the holders of thesecurities; the credit worthiness of the issuer and guarantors (if any) and thesufficiency of the collateral; trading characteristics of the securities;ability to borrow against the ARS; evidence from 

 

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secondary market sales; and the market-clearing yield for thesecurities. Based upon the valuation performed, the Company concluded that thefair value of these ARS at December 31, 2008 was $18,022, a decline of$6,028 from par value. Since the Company’s signed settlement agreementwith UBS indicates that the Company intends to sell the ARS to UBS affiliatesbefore their stated maturity dates under the terms of the ARS, the decline infair value is deemed other-than-temporary. Accordingly, the Companyrecorded a loss on these securities of $6,028 in the accompanying unauditedcondensed consolidated statement of income for the year ended December 31,2008 as it was deemed to be other-than-temporary.  As of March 31,2009, the Company concluded that the fair value of these ARS had increased to$18,459 and therefore, recorded the change in fair value of the securities of$437 in the accompanying unaudited condensedconsolidated statement of income for the three months ended March 31,2009.

 

The Company elected tomeasure the fair value of the settlement agreement (the “put option”) under thefair value option of SFAS No. 159, *The Fair Value Option forFinancial Assets and Liabilities- including an amendment of FASB Statement No. 115*.Fair value was determined using a discounted cash flow method, which consideredthe following factors: term of the agreement, the availability to borrowagainst the ARS, the creditworthiness of UBS and current market interest rates.Based on the valuation performed, the Company concluded that the fair value ofthe put option was $5,322 as of December 31, 2008.  Accordingly, a gain of $5,322 was recorded inthe consolidated statement of income for the year ended December 31, 2008with a corresponding long term asset, “securities settlement agreement”, in theconsolidated balance sheet at December 31, 2008.  In the three months ended March 31,2009, the Company concluded that the fair market value of the securitiessettlement agreement had decreased to $5,137 and therefore recorded the changein fair value of the securities settlement agreement of ($185) which wasrecorded in the accompanying unaudited condensed consolidated statement ofincome for the three months ended March 31, 2009.

 

Refer to Note 18 forfurther discussion on the adoption of SFAS No. 157, *Fair ValueMeasurements*, and SFAS No. 159.

 

**9.****   Goodwill andIntangible Assets**

 

Goodwill and intangible assets that have indefinite livesare not amortized but are evaluated for impairment annually or whenever eventsor changes in circumstances indicate the carrying value may not be recoverable.Intangible assets that have finite lives are amortized over their useful lives.

 

The goodwill resulting from acquisitions is reviewed for impairment onan annual basis in accordance with SFAS No. 142,*Goodwill and Other Intangible Assets.*  Consistent with prior years, the Companyconducted its annual impairment test of goodwill during the fourth quarter of2008.  Based on the results of the firststep of the goodwill impairment test, the Company determined that no impairmentof goodwill existed at December 31, 2008, as the carrying amount ofgoodwill of the reporting unit was less than its fair value and therefore, thesecond step of the goodwill impairment test was not necessary.

 

A rollforward of the netcarrying amount of goodwill is as follows:

 
| ** **                                                            | ** ** | **Amount** | ** ** |
|-----------------------------------------------------------------------|------------|------------|------------|
|                                                                  |       |       |       |
| Balance as of  December 31, 2008                                 |       | $          | 39,125     |   |
| Purchase price  adjustments associated with the acquisition of Clarix |       | 144        |       |
| Balance as of  March 31, 2009                                    |       | $          | 39,269     |   |

 

 Finite-livedintangible assets consist of the following:

 
| ** **                         | ** ** | ** **                 | ** ** | **As of December 31, 2008** | ** ** | **As of March 31, 2009** | ** ** |
|------------------------------------|------------|----------------------------|------------|----------------------------------|------------|-------------------------------|------------|
| **Description**                    | ** ** | **Estimated  Useful Life** | ** ** | **Gross  Carrying  Value**       | ** ** | **Accumulated  Amortization** | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed  technology and know-how |       | 5-8 years                  |       | $                                | 15,460     |                          | $          | 1,743 |   | $ | 15,460 |   | $ | 2,158 |   |
| Customer  relationships            |       | 5-13 years                 |       | 10,010                           |       | 1,309                         |       | 10,010 |   | 1,554 |   |
| Non-compete  agreements            |       | 2-3 years                  |       | 610                              |       | 335                           |       | 610 |   | 360 |   |
| Tradename                          |       | 5 years                    |       | 300                              |       | 157                           |       | 300 |   | 173 |   |
| Customer backlog                   |       | 3 years                    |       | 720                              |       | 80                            |       | 720 |   | 140 |   |
| Total                              |       |                       |       | $                                | 27,100     |                          | $          | 3,624 |   | $ | 27,100 |   | $ | 4,385 |   |

 

Amortization expenserelated to intangible assets for the three months ended March 31, 2008 and2009 was $255 and $761, respectively.

 

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The estimated remainingamortization expense for each of the five succeeding years is as follows:

 
| **Year ended December 31,**            | ** ** | **Amount** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| 2009 (nine  months ended December 31, 2009) |       | $          | 2,284      |   |
| 2010                                             |       | 3,394      |       |
| 2011                                             |       | 2,887      |       |
| 2012                                             |       | 2,687      |       |
| 2013                                             |       | 2,515      |       |
| 2014 and  thereafter                             |       | 8,948      |       |
| Total                                            |       | $          | 22,715     |   |

 

In connection with theacquisition of Clarix (Note 5), the Company identified certain acquiredintangible assets which were determined to have an indefinite life.  The assets, which relate to the tradename ofClarix, totaled $4,110.

 

**10.**   **Accrued Expenses**

 

Accrued expenses consistof the following:

 
| ** **                            | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|---------------------------------------|------------|------------------------------|------------|---------------------------|------------|
| ** **                            | ** ** | **2008**                     | ** ** | **2009**                  | ** ** |
| Accrued payroll  and related benefits |       | $                            | 14,108     |                      | $          | 9,442 |   |
| Accrued  royalties                    |       | 1,839                        |       | 1,219                     |       |
| Loss on foreign  exchange contracts   |       | 1,059                        |       | 248                       |       |
| Lease exit costs                      |       | 527                          |       | 22                        |       |
| Accrued other  expenses               |       | 5,153                        |       | 4,868                     |       |
|                                  |       |                         |       |                      |       |
| Total                                 |       | $                            | 22,686     |                      | $          | 15,799 |   |

 

**11.**   **Restricted Cash**

 

Asof December 31, 2008 and March 31, 2009, the Company had a $500collateral obligation for the Company’s leased corporate headquarters facilitywhich was secured by a certificate of deposit. The certificate of deposit has been classified as “Restricted cash,current portion” in the accompanying unaudited condensed consolidated balancesheets.

 

Inconnection with the signing of a lease on February 13, 2008 to secureoffice space for the Company’s corporate headquarters at 77 Fourth Avenue,Waltham, Massachusetts, the Company deposited with the landlord anunconditional, irrevocable letter of credit in the landlord’s favor in theamount of $962, secured by a certificate of deposit.  The certificate of deposit has beenclassified as “Restricted cash, net of current portion” in the accompanyingunaudited condensed consolidated balance sheets as of December 31, 2008and March 31, 2009.  See Note 12 forfurther discussion regarding this lease.

 

**12.**   **Commitments and Contingencies**

 

From time to time and in the ordinary course of business,the Company is subject to various claims, charges and litigation. Intellectualproperty disputes often have a risk of injunctive relief which, if imposedagainst the Company, could materially and adversely affect its financialcondition or results of operations. From time to time, third parties haveasserted and may in the future assert intellectual property rights totechnologies that are important to the Company’s business and have demanded andmay in the future demand that the Company license their technology. Althoughthe outcome of litigation cannot be predicted with certainty and some lawsuits,claims or proceedings may be disposed of unfavorably to the Company, whichcould materially and adversely affect its financial condition or results ofoperations, the Company does not believe that it is currently a party to anymaterial legal proceedings.

 

On February 13, 2008,the Company entered into a lease (“Lease”) with BP Fourth Avenue, L.L.C. (the “Landlord”)to secure office space for the Company’s current corporate headquarters at 77Fourth Avenue, Waltham, Massachusetts. The commencement date for occupancyunder the Lease was December 2008. The lease for the Company’s previouscorporate headquarters at 880 Winter Street in Waltham, Massachusetts expiredin February 2009.  The new Leaseprovides for the rental of 165,129 rentable square feet of space and has aninitial term of 10 years and three months. The Company can, subject to certainconditions, extend this term by exercising up to two consecutive five yearoptions. The Company is not required to pay any rent for the first three monthsof the initial Lease term.  After the initialthree months, the annual rent under the Lease for years one through five is$6,600, or approximately $548 per month. For years six through ten, the annual rent will be $7,200, orapproximately $603 per month.  The totalbase rent payable in the initial term is $69,100.  In connection with the signing of the Lease,the Company has deposited with the Landlord an unconditional, irrevocableletter of credit in Landlord’s favor in the amount of $962.

 

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**13.   LeaseholdIncentive Obligation**

** **

In conjunction with the February 2008lease agreement for the Company’s current headquarters, the landlord agreed toreimburse the Company for leasehold improvements totaling $8,104, which wasreceived in 2008.  In accordance withSFAS No. 13, *Accounting for Leases*, and FASBTechnical Bulletin 88-1, *Issues Relating toAccounting for Leases*, the leasehold improvements are recognized inproperty and equipment on the consolidated balance sheet, with thecorresponding reimbursement recognized as “leasehold incentive obligations” onthe consolidated balance sheet.  Theamount of the incentive will be amortized on a straight-line basis over thelease term as a reduction of rental expense at the beginning of occupancy.  The leasehold improvements in property, plantand equipment will be amortized over the shorter of the lease term or theestimated useful life of the asset.  Forthe three months ended March 31, 2009, the Company amortized $198 of theleasehold incentive obligations as a reduction to rent expense.

 

**14.   Stockholders’Equity and Stock-Based Compensation**

 

For optionsaccounted for under SFAS No. 123(R), *Share-BasedPayments*, the fair value of each option grant is estimated on thedate of grant using the Black-Scholes pricing model. No options were granted duringthe three months ended March 31, 2008 and 2009. In addition, while SFAS No. 123,*Accounting for Stock-Based Compensation,*permitted companies to record forfeitures based on actual forfeitures, whichwas the Company’s historical policy under SFAS No. 123, SFAS No. 123(R) requirescompanies to utilize an estimated forfeiture rate when calculating stock-basedcompensation expense for the period. During the three months ended March 31, 2008 and 2009, the Companyrecorded $1,746 and $2,569 of aggregate stock-based compensation expense,respectively. As of March 31, 2009, there was $24,335 of unrecognizedstock-based compensation expense related to stock-based awards that is expectedto be recognized over a weighted average period of 2.67****years.

 

The Company appliedforfeiture rates derived from an analysis of its historical data in determiningthe expense recorded in the Company’s consolidated statements of income asfollows:

 
| ** **                        | ** ** | **Three Months Ended********March 31,** | ** ** |
|-----------------------------------|------------|----------------------------------------------|------------|
| ** **                        | ** ** | **2008**                                     | ** ** | **2009** | ** ** |
| Restricted stock units and awards |       | 5.0                                          | %          | 5.8 | % |
| Service-based stock options       |       | 8.0                                          | %          | 9.0 | % |
| Milestone options                 |       | 12.0                                         | %          | 12.0 | % |

 

*Common Stock*

 

In the three months ended March 31,2009, the company issued 89,518 shares of common stock in connection with theexercise of stock options resulting in proceeds of $342.  The company also released 103,258 shares ofcommon stock in connection with the vesting of restricted stock units andretired 35,423 of these shares to cover withholding taxes in the amount of $458.

 

*Stock Option Activity*

 

A summary of stock option activity under the PhaseForward Incorporated 1997 Stock Option Plan, the Phase Forward Incorporated2004 Stock Option and Incentive Plan and the 2003 Non-Employee Director StockOption Plan as of March 31, 2009, and changes during the three monthsended March 31, 2009, is as follows:

 
| ** **                                             | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price per  Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value (2)** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|---------------------------------------------------|------------|-------------------------------------------------------------|------------|-------------------------------------|------------|
| Outstanding at  December 31, 2008                 |       | 2,187,123             |       | $                                                 | 4.84       |                                                        | 4.77       |                                | $          | 16,805 |   |
| Granted                                                |       | —                |       |                                              |       |                                                        |       |                                |       |
| Exercised                                              |       | (89,518               | )          | 3.83                                              |       |                                                        |       | 802                                 |       |
| Canceled                                               |       | 469                   |       | 6.53                                              |       |                                                        |       |                                |       |
|                                                   |       |                  |       |                                              |       |                                                        |       |                                |       |
| Outstanding at  March 31, 2009                    |       | 2,098,074             |       | $                                                 | 4.88       |                                                        | 4.53       |                                | $          | 16,597 |   |
|                                                   |       |                  |       |                                              |       |                                                        |       |                                |       |
| Exercisable at  March 31, 2009                    |       | 1,976,745             |       | $                                                 | 4.75       |                                                        | 4.43       |                                | $          | 15,895 |   |
|                                                   |       |                  |       |                                              |       |                                                        |       |                                |       |
| Vested or  expected to vest at March 31, 2009 (1) |       | 2,090,059             |       | $                                                 | 4.87       |                                                        | 4.52       |                                | $          | 16,545 |   |

 

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(1)          Thevested or expected to vest options at March 31, 2009 include both thevested options and the number of options expected to vest calculated afterapplying an estimated forfeiture rate to the unvested options.

 

(2)          Theaggregate intrinsic value is calculated based on the positive differencebetween the fair value per share of the Company’s common stock on March 31,2009 of $12.79 and the exercise price of the underlying options.

 

*Restricted Stock Awards and Unit Activity*

 

A summary of activity related to restricted common stock awards andunit awards during the three months ended March 31, 2009 is as follows:

 
| ** **                              | ** ** | **Number  of Shares** | ** ** | **Market Price  Per Share** | ** **       | **Weighted  Average  Grant Date  Fair Value  Per Share** | ** ** | **Weighted  Average  Remaining  contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value (2)** | ** ** |
|-----------------------------------------|------------|-----------------------|------------|-----------------------------|------------------|----------------------------------------------------------|------------|--------------------------------------------------------------|------------|-------------------------------------|------------|
| Unvested at  December 31, 2008     |       | 2,139,964             |       | $                           | 10.85—23.20 |                                                     | $          | 15.66                                                        |       |                                |       |   |   |
| Granted                                 |       | 297,600               |       | 13.98—14.37            |             |                                                     |       |                                                         |       |                                |       |
| Vested                                  |       | (103,258              | )          | 13.23—17.45            |             |                                                     |       |                                                         |       |                                |       |
| Forfeited                               |       | (2,996                | )          | 10.85—23.03            |             |                                                     |       |                                                         |       |                                |       |
| Unvested at  March 31, 2009        |       | 2,331,310             |       | $                           | 10.85—23.20 |                                                     | $          | 15.57                                                        |       | 2.68                                |       | $ | 29,817 |   |
|                                    |       |                  |       |                        |             |                                                     |       |                                                         |       |                                |       |
| Expected to be  free of restrictions(1) |       | 1,833,255             |       | $                           | 10.85—23.20 |                                                     | $          | 15.63                                                        |       | 2.68                                |       | $ | 23,447 |   |

 

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(1)          Theexpected to be free of restrictions at March 31, 2009 was calculated byapplying an estimated forfeiture rate to the unvested shares.

 

(2)          Theaggregate intrinsic value is calculated based on the fair value per share ofthe Company’s common stock on March 31, 2009 of $12.79.

 

**15.   ComprehensiveIncome**

 

TheCompany’s other comprehensive income relates to foreign currency translationadjustments and unrealized losses on its ARS that are classified asavailable-for-sale.  Comprehensive incomeis presented separately on the balance sheet as required.

 

Comprehensiveincome consisted of the following:

 
| ** **                                                  | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                  | ** ** | **2008**                               | ** ** | **2009** | ** ** |
| Net income                                                  |       | $                                      | 4,002      |   | $ | 4,078 |   |
| Cumulative  translation adjustment                          |       | 532                                    |       | 373 |   |
| Impairment of  auction rate securities, net of tax (Note 8) |       | (709                                   | )          | — |   |
| Comprehensive  income                                       |       | $                                      | 3,825      |   | $ | 4,451 |   |

 

**16.**   **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 andintercompany receivables and cash balances. The contracts, which relate to theBritish pound, euro, and the Japanese yen, generally have terms of one month.These hedges are deemed fair value hedges and have not been designated forhedge accounting. The gains or losses on the forward foreign exchange contractsalong with the associated losses and gains on the revaluation and settlement ofthe short-term intercompany balances, accounts receivable and cash balances arerecorded in current operations in other income.

 

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The following table summarizes the outstanding forward foreign exchangecontracts held by the Company as of December 31, 2008 and March 31,2009:

 
| ** **    | ** ** | ** **     | ** ** | **As of December 31, 2008** | ** ** | **As of March 31, 2009**            | ** ** |
|---------------|------------|----------------|------------|----------------------------------|------------|------------------------------------------|------------|
| **Currency**  | ** ** | **Hedge Type** | ** ** | **Local  Currency  Amount**      | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** | **Local  Currency  Amount** | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** |
| British pound |       | Sale           |       | —                           |       | $                                        | —     |   | 750 |   | $ | 1,073 |   |
| British pound |       | Buy            |       | 1,200                            |       | 1,765                                    |       | — |   | — |   |
| Euro          |       | Sale           |       | 7,500                            |       | 10,454                                   |       | 6,100 |   | 8,073 |   |
| Japanese yen  |       | Sale           |       | 45,000                           |       | 477                                      |       | — |   | — |   |
|          |       |           |       |                             |       | $                                        | 12,696     |   |   |   | $ | 9,146 |   |

 

The forward foreign exchange contracts are short-term andgenerally mature within one month of origination.

 

Realizedand unrealized foreign currency losses, net of hedging, are accounted for inother income. There were no foreign currency gains or losses for the threemonths ended March 31, 2008. Foreign currency gains, net of hedging, were $147 for the three monthsended March 31, 2009.  The Companysettles forward foreign exchange contracts in cash.

 

**17.**   IncomeTaxes

** **

**The Company’s effective tax rates forthe three months ended March 31, 2008 and 2009 were 38% and 34%,respectively. **In the three months ended March 31, 2008, the Company’s effectivetax rate was higher than its statutory rate of 37% due to non-deductiblestock-based compensation expense.  In thethree months ended March 31, 2009, the Company’s effective tax rate waslower than its statutory rate of 37% primarily due to the release of a portionof its unrecognized tax benefits.

 

On January 1, 2007,the Company adopted the provisions of Financial Standards Accounting Board(FASB) Interpretation No. 48 *Accounting for Uncertaintyin Income Taxes*, an interpretation of SFAS No. 109, *Accounting for Income Taxes*.  As of March 31,2009, the Company had a liability of $1,361 for net unrecognized tax benefits,all of which would favorably impact the Company’s effective tax rate ifrecognized.  The Company recognizesinterest and penalties related to uncertain tax positions as a component ofincome tax expense.  As of March 31,2009, the Company had approximately $50 and $40, respectively, of accruedinterest and penalties related to unrecognized tax benefits.  The Companyanticipates a reduction of approximately $291 to the amount of unrecognized taxbenefits over the next twelve months associated with lapsing statutes oflimitations.  The unrecognized taxliability of $1,361 and accrued interest and penalties of $90 are classified asother long-term liabilities on the unaudited condensed consolidated balancesheet.

 

**18.**   **Fair Value Measurements**

 

In September 2006,the FASB issued SFAS No. 157, *Fair Value Measurements*,which defines fair value, establishes a framework for measuring fair value inaccordance with generally accepted accounting principles and expands disclosuresabout fair value measurements. SFAS No. 157 does not require any new fairvalue measurements, but its provisions apply to all other accountingpronouncements that require or permit fair value measurement. SFAS No. 157was effective for the Company’s fiscal year beginning January 1, 2008 andfor interim periods within that year. In February 2008, the FASB issuedFASB Staff Position (FSP) No. 157-2,*  Effective Date of FASB Statement No. 15**7*, which delayed for one year the effective date of SFAS No. 157for nonfinancial assets and nonfinancial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). As required, the Company adopted SFAS No. 157for its financial assets on January 1, 2008. Adoption did not have amaterial impact on the Company’s financial position or results of operations.The Company has not yet determined the impact on its financial statements ofthe January 1, 2009 adoption of SFAS No. 157 as it pertains tonon-financial assets and liabilities.

 

**SFAS No. 157 clarifiesthat fair value is an exit price, representing the price that would be receivedto sell an asset or paid to transfer a liability in an orderly transactionbetween market participants based on the highest and best use of the asset orliability. As such, fair value is a market-based measurement that should bedetermined based on assumptions that market participants would use in pricingan asset or liability. SFAS No. 157 requires the Company to use valuationtechniques to measure fair value that maximize the use of observable inputs andminimize the use of unobservable inputs. These inputs are prioritized asfollows:**

 

·                     *Level1*: Observable inputs such as quoted prices for identical assets or liabilitiesin active markets;

·                     *Level2*: Inputs, other than the quoted prices in active markets, that areobservable either directly or indirectly such as quoted prices for similarassets or liabilities or market-corroborated inputs; and

·                     *Level3*: Unobservable inputs for which there is little or no market data,which require the reporting entity to develop its own assumptions about howmarket participants would price the assets or liabilities.

 

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The valuation techniquesthat may be used to measure fair value are as follows:

 

A.     *Marketapproach* - Uses prices and other relevant information generated bymarket transactions involving identical or comparable assets or liabilities

B.       *Incomeapproach* - Uses valuation techniques to convert future amounts to asingle present amount based on current market expectations about those futureamounts, including present value techniques, option-pricing models and excessearnings method

C.       *Costapproach* - Based on the amount that currently would be required toreplace the service capacity of an asset (replacement cost)

 

The following table setsforth the Company’s financial instruments carried at fair value within the SFASNo. 157 hierarchy and using the lowest level of input as of March 31,2009:

 
| ** **                                 | ** ** | **Quoted Prices**       | ** ** | **Significant Other** | ** ** | **Significant**  | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------|------------|------------------|------------|------------|------------|
| ** **                                 | ** ** | **in Active Markets**   | ** ** | **Observable**        | ** ** | **Unobservable** | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **for Identical Items** | ** ** | **Inputs**            | ** ** | **Inputs**       | ** ** | ** ** | ** ** |
| ** **                                 | ** ** | **(Level 1)**           | ** ** | **(Level 2)**         | ** ** | **(Level 3)**    | ** ** | **Total**  | ** ** |
|                                       |       |                    |       |                  |       |             |       |       |       |
| Assets:                                    |       |                    |       |                  |       |             |       |       |       |
| Money market funds                         |       | $                       | 111,416    |                  | $          | —           |       | $          | —     |   | $ | 111,416 |   |
| Restricted cash                            |       | 1,462                   |       | —                |       | —           |       | 1,462      |       |
| Total cash equivalents and restricted cash |       | $                       | 112,878    |                  | $          | —           |       | $          | —     |   | $ | 112,878 |   |
|                                       |       |                    |       |                  |       |             |       |       |       |
| Corporate bonds                            |       | $                       | —     |                  | $          | 22,091           |       | $          | —     |   | $ | 22,091 |   |
| Total short-term investments               |       | $                       | —     |                  | $          | 22,091           |       | $          | —     |   | $ | 22,091 |   |
|                                       |       |                    |       |                  |       |             |       |       |       |
| Corporate bonds                            |       | $                       | —     |                  | $          | 3,341            |       | $          | —     |   | $ | 3,341 |   |
| Auction rate securities (1)                |       | —                  |       | —                |       | 18,459           |       | 18,459     |       |
| Securities settlement agreement            |       | —                  |       | —                |       | 5,137            |       | 5,137      |       |
| Long-term investments                      |       | $                       | —     |                  | $          | 3,341            |       | $          | 23,596     |   | $ | 26,937 |   |
|                                       |       |                    |       |                  |       |             |       |       |       |
| Total Assets                               |       | $                       | 112,878    |                  | $          | 25,432           |       | $          | 23,596     |   | $ | 161,906 |   |

 

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(1)          The Company’s investmentsin ARS and the securities settlement agreement with UBS are classified withinLevel 3 because there are currently no active markets for ARS and theCompany is unable to obtain independent valuations from market sources.  Therefore, the ARS were primarilyvalued based on an income approach using an estimate of future cashflows.  For additional information regarding ARS, see Note 8.

 

The following table setsforth a summary of changes in the fair value of the Company’s Level 3financial assets for the three months ended March 31, 2009:

 
| ** **                                                 | ** ** | **Level 3 Financial** | ** ** |
|------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                 | ** ** | **Assets**            | ** ** |
| Balance, beginning of period                               |       | $                     | 23,344     |   |
| Transfers in (out) of Level 3                              |       | —                |       |
| Sales                                                      |       | —                |       |
| Realized gains (losses)                                    |       | —                |       |
| Unrealized gains (losses) on securities held at period end |       | 252                   |       |
| Balance, end of period                                     |       | $                     | 23,596     |   |

 

Realized gains and lossesfrom sales of the Company’s investments are included in “Other income” andunrealized gains and losses are included as a separate component of equity, netof tax, unless the loss is determined to be other-than-temporary.

 

The Company also adoptedthe provisions of SFAS No. 159 in the first quarter of 2008. SFAS No. 159allows companies to choose to measure eligible assets and liabilities at fairvalue with changes in value recognized in earnings. Fair value treatment may beelected either upon initial recognition of an eligible asset or liability or,for an existing asset or liability, if an event triggers a new basis ofaccounting. The Company did not elect to re-measure any of its existingfinancial assets or liabilities under the provisions of this Statement, and didnot elect the fair value option for any financial assets and liabilitiestransacted in the year-ended December 31,

 

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2008, except for the put option related to the Company’s ARS that wasrecorded in conjunction with a settlement agreement with UBS as more fullydescribed in Note 2.

 

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

 

In December 2007, the FASBissued SFAS No. 141 (Revised 2007), *BusinessCombinations* (“SFAS No. 141(R)”).SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141that the acquisition method of accounting (which SFAS No. 141 called thepurchase method) be used for all business combinations and for an acquirer tobe identified for each business combination. SFAS No. 141(R) requiresan acquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in the acquiree at the acquisition date, measured attheir fair values as of that date, with limited exceptions specified in SFAS No. 141(R).  This method replaces SFAS No. 141’scost-allocation method, which required the cost of an acquisition to beallocated to the individual assets acquired and liabilities assumed based ontheir estimated fair values.  SFAS No. 141(R) retainsthe guidance in SFAS No. 141 for identifying and recognizing intangibleassets separately from goodwill. SFAS No. 141(R) will now require the following:acquisition costs to be expensed as incurred, restructuring costs associatedwith a business combination must be expensed prior to the acquisition date andchanges in deferred tax asset valuation allowances and income tax uncertaintiesafter the acquisition date generally will affect income tax expense.  SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008, which is the Company’s 2009 fiscal year. Earlier adoption is prohibited. The adoption of SFAS No. 141(R) may have a significant impact on the Company’s accounting for futureacquisitions, including its acquisition of Waban in the second quarter.

 

In April 2009, theFASB issued FASB Staff Position No. 141(R)-1 (“FSP FAS 141(R)-1”*), Accounting for AssetsAcquired and Liabilities Assumed in a Business Combination That Arise fromContingencies,* which provides additional clarification on theinitial recognition and measurement of assets acquired and liabilities assumedin a business combination that arise from contingencies.  FSP FAS141(R)-1 is effective for all fiscal years beginning on or after December 15,2008.  FSP FAS 141(R)-1 may have an impact on the accounting for anybusiness acquired in the future.

 

InDecember 2007, the FASB issued SFAS No. 160, *NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51*.SFAS No. 160 was issued to improve the relevance comparability, andtransparency of financial information provided in financial statements byestablishing accounting and reporting standards for the noncontrolling interestin a subsidiary and for the deconsolidation of a subsidiary. SFAS No. 160is effective for fiscal years beginning after December 15, 2008 and willbe applied prospectively, except for the presentation and disclosurerequirements which will be applied retrospectively. The adoption of SFAS No. 160is not expected to have a material effect on the Company’s consolidatedfinancial position or results of operations.

 

In March 2008, theFASB issued SFAS No. 161,*Disclosuresabout Derivative Instruments and Hedging Activities an amendment of FASBStatement No. 133.*  SFAS No. 161requires disclosure of how and why an entity uses derivative instruments, howderivative instruments and related hedged items are accounted for and howderivative instruments and related hedged items affect an entity’s financialposition, financial performance, and cash flows. SFAS No. 161 is effectivefor fiscal years beginning after November 15, 2008, with early adoptionpermitted. The adoption of SFAS No. 161 is not expected to have a materialeffect on the Company’s consolidated financial position and results ofoperations.

 

In May 2008, theFASB issued SFAS No. 162,*The Hierarchyof Generally Accepted Accounting Principles*.  SFAS No. 162 identifies the sources ofgenerally accepted accounting principles in the United States. SFAS No. 162is effective sixty days following the SEC’s approval of the Public CompanyAccounting Oversight Board amendments to AU Section 411,*The Meaning of Present Fairly in Conformity WithGenerally Accepted Accounting Principles*.  The adoption of SFASNo. 162 is not expected to have a material effect on the Company’sconsolidated financial position and results of operations.

 

In April 2009, theFASB issued FASB Staff Position No. 107-1 (“FSP FAS 107-1”) and APB 28-1 (“APB28-1”), *Interim Disclosures about FairValue of Financial Instruments,*****whichamends FASB Statement No. 107, *Disclosures about FairValue of Financial Instruments* and APB Opinion NO. 28, *Interim Financial Reporting, to require disclosures about the fairvalue of financial instruments for interim reporting periods*. FSPFAS 107-1 and APB 28-1 will be effective for interim reporting periods endingafter June 15, 2009. The Company is currently evaluating whether theadoption of this staff position will have a material impact on the Company’sfinancial position or results of operation.

 

In April 2009, theFASB issued FASB Staff Position No. 115-2 (“FSP FAS 115-2”) and FASB StaffPosition No. 124-2 (“FSP FAS 124-2”), *Recognitionand Presentation of Other-Than-Temporary Impairments*, which amends the other-than-temporaryimpairment guidance for debt and equity securities. FSP FAS 115-2 and FSP FAS124-2 shall be effective for interim and annual reporting periods ending after June 15,2009. The Company is currently evaluating whether the adoption of this staffposition will have a material impact on the Company’s financial position orresults of operation.

 

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In April 2009, theFASB issued FSP Issue No. FAS No. 157-4 (“FSP FAS 157-4”), *Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying Transactionsthat are not Orderly*. FSP FAS No. 157-4 provides additionalguidance for estimating fair value in accordance with SFAS No. 157, *Fair Value Measurements*. This FSP No. 157-4 iseffective in reporting periods ending after June 15, 2009. The Company iscurrently evaluating whether the adoption of this staff position will have amaterial impact on the Company’s financial position or results of operation.

 

**Item 2. *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations.***

 

*The following discussion and analysis of ourfinancial condition and results of operations should be read in conjunctionwith our unaudited condensed consolidated financial statements and relatednotes thereto that appear elsewhere in this Quarterly Report on Form 10-Qand the audited financial statements and related notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded in our Annual Report on Form 10-K for the year ended December 31,2008, which has been filed with the Securities and Exchange Commission (“SEC”).*

 

**Overview**

 

Phase ForwardIncorporated is a provider of integrated enterprise-level software products,services and hosted solutions for use in our customers’ global clinical trialand drug safety monitoring activities. Our customers include pharmaceutical,biotechnology and medical device companies, as well as academic institutions,governmental regulatory agencies, contract research organizations, or CROs, andother entities engaged in clinical trial and drug safety monitoring activities.By automating essential elements of the clinical trial and drug safetymonitoring processes, we believe our products allow our customers to acceleratethe market introduction of new medical therapies and corresponding revenues,reduce overall research and development expenditures, enhance existing dataquality control efforts, increase drug safety compliance and reduce clinicaland economic risk.

 

**Acquisitions**

 

From time to time wehave expanded our product and service offerings through the acquisition ofother businesses or technologies. These transactions include the acquisitionsof Clinsoft Corporation, or Clinsoft, in 2001, Lincoln Technologies, Inc.,or Lincoln, in 2005, Green Mountain Logic, Inc., or Green Mountain, in2007, and the more recent acquisitions of Waban Software, Inc., or Waban,in 2009, and Clarix LLC, or Clarix, in 2008, which are described below.

 

*Waban*

 

On April 22, 2009,we acquired all of the outstanding common stock of Waban Software, Inc. (“Waban”),a provider of platform solutions for the automation and compliance of clinicaldata analysis.  Waban’s StatisticalComputing Environment and Clinical Data Repository (SCE/CDR) solutions provideautomation, traceability and control of the key activities involved in theintegration, analysis and reporting on clinical trial data.  The aggregate purchase price was $14.0million in cash, as adjusted by working capital adjustments, and minus any transactionfees or indebtedness of Waban.  Weacquired the technology of Waban to allow it to penetrate the market forstatistical computing and clinical data repository solutions.  The acquisition of Waban will be accountedfor as a purchase under SFAS No. 141 (R), *BusinessCombinations*.  Accordingly,the results of Waban will be included in our consolidated financial statementssince the date of acquisition.

 

*Clarix*

 

On September 5,2008, we acquired all of the outstanding membership interests of Clarix LLC (“Clarix”),a provider of Web-integrated interactive response technology, or IRT, forclinical trial management.  Clarix’s Web-integrated IRT is used forsubject randomization, predictive medication inventory management, andoperational management in reporting clinical trials.  The aggregate purchase price was $41.3 million incash.  The acquisition of Clarix was accounted for as a purchase underStatement of Financial Accounting Standards, or SFAS, No. 141,*Business Combinations*.  Accordingly,the results of Clarix have been included in our consolidated financialstatements since the date of acquisition.

 

**Sourcesof Revenues**

 

We derive ourrevenues from software licenses and services. Our product line is comprised of four general categories that include thefollowing software products:

 

·*Electronic Data Capture (EDC)*

 

·*      **InForm*,our Internet-based electronic data capture solution for collection andtransmission of patient information in clinical trials; and

 

·***   **LabPas*, our system for Phase I clinic automation.

 

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·*Clinical Data Management*

 

·*      **Clintrial*, our clinical data management solution; and

 

·       *WebSDM*,our system for validating and reviewing clinical trial data represented informats meeting industry standards, such as those established by the ClinicalData Interchange Standards Consortium, or CDISC.

 

·*Drug Safety*

 

·*      **Empirica Trace*, our adverse event management solution formonitoring drug safety and reporting adverse events that occur during and afterconclusion of the clinical trial process;

 

·*      **Empirica Signal*, our data mining and signal detection solution forpost-marketing data; and

 

·*        **CTSD*, our signal detection solution for data fromclinical trials.

 

·*Interactive ResponseTechnology (IRT)*

 

·            *Clarix*, our Web-integrated interactive responsetechnology.

 

License revenues arederived principally from the sale of term licenses for our software productsother than *Clarix,*which ispresently available only on a hosted application basis.  Service revenues are derived principally fromour delivery of the hosted solution of our *InForm,**Clarix,**Empirica Signal*, *CTSD*and *WebSDM* software products, and consultingservices and customer support, including training, for all of our products. Wegenerally recognize revenues ratably over the life of a license or servicecontract.

 

One customer,GlaxoSmithKline, accounted for approximately 12% of our total revenues in thethree months ended March 31, 2008, and $863,000 of accounts receivableoutstanding as of December 31, 2008. In the three months ended March 31, 2009, no customer accounted for10% or more of our total revenues for the period.  Our top 20 customers accounted forapproximately 64% of our total revenues, net of reimbursable out-of-pocketexpenses, in the three months ended March 31, 2008 and 2009.

 

* License Revenues*

 

We derive our licenserevenues principally from the sale of term licenses for the following softwareproducts:*InForm*, ourInternet-based electronic data capture, or EDC, solution;*  Clintrial*  and*  WebSDM*, our clinical datamanagement solutions; our drug safety solutions, including our*  EmpiricaTrace*,*  Empirica Signal*  and*  CTSD*  products; and our*  LabPas*  Phase I clinic automation solution. Although each of our software solutions is available as a stand-aloneenterprise application, we offer integrated enterprise solutions incorporatingcertain of our electronic data capture, data management and drug safetyproducts.

 

License revenues for our*InForm *electronic data capturesoftware solution, either on a stand-alone or integrated basis, are determinedprimarily by the number, complexity and duration of the clinical trials and thenumber of participants in each clinical trial. License revenues for our *Clintrial, WebSDM, Empirica Trace, Empirica Signal*,*CTSD* and*LabPas* software solutions are determined primarily by the number ofusers accessing the software solution. Except as discussed below, we enter intosoftware license agreements for our*  InForm*,*  Clintrial*  and*  Empirica Trace*  products with terms generally of three tofive years with payment terms generally annually in advance. License agreementsfor our other licensed products are generally annual or multi-year with paymentterms generally annually in advance.  License revenues are recognizedratably over the duration of the software term license agreement, to the extentthat amounts are fixed or determinable and collectable.

 

Following our acquisitionof Clinsoft Corporation (“Clinsoft”) in August 2001, we began convertingholders of Clinsoft perpetual software licenses to our software term licensearrangements. We continue to sell additional perpetual licenses of theseproducts in certain situations to our existing customers with the option topurchase customer support, and may in the future do so for new customers basedon customer requirements or market conditions. We recognize revenues on theperpetual licenses upon delivery of the software when all other revenuerecognition criteria are met. We continue to provide and charge for maintenanceand support on our products to those customers who do not convert to oursoftware term license arrangements.  We will continue our efforts toconvert the remaining former Clinsoft customer base to software term licensearrangements. However, we anticipate that some customers will not convert andinstead will continue to make annual customer support payments.

 

*ServiceRevenues*

 

*ApplicationHosting Services.*  Inaddition to making our software products other than *Clarix*available to customers through licenses, we offer our*InForm*,*Empirica Signal, CTSD* and*WebSDM*software as hosted application solutions delivered through a standardWeb-browser, with customer support and training services.  Our *Clarix*solution ispresently available only on a hosted application basis.  Service revenues from application hosting services arederived principally from our*InForm *hostedsolution.

 

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Revenues resulting fromthe*InForm *hosting serviceconsist of three stages for each clinical trial:

 

·                     *First stage—*trial and application set up, includingdesign of electronic case report forms and edit checks, installation and serverconfiguration of the system;

 

·                     *Second stage—*application hosting and related supportservices; and

 

·                     *Third stage—*services required to close out, or lock,the database for the clinical trial.

 

Revenuesresulting from the*Clarix* hostingservice also consist of three stages for each clinical trial:

 

·                     *First stage*—trial and application set up, includingdesign and set up of the subject randomization and medication inventory management,installation and server configuration of the system;

 

·                     *Second stage*—application hosting and related supportservices; and

 

·                     *Third stage*—services required to close out theclinical trial.

 

Services provided for thefirst and third stages of both*InForm *and*Clarix* 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. Werecognize revenues from all stages of the hosting service ratably over thehosting period. Fees charged and costs incurred for the trial system design,set up and implementation are deferred until the start of the hosting periodand are amortized and recognized ratably over the estimated hosting period. Thedeferred costs include direct costs related to the trial and application setup. Fees for the first and third stages of the services are billed based uponmilestones. Fees for application hosting and related services in the secondstage are generally billed quarterly in advance. Bundled into this revenueelement are the revenues attributable to the software license used by thecustomer.

 

In the event that anapplication hosting customer cancels a clinical trial and its related statementof work, all deferred revenues are recognized and all deferred set up costs areexpensed.  In addition, certain termination-related fees may be chargedand if so, such fees are recognized in the period of termination.

 

Revenues resulting fromhosting services for our*Empirica Signal*,*CTSD* and*WebSDM* products consist of installation and server configuration,application hosting and related support services.  Services for theseofferings are charged monthly as a fixed fee.  Revenues are recognizedratably over the period of the service.

 

In addition, applicationhosting service revenues include hosting services associated with term licensecustomers and reimbursable out-of-pocket expenses.

 

* ConsultingService**s .*Consulting services include the designand documentation of the processes related to our customers’ use of ourproducts and services in their clinical trials and safety monitoringactivities. Consulting services also include project planning and managementservices, guidance on best practices in using our software products, datamanagement and configuration services for data mining and reporting, as well asimplementation services consisting of application architecture design, systemsintegration, installation and validation.  Consulting services can be soldon a stand-alone basis or as part of a bundled arrangement.  In somecircumstances, we sell additional follow on consulting services to a customerat a later date even if the customer purchased consulting services at the timeof the initial license purchase under a bundled arrangement.  Revenuesfrom consulting services included in either a multiple element software licenseagreement or in an application hosting agreement are recognized ratably overthe term of the arrangement. The value of our consulting services sold within abundled arrangement is equal to the value of consulting services sold on astand-alone basis, as the activities performed under both types of arrangementsare similar in nature.  The associated costs are expensed asincurred.  We may also enter into arrangements to provide consultingservices separate from a license arrangement. In these situations, revenue isrecognized in accordance with the American Institute of Certified PublicAccountants, or AICPA, Statement of Position, or SOP, No. 81-1,*Accounting for Performance of Construction-Type andCertain Production-Type Contracts,* on either a time and materialsbasis or using the proportional performance method. If we are not able toproduce reasonably dependable estimates, revenue is recognized upon completionof the project and final acceptance from the customer. If significantuncertainties exist about project completion or receipt of payment, the revenueis deferred until the uncertainty is resolved. Provisions for estimated losseson contracts are recorded during the period in which they are resolved.Provisions for estimated losses on contracts are recorded during the period inwhich they are identified.

 

*CustomerSupport.*    Wehave a multinational services organization to support our software products andhosted solutions worldwide. Customer support includes multilingual trainingservices, telephone support and software maintenance. We bundle 

 

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customer support in oursoftware term licenses and allocate 10% of the value of the license to customersupport revenues. The customer support services rate of 10% for multi-yearterm-based licenses reflects a significant discount from the rate for customersupport services associated with perpetual licenses due to the reduction in thetime period during which the customer can utilize the upgrades andenhancements. We believe this rate is substantive and represents an amount webelieve reasonable to be allocated.  Our customer support revenues alsoconsist of customer support fees paid by perpetual license customers. Customersupport revenues are recognized ratably over the period of the customer supportor term license agreement, with payment terms generally annually in advance.

 

**Costs ofRevenues and Operating Expenses**

 

We allocate overheadexpenses such as rent and occupancy charges and employee benefit costs to alldepartments based on headcount. As such, general overhead expenses arereflected in costs of service revenues and in the sales and marketing, researchand development, and general and administrative expense categories.

 

*Costsof Revenues.*    Costsof license revenues consists primarily of the amortization of royalties paidfor certain modules within our*Clintrial*software product as well as our*InForm *softwareproduct. In addition, costs of revenues include expense for the amortization ofacquired technologies associated with the acquisitions of Lincoln Technology, Inc.(“Lincoln”) in 2005 and Green Mountain Logic, Inc. in 2007.  The costs of license revenues vary based uponthe mix of revenues 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. Costsfor these services consist primarily of employee-related costs associated withthese services, amortization of the deferred clinical trial set up costs,allocated overhead, outside contractors, royalties associated with providingcustomer support for use with the*Clintrial*and*InForm *software productsand reimbursable out-of-pocket expenses. Costs of services also include hostingcosts that primarily consist of hosting facility fees and server depreciationand amortization of acquired technologies associated with the acquisition ofClarix.

 

The costs of servicerevenues vary based upon the number of employees in the service organization,the type of work performed, and royalties associated with revenues 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 our*InForm *applicationhosting services through the use of outside contractors. This allows us toutilize outside contractors in those periods where trial design and set upactivity is highest while reducing the use of outside contractors in thoseperiods where trial activity lessens, allowing for a more flexible deliverymodel. The percentage of the services workforce represented by outsidecontractors varies from period to period depending on the volume of specificsupport required. The costs of service revenues is significantly higher as apercentage of revenues as compared to our costs of license revenues primarilydue to the employee-related and outside contractor expenses associated with providingservices.

 

*Gross Margin.*    Our gross marginon license revenues varies based on the mix of royalty- and non-royalty-bearinglicense revenues and the amount of amortization of acquired technologies. Ourgross margin on service revenues varies primarily due to variations in theutilization levels of the professional service team and the timing of expenseand revenue recognition under our service arrangements. In situations where theservice revenues are recognized ratably over the software license term, ourcosts associated with delivery of the services are recognized as the servicesare performed, which is typically during the first 6 to 12 months of thecontract period. Accordingly, our gross margin on service revenues will varysignificantly over the life of a contract due to the timing, amount and type ofservice required in delivering certain projects. In addition, consolidatedgross margin will vary depending upon the mix of license and service revenues.

 

*Sales and Marketing.*    Sales andmarketing expenses consist primarily of employee-related expenses, includingtravel, marketing programs which include product marketing expenses such astrade shows, workshops and seminars, corporate communications, other brandbuilding and advertising, allocated overhead and the amortization ofcommissions. In addition, sales and marketing include expense for theamortization of acquired technologies associated with the acquisition ofLincoln.  We expect that sales and marketing expenses will continue to increasein absolute dollars as commission expense increases with our revenues and as wecontinue to expand sales coverage and to build brand awareness through what webelieve are the most cost effective channels available, but may fluctuatequarter over quarter due to the timing of marketing programs.

 

*Research and Development.*    Research anddevelopment expenses consist primarily of employee-related expenses, allocatedoverhead and outside contractors. We focus 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 continue to add features and functionalityto our products, introduce additional integrated software solutions to ourproduct suite and expand our product and service offering.

 

*General and Administrative.*    General andadministrative expenses consist primarily of employee-related expenses,professional fees, primarily consisting of expenses for accounting, compliancewith the Sarbanes-Oxley Act of 2002, and legal services, including 

 

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litigation,information technology and other corporate expenses and allocated overhead. Weexpect that in the future our general and administrative expenses will increasein absolute dollars as we add personnel and incur additional costs related tothe growth of our business and operations.

 

*Stock-Based Compensation Expenses**. *Our cost of service revenues, sales and marketing,research and development, and general and administrative expenses includestock-based compensation expense. Stock-based compensation expenseis the fair value of outstanding stock options and restricted stock awards andunits, which are recognized over the respective stock option and award or unitservice periods. It also includes amortization of the excess of the deemed fairmarket value over the exercise price of stock options granted prior to when webecame a public company. During the three monthsended March 31, 2008 and 2009, we recorded $1.7 million and $2.6 millionof stock-based compensation expense, respectively.

 

**ForeignCurrency Translation**

 

With regard to our international operations, wefrequently enter into transactions in currencies other than the U.S. dollar. Asa result, our revenues, expenses and cash flows are subject to fluctuations dueto changes in foreign currency exchange rates, particularly changes in theeuro, British pound, Australian dollar, Indian rupee,Japanese yen andRomanian leu. In the three months ended March 31, 2008 and2009, approximately 47% and 38%, respectively, of our revenues were generatedin locations outside the United States. Themajority of these revenues are in currencies other than the U.S. dollar, as aremany of the associated expenses. In periods when the U.S. dollar declines invalue as compared to the foreign currencies in which we conduct business, ourforeign currency-based revenues and expenses generally increase in value whentranslated into U.S. dollars.

 

**CriticalAccounting Policies and Estimates**

 

Ourunaudited condensed consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the United States.The preparation of these financial statements requires us to make estimates andassumptions that affect the reported amounts of assets, liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting periods. On an ongoing basis, we evaluate our estimates andassumptions with our audit committee, including those related to revenue recognition,deferred set up costs, commissions and royalties, accounts receivable reserves,stock-based compensation expenses, long-lived assets, intangibles assets andgoodwill, income taxes, restructuring, contingencies and litigation. We baseour estimates on historical experience and on various other assumptions thatare believed to be reasonable under the circumstances, the results of whichform the basis for making judgments about the carrying values of assets andliabilities that are not readily apparent from other sources. There have beenno material changes to these estimates for the periods presented in thisQuarterly Report on Form 10-Q. Our actual results may differ from theseestimates under different assumptions or conditions.

 

Webelieve that of our significant accounting policies, which are described inNote 2 of the notes to our consolidated financial statements included inour Annual Report on Form 10-K for the year ended December 31, 2008,the following accounting policies involve a greater degree of judgment andcomplexity. Accordingly, these are the policies we believe are the mostcritical to aid in fully understanding and evaluating our consolidatedfinancial condition and results of operations.

 

*Revenue Recognition and Deferred SetUp Costs.*    Werecognize software license revenues in accordance with SOP No. 97-2,*  SoftwareRevenue Recognition,*  asamended, issued by the AICPA, while revenues resulting from applicationservices are recognized in accordance with Emerging Issues Task Force, or EITF,Issue No. 00-3,*  Application of AICPA Statement of Position97-2 to Arrangements that Include the Right to Use Software Stored on AnotherEntity’s Hardware*, the Securities and Exchange Commission, or SEC,Staff Accounting Bulletin, or SAB, No. 104,*  Revenue Recognition*, and EITF Issue No. 00-21,*  Revenue Arrangements with MultipleDeliverables.*

 

Customers generally havethe ability to terminate application hosting, consulting and training serviceagreements upon 30 days notice. License agreements, multiple elementarrangements, including license and services agreements and certain applicationhosting services can generally be terminated by either party for materialbreach of obligations not corrected within 30 days after notice of thebreach.

 

We recognize revenueswhen all of the following conditions are satisfied: (1) there ispersuasive evidence of an arrangement; (2) the product or service has beenprovided to the customer; (3) the collection of our fees is probable; and (4) theamount of fees to be paid by the customer is fixed or determinable.

 

We generally enter intosoftware term licenses for our*InForm*,*Clintrial* and*Empirica Trace* products with our customers for 3- to 5-yearperiods. License agreements for our*EmpiricaSignal, CTSD* and*WebSDM*products are generally annual or multi-year terms.  We do not license our *Clarix* product, which is presently offeredonly on a hosted application basis. These arrangements typically include multiple elements: softwarelicense, consulting services and customer support. We bill our customers inaccordance 

 

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with the terms of theunderlying contract. Generally, we bill license fees annually in advance foreach year of the license term. Our payment terms are generally net30 days.

 

Our software licenserevenues are 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, loadingof software, building simple interfaces and running test data and documentationof procedures.

 

Customer support includestraining services, telephone support and software maintenance. Wegenerally bundle customer support with the software license for the entire termof the arrangement. As a result, we generally recognize revenues for allelements, including consulting services, ratably over the term of the softwarelicense and support arrangement. We allocate the revenues recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For our term-based licenses, we allocateto consulting services the anticipated service effort and value throughout theterm of the arrangement at an amount that would have been allocated had thoseservices been sold separately to the customer. The value of our consultingservices sold within a bundled arrangement is equal to the value of consultingservices sold on a stand-alone basis, as the activities performed under bothtypes of arrangements are similar in nature.  The remaining value isallocated to license and support services, with 10% of this amount allocated tosupport services. The customer support services rate of 10% for multi-year term-basedlicenses reflects a significant discount from the rate for customer supportservices associated with perpetual licenses due to the reduction in the timeperiod during which the customer can utilize the upgrades and enhancements. Webelieve this rate is substantive and represents a reasonable basis ofallocation. We have allocated the estimated fair value to our multiple elementarrangements to provide meaningful disclosures about each of our revenuestreams. The costs associated with the consulting and customer support servicesare expensed as incurred. There are instances in which we sell softwarelicenses based on usage levels. These software licenses can be based onestimated usage, in which case the license fee charged to the customer is fixedbased on this estimate. When the fee is fixed, the revenues are generallyrecognized ratably over the contractual term of the arrangement. If the fee isbased on actual usage, and therefore variable, the revenues are recognized inthe period of use. Revenues from certain follow-on consulting services, whichare sold separately to customers with existing software licenses and are notconsidered part of a multiple element arrangement, are recognized as theservices are performed.

 

We continue to selladditional perpetual licenses for the*Clintrial* and*Empirica Trace*software products in certain situations to our existing customers with theoption to purchase customer support and may in the future do so for newcustomers based on customer requirements or market conditions. We haveestablished vendor specific objective evidence of fair value for the customersupport. Accordingly, license revenues are recognized upon delivery of thesoftware and when all other revenue recognition criteria are met. Customer support revenues are recognized ratably over the term of theunderlying support arrangement. We continue to generate customer support andmaintenance revenues from our perpetual license customer base. Trainingrevenues are recognized as earned.

 

In addition to making oursoftware products other than *Clarix*availableto customers through licenses, we offer our*InForm, Empirica Signal*,*CTSD*and*WebSDM* software solutionsthrough a hosted application solution delivered through a standardWeb-browser.  Our *Clarix*solution is presently availableonly on a hosted application basis.

 

Revenues resulting from*InForm *and*Clarix *application hosting services consist of threestages for each clinical trial: the first stage involves application set up,including design, implementation of the system and server configuration; thesecond stage involves application hosting and related support services; and thethird stage involves services required to close out the clinical trial.Services provided for the first and third stages are provided on a fixed feebasis based upon the complexity of the trial and system requirements. Servicesfor the second stage are charged separately as a fixed monthly fee. Werecognize revenues from all stages of the*InForm *and*Clarix *hosting service ratably overthe hosting period. Fees charged and costs incurred for the trial systemdesign, set up and implementation are deferred as applicable, until the startof the hosting period and then amortized and recognized, as applicable, ratablyover the estimated hosting period. The deferred costs include incrementaldirect costs with third parties and certain internal direct costs related tothe trial and 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 recognizedratably over the remaining term of the hosting period. Fees for the first andthird stages of the services are billed based upon milestones. Fees for applicationhosting and related services in the second stage are billed quarterly inadvance. Bundled into this revenue element are the revenues attributable to thesoftware license used by the customer.

 

Revenues resulting from hosting services for our *Empirica Signal*, *CTSD* and *WebSDM*products consist of installation and server configuration, application hostingand related support services.  Servicesfor this offering are charged monthly as a fixed fee.  Revenues are recognized ratably over theperiod of the service.

 

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In the event that an application hosting customer cancels a clinicaltrial and its related statement of work, all deferred revenues are recognizedand all deferred set up costs are expensed.  In addition, certain termination related fees may be charged and if so,such fees are recognized in the period of termination.

 

We deferred $1.2 millionand $1.3 million of set up costs and amortized $805,000****and$917,000 during the three months ended March 31, 2008 and 2009,respectively. The amortization of deferred set up costs is a component of costof services.

 

We may also enter intoarrangements to provide consulting services separate from a licensearrangement. In these situations, revenue is recognized in accordance with SOP No. 81-1on either a time and materials basis or using the proportional performancemethod. If we are not able to produce reasonably dependable estimates, revenueis recognized upon completion of the project and final acceptance from thecustomer. If significant uncertainties exist about project completion orreceipt of payment, the revenue is deferred until the uncertainty is resolved.Provisions for estimated losses on contracts are recorded during the period inwhich they are identified.

 

Deferred revenuesrepresent amounts billed or cash received in advance of revenue recognition.

 

*Accountingfor Prepaid Sales Commissions and Royaltie**s**. *For arrangements where we recognize revenue over therelevant contract period, we defer related commission payments to our directsales force and software license royalties paid to third parties and amortizethese amounts over the same period that the related revenues are recognized.This is done to better match commission and royalty expenses with the relatedrevenues. 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 whichwere paid are recoverable by us.  During the three months ended March 31, 2008 and2009, we deferred $2.0 million and $2.0 million, respectively, ofcommissions and amortized $1.8 million and $1.7 million, respectively, to salesand marketing expense. Royalties are paid on a percentage of billings basis forcertain of our products, and we have the right to recover royalties in theevent an arrangement is cancelled. During the three months ended March 31,2008 and 2009, we deferred $1.0 million and $1.1 million, respectively, ofroyalty expenditures and amortized $691,000 and $661,000, respectively, to costof license and service revenues.

 

        *Accounts ReceivableReserve.*    We maintain allowances for doubtfulaccounts for estimated losses resulting from the inability of our customers tomake required payments. We regularly evaluate the collectability 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 continuouslymonitor collections from our customers and maintain a provision for estimatedcredit losses based upon our historical experience and any specific customercollection issues that we have identified. While such credit losses havehistorically been within our expectations and the provisions established, wecannot guarantee that we will continue to experience the same credit loss ratesin the future. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required.  Our accounts receivable reserves were$578,000 and $562,000 as of December 31, 2008 and March 31, 2009,respectively.

 

*Accountingfor Income Taxes.*   Weare subject to income taxes in both the United States and foreignjurisdictions, and we use estimates in determining our provision for incometaxes.  We account for income taxes in accordance with SFAS No. 109,*Accounting for Income Taxes*, which is theasset and liability method for accounting and reporting for income taxes. We adopted the provisions of FASB Interpretation No., or FIN, 48,*Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109* on January 1,2007.  Under SFAS No. 109, deferred tax assets and liabilities arerecognized based on temporary differences between the financial reporting andincome tax bases of assets and liabilities using statutory rates. This processrequires that we project our current tax liability and estimate our deferredtax assets and liabilities, including net operating loss and tax creditcarryforwards. In assessing the need for a valuation allowance, we have consideredour recent operating results, future taxable income projections and all prudentand feasible tax planning strategies.

 

*Accounting for Stock-Based Awards. * On January 1,2006, we adopted the provisions of SFAS No. 123(R),*Share-based Payment*, which requires us torecognize expense related to the fair value of stock-based compensation awards.We elected to use the modified prospective transition method as permitted bySFAS No. 123(R) and therefore have not restated our financialresults for prior periods. Under this transition method, stock-basedcompensation expense includes compensation expense for all stock-basedcompensation awards granted on or after March 15, 2004 (the filing datefor the initial registration statement for our initial public offering), basedon the grant-date fair value estimated in accordance with the provisions ofSFAS No. 123(R).

 

Stock options grantedprior to March 15, 2004 are minimum value options pursuant to SFAS No. 123,*Accounting for Stock-Based Compensation*.Under the provisions of SFAS No. 123(R), the value of these optionswill not be recorded in the statement of income subsequent to the date of ouradoption of SFAS No. 123(R). Instead, we will continue to account forthese options using Accounting Principles Board (APB) Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations.

 

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For service-based options,accounted for under SFAS No. 123(R), we recognize compensationexpense on a straight-line basis over the requisite service period of theaward.  For performance-based options, we recognize expense over theestimated performance period. In addition, SFAS 123(R) requires thebenefits of tax deductions in excess of recognized stock-based compensation tobe reported as a financing activity rather than an operating activity in thestatements of cash flows. This requirement can have the effect of reducing ournet operating cash flows and increasing our net financing cash flows in certainperiods.  To date, we have not recorded these benefits as they have notbeen realized.

 

Effectivewith the adoption of SFAS No. 123(R), we use the Black-Scholes optionpricing model to determine the weighted average fair value of options granted.

 

During the three months ending March 31, 2008 and 2009, werecorded $1.7 million and $2.6 million of aggregate stock-based compensationexpense, respectively.  For the threemonths ending March 31, 2008 and 2009, stock-based compensation expensereduced basic earnings per share by $0.02 and $0.04, respectively, and dilutedearnings per share by $0.03 and $0.04, respectively.  As of March 31, 2009, we had $24.3million of unrecognized stock-based compensation expense related tomarket-based share awards that we expect to recognize over a weighted averageperiod of 2.67 years.

 

*Other Significant Estimates*

 

*Goodwilland Intangible Assets Impairment.  *We review the carrying value of goodwilland intangible assets periodically based upon the expected future discountedoperating cash flows of our business. Our cash flow estimates are based onhistorical results adjusted to reflect our best estimate of our operatingresults in future periods. Actual results may differ materially from theseestimates. The timing and size of impairment charges, if any, involves theapplication of management’s judgment regarding the estimates and couldsignificantly affect our operating results.

 

**Overviewof Results of Operations for the Three Months Ended March 31, 2008 and2009**

 

Total revenues increasedby 28%, or $10.8 million, in the three months ended March 31, 2009compared to the same period in 2008 due to increases in both service and licenserevenues of 37% and 12%, respectively.

 

Our gross marginincreased by 30%, or $6.5 million, in the three months ended March 31,2009 compared to the same period in 2008, primarily due to the increase inrevenues.

 

Operating income for thethree months ended March 31, 2009 of $5.2 million increased 17%, or$733,000, compared to the same period in 2008. The operating income for the three months ended March 31, 2008 and2009 also included $1.7 million and $2.6 million of stock-based compensationexpense, respectively.

 

The results for the threemonths ended March 31, 2009 were impacted by foreign exchange ratefluctuations, resulting in a decrease in revenue of approximately $420,000, or1% of revenues, and a decrease in expense of approximately $2.3 million, or 7%of expenses.

 

As of March 31,2009, we had $156.3 million of unrestricted cash, cash equivalents andshort-term investments, a decrease of $3.1 million from$159.4 million at December 31, 2008. As of March 31, 2009, we had $21.8 million of long-terminvestments.  As of March 31, 2009,we had no outstanding debt.

 

*Revenues*

 
| ** **                       | ** ** | **Three Months Ended  March 31,** | ** ** | ** **     | ** ** |
|----------------------------------|------------|----------------------------------------|------------|----------------|------------|
| ** **                       | ** ** | **2008**                               | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **                             | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** |
| ** **                       | ** ** | ** **                             | ** ** | **of**         | ** ** | ** ** | ** ** | **of** | ** ** | **Change** | ** ** |
| **Revenues by Product Line (1)** | ** ** | **Amount**                             | ** ** | **Revenues**   | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                       | ** ** | **(in thousands)**                     | ** ** |
| Electronic data capture          |       | $                                      | 28,950     |           | 76         | % | $ | 36,527 |   | 75 | % | $ | 7,577 |   | 26 | % |
| Clinical data management         |       | 5,529                                  |       | 15             |       | 5,618 |   | 11 |   | 89 |   | 2 |   |
| Safety                           |       | 3,541                                  |       | 9              |       | 5,383 |   | 11 |   | 1,842 |   | 52 |   |
| Interactive Response Technology  |       | —                                 |       | —         |       | 1,288 |   | 3 |   | 1,288 |   | NM | * |
| Total                            |       | $                                      | 38,020     |           | 100        | % | $ | 48,816 |   | 100 | % | $ | 10,796 |   | 28 | % |

 

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(1) Revenues by Product Lineinclude product license revenues and product-related service revenues.

*    Not meaningful

 

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Our electronic datacapture revenues increased primarily due to an increase in application hostingservice revenues of $6.1 million, as well as increases in license revenues andconsulting services of $825,000 and $653,000, respectively, compared to thesame period in 2008.  The increase insafety revenues is primarily due to increases in consulting services revenuesand license revenues of $1.3 million and $404,000, respectively.   The inclusion of interactive responsetechnology revenues is due to the introduction of a new offering following theacquisition of Clarix on September 5, 2008.

 
| ** **                   | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|------------------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **                   | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                   | ** ** | ** **                            | ** ** | **of**         | ** ** | ** ** | ** ** | **of** | ** ** | **Change** | ** ** |
| **Revenues by Type**         | ** ** | **Amount**                            | ** ** | **Revenues**   | ** ** | **Amount** | ** ** | **Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                   | ** ** | **(in thousands)**                    | ** ** |
| License                      |       | $                                     | 12,614     |           | 33         | %          | $          | 14,116 |   | 29 | % | $ | 1,502 |   | 12 | % |
| Application hosting services |       | 19,185                                |       | 51             |       | 26,626     |       | 55 |   | 7,441 |   | 39 |   |
| Consulting services          |       | 3,099                                 |       | 8              |       | 4,861      |       | 10 |   | 1,762 |   | 57 |   |
| Customer support             |       | 3,122                                 |       | 8              |       | 3,213      |       | 6 |   | 91 |   | 3 |   |
| Total                        |       | $                                     | 38,020     |           | 100        | %          | $          | 48,816 |   | 100 | % | $ | 10,796 |   | 28 | % |

 

Total revenues increased in the three months ended March 31,2009 as compared to the same period in 2008, primarily due to increases inapplication hosting services, consulting services and license revenues. Theincrease in revenues associated withour application hosting services was due to a 26%increase in *InForm *productiontrials under management from approximately 760 as of March 31, 2008 toapproximately 955 as of March 31, 2009, whichincludes both *InForm *application hostingservices trials as well as trials hosted for our electronic data capture**licensecustomers. The increase in*InForm *production trials is primarilyfrom customers that purchase all trial-related services from us and who do nothave a separate license to*InForm*,as well as an increase in the average fee per trial.  Our application hosting services also increased due tothe impact of additional trials under management as a result of our recentacquisition of Clarix.  The increase inrevenues associated with consulting services was 57% as compared to the sameperiod in 2008.  The increase was causedby the completion of several large *InForm *and*Safety*engagements in the quarter.  License revenue of $14.1 million increased by$1.5 million, or 12%, over the same period in 2008.  The increase was driven primarily byadditional *InForm *license revenue as customerscontinue to utilize our technology to build trials as well as increased demandfor our safety products.  Our revenueswere not significantly impacted by price increases or decreases.  Inflation had only a nominal impact on ourrevenues.

 
| ** **                | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|---------------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **                | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **                | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                            | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                | ** ** | **(in thousands)**                    | ** ** |
| United States             |       | $                                     | 20,194     |           | 53         | %          | $          | 30,339 |   | 62 | % | $ | 10,145 |   | 50 | % |
|                      |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| United Kingdom            |       | 12,094                                |       | 32             |       | 12,619     |       | 26 |   | 525 |   | 4 |   |
| France                    |       | 3,586                                 |       | 9              |       | 3,651      |       | 7 |   | 65 |   | 2 |   |
| Asia Pacific              |       | 2,146                                 |       | 6              |       | 2,207      |       | 5 |   | 61 |   | 3 |   |
|                      |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| International  subtotal   |       | 17,826                                |       | 47             |       | 18,477     |       | 38 |   | 651 |   | 4 |   |
|                      |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| Total                     |       | $                                     | 38,020     |           | 100        | %          | $          | 48,816 |   | 100 | % | $ | 10,796 |   | 28 | % |

 

 

The increase in revenues worldwide wasprimarily due to an increase in application hosting service revenues,consulting service revenues and license revenues. The increase in U.S. revenuesis primarily related to additional application hosting services as well as an increase in electronicdata capture**and safety revenues. The growth in international revenues is primarily related to additionalapplication hosting services.

 

*Cost ofRevenues*

 
| ** **            | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-----------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **            | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **            | ** ** | ** **                            | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | **Change** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                            | ** ** | **Revenue**    | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                    | ** ** |
| License               |       | $                                     | 655        |           | 5          | %          | $          | 566 |   | 4 | % | $ | (89 | ) | 14 | % |
| Services              |       | 15,528                                |       | 61             |       | 19,899     |       | 57 |   | 4,371 |   | 28 |   |
|                  |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| Total                 |       | $                                     | 16,183     |           | 43         | %          | $          | 20,465 |   | 42 | % | $ | 4,282 |   | 26 | % |

 

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The increase in cost ofservices revenues in the three months ended March 31, 2009 was due primarilyto increases in employee-related expense of $1.3 million, related to aheadcount increase of 138 people, and increases in facilities expense andcontractor expense of $755,000 and $734,000, respectively.  In addition, depreciation expense, hosting expenseand amortization expenses increased by $590,000, $271,000, and $261,000,respectively.  Other cost of servicesexpenses increased in 2009 by approximately $405,000, which included travel,stock-based compensation, legal and royalty expenses.

 

*Gross Margin*

 
| ** **       | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **       | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **       | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **       | ** ** | ** **                            | ** ** | **of Related** | ** ** | ** ** | ** ** | **of Related** | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | **Amount**                            | ** ** | **Revenue**    | ** ** | **Amount** | ** ** | **Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **       | ** ** | **(in thousands)**                    | ** ** |
| License          |       | $                                     | 11,959     |           | 95         | %          | $          | 13,550 |   | 96 | % | $ | 1,591 |   | 13 | % |
| Services         |       | 9,878                                 |       | 39             |       | 14,801     |       | 43 |   | 4,923 |   | 50 |   |
|             |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| Total            |       | $                                     | 21,837     |           | 57         | %          | $          | 28,351 |   | 58 | % | $ | 6,514 |   | 30 | % |

 

The license gross margin percentage slightly increased in2009 as compared to 2008.  The servicesgross margin percentage increased during 2009 due to lower services expenses asa percentage of related revenues.  Thiswas due to increased efficiencies resulting in a decrease in services expenseper services employee.  The overall grossmargin percentage increased in 2009 due to the higher services gross marginpercentage.  It is likely that grossmargin, as a percentage of revenues, will fluctuate quarter by quarter due tothe timing and mix of license and service revenues, and the type, amount andtiming of service required in delivering certain projects.

 

*Operating Expenses*

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **                  | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| **Operating Expenses**      | ** ** | **Amount**                            | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                    | ** ** |
| Sales and  marketing        |       | $                                     | 6,151      |           | 16         | %          | $          | 7,206 |   | 15 | % | $ | 1,055 |   | 17 | % |
| Research and  development   |       | 5,558                                 |       | 15             |       | 8,180      |       | 17 |   | 2,622 |   | 47 |   |
| General and  administrative |       | 5,700                                 |       | 15             |       | 7,804      |       | 16 |   | 2,104 |   | 37 |   |
|                        |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| Total                       |       | $                                     | 17,409     |           | 46         | %          | $          | 23,190 |   | 48 | % | $ | 5,781 |   | 33 | % |

 

*Salesand Marketing.*    Sales andmarketing expenses increased in the three months ended March 31, 2009primarily due to increases in employee-related expense of $237,000, related toa headcount increase of 15 people, as well as increases in amortization expenseand marketing programs expense of $220,000 and $177,000, respectively.  There were also other expense increasesrelated primarily to facilities, recruiting and stock-based compensation.  We expect that our sales and marketing expense will continue to increase inabsolute dollars as commission expense increases with our revenues and as wecontinue to expand sales coverage and to build brand awareness through what webelieve are the most cost effective channels available.  We expect that such increases may fluctuate,however, due to the timing of marketing programs.

 

*Researchand Development.*    Research anddevelopment expenses increased in the three months ended March 31, 2009primarily due to employee-related expenses of $1.0 million related to aheadcount increase of 31 people.  We alsohad expense increases related to outside contractors, facilities, stock-basedcompensation and depreciation expenses of $484,000, $435,000, $343,000, and$191,000 respectively.  We expect that our research and development costs willcontinue to increase in absolute dollars as we continue to add features andfunctionality to our products, introduce additional integrated softwaresolutions to our product suite and expand our product and service offerings.

 

*Generaland Administrative.*    Generaland administrative expenses increased in the three months ended March 31,2009 primarily due to increases in employee-related expenses of $924,000related to a headcount increase of 36 people, as well as increases 

 

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in stock-basedcompensation, computer-related and phone and internet expenses of $296,000,$216,000 and $190,000, respectively. In addition, there were increases in expenses related to supplies, traveland contractors expenses of $458,000.  We expect that in the future our general and administrative expenses willincrease in absolute dollars as we add personnel and incur additional costsrelated to the growth of our business and operations.

 

*OtherIncome*

 
| ** **          | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|---------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **          | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **          | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **          | ** ** | **Amount**                            | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **          | ** ** | **(in thousands)**                    | ** ** |
| Other income:       |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| Interest income     |       | $                                     | 1,901      |           | 5          | %          | $          | 640 |   | 1 | % | $ | (1,261 | ) | 67 | % |
| Other income        |       | 134                                   |       | —         |       | 409        |       | 1 |   | 275 |   | NM | * |
|                |       |                                  |       |           |       |       |       |   |   |   |   |   |   |
| Total other  income |       | $                                     | 2,035      |           | 5          | %          | $          | 1,049 |   | 2 | % | $ | (986 | ) | 48 | % |

 

----

* Not meaningful

 

Our interest income decreased in the three monthsended March 31, 2009, primarily due to a decline in interest rates.  Other income increased primarily due to achange in fair value associated with auction rate securities of $437,000partially offset by a change in fair value of a securities settlement agreementof ($185,000).

 

*Provision for Income Taxes*

 
| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** | ** **     | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------|------------|----------------|------------|------------|------------|
| ** **                  | ** ** | **2008**                              | ** ** | **2009**       | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                            | ** ** | ** **     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                  | ** ** | ** **                            | ** ** | **Percentage** | ** ** | ** ** | ** ** | **Percentage** | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **Amount**                            | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                    | ** ** |
| Provision for  income taxes |       | $                                     | 2,461      |           | 6          | %          | $          | 2,132 |   | 4 | % | $ | (329 | ) | 13 | % |
|                             |            |                                       |            |                |            |            |            |  |  |  |  |  |  |  |  |  |

 

**Our effective tax rates for the threemonths ended March 31, 2008 and 2009 were 38% and 34%, respectively. **In the three months ended March 31, 2008, oureffective tax rate was higher than our statutory rate of 37% due to non-deductiblestock-based compensation expense.  In thethree months ended March 31, 2009, our effective tax rate was lower thanour statutory rate of 37% due to a release of a portion of unrecognized taxbenefits.

** **

**Liquidityand Capital Resources**

 

Our principal sources ofliquidity were unrestricted cash, cash equivalents, short and long-terminvestments totaling $177.5 million and $178.1 million at December 31,2008 and March 31, 2009, respectively, and accounts receivable of$40.0 million and $42.5 million, respectively.

 

Cash provided by and used in operating activities hashistorically been affected by changes in working capital accounts, primarilydeferred revenues, accounts receivable and accrued expenses, and add-backs ofnon-cash expense items such as depreciation and amortization and stock-basedcompensation expense. Fluctuations within accounts receivable and deferredrevenues are primarily related to the timing of billings of our term licensecustomers and the associated revenue recognition. Movements in deferred costsare related to the volume and stages of hosted clinical trials and movements inaccrued expenses and accounts payable are due to the timing of certaintransactions.

 

Net cash provided byoperating activities was $6.0 million in the three months ended March 31,2009, which was more than net income of $4.1 million. The difference is primarily due to non-cashadjustments of $3.7 million of depreciation and amortization expense, $2.6million of stock-based compensation expense, $2.4 million of deferred incometax expense, and $185,000 change in fair value of a securities settlementagreement.  Cash provided by workingcapital and other activities primarily reflected an increase in deferredrevenues of $7.5 million and deferred rent of $1.1 million. These increaseswere partially offset by decreases in accrued expenses of $6.7 million andaccounts payable of $4.1 million, and increases in accounts receivable of $2.2million, deferred costs of $1.2 million and prepaid expenses and other currentassets of $726,000.  In addition, therewere decreases due to the impairment of long-term investments of $437,000 andamortization of leasehold incentive obligations of $198,000. Net cash providedby operating activities was $18.6 million in the three months ended March 31,2008, which was greater than net income of $4.0 million. This difference isprimarily due to $2.2 million of non-cash charges of depreciation andamortization, increases in deferred revenue of $16.4 million and deferredincome taxes of $2.3 million, stock based compensation expense of $1.7 million,and an increase in accounts payable of $1.7 million. These increases werepartially offset by decreases in accrued expenses of $4.9 million and anincrease in accounts receivable of $4.7 million.

 

Net cash used ininvesting activities was $2.7 million during the three months ended March 31,2009, which was primarily due to the purchase of short-term and long-terminvestments of $9.5 million and capital expenditures of $5.2 million. These decreases in cash were partially offset by $12.0 million of proceeds frommaturities of short-term and long-term investments. Net cash provided byinvesting activities was $1.3 million during the three months ending March 31,2008, which was primarily due to proceeds from maturities of short-terminvestments of $28.3 million, offset by purchases of short-term investments of$25.6 million and capital expenditures of $1.4 million.

 

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Net cash used in financing activities was $117,000in the three months ended March 31, 2009, due to the payment of withholding taxesassociated with the vesting of restricted stock awards of $459,000, partiallyoffset by the proceeds received from the exercise of stock options of $342,000.Net cash provided by financing activities was $446,000 in the three monthsended March 31, 2008, consisting of proceeds from the exercise of stockoptions.

 

Substantially all of ourlong-lived assets at December 31, 2008 and March 31, 2009 are locatedin the United States.

 

We generally do not enterinto long-term binding purchase commitments. Our principal commitments consistof obligations under non-cancelable operating leases for office space.

 

The following table of ourmaterial contractual obligations as of December 31, 2008 summarizes theaggregate effect that these obligations are expected to have on our cash flowsin the periods indicated:

 
| ** **                  | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------|------------|----------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                  | ** ** | **1 year or less** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **More than  5 years** | ** ** |
| ** **                  | ** ** | **(in thousands)**         | ** ** |
| Operating lease obligations |       | $                          | 73,029     |   | $ | 7,357 |   | $ | 14,925 |   | $ | 13,424 |   | $ | 37,323 |   |
| Total                       |       | $                          | 73,029     |   | $ | 7,357 |   | $ | 14,925 |   | $ | 13,424 |   | $ | 37,323 |   |

 

On February 13, 2008, we entered into a lease withBP Fourth Avenue, L.L.C. to secure office space for our current corporateheadquarters at 77 Fourth Avenue, Waltham, Massachusetts. The commencement datefor occupancy under the lease was December 2008. The lease for our priorcorporate headquarters at 880 Winter Street in Waltham expired in February 2009.

 

The lease for our currentheadquarters provides for the rental of 165,129 rentable square feet of spaceand has an initial term of 10 years and three months. We can, subject tocertain conditions, extend this term by exercising up to two consecutive fiveyear options. We are not required to pay any rent for the first three months ofthe initial lease term. Thereafter, the annual rent on the new lease for yearsone through five is $6.6 million, or approximately $548,000 per month.  For years six through ten, the annual rentwill be $7.2 million, or approximately $603,000 per month.  The total base rent payable in the initialterm is $69.1 million.

 

In addition to baserent, commencing on January 1, 2010, the lease for our currentheadquarters requires us to pay our proportionate share of the amount by whichdefined operating expenses incurred by the landlord exceed the base year (2009)operating expenses, as defined in the lease. The lease also requires us to payour proportionate share of the amount by which real estate taxes paid orincurred by the landlord exceed the tax base year (fiscal 2010), as defined inthe lease.  In addition, we are receiving lease incentives, including freerent for the first three months of occupancy which totaled approximately $1.6million and allowances for tenant improvements totaling approximately $8.1million. The allowances for tenant improvements are being amortized on a straight-linebasis over the lease term as a reduction of rental expense.

 

In connection with thesigning of the lease for our current headquarters, we have deposited with thelandlord an unconditional, irrevocable letter of credit in the landlord’s favorin the amount of $962,000.

 

As of March 31,2009, we had a $500,000 collateral obligation for our prior leased headquarterswhich was secured by a certificate of deposit.

 

At December 31, 2008,we had $30.4 million of net operating loss carryforwards that may be used tooffset future U.S. federal taxable income. These attributes may reduce our future cash tax liability.  In addition, we had $18.3 million of netoperating losses resulting from excess tax deductions related to stock-basedcompensation.  We will realize thebenefit of these excess tax deductions through increases to stockholders’equity in the periods in which the losses are utilized to reduce taxpayments.  In addition, we had $2.4million of federal research and development tax credit carryforwards that maybe utilized to offset future U.S. taxes. The net operating loss and tax credit carryforward periods extendthrough 2028.  In addition, we had $1.2million of foreign net operating loss carryforwards that may be used to offsetfuture foreign taxable income. These foreign net operating loss carryforwardshave an unlimited carryforward period. We also had $3.8 million of research anddevelopment tax credit carryforwards that may be utilized to offset futureMassachusetts state taxable income.  TheMassachusetts tax credit carryforward period extends through 2023.  The federal and state net operating losscarryforwards and research and development tax credits are subject to reviewand possible adjustment by the taxing authorities.  Also, the Internal Revenue Code containsprovisions that may limit the net operating loss and tax credit carryforwardsavailable in any given year in the event of certain changes in the ownershipinterests of significant stockholders. We currently expect to realize the benefit of recorded deferred taxassets as of December 31, 2008 of $20.0 million.  Our conclusion that such assets will berecovered is based upon our expectation that our future earnings combined withtax planning strategies available to us will provide sufficient taxable incometo realize recorded tax assets.

 

We may be required to makecash outlays related to our unrecognized tax benefits.  However, due to the uncertainty of the timingof future cash flows associated with our unrecognized tax benefits, we areunable to make reasonably reliable estimates of the period 

 

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of cash settlement, if any, with the respective taxingauthorities.  Accordingly, unrecognizedtax benefits of $1.4 million as of December 31, 2008 have been excludedfrom the contractual obligations table above. For further information on unrecognized tax benefits, see Note 6 in thenotes to our 2008 consolidated financial statements included in our AnnualReport on**Form 10-Kfor the year ended December 31, 2008.

 

We believe our existing cash, cash equivalents,short-term investments and cash provided by operating activities will besufficient to meet our working capital and capital expenditure needs over atleast the next 12 months. Our future capital requirements will depend on manyfactors, including our rate of revenue growth, the expansion of our marketingand sales activities, the timing and extent of spending to support productdevelopment efforts, the timing of introductions of new products and servicesand enhancements to existing products and services and the continuing marketacceptance of our products and services. From time to time, we may also enterinto agreements with respect to potential investments in, or acquisitions of,businesses, services or technologies, which could also require us to seekadditional equity or debt financing.  To the extent that existingcash and securities and cash from operations are insufficient to fund ourfuture activities, we may need to raise additional funds through public orprivate equity or debt financing.

 

Includedwithin our investment portfolio at December 31, 2008 and March 31,2009 were $24.1 million of auction rate securities, or ARS, at par value,which are classified as long-term investments on our unaudited condensedconsolidated balance sheets, and recorded at fair market value. These ARS aredebt instruments issued by various states throughout the United States tofinance student loans. The types of ARS that we own are backed by studentloans, 95% of which are guaranteed under the Federal Family Education LoanProgram, and all had credit ratings of AAA (or equivalent) from a recognizedrating agency. Historically, the carrying value of ARS approximated fair valuedue to the frequent resetting of the interest rates. With the liquidity issuesexperienced in the global credit and capital markets, our ARS have experiencedmultiple failed auctions. While we continue to earn and receive interest onthese investments at the maximum contractual rate, the estimated fair value ofthese ARS no longer approximates par value.

 

        InNovember 2008, we accepted an offer from UBS AG, or UBS, with respect toall of our ARS held at that time. Under our agreement with UBS, we receivedcertain rights which entitle us to sell our ARS to UBS affiliates during theperiod from June 30, 2010 to July 20, 2012, for a price equal to parvalue. In accepting the offer, we granted UBS the authority to sell or auctionthe ARS at par at any time up until the expiration date of our agreement withUBS and released UBS from any claims relating to the marketing and sale of theARS. UBS’s obligations under the agreement are not secured by its assets and donot require UBS to obtain any financing to support its performance obligations.UBS has disclaimed any assurance that it will have sufficient financialresources to satisfy its obligations under the agreement. If UBS has insufficientfunding to buy back the ARS and the auction process continues to fail, then wemay incur further losses on the carrying value of the ARS.

 

        Inprior periods and up through the execution of our signed settlement agreementwith UBS in November 2008, the ARS were classified as available-for-salesecurities and were reported at fair value, with temporary unrealized gains(losses) excluded from earnings and reported in a separate component ofstockholders’ equity and other-than-temporary unrealized losses included inearnings. Upon the execution of the settlement agreement with UBS, we electedto make a one-time transfer of the ARS from available-for-sale securities totrade securities. Accordingly, on a prospective basis, all unrealized gains(losses) for these trading securities will be included in earnings.

 

We performed a fair valuecalculation of our ARS as of December 31, 2008 and March 31, 2009.Fair value was determined using a secondary market indications method (directdiscounts) and a discounted cash flow method as recent auctions of thesesecurities were not successful, resulting in our continuing to hold thesesecurities and issuers paying interest at the maximum contractual rate. Thisvaluation technique considers the following: time left to maturity, the rate ofinterest paid on the securities, the amount of principal to be repaid to theholders of the securities; the credit worthiness of the issuer and guarantors(if any) and the sufficiency of the collateral; trading characteristics of the securities;ability to borrow against the ARS; evidence from secondary market sales; andthe market-clearing yield for the securities. Based upon the valuationperformed, we concluded that the fair value of these ARS at December 31,2008 was $18.0 million, a decline of $6.0 million from par value. Asour settlement agreement with UBS indicates that we intend to sell our ARS toUBS affiliates before their stated maturity under the ARS terms, thedecline in fair value is deemed other-than-temporary. Accordingly, we recordeda loss on these securities of $6.0 million in our consolidated statementof income for the year ended December 31, 2008.  As of March 31, 2009, weconcluded that the fair value of these ARS was $18,459 and therefore, werecorded a change in fair value of the securities of $437,000 in our unauditedcondensed consolidated statement of income for the three months ended March 31,2009.

 

We elected to measure thefair value of the settlement agreement (the “put option”) under the fair valueoption of SFAS No. 159,*The Fair ValueOption for Financial Assets and Liabilities—including an amendment of FASBStatement No. 115.*  Fairvalue was determined using a discounted cash flow method which considered thefollowing factors: the term of the agreement, the availability to borrowagainst the ARS, the creditworthiness of UBS and current market interest rates.Based on the valuation performed, we concluded that the fair value of the putoption was $5.3 million. Accordingly, we recorded a gain of $5.3 millionin the consolidated statement of income for the year ended December 31,2008 with a corresponding long term asset, “securities settlement 

 

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agreement” in theconsolidated balance sheet at December 31, 2008.  As of March 31, 2009, we concluded thatthe fair market value of the securities settlement agreement was $5.1 million,resulting in a change in fair value of the securities settlement agreement of ($185,000)which was recorded in our accompanying unaudited condensed consolidatedstatement of income for the three months ended March 31, 2009.

 

Webelieve that, based on our cash, cash equivalents and short-term marketablesecurities balances of $156.3 million at March 31, 2009, excluding fairmarket value of ARS of $18.5 million, the current lack of liquidity in thecredit and capital markets will not have a material impact on our liquidity,cash flow or the ability to fund our operations.

 

**Recently Issued Accounting Pronouncements**

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), *BusinessCombinations*(“SFAS No. 141(R)”)*.  *SFAS No. 141(R) retainsthe fundamental requirements in SFAS 141 that the acquisition method ofaccounting (which SFAS No. 141 called the “purchase method”) be used forall business combinations and for an acquirer to be identified for eachbusiness combination. SFAS 141(R) requires an acquirer to recognize theassets acquired, the liabilities assumed, and any noncontrolling interest inthe acquiree at the acquisition date, measured at their fair values as of thatdate, with limited exceptions specified in the Statement. This approachreplaces SFAS No. 141’s cost-allocation process, which required the costof an acquisition to be allocated to the individual assets acquired andliabilities assumed based on their estimated fair values. SFAS No. 141(R) retainsthe guidance in SFAS No. 141 for identifying and recognizing intangibleassets separately from goodwill. SFAS 141(R) will now require acquisitioncosts to be expensed as incurred, restructuring costs associated with abusiness combination must generally be expensed prior to the acquisition dateand changes in deferred tax asset valuation allowances and income taxuncertainties after the acquisition date generally will affect income taxexpense. SFAS No. 141(R) applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008,which is our 2009 fiscal year. Earlier adoption is prohibited. The adoption ofSFAS No. 141 (R) may have a significant impact on our accounting forfuture acquisitions, including our acquisition of Waban in the second quarter.

 

In April 2009, theFASB issued FASB Staff Position No. 141(R)-1 (“FSP FAS 141(R)-1”*), Accounting for AssetsAcquired and Liabilities Assumed in a Business Combination That Arise fromContingencies,* which provides additional clarification on theinitial recognition and measurement of assets acquired and liabilities assumedin a business combination that arise from contingencies.  FSP FAS141(R)-1 is effective for all fiscal years beginning on or after December 15,2008.  FSP FAS 141(R)-1 may have an impact on the accounting for anybusiness acquired in the future.

 

InDecember 2007, the FASB released SFAS No. 160, *NoncontrollingInterests in Consolidated Financial Statements—an amendment of ARB No. 51(“SFAS No. 160”)*. SFAS No. 160 was issued to improve therelevance comparability, and transparency of financial information provided infinancial statements by establishing accounting and reporting standards for thenoncontrolling interest in a subsidiary and for the deconsolidation of asubsidiary. SFAS No. 160 is effective for fiscal years beginning after December 15,2008 and will be applied prospectively, except for the presentation anddisclosure requirements which will be applied retrospectively. The adoption ofSFAS No. 160 is not expected to have a material effect on our consolidatedfinancial position or results of operations.

 

In March 2008, theFASB issued SFAS No. 161,*Disclosuresabout Derivative Instruments and Hedging Activities an amendment of FASBStatement No. 133*(“SFASNo. 161”)*.*   SFAS No. 161requires disclosures of how and why an entity uses derivative instruments, howderivative instruments and related hedged items are accounted for and howderivative instruments and related hedged items affect an entity’s financialposition, financial performance, and cash flows. SFAS No. 161 is effectivefor fiscal years beginning after November 15, 2008, with early adoptionpermitted. The adoption of SFAS No. 161 is not expected to have a materialeffect on our consolidated financial position and results of operations.

 

In May 2008, theFASB issued SFAS No. 162,*The Hierarchyof Generally Accepted Accounting Principles* (“SFAS No. 162”).SFAS No. 162 identifies the sources of generally accepted accountingprinciples in the United States and prioritizes the generally acceptedaccounting principles thereunder. SFAS No. 162 is effective sixty daysfollowing the SEC’s approval of the Public Company Accounting Oversight Boardamendments to AU Section 411,*TheMeaning of Present Fairly in Conformity With Generally Accepted AccountingPrinciples*. The adoption of SFAS No. 162 is not expected tohave a material effect on our consolidated financial position and results ofoperations.

 

In April 2009, theFASB issued FASB Staff Position No. 107-1 (“FSP FAS 107-1”) and APB 28-1 (“APB28-1”), *Interim Disclosures aboutFair Value of Financial Instruments,*****which amends FASB Statement No. 107, *Disclosures about Fair Value of Financial Instruments* andAPB Opinion NO. 28, *Interim Financial Reporting,to require disclosures about the fair value of financial instruments forinterim reporting periods*. FSP FAS 107-1 and APB 28-1 will beeffective for interim reporting periods ending after June 15, 2009. We arecurrently evaluating the impact that this position will have on ourconsolidated financial position and results of operations.

 

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In April 2009, theFASB issued FASB Staff Position No. 115-2 (“FSP FAS 115-2”) and FASB StaffPosition No. 124-2 (“FSP FAS 124-2”), *Recognitionand Presentation of Other-Than-Temporary Impairments*, which amends theother-than-temporary impairment guidance for debt and equity securities. FSPFAS 115-2 and FSP FAS 124-2 shall be effective for interim and annual reportingperiods ending after June 15, 2009. We are currently evaluating the impactthat this position will have on our consolidated financial position and resultsof operations.

 

In April 2009, theFASB issued FSP Issue No. FAS No. 157-4 (“FSP FAS 157-4”), *Determining Fair Value When the Volume and Level of Activity for theAsset or Liability Have Significantly Decreased and Identifying Transactionsthat are not Orderly*. FSP FAS No. 157-4 provides additionalguidance for estimating fair value in accordance with SFAS No. 157. ThisFSP No. 157-4 is effective in reporting periods ending after June 15,2009.  We are currently evaluating theimpact that this position will have on our consolidated financial position andresults of operations.

 

**Off-Balance Sheet Arrangements**

 

We do not have anyspecial purpose entities or off-balance sheet arrangements.

 

**SpecialNote Regarding Forward-Looking Statements**

 

Inaddition to historical consolidated financial information, this QuarterlyReport on Form 10-Q contains forward-looking statements **within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities and Exchange Act of 1934, as amended, and are intended to be coveredby the “safe harbor” created by those sections. **All statements, other than statements ofhistorical facts, included in this Quarterly Report on From 10-Q regarding ourstrategy, future operations, future financial position, future net sales,projected costs, projected expenses, prospects and plans and objectives ofmanagement are forward-looking statements. The words “anticipates,” “believes,”“estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would”and similar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifying words.

 

We maynot actually achieve the plans, intentions or expectations disclosed in ourforward-looking statements and you should not place undue reliance on ourforward-looking statements. We have based these forward-looking statements onour current expectations and projections about future events. Although webelieve that the expectations underlying any of our forward-looking statementsare reasonable, these expectations may prove to be incorrect, and all of thesestatements are subject to risks and uncertainties. We discuss many of the risksthat we believe could cause actual results or events to differ materially fromthese forward-looking statements in greater detail in the section entitled “RiskFactors” in **ourAnnual**Report on**Form 10-Kfor the year ended December 31, 2008. **We urge you to considerthe risks and uncertainties described in Item 1A of our Annual**Reporton**Form 10-K for the year ended December 31,2008**in evaluating ourforward-looking statements.**Should one or more of theserisks and uncertainties materialize, or should underlying assumptions,projections or expectations prove incorrect, actual results, performance orfinancial condition may vary materially and adversely from those anticipated,estimated or expected. Our forward-looking statements do not reflect thepotential impact of any future acquisitions, mergers, dispositions, jointventures or investments we may make.

 

**We caution readers not to place undue reliance uponany such forward-looking statements, which speak only as of the date made.Except as otherwise required by the federal securities laws, we disclaim anyobligation or undertaking to publicly release any updates or revisions to anyforward-looking statement contained herein (or elsewhere) to reflect any changein our expectations with regard thereto or any change in events, conditions orcircumstances on which********any suchstatement is based.**

 

**Item 3.        *Quantitative and 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, Australian dollar, Indian rupee and Japanese yen. During the threemonths ended March 31, 2008 and 2009, 47% and 38%, respectively, of ourrevenues were generated in locations outside the United States. During the sameperiods, 34% and 22%, respectively, of revenues were in currencies other thanthe U.S. dollar.  During the three monthsended March 31, 2009, 11% of our revenues were in euros, 7% were in theBritish pound and 4% in Japanese yen. Except for revenue transactions in Japan,we enter into transactions directly with substantially all of our foreigncustomers. During the three months ended March 31, 2008 and 2009, 30% and 21%, respectively, of expenses were in currenciesother than the U.S. dollar. During the three months ended March 31, 2009,12% of our expenses were in British pound, 4% in euro, 1% in Australian dollarand 4% in Japanese yen.

 

As of March 31,2009, we had $9.0 million of receivables denominated in currencies other thanthe U.S. dollar.  We also maintain cash accounts denominated in currencies other that thelocal currency which exposes us to foreign exchange rate movements.

 

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In addition, although our foreign subsidiaries haveintercompany accounts that eliminate upon consolidation, such accounts exposeus to foreign currency rate movements. Exchange rate fluctuations on short-termintercompany accounts are recorded in our consolidated statements of operationsunder “other income”, while exchange rate fluctuations on long-termintercompany accounts are recorded in our consolidated balance sheets under “accumulatedother comprehensive loss” in stockholders’ equity, as they are considered partof our net investment and hence do not give rise to gains or losses.

 

We have implemented a riskmanagement program under which we measure foreign currency exchange riskmonthly and manage those exposures through the use of various operatingstrategies As more fully described in Note 16 in the notes to the accompanyingunaudited condensed consolidated financial statements included in thisQuarterly Report, we regularly purchase short-termforeign currency forward contracts, designed to hedge fluctuation in thenon-functional currencies of the Company and its subsidiaries against the U.S.dollar. This process is designed to minimize foreign currency translationexposures that could otherwise affect consolidated results of operations. Theterms of these contracts are for periods generally for one month.

 

Currently, our largest foreign currency exposures are theBritish pound and euro, primarily because our European operations have a higherproportion of our local currency denominated expenses. Relative to foreigncurrency exposures existing at December 31, 2007 and 2008, a 10%unfavorable movement in foreign currency exchange rates would not expose us tosignificant losses in earnings or cash flows or significantly diminish the fairvalue of our foreign currency financial instruments. This is primarily due tothe short lives of the affected financial instruments that effectively hedgesubstantially all of our period-end exposures against fluctuations in foreigncurrency exchange rates.

 

Asof March 31, 2009, we entered into forward foreign exchange contracts tohedge approximately $9.0 million of receivables, intercompany accounts and cashbalances denominated in currencies other than the U.S. dollar.  For the three months ended March 31,2009, we recorded $248,000 of foreign exchange losses in other income andaccrued expenses as a result of the outstanding forward foreign exchangecontracts.

 

*InterestRate Sensitivity*

 

We had unrestricted cash, cash equivalents, short-term andlong-term investments totaling $178.1 million at March 31, 2009. These amounts were invested primarily in money market funds, corporate bondsand government agency securities, and are held for working capitalpurposes.  We do not use derivative financial instruments in ourinvestment portfolio.  We have established investment guidelines relativeto credit quality, diversification, marketability and performance measurementdesigned to maintain safety and liquidity.  With the exception of auctionrate securities, investments in securities are invested primarily in highquality securities of a short duration and historically have not been materiallyaffected by fluctuations in interest rates. With the exception of auction ratesecurities, which are recorded at fair value, investments are reported atamortized cost.  We considered thehistorical volatility of short-term and long-term interest rates and determinedthat, due to the size and duration of our investment portfolio, a100-basis-point increase in interest rates would not have any material exposureto changes in the fair value of our portfolio at March 31, 2009.  Adecline in interest rates, however, would reduce future investment income.

 

We believe that, based onour unrestricted cash, cash equivalents and short-term marketable securitiesbalances of $156.3 million at March 31, 2009, which exclude the fairmarket value of ARS of $18.5 million and the fair value of the securitiessettlement agreement with UBS of $5.1 million, the current lack of liquidity inthe credit and capital markets will not have a material impact on ourliquidity, cash flow or our ability to fund our operations.

 

**Item4.         *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 March 31, 2009, we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective at that reasonableassurance level in (i) enabling us to record, process, summarize and reportinformation required to be included in our periodic SEC filings within therequired time period and (ii) ensuring that information required to bedisclosed in the

 

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reports that we file orsubmit under the Securities Exchange Act is accumulated and communicated to ourmanagement, including our Chief Executive Officers and Chief Financial Officer,to allow timely decisions regarding required disclosure.

 

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.

 

**Part II—OtherInformation**

 

**Item 1.        *Legal Proceedings***

 

From time to timeand in the ordinary course of business, we are subject to various claims,charges and litigation.  The outcome oflitigation cannot be predicted with certainty and some lawsuits, claims orproceedings may be disposed of unfavorably to us, which could materially affectour financial condition or results of operations.

** **

**Item 1A.     *Risk Factors***

 

**Certain Factors Which May AffectFuture Results**

 

*We operate in a rapidly changing environment thatinvolves a number of risks, some of which are beyond our control.  Therisks and uncertainties that we believe are most important for you to considerare described under the title “Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2008.  There are no material changesto the risk factors described in the “Risk Factors” section in our AnnualReport on Form 10-K for the year ended December 31, 2008.  Additional risks and uncertainties notpresently known to us, which we currently deem immaterial or which are similarto those faced by other companies in our industry or business in general, mayalso impair our business operations.  If any of the foregoing risks oruncertainties actually occurs, our business, financial condition and operatingresults would likely suffer.*

 

**Item 2.        *Unregistered Sale ofEquity Securities and Use of Proceeds***

 

Underthe terms of our 2004 Stock Option and Incentive Plan, or 2004 Plan, we haveissued shares of restricted stock and restricted stock units to ouremployees.  On the date that theserestricted shares vest, we withhold, via a net exercise provision pursuant toour applicable restricted stock agreements and the 2004 Plan, the number ofvested shares (based on the closing price of our common stock on such vestingdate) equal to tax withholdings required by us. The shares withheld from thegrantees to settle their tax liability are reallocated to the number of sharesavailable for issuance under the 2004 Plan. For the three month period ending March 31,2009, we withheld an aggregate of 35,423 common shares under restrictedstock units at a price of $12.95 per share.

 

**Item 5.        *Other Information***

 

Our policy governingtransactions in our securities by directors, officers and employees permits ourofficers, directors and certain other persons to enter into trading planscomplying with Rule 10b5-1 under the Securities Exchange Act of 1934, asamended. We have been advised that our Senior Vice President and GeneralCounsel, D. Ari Buchler, and our Vice President, Corporate Development, MartinYoung, have each entered into a trading plan covering periods after the date ofthis Quarterly Report in accordance with Rule 10b5-1 and our policygoverning transactions in our securities. Generally, under these trading plans, the individual relinquishescontrol over the transactions once the trading plan is put into place.  Accordingly, sales under these plans mayoccur at any time, including possibly before, simultaneously with, orimmediately after significant events involving our company.

 

**We anticipate that, aspermitted by Rule 10b5-1 and our policy governing transactions in oursecurities, some or all of our officers, directors and employees may establishtrading plans in the future. We intend to disclose the names of executiveofficers and directors who establish a trading plan in compliance with Rule 10b5-1and the requirements of our policy governing transactions in our securities inour future quarterly and annual reports on Form 10-Q and 10-K filed withthe Securities and Exchange Commission. However, we undertake no obligation toupdate or revise the information provided herein, including for revision ortermination of an established trading plan, other than in such quarterly andannual reports.**

 

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**Item 6.        Exhibits.**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                    |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                                                                                                               |
| 10.1        | +          | Phase Forward  Incorporated Management Incentive Plan (Incorporated by reference herein to  the exhibits to the Company’s Current Report on Form 8-K filed with the  SEC on February 13, 2009) |
| 10.2        | *          | Non-Employee Directors’  Deferred Compensation Program                                                                                                                                                   |
| 31.1        | *          | Certification of CEO pursuant  to Rule 13a-14(a) and 15d-14(a) under the Securities Exchange  Act of 1934.                                                                                     |
| 31.2        | *          | Certification of CFO  pursuant to rules 13a-14(a) and 15d-14(a) 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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+     Indicatesa management contract or any compensatory plan, contract or arrangement.

*     Filedherewith.

 

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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  (Duly authorized officer)* |
|                    |                            |   |
|                    | By:                             | /s/ CHRISTOPHER  MENARD |
|                    |                            | Christopher  Menard*Chief Financial Officer  (Duly authorized officer and  principal financial officer)* |
|                    |                            |   |
| Date:  May 8, 2009 |                            |   |

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                    |
|-------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                                                                                                               |
| 10.1        | +          | Phase Forward  Incorporated Management Incentive Plan (Incorporated by reference herein to  the exhibits to the Company’s Current Report on Form 8-K filed with the  SEC on February 13, 2009) |
| 10.2        | *          | Non-Employee Directors’  Deferred Compensation Program                                                                                                                                                   |
| 31.1        | *          | Certification of CEO  pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                     |
| 31.2        | *          | Certification of CFO  pursuant to rules 13a-14(a) and 15d-14(a) 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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+     Indicatesa management contract or any compensatory plan, contract or arrangement.

*     Filedherewith.

 

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