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SECURITIES AND EXCHANGE COMMISSION    FORM 10-Q x
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
  OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 Commission File Number: 000-50839 Phase Forward Incorporated  Delaware
(State or other jurisdiction of
    
    04-3386549
(I.R.S. Employerincorporation or organization)
    
    Identification No.)880 Winter Street
    
    02451Waltham, Massachusetts(Address of principal executive offices)
    
    (Zip Code)
 (888) 703-1122
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes o            No x Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes o            No x As of July 30, 2004, the registrant had 31,902,226 shares of Common Stock
outstanding.




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##### Table of Contents



Phase Forward Incorporated INDEX PageNumberPart I  Financial InformationItem 1.
    

Condensed Consolidated Financial Statements (unaudited);Condensed Consolidated Balance Sheets as of December 31, 2003 and
June 30, 2004
    
    
    3Condensed Consolidated Statements of Operations for the three
months and six months ended June 30, 2003 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 2003 and June 30, 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    19Item 3.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    50Item 4.
    
    Controls and Procedures
    
    
    51Part II  Other InformationItem 1.
    
    Legal Proceedings
    
    
    52Item 2.
    
    Change in Securities and Use of Proceeds
    
    
    52Item 3.
    
    Defaults upon Senior Securities
    
    
    53Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    53Item 5.
    
    Other Information
    
    
    54Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    54Signatures
    
    
    55Exhibit Index
    
    
    56SECTION 302 CERTIFICATION CEOSECTION 302 CERTIFICATION CFOSECTION 906 CERTIFICATION CEOSECTION 906 CERTIFICATION CFO




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##### Table of Contents



Part I  Financial Information 
 Item 1. Condensed Consolidated Financial Statements Phase Forward Incorporated and Subsidiaries 
 Condensed Consolidated Balance Sheets
 (unaudited)
  As of
    
    As ofDecember 31,
    
    June 30,2003
    
    2004AssetsCurrent assets:Cash and cash equivalents
    
    $
    19,046
    
    
    $
    26,370Accounts receivable, net of allowance of $425 and $477 in 2003 and 2004,
respectively
    
    
    22,947
    
    
    
    15,347Deferred set up costs, current portion
    
    
    1,115
    
    
    
    1,109Prepaid commissions and royalties, current portion
    
    
    2,192
    
    
    
    3,703Prepaid expenses and other current assets
    
    
    1,434
    
    
    
    1,922Total current assets
    
    
    46,734
    
    
    
    48,451Property and equipment, net
    
    
    5,299
    
    
    
    5,053Restricted cash, net of current portion
    
    
    1,611
    
    
    
    Deferred set up costs, net of current portion
    
    
    697
    
    
    
    672Prepaid commissions and royalties, net of current portion
    
    
    2,527
    
    
    
    2,359Goodwill
    
    
    23,780
    
    
    
    22,758Other assets
    
    
    196
    
    
    
    1,285Total assets
    
    $
    80,844
    
    
    $
    80,578Liabilities and Stockholders (Deficit) EquityCurrent Liabilities:Lines of credit
    
    $
    2,500
    
    
    $
    2,500Current portion of notes payable
    
    
    2,218
    
    
    
    2,684Accounts payable
    
    
    947
    
    
    
    1,184Accrued expenses
    
    
    10,973
    
    
    
    10,577Restructuring accrual
    
    
    1,989
    
    
    
    1,445Deferred revenue, current portion
    
    
    33,050
    
    
    
    32,346Accrued dividend payable
    
    
    
    
    
    
    4,700Total current liabilities
    
    
    51,677
    
    
    
    55,436Notes payable, net of current portion
    
    
    1,970
    
    
    
    2,170Restructuring accrual, net of current portion
    
    
    497
    
    
    
    Deferred revenue, net of current portion
    
    
    4,738
    
    
    
    2,812Deferred rent
    
    
    288
    
    
    
    960Total liabilities
    
    
    59,170
    
    
    
    61,378Commitments and contingencies (Note 8)Redeemable convertible preferred stock at redemption value
    
    
    123,951
    
    
    
    127,787Redeemable convertible preferred stock warrant
    
    
    169
    
    
    
    169Stockholders (deficit) equity:Common stock, $.01 par value:Authorized32,804 and 100,000 shares in 2003 and 2004, respectively
Issued3,602 and 3,704 shares in 2003 and 2004, respectively
    
    
    36
    
    
    
    37Additional paid-in capital
    
    
    
    
    
    
    Subscription receivable
    
    
    (627
    )
    
    
    (113
    )Deferred stock-based compensation
    
    
    (2,333
    )
    
    
    (2,922
    )Treasury stock, 37 shares at cost in 2003 and 2004
    
    
    (111
    )
    
    
    (111
    )Accumulated other comprehensive loss
    
    
    (500
    )
    
    
    (609
    )Accumulated deficit
    
    
    (98,911
    )
    
    
    (105,038
    )Total stockholders (deficit) equity
    
    
    (102,446
    )
    
    
    (108,756
    )Total liabilities and stockholders (deficit) equity
    
    $
    80,844
    
    
    $
    80,578
 See accompanying notes. 3




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Phase Forward Incorporated and Subsidiaries 
 Condensed Consolidated Statements of Operations
 (unaudited)
  Three Months
    
    Six MonthsEnded
    
    EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Revenues:License
    
    $
    5,164
    
    
    $
    6,357
    
    
    $
    9,930
    
    
    $
    12,523Service
    
    
    9,512
    
    
    
    11,336
    
    
    
    19,693
    
    
    
    22,132Total revenues
    
    
    14,676
    
    
    
    17,693
    
    
    
    29,623
    
    
    
    34,655Costs of revenues:License
    
    
    681
    
    
    
    448
    
    
    
    1,329
    
    
    
    870Service(1)
    
    
    6,837
    
    
    
    6,842
    
    
    
    14,187
    
    
    
    13,623Total cost of revenues
    
    
    7,518
    
    
    
    7,290
    
    
    
    15,516
    
    
    
    14,493Gross margin:License
    
    
    4,483
    
    
    
    5,909
    
    
    
    8,601
    
    
    
    11,653Service
    
    
    2,675
    
    
    
    4,494
    
    
    
    5,506
    
    
    
    8,509Total gross margin
    
    
    7,158
    
    
    
    10,403
    
    
    
    14,107
    
    
    
    20,162Operating expenses:Sales and marketing(1)
    
    
    3,258
    
    
    
    3,536
    
    
    
    6,431
    
    
    
    6,841Research and development(1)
    
    
    2,609
    
    
    
    3,018
    
    
    
    5,192
    
    
    
    5,954General and administrative(1)
    
    
    2,424
    
    
    
    2,903
    
    
    
    5,042
    
    
    
    5,546Total operating expenses
    
    
    8,291
    
    
    
    9,457
    
    
    
    16,665
    
    
    
    18,341Income (loss) from operations
    
    
    (1,133
    )
    
    
    946
    
    
    
    (2,558
    )
    
    
    1,821Other income (expense):Interest income
    
    
    31
    
    
    
    67
    
    
    
    59
    
    
    
    172Interest expense
    
    
    (93
    )
    
    
    (128
    )
    
    
    (185
    )
    
    
    (210
    )Other income (expense)
    
    
    306
    
    
    
    87
    
    
    
    143
    
    
    
    71Total other income
    
    
    244
    
    
    
    26
    
    
    
    17
    
    
    
    33Income (loss) before provision for income taxes
    
    
    (889
    )
    
    
    972
    
    
    
    (2,541
    )
    
    
    1,854Provision for income taxes
    
    
    33
    
    
    
    542
    
    
    
    136
    
    
    
    1,041Net income (loss)
    
    
    (922
    )
    
    
    430
    
    
    
    (2,677
    )
    
    
    813Accretion of preferred stock and dividend declared
    
    
    1,918
    
    
    
    6,618
    
    
    
    3,836
    
    
    
    8,536Net loss applicable to common stockholders
    
    $
    (2,840
    )
    
    $
    (6,188
    )
    
    $
    (6,513
    )
    
    $
    (7,723
    )Net loss per share applicable to common stockholders -
basic and diluted
    
    $
    (0.85
    )
    
    $
    (1.70
    )
    
    $
    (1.95
    )
    
    $
    (2.15
    )Weighted average number of common shares used in net
loss per share calculations  basic and diluted
    
    
    3,348
    
    
    
    3,646
    
    
    
    3,332
    
    
    
    3,598(1) Amounts include stock based expenses, as follows:Costs of service revenues
    
    $
    2
    
    
    $
    24
    
    
    $
    2
    
    
    $
    50Sales and marketing
    
    
    20
    
    
    
    40
    
    
    
    25
    
    
    
    79Research and development
    
    
    40
    
    
    
    83
    
    
    
    41
    
    
    
    179General and administrative
    
    
    
    
    
    
    326
    
    
    
    
    
    
    
    611Total stock based expenses
    
    $
    62
    
    
    $
    473
    
    
    $
    68
    
    
    $
    919
 See accompanying notes. 4




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Phase Forward Incorporated and Subsidiaries 
 Condensed Consolidated Statements of Cash Flows
 (unaudited)
  Six Months EndedJune 30,2003
    
    2004Operating activitiesNet income (loss)
    
    $
    (2,677
    )
    
    $
    813Adjustments to reconcile net income (loss) to net cash provided by operating activities:Depreciation and amortization
    
    
    2,820
    
    
    
    1,492Stock-based compensation
    
    
    68
    
    
    
    919Foreign currency exchange gain
    
    
    (145
    )
    
    
    (38
    )Provision for allowance for doubtful accounts
    
    
    
    
    
    
    65Non-cash income tax expense
    
    
    
    
    
    
    1,022Deferred rent
    
    
    (30
    )
    
    
    664Changes in assets and liabilities:Accounts receivable
    
    
    5,836
    
    
    
    7,495Deferred costs
    
    
    (345
    )
    
    
    (1,310
    )Prepaid expenses and other current assets
    
    
    32
    
    
    
    (474
    )Accounts payable
    
    
    (530
    )
    
    
    229Accrued expenses
    
    
    (790
    )
    
    
    (1,465
    )Deferred revenue
    
    
    (3,096
    )
    
    
    (2,647
    )Net cash provided by operating activities
    
    
    1,143
    
    
    
    6,765Investing activitiesPurchase of property and equipment
    
    
    (1,795
    )
    
    
    (1,240
    )Decrease in restricted cash, net
    
    
    310
    
    
    
    1,611Decrease (increase) in other assets
    
    
    182
    
    
    
    (13
    )Net cash provided by (used in) investing activities
    
    
    (1,303
    )
    
    
    358Financing activitiesProceeds from issuance of notes payable and borrowings under lines of credit
    
    
    681
    
    
    
    1,932Payments on lines of credit and notes payable
    
    
    (1,911
    )
    
    
    (1,266
    )Stock issuance costs
    
    
    
    
    
    
    (1,075
    )Repurchase of restricted common stock
    
    
    (111
    )
    
    
    Proceeds from issuance of common stock
    
    
    80
    
    
    
    90Proceeds from repayment of subscriptions receivable
    
    
    
    
    
    
    514Net cash provided by (used in) financing activities
    
    
    (1,261
    )
    
    
    195Effect of exchange rate changes on cash and cash equivalents
    
    
    162
    
    
    
    6Net change in cash and cash equivalents
    
    
    (1,259
    )
    
    
    7,324Cash and cash equivalents at beginning of year
    
    
    17,960
    
    
    
    19,046Cash and cash equivalents at end of period
    
    $
    16,701
    
    
    $
    26,370Non-cash financing activitiesAccretion of Series B, C, and D redeemable convertible preferred stock to redemption value
    
    $
    3,836
    
    
    $
    3,836Declaration of Special Dividend
    
    $
    
    
    
    $
    4,700
 See accompanying notes. 5




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Phase Forward Incorporated and Subsidiaries 
 Notes to Condensed Consolidated Financial Statements
(unaudited)
(in thousands, except share and per share amounts) 1. Organization and Basis of Presentation Organization Phase Forward Incorporated (the Company) is a provider of integrated
enterprise-level electronic data capture, data management and adverse event
reporting software solutions for use in the clinical trial component of the
Companys customers global research and development initiatives. The Company
offers software products, services and hosted solutions to pharmaceutical,
biotechnology and medical device companies, as well as academic institutions,
clinical research organizations and other entities engaged in clinical trials. The Company has operations in the United States, United Kingdom, France,
Germany, Japan and Australia. Basis of Presentation The accompanying unaudited condensed consolidated financial statements
included herein have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission (the SEC). Certain
information and footnote disclosures, normally included in financial statements
prepared in accordance with generally accepted accounting principles in the
United States have been condensed or omitted pursuant to such SEC rules and
regulations. Nevertheless, the management of the Company believes that the
disclosures herein are adequate to make the information presented not
misleading. In the opinion of management, the unaudited condensed consolidated
financial statements have been prepared on the same basis as the audited
consolidated financial statements and reflect all material adjustments
(consisting only of those of a normal and recurring nature) which are necessary
to present fairly the consolidated financial position of the Company as of June
30, 2004, the results of its operations for the three and six months ended June
30, 2003 and 2004 and its cash flows for the six months ended June 30, 2003 and
2004. These condensed consolidated financial statements and notes thereto
should be read in conjunction with the consolidated financial statements and
notes thereto included in the Companys Registration Statement No. 333-113594
on Form S-1. The results of operations for the interim periods are not
necessarily indicative of the results of operations to be expected for the year
ending December 31, 2004. On July 15, 2004, the Company sold 5,250,000 shares of common stock at
$7.50 per share in an initial public offering (IPO) resulting in net proceeds
of $34,600 after deducting underwriters discounts and estimated
offering-related expenses. These proceeds were received by the Company on July
20, 2004. In connection with the IPO, all of the
outstanding shares of the Companys preferred stock (and a warrant to purchase
preferred stock) were converted into an equal number of shares of common stock
(and a warrant to purchase common stock). Because the offering closed after
June 30, 2004, the results of the offering are not reflected in the
accompanying unaudited condensed consolidated financial statements. A summary
of the terms of the offering can be found in the Companys Registration
Statement No. 333-113594 on Form S-1 as filed with the SEC. 6




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) 2. Accounting Policies Principles of Consolidation The condensed consolidated financial statements include the accounts of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates. Revenue Recognition and Deferred Setup Costs The Company derives revenues from software licenses and services. License
revenue is derived principally from the sale of multi-year software term
licenses of the Companys InForm, Clintrialand Clintracesoftware products.
Service revenue is derived from the Companys delivery of the hosted solution
of its InFormsoftware product, consulting services and customer support,
including training. The components of revenue are as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004License
    
    $
    5,164
    
    
    $
    6,357
    
    
    $
    9,930
    
    
    $
    12,523Application hosting
services
    
    
    4,899
    
    
    
    6,689
    
    
    
    10,102
    
    
    
    12,601Consulting services
    
    
    1,147
    
    
    
    1,215
    
    
    
    2,319
    
    
    
    2,779Customer support
    
    
    3,466
    
    
    
    3,432
    
    
    
    7,272
    
    
    
    6,752Total
    
    $
    14,676
    
    
    $
    17,693
    
    
    $
    29,623
    
    
    $
    34,655
 The Company recognizes software license revenue in accordance with
Statement of Position (SOP) No. 97-2, Software Revenue Recognition,as amended,
issued by the American Institute of Certified Public Accountants, while
revenues resulting from application hosting services are recognized in
accordance with Emerging Issues Task Force (EITF) Issue No. 00-03 Application
of AICPA Statement of Position 97-2 to Arrangements that include the Right to
Use Software Stored on Another Entitys Hardwareand Securities and Exchange
Commissions (SEC) Staff Accounting Bulletin (SAB) Nos. 101 and No. 104,
Revenue Recognition. On August 1, 2003, the Company adopted EITF Issue No.
00-21, Revenue Arrangements with Multiple Deliverables.This adoption did not
have, and is not expected to have in future reporting periods, a material
impact on the Companys financial position or results of operations. 7




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) Customers generally have the ability to terminate application hosting,
consulting and training service agreements upon 30 days notice to the Company.
Multiple element arrangements, including license and services agreements, and
certain application hosting services can generally be terminated by either
party for material breach of obligations generally not corrected within 30 days
after notice of the breach. The Company recognizes revenue when all of the following conditions are
satisfied: (1) there is persuasive evidence of an arrangement; (2) the service
has been provided to the customer; (3) the collection of fees is probable; and
(4) the amount of fees to be paid by the customer is fixed or determinable. The Company generally enters into software term licenses with its
customers for three to five year periods. These arrangements typically include
multiple elements: a software license, consulting services and customer
support. The Company bills its customers in accordance with the terms of the
underlying contract. Generally, the Company bills the annual license fee for
the first year of a multi-year contract in advance and bills the license fees
for the subsequent years on the anniversary date. The Companys payment terms
are generally net 30 days. The Companys software license revenue is earned from the sale of
off-the-shelf software requiring no significant modification or customization
subsequent to delivery to the customer. Consulting services, which can also be
performed by third-party consultants, are deemed to be non-essential to the
functionality of the software and typically are for trial configuration,
implementation planning, loading of software, building simple interfaces and
running test data and documentation of procedures. The Company generally bundles customer support with the software license
for the entire term of the license. As a result, the Company generally
recognizes revenues for all elements, including consulting services, ratably
over the term of the software license and support arrangement. The Company
allocates the revenue recognized for these arrangements to the different
elements based on managements estimate of the relative fair value of each
element. For its term-based licenses, the Company allocates to consulting
services the anticipated service effort and value throughout the term of the
arrangement at an amount that would have been allocated had those services been
sold separately to the customer. The remaining value is allocated to license
and support services, with 10% of this amount allocated to support services.
The Company has allocated the estimated fair value to its multiple element
arrangements to provide meaningful disclosures about each of its revenue
streams. The costs associated with the consulting and customer support services
are expensed as incurred. There are instances in which the Company sells
software licenses based on usage levels. These software licenses can be based
on estimated usage, in which case the license fee charged to the customer is
fixed based on this estimate. When the fee is fixed, the revenue is recognized
ratably over the contractual term of the arrangement. If the fee is based on
actual usage, and therefore variable, the revenue is recognized in the period
of use. Revenues from certain follow-on consulting services, which are sold
separately to customers with existing software licenses and are not considered
part of a multiple element arrangement, are recognized as the services are
performed. In addition to making its software products available to customers through
licenses, the Company offers its InFormelectronic data capture software
product through a fully-hosted, turnkey deployment. Revenues resulting from
application hosting services consist of three stages for each clinical trial.
The first stage includes trial and application setup, including design of
electronic case report forms and edit checks, implementation of the system and
server configuration. The second 8




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) stage consists of application hosting and related support services. The third
stage, database lock, consists of services required to close out, or lock, the
database for the clinical trial. Services provided for the first and third
stages are provided on a fixed fee based upon the complexity of the trial and
system requirements. Services for the second stage are charged separately as a
fixed monthly fee. The Company recognizes revenue from application hosting and
related services over the hosting period. Fees charged and costs incurred for
the trial system design, setup and implementation are deferred and capitalized
as applicable, until the start of the hosting period. These revenues and costs
are recognized and amortized, as applicable, ratably over the estimated hosting
period. The capitalized costs include incremental direct costs with third
parties and certain internal direct costs of the trial and application setup,
as defined under Statement of Financial Accounting Standards (SFAS) No. 91,
Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Indirect Costs of Leases.These costs include salary and
benefits associated with direct labor costs incurred during trial setup, as
well as third-party subcontract fees and other contract labor costs. Work
performed outside the original scope of work is contracted for separately as an
additional fee and is generally recognized over the remaining term of the
hosting period. In the event that an application hosting customer cancels a clinical trial
and its related statement of work, all deferred revenue is recognized and all
deferred setup costs are expensed and certain termination related fees may be
charged. The Company capitalized $719 and $849 of deferred setup costs and
amortized $946 and $880 during the six months ended June 30, 2003 and 2004,
respectively. The amortization of deferred setup costs is a component of cost
of services. The Company continues to sell the Clintrialand Clintracesoftware
products to certain existing customers as perpetual software licenses with the
option to purchase customer support. The Company does not sell perpetual
licenses to new customers. The Company has established vendor specific
objective evidence of fair value for the customer support in these
arrangements. Accordingly, the license revenue is recognized upon delivery of
the software and when all other revenue recognition criteria are met. The
customer support is recognized ratably over the term of the underlying support
arrangement. The Company continues to generate customer support and maintenance
revenue from its perpetual license customer base. Training revenue is
recognized as earned. Deferred revenue represents amounts billed or cash received in advance of
revenue recognition. Provisions for estimated losses on uncompleted contracts are made on a
contract-by-contract basis and are recognized in the period in which such
losses become probable and can be reasonably estimated. To date, the Company
has not experienced any material losses on uncompleted application hosting
contracts. In November 2001, the EITF of the Financial Accounting Standards Board
(FASB) issued EITF Issue No. 01-14, Income Statement Characterization of
Reimbursements Received for Out-of-Pocket Expenses Incurred.EITF Issue No.
01-14 requires reimbursable out-of-pocket expenses incurred to be characterized
as revenue in the income statement. The Company included $526 and $424 of
reimbursable out-of-pocket expenses in service revenue and cost of service
revenue in the six months ended June 30, 2003 and 2004, respectively. 9




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) Prepaid Sales Commissions and Royalties The Company capitalized $1,278 and $1,580 of commissions and amortized to
sales and marketing expense $703 and $1,249 during the six months ended June
30, 2003 and 2004, respectively. The Company capitalized $828 and $2,201 of
royalties and amortized to cost of revenues $815 and $1,189 during the six
months ended June 30, 2003 and 2004, respectively. Net Loss Per Share Basic net loss per common share was determined by dividing net loss
applicable to common stockholders by the weighted average common shares
outstanding during the period. Weighted average shares outstanding exclude
unvested restricted common stock. The Companys potentially dilutive shares,
which include outstanding common stock options, warrants, and redeemable
convertible preferred stock also have not been included in the computation of
diluted net loss per share for all periods as the result would be
anti-dilutive. The calculation of basic and diluted net loss per share is as
follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Net loss applicable
to common
stockholders
    
    $
    (2,840
    )
    
    $
    (6,188
    )
    
    $
    (6,513
    )
    
    $
    (7,723
    )Computation of
basic and diluted
net loss per share:Weighted average
shares outstanding
    
    
    3,421,805
    
    
    
    3,676,748
    
    
    
    3,410,321
    
    
    
    3,633,898Less: Weighted
average unvested
restricted common
shares outstanding
    
    
    (73,316
    )
    
    
    (30,399
    )
    
    
    (78,681
    )
    
    
    (35,764
    )Shares used in
computing net loss
per share
    
    
    3,348,489
    
    
    
    3,646,349
    
    
    
    3,331,640
    
    
    
    3,598,134Net loss per share
applicable to
common stockholders
- basic and diluted
    
    $
    (0.85
    )
    
    $
    (1.70
    )
    
    $
    (1.95
    )
    
    $
    (2.15
    )
 10




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) The following common share equivalents and unvested restricted shares have
been excluded from the computation of diluted weighted average shares
outstanding as of June 30, 2003 and 2004, as they would be anti-dilutive. As of June 30,2003
    
    2004Redeemable convertible preferred stock
    
    
    22,841,157
    
    
    
    22,841,157Options outstanding
    
    
    4,220,111
    
    
    
    4,457,525Unvested restricted shares
    
    
    67,971
    
    
    
    25,035Warrant
    
    
    34,330
    
    
    
    34,330
 Foreign Currency Translation The financial statements of the Companys foreign subsidiaries are
translated in accordance with No. 52, Foreign Currency Translation.The
reporting currency for the Company is the U.S. dollar (dollar). The functional
currency of the Companys subsidiaries in the United Kingdom, France, Japan and
Australia are the local currencies of those countries. Accordingly, the assets
and liabilities are translated into U.S. dollars using the exchange rate in
effect at each balance sheet date. Revenue and expense accounts are generally
translated using an average rate of exchange during the period. Foreign
currency translation adjustments are accumulated as a component of other
comprehensive loss as a separate component of stockholders deficit. Gains and
losses arising from transactions denominated in foreign currencies are
primarily related to intercompany accounts that have been determined to be
temporary in nature and cash and accounts receivable denominated in
nonfunctional currencies. The Company has recorded foreign currency gains of
approximately $308 and $54 in the three months ended June 30, 2003 and 2004,
respectively, and approximately $145 and $38 in the six months ended June 30,
2003 and 2004, respectively, and such gains are included in other income
(expense) in the accompanying condensed consolidated statements of operations. Cash and Cash Equivalents The Company 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 positive intent and ability to
hold to maturity are reported at amortized cost, which approximates market
value, and are classified as held-to-maturity. The Company considers all highly
liquid investments with original maturities of 90 days or less at the time of
purchase to be cash equivalents. At December 31, 2003 and June 30, 2004, cash
equivalents primarily consisted of money market funds that were readily
convertible to cash. At December 31, 2003, the Company had approximately $1,611 of restricted
cash held in certificates of deposit as collateral for letters of credit
related to facility leases. The certificates of deposit matured and the
collateral for the letters of credit is now reflected as a reduction in the
amount available under the line of credit. 11




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) Cash and cash equivalents as of December 31, 2003 and June 30, 2004 were
as follows: December 31, 2003Description
    
    Contracted Maturity
    
    Amortized Cost
    
    Fair Market ValueCash and cash equivalents
    
    
    
    
    
    $
    14,927
    
    
    $
    14,927Money market funds
    
    0-3 months
    
    
    4,119
    
    
    
    4,119Total
    
    
    
    
    
    $
    19,046
    
    
    $
    19,046
 June 30, 2004Description
    
    Contracted Maturity
    
    Amortized Cost
    
    Fair Market ValueCash and cash equivalents
    
    
    
    
    
    $
    14,897
    
    
    $
    14,897Money market funds
    
    0-3 months
    
    
    9,648
    
    
    
    9,648Certificate of deposit
    
    1 month
    
    
    1,825
    
    
    
    1,825Total
    
    
    
    
    
    $
    26,370
    
    
    $
    26,370
 The Company has had no realized gains or losses to date on the sale of
money market funds. The numbers contained in the foregoing table do not
include $34,600 of net proceeds from the Companys initial public offering,
which were received by the Company on July 20, 2004, after the end of the
second quarter of 2004. Stock-Based Compensation In January 2003, the FASB issued SFAS No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure, an amendment of FASB Statement No. 123,
which provides alternative methods of transition for a voluntary change to a
fair-value-based method of accounting for stock-based employee compensation. In
addition, SFAS No. 148 amends the disclosure requirements of SFAS No. 123,
Accounting for Stock-Based Compensation,to require prominent disclosures in
annual financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used on reported results.
The Company has determined that it will continue to account for options granted
under its stock-based compensation plans for employees (see Note 11) under
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued
to Employees, and has elected the disclosure-only alternative under SFAS No.
123 and the enhanced disclosures as required by SFAS No. 148. Under APB Opinion
No. 25, when the exercise price of options granted under these plans equals or
exceeds the market price of the underlying stock on the date of grant, no
compensation expense is required. The following tables illustrate the assumptions used and the effect on net
loss if the Company had applied the fair value recognition provisions of SFAS
No. 123 to stock-based employee compensation. The Company has computed the pro
forma disclosures required under SFAS No. 123 12




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) for all employee stock options granted using the Black-Scholes option
pricing model prescribed by SFAS No. 123. The assumptions used and weighted average information are as follows: Three Months
    
    Six MonthsEnded
    
    EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Average risk-free interest rate
    
    
    3.37%
    
    
    
    4.07%
    
    
    
    3.34%
    
    
    
    3.61%Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Expected life
    
    7 years
    
    
    7 years
    
    
    7 years
    
    
    7 yearsExpected volatility
    
    
    0%
    
    
    
    90%
    
    
    
    0%
    
    
    
    0-90%Weighted average fair value at grant date
    
    $
    2.63
    
    
    $
    5.49
    
    
    $
    1.96
    
    
    $
    6.00
 Had compensation costs been determined consistent with SFAS No. 123, the
Companys net loss would have been the following pro-forma amounts: Three Months
    
    Six MonthsEnded
    
    EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Net loss applicable to
common stockholders, as
reported
    
    $
    (2,840
    )
    
    $
    (6,188
    )
    
    $
    (6,513
    )
    
    $
    (7,723
    )Add: Stock-based
compensation expense
included in reported
net income (loss)
    
    
    62
    
    
    
    473
    
    
    
    68
    
    
    
    919Less: Total
stock-based employee
compensation expense
determined under
fair-value-based
method for all awards
    
    
    (375
    )
    
    
    (604
    )
    
    
    (712
    )
    
    
    (1,202
    )Pro forma net loss
    
    $
    (3,153
    )
    
    $
    (6,319
    )
    
    $
    (7,157
    )
    
    $
    (8,006
    )Pro forma net loss per
share applicable to
common stockholders
    
    $
    (0.94
    )
    
    $
    (1.73
    )
    
    $
    (2.15
    )
    
    $
    (2.23
    )
 13




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) 3. Goodwill A rollforward of the net carrying amount of goodwill is as follows: Six Months EndedJune 30,2004Balance as of December 31, 2003
    
    $
    23,780Utilization of acquired net operating
losses
    
    
    (1,022
    )Balance as of June 30, 2004
    
    $
    22,758
 Phase Forward acquired Clinsoft Corporation, which developed and sold the
Clintrialand Clintraceproducts, on August 14, 2001. The goodwill resulting
from the acquisition is reviewed for impairment on an annual basis in
accordance with SFAS No. 142, Goodwill and Other Intangible Assets.The
Company performed its annual impairment test as of October 1, 2002 and 2003 and
determined that no impairment of goodwill or intangible assets existed. The utilization of acquired net losses reflects a reduction in cash
payments to local taxing authorities for income taxes that are not reflected as
a benefit in the income tax provision for financial statement purposes. 4. Accrued Expenses Accrued expenses consist of the following: As of December 31,
    
    As of June 30,2003
    
    2004Accrued payroll and
related benefits
    
    $
    4,682
    
    
    $
    4,066Accrued other expenses
    
    
    4,694
    
    
    
    4,237Accrued royalties
    
    
    1,597
    
    
    
    2,274$
    10,973
    
    
    $
    10,577
 5. Restructuring Charge The Company recorded a $4,503 restructuring charge for the year ended
December 31, 2003 that related to the relocation of the Companys corporate
headquarters in December 2003. $2,486 of this charge represents the loss on a
facilities lease and $2,017 related to the abandonment of the related fixed
assets and leasehold improvements. The facility lease loss represents 15 months
of rent remaining under an existing lease and related operating expenses. The
Company anticipates that the lease loss will be settled by March 2005. The
Company does not anticipate any sublease income over the remaining term of the
lease agreement. 14




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) The components of the restructuring charges are as follows: LeaseLossBalance as of December 31, 2003
    
    $
    2,486Payments made during the six months ended June 30, 2004
    
    
    (1,041
    )Balance as of June 30, 2004
    
    $
    1,445
 6. Income Taxes The effective tax rate for 2003 was approximately 7% and represents
foreign withholding taxes and income taxes payable in certain foreign locations
that cannot be offset through loss carryforwards. The effective tax rate for
2004 is approximately 37% before stockbased compensation and represents income
tax expense that cannot be offset through the use of acquired net operating
losses for financial statement purposes. The increase in the effective tax
rate is primarily due to the profitability of the Companys U.S. operations.
In utilizing its net operating loss carryforwards, the Company is required to
use its oldest net operating losses first. As a result the Company will first
use the net operating losses acquired in the Clinsoft acquisition. The
utilization of the acquired net operating losses will reduce the amount of
income taxes payable to local tax authorities. This cash benefit will be
reflected as a reduction of goodwill. Additionally, the Companys effective tax
rate exceeds its statutory tax rate due to the current non-deductibility of its
stock-based compensation. 7. Debt Lines of Credit Between April 2000 and March 2004, the Company entered into several
equipment lines of credit with a bank. All advances under these equipment lines
of credit are payable in 30 to 36 equal monthly installments of principal, plus
accrued interest. The interest that accrues under these notes ranges from prime
rate (4.0% and 4.25% at December 31, 2003 and June 30, 2004, respectively) to
prime rate plus 1.0%. As of December 31, 2003 and June 30, 2004, there was a
total of $4,188 and $4,854, respectively, outstanding under all of the
Companys equipment lines of credit. At December 31, 2003 and June 30, 2004
there was $2,155 and $4,052, respectively, available under the equipment lines
of credit. In 2003, the Company renewed its $2,500 working capital line of credit
with a bank. Interest accrued at prime rate plus 0.25%. Effective March 31,
2004, the Company renewed its working capital line of credit with a bank under
which it can borrow up to $5,000. Interest accrues at prime rate. All advances
made under the working capital line shall be immediately due and payable on
March 31, 2006. As of each of December 31, 2003 and June 30, 2004, $2,500 was
outstanding under the working capital line of credit. At June 30, 2004, there
was $889 available under the line of credit, which reflects amounts used to
replace the restricted cash associated with the Companys leased facilities.
Subsequent to June 30, 2004, the Company paid the $2,500 outstanding under the
working capital line of credit. 15




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) Borrowings under these agreements are secured by substantially all assets
of the Company, excluding intellectual property. The Company has entered into a
negative pledge agreement that, subject to certain exceptions, generally
prohibits the Company from pledging its intellectual property to others. Under
the terms of the agreement, the Company is required to comply with certain
financial covenants, including attainment of minimum revenues, minimum earnings
and financial ratios. At December 31, 2003, the Company was in violation of the
financial covenant related to minimum revenue levels in the fourth quarter of
2003 and received a waiver from the bank. The bank waived the Companys
covenant violation for only the fourth quarter of 2003. At June 30, 2004, the
Company was in compliance with all financial covenants. 8. Contingencies From time to time and in the ordinary course of business, the Company may
be subject to various claims, charges and litigation. At June 30, 2004, the
Company did not have any pending claims, charges or litigation that it expects
would have a material adverse effect on its consolidated financial position,
results of operations or cash flows. On April 26, 2004, Datasci, LLC (Datasci) filed suit (Civil Action No.
04-1328 (MJG)) in the United States District Court for the District of Maryland
(Greenbelt Division) against Phase Forward Incorporated and Quintiles Inc., one
of the Companys customers. Datasci had asserted that the Companys InForm,
Clintrialand Clintrial Integration Solutionproducts and its services, and the
products and services of Quintiles, infringe a United States patent claimed to
be owned by Datasci (Patent No. 6,496,827). Datasci sought an injunction and
unspecified damages from each of the Company and Quintiles. On May 4, 2004, the Company filed an Answer and Counterclaim to Datascis
complaint denying that it infringes the patent which Datasci claimed to own.
The Answer also challenged the validity of the patent and asserted numerous
affirmative defenses. The Companys Counterclaim sought a declaratory judgment
that the Company does not infringe the patent claimed to be owned by Datasci.
Datasci responded by denying all the allegations in the Companys Counterclaim.
On or about June 7, 2004, Datasci filed a motion to dismiss its complaint
against Phase Forward and Quintiles. In its filing, Datasci disclosed that it
did not exist when its complaint against Phase Forward and Quintiles was filed.
That motion was granted and, thus, the entire action was dismissed on August 5,
2004. Also on or about June 7, 2004, Dr. Mark L. Kozam, doing business under the
name MLK Software and claiming to be the owner of the patent, filed suit (Civil
Action No. 04-CV-1787 (PJM)) in the same court where Datasci filed its initial
complaint against Phase Forward and Quintiles. Dr. Kozams complaint contains
the same allegations and seeks the same remedies that were contained in the
Datasci complaint. On June 22, 2004, the Company filed an Answer and
Counterclaim to Dr. Kozams complaint denying that it infringes the patent,
challenging the validity of the patent, asserting numerous affirmative
defenses, and counterclaiming for a declaratory judgment that the Company does
not infringe any valid claim of the patent. Dr. Kozam responded by denying all
the allegations in the Companys Counterclaim. Although this action is in the initial pleading stage, the Company is
prepared to vigorously defend the claims and pursue its Counterclaims and any
other remedies available to the Company. Due to the preliminary nature of this
action, the Company is unable to assess whether its outcome will have a
material adverse effect on its results of operations. 16




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) 9. Redeemable Convertible Preferred Stock and Warrant On June 1, 2004, the Companys board of directors declared a special cash
dividend of $4,700, payable on September 15, 2004, to the holders of
record of Series B, C and D Preferred Stock as of June 15, 2004. This
distribution is included in accrued special distribution and net loss to common
stockholders as of June 30, 2004. Accretion of Series B, C and D redeemable convertible preferred stock was
$1,918 for the three months ended June 30, 2003 and 2004, and $3,836 for the
six months ended June 30, 2003 and 2004. In connection with the closing of the Companys initial public offering in
July 2004, all outstanding shares of the redeemable convertible preferred stock
were converted into 22,841,157 shares of common stock and the preferred stock
warrant automatically converted into a warrant to purchase 34,330 shares of
common stock. 10. Stockholders Equity Common Stock On July 15, 2004, the Company sold 5,250,000 shares of common stock at
$7.50 per share in an initial public offering (IPO) resulting in net proceeds
of $34,600 after deducting underwriters discounts and estimated
offering-related expenses. On March 11, 2004, the Board of Directors approved an increase to the
number of authorized shares of the capital stock to 105 million shares,
consisting of 100 million shares of common stock and 5 million shares of
preferred stock. Also on March 11, 2004, the Board of Directors approved the
2004 Stock Option and Incentive Plan and the 2004 Employee Stock Purchase Plan,
each to become effective upon the closing of the Companys initial public
offering, and an amendment to the 2003 Non-Employee Director Stock Option Plan,
all of which were approved by the stockholders on April 20, 2004. The 2004
Employee Stock Purchase Plan is available to all eligible employees, who may
individually purchase a maximum of 10,000 shares annually at a price equal to
85 percent of the lower of the fair market value at the start date of the
offering or fair market value on the semi-annual purchase dates. The Company
has reserved for issuance an aggregate of 320,000 shares of common stock for
this plan. The Company has reserved for issuance an aggregate of 1,500,000
shares of common stock under the 2004 Stock Option and Incentive Plan which
will be the successor equity incentive program to the 1997 Stock Option Plan.
For the 2003 Non-Employee Director Stock Option Plan, the Company has reserved
for issuance an aggregate of 562,000 shares of common stock. There was $627 and $113 of notes receivable outstanding at December 31,
2003 and June 30, 2004, respectively. Deferred Compensation The Company records deferred stock-based compensation in the amount by
which the exercise price of an option is less than the deemed fair value of its
common stock at the date of grant. Because there had been no public market for
the Company stock, the Companys Board of Directors had determined the fair
value of the common stock on the date of grant based upon several factors,
including, but not limited to, the Companys operating and financial
performance, the issuances of 17




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Phase Forward Incorporated and Subsidiaries Notes to Condensed Consolidated Financial Statements (continued)
(unaudited)
(in thousands, except share and per share amounts) convertible preferred stock, the rights and preferences of all securities
senior to common stock and the anticipated offering price of the common stock
in connection with the Companys initial public offering. During 2003, all
stock options were granted with an exercise price of $3.00 per share, while the
estimated per share fair value of the Companys common stock ranged from $3.00
to $4.00 in the first quarter of 2003, $4.00 to $5.00 in the second quarter of
2003, $5.00 to $7.50 in the third quarter of 2003 and $7.50 to $9.00 in the
fourth quarter of 2003. During the six months ended June 30, 2004, options were
granted at exercise prices ranging from $4.50 to $6.00 per share while the
estimated fair value of the Companys common stock was $10.00 per share. The
Company recorded deferred compensation of $3,060 and $1,508 in the year ended
December 31, 2003 and the six months ended June 30, 2004, respectively. The
Company amortized $62 and $68 to expense in the three months ended June 30,
2003 and 2004, respectively. The Company amortized $473 and $919 to expense in
the six months ended June 30, 2003 and 2004, respectively. As of June 30,
2004, there was an aggregate of $2,922 of deferred stock-based compensation
remaining to be amortized approximately as follows: $870 in the year ending
December 31, 2004; $1,042 in the year ending December 31, 2005; $583 in the
year ending December 31, 2006; $270 in the year ending December 31, 2007 and
$157 through December 31, 2011. The Company amortizes the deferred compensation
charges over the vesting period of the underlying option awards in accordance
with FIN 28. In the six months ended June 30, 2004, the Company granted options to purchase
205,000 shares of common stock that vest upon the earlier of 7 years from date
of grant or the attainment of specified milestones. As a result of the
Companys initial public offering on July 15, 2004, 61,250 of these options
were accelerated and became vested and exercisable, resulting in the
acceleration of $264,300 in stock-based compensation. 12. Comprehensive Income (Loss) Comprehensive income (loss) consisted of the following: Three Months
    
    Six MonthsEnded
    
    EndedJune 30,
    
    June 30,2003
    
    2004
    
    2003
    
    2004Net income (loss)
    
    $
    (922
    )
    
    $
    430
    
    
    $
    (2,677
    )
    
    $
    813Cumulative translation adjustment
    
    
    (351
    )
    
    
    (28
    )
    
    
    (114
    )
    
    
    (109
    )Comprehensive income (loss)
    
    $
    (1,273
    )
    
    $
    402
    
    
    $
    (2,791
    )
    
    $
    704
 18




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and
Results of Operations. Forward Looking Statements May Prove Inaccurate The following discussion and analysis of our financial condition and
results of operations should be read in conjunction with our condensed
consolidated financial statements and related notes that appear elsewhere in
this Quarterly Report onForm 10-Q. In addition to historical consolidated
financial information, the following discussion contains forward-looking
statements that reflect our plans, estimates and beliefs. Our actual results
could differ materially from those discussed in the forward-looking statements.
Factors that could cause or contribute to these differences include those
discussed below and elsewhere in this Quarterly Report onForm 10-Q. Overview We are a provider of integrated enterprise-level electronic data capture,
management and adverse event reporting software solutions for use in the
clinical trial component of our customers global research and development
initiatives. We offer software products, services and hosted solutions to
pharmaceutical, biotechnology and medical device companies, as well as academic
institutions, clinical research organizations and other entities engaged in
clinical trials. By automating essential elements of the clinical trial
process, we believe our products allow our customers to accelerate the market
introduction of new medical therapies and corresponding revenue, reduce overall
research and development expenditures, enhance existing data quality control
efforts and reduce clinical and economic risk. Initial Public Offering On
July 15, 2004, we sold 5,250,000 shares of common stock at $7.50 per
share in an initial public offering (IPO) resulting in net proceeds of $34.6
million after deducting underwriters discounts and estimated offering-related
expenses. Sources of Revenues We derive our revenues from software licenses and services. License
revenue is derived principally from the sale of multi-year software term
licenses for our InForm, Clintrialand Clintracesoftware products. Service
revenue is derived from our delivery of the hosted solution of our InForm
software product, consulting services and customer support, including training.
We generally recognize revenues ratably over the life of a license or service
contract. This allows us to maintain a backlog that provides multi-year
visibility in revenue. As our backlog grows, we believe that the predictability
of our future revenues will increase. One customer, Eli Lilly and Company, the
holder of record of approximately one percent of our capital stock, accounted
for approximately 8% and 12% of our total revenues in the six months ended June
30, 2003 and 2004, respectively. Our top 20 customers accounted for
approximately 68% and 69% of our total revenues in the six months ended June
30, 2003 and 2004, respectively, net of reimbursable out-of-pocket expenses. License Revenue We derive our license revenues from our three major software products:
InForm, our Internet based electronic data capture solution; Clintrial, our
clinical data management solution; and Clintrace, our adverse event reporting
solution. Although each of our InForm, Clintrialand 19




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##### Table of Contents



Clintracesoftware solutions are available as stand-alone enterprise
applications, we offer integrated enterprise solutions incorporating certain of
our electronic data capture, data management and adverse event reporting
products. License revenues for our InFormelectronic data capture software solution,
either on a stand-alone or integrated basis, are determined primarily by the
number, complexity and duration of the clinical trials and the number of
participants in each clinical trial. License revenues for our Clintrialand
Clintracesoftware solutions are determined primarily by the number of users
accessing the software solution. Except as discussed below, we enter into
software license agreements with terms generally of three to five years with
payment terms generally annually in advance. License revenues are recognized
ratably over the duration of the software term license agreement, to the extent
that amounts are fixed or determinable and collectable. In August 2001, we acquired Clinsoft Corporation, which developed,
marketed and sold the Clintrialclinical data management and Clintraceadverse
event reporting and tracking products. Historically, Clinsoft sold the
Clintrialand Clintracesoftware products as a perpetual software license with
the option to purchase customer support. Following the acquisition and
subsequent integration of our software products, we began converting holders of
Clinsoft perpetual software licenses to our software term license arrangements.
We continue to sell perpetual licenses of these products in certain situations
to our existing customers. We recognize revenue on the perpetual licenses upon
delivery of the software. Perpetual license revenue represented less than one
percent of total revenue for the six months ended June 30, 2003 and June 30,
2004. We continue to provide and charge for maintenance and support on our
products to those customers who do not convert to our software term license
arrangements. We generally charge 18% of the perpetual license fee for customer
support. We will continue our efforts to convert the remaining former Clinsoft
customer base to software term license arrangements. Service Revenue Application Hosting ServicesIn addition to making our software products
available to customers through licenses, we offer our InFormelectronic data
capture software as a hosted application solution delivered through a standard
web-browser, with customer support and training services. Revenue resulting
from this hosting service consists of three stages for each clinical trial:  
    
    First stage trial and application setup, including design of
electronic case report forms and edit checks, installation and server
configuration of the system;  
    
    Second stage application hosting and related support services; and  
    
    Third stage services required to close out, or lock, the database for the clinical trial. Services provided for the first and third stages are provided on a fixed
fee basis depending upon the complexity of the trial and system requirements.
Services for the second stage are charged separately as a fixed monthly fee. We
recognize revenue from all stages of the hosting service over the second and
third stages. Fees charged and costs incurred for the trial system design,
setup and implementation are deferred until the start of the second stage and
then amortized ratably over the estimated hosting period. The deferred costs
include direct costs related to the trial and application setup. Fees for the
first and third stages of the services are billed based upon milestones. Fees
for application hosting and related services in the second stage are billed
quarterly in advance. Bundled into this revenue element is the revenue
attributable to the software license used by the customer. In the event that an application hosting customer cancels a clinical trial
and its related statement of work, all deferred revenue is recognized and all
deferred setup costs are expensed and certain termination-related fees may be
charged. In addition, application hosting services revenue includes 20




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hosting services associated with term license arrangements and
reimbursable out-of-pocket expenses. Consulting Services.Consulting services include the design and
documentation of the processes related to our customers use of our products
and services in their clinical trials. Consulting services also include project
planning and management services, guidance on best practices in using our
software products, as well as implementation services consisting of application
architecture design, systems integration, installation and validation. In
addition, consulting services revenue includes reimbursable out-of-pocket
expenses. Revenues from consulting services included in a multiple element
software license agreement or in a hosted solution are recognized ratably over
the term of the arrangement. The associated costs are expensed as incurred.
Revenues from consulting services that are not included in a multiple element
software license arrangement are recognized as services are performed. Fixed
priced arrangements are billed based upon contractual milestones, and
time-and-materials arrangements are billed monthly. Customer Support.We have a multinational services organization to support
our software products and hosted solutions worldwide. Customer support includes
telephone support, software maintenance and training. We bundle customer
support in our software term licenses and allocate 10% of the value of the
license to customer support revenue. Our customer support revenue also consists
of customer support fees paid by the Clintrialand Clintraceperpetual license
customers. Customer support revenue is recognized ratably over the period of
the customer support or term license agreement, with payment terms generally
annually in advance. Cost of Revenues and Operating Expenses We allocate overhead expenses such as rent and occupancy charges and
employee benefit costs to all departments based on headcount. As such, general
overhead expenses are reflected in cost of service revenues and in the sales
and marketing, research and development, and general and administrative expense
categories. Cost of Revenues.Cost of license revenues consists primarily of the
amortization of royalties paid for certain modules within our Clintrial
software product and the amortization of acquired technologies. The cost of
license revenue varies based upon the mix of revenue from software licenses for
our products. We operate our service organization on a global basis as one
distinct unit, and do not segment costs for our various service revenue
elements. These services include performing application hosting, consulting and
customer support services, and costs consist primarily of employee-related
costs associated with these services, amortization of the deferred clinical
trial setup costs, allocated overhead, outside contractors, royalties
associated with providing customer support for third-party modules licensed to
our customers for use with the Clintrialsoftware product and reimbursable
out-of-pocket expenses. Cost of services also includes hosting costs that
primarily consist of hosting facility fees and server depreciation. The cost of
service revenue varies based upon employee utilization levels in the service
organization and royalties associated with revenue derived from providing
customer support, as well as costs associated with the flexible use of outside
contractors to support internal resources. We supplement the trial design and
setup activity for application hosting services through the use of outside
contractors. This allows us to utilize outside contractors in those periods
where trial design and setup activity is highest while reducing the use of
outside contractors in those periods where trial activity lessens, allowing for
a more flexible delivery model. The percentage of the services workforce
represented by outside contractors varies from period to period depending on
the volume of specific support required. The cost of services is significantly
higher as a percentage of revenue as compared to our cost of license revenue
primarily due to the employee-related and outside contractor expenses
associated with providing services. Gross Margin.Our gross margin on license revenue varies based on the mix
of royalty-and non-royalty-bearing license revenue and the amount of
amortization of acquired technologies. Our gross 21




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margin on service revenue varies primarily due to variations in the
utilization levels of the professional service team and the timing of expense
and revenue recognition under our service arrangements. In situations where the
service revenue is recognized ratably over the software license term, typically
three to five years, our costs associated with delivery of the services are
recognized as the services are performed, which is typically during the first 9
to 12 months of the contract period. Accordingly, our gross margin on service
revenue may vary depending upon the length of these arrangements. Sales and Marketing.Sales and marketing expenses consist primarily of
employee-related expenses, including travel, marketing programs (which include
product marketing expenses such as trade shows, workshops and seminars,
corporate communications, other brand building and advertising), allocated
overhead and the amortization of commissions. We expect that sales and
marketing expenses will increase as we expand and further penetrate our
customer base, expand our domestic and international selling and marketing
activities associated with existing and new product and service offerings,
build brand awareness and sponsor additional marketing events. Research and Development.Research and development expenses consist
primarily of employee-related expenses, allocated overhead and outside
contractors. We have historically focused our research and development efforts
on increasing the functionality, performance and integration of our software
products. We expect that in the future, research and development expenses will
increase as we introduce additional integrated software solutions to our
product suite. General and Administrative.General and administrative expenses consist
primarily of employee-related expenses, professional fees, other corporate
expenses and allocated overhead. We expect that in the future, general and
administrative expenses will increase as we add personnel and incur additional
professional fees and insurance costs related to the growth of our business and
operations. Stock-Based Expenses.Our cost of service revenues and operating expenses,
excluding our restructuring charges, include stock-based expenses related to
the fair value of options issued to non-employees and option grants to
employees in situations where the exercise price is determined to be less than
the deemed fair value of our common stock at the date of grant. Foreign Currency Translation With regard to our international operations, we frequently enter into
transactions in currencies other than the U.S. dollar. As a result, our
revenues, expenses and cash flows are subject to fluctuations due to changes in
foreign currency exchange rates, particularly changes in the Euro, British
pound sterling, Australian dollar and Japanese yen. In the six months ended
June 30, 2003 and 2004, approximately 39% and 40%, respectively, of our
revenues were generated in locations outside the United States. In the three
months ended June 30, 2003 and 2004, approximately 39% and 41%, respectively,
of our revenues were generated in locations outside the United States. The
majority of these revenues were in currencies other than the U.S. dollar. In
periods when the U.S. dollar declines in value as compared to the foreign
currencies in which we conduct business, our foreign currency-based revenues
and expenses increase in value when translated into U.S. dollars. Critical Accounting Policies and Estimates Our condensed consolidated financial statements are prepared in accordance
with accounting principles generally accepted in the United States. The
preparation of these condensed consolidated financial statements requires us to
make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues, costs and expenses and related disclosures. On an
ongoing basis, we evaluate our estimates and assumptions. Our actual results
may differ from these estimates. 22




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We believe that of our significant accounting policies, which are
described in Note 2 of the condensed consolidated financial statements included
in this Quarterly Report on Form 10-Q, the following accounting policies
involve a greater degree of judgment and complexity. Accordingly, these are the
policies we believe are the most critical to aid in fully understanding and
evaluating our consolidated financial condition and results of operations. Revenue Recognition and Deferred Setup Costs.We recognize software
license revenue in accordance with Statement of Position (SOP) No. 97-2,
Software Revenue Recognition,as amended, issued by the American Institute of
Certified Public Accountants, while revenues resulting from application
services are recognized in accordance with Emerging Issues Task Force (EITF)
Issue No. 00-03, Application of AICPA Statement of Position 97-2 to
Arrangements that include the Right to Use Software Stored on Another Entitys
Hardwareand Securities and Exchange Commissions (SEC) Staff Accounting
Bulletin (SAB) Nos. 101 and 104, Revenue Recognition. On August 1, 2003, we
adopted Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue
Arrangements with Multiple Deliverables.The adoption did not have a material
impact on our financial position or results of operations. Our customers generally have the ability to terminate service agreements
upon 30 days notice to us. License and services agreements can be terminated by
either party for material breach of obligations generally not corrected within
30 days after notice of the breach. We recognize revenue when all of the following conditions are satisfied:
(1) there is persuasive evidence of an arrangement; (2) the service has been
provided to the customer; (3) the collection of our fees is probable; and (4)
the amount of fees to be paid by the customer is fixed or determinable. We generally enter into software term licenses with our customers for
three to five year periods. These arrangements typically include multiple
elements: software license, consulting services and customer support. We bill
our customers in accordance with the terms of the underlying contract.
Generally, we bill the annual license fee for the first year of the multi-year
contract in advance and bill license fees for subsequent years on the
anniversary date. Our payment terms are generally net 30 days. Our software license revenue is earned from the sale of off-the-shelf
software requiring no significant modification or customization subsequent to
delivery to the customer. Consulting services, which can also be performed by
third-party consultants, are deemed to be non-essential to the functionality of
the software and typically are for trial configuration, implementation
planning, loading of software, building simple interfaces and running test data
and documentation of procedures. We generally bundle customer support with the software license for the
entire term of the arrangement. As a result, we generally recognize revenue for
all elements ratably over the term of the multiple element arrangement. We
allocate the revenue for these arrangements to the different elements based on
managements estimate of the relative fair value of each element. For our
contracts accounted for ratably under SOP 97-2, we allocate to consulting
services the anticipated service level throughout the term of the arrangement
at an amount equal to what it would have been had those services been sold
separately to the customer. The remaining value is allocated to license and
support services, with a 10% value allocated to support services. The costs
associated with the consulting and customer support services are expensed as
incurred. There are instances in which we sell software licenses based on usage
levels. These software licenses can be based on estimated usage, in which case
the license fee charged to the customer is fixed based on this estimate. When
the fee is fixed, the revenue is recognized over the contractual term of the
arrangement. If the fee is based on actual usage, and therefore variable, the
revenue is recognized in the period of use. Revenue from certain follow-on
consulting services, which are sold separately to customers with existing
software licenses and are not considered part of a multiple element
arrangement, are generally recognized as the services are performed. 23




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Revenue from perpetual software licenses represented less than one percent
of total revenues for the six months ended June 30, 2003 and June 30, 2004. We
continue to sell perpetual licenses for the Clintrialand Clintracesoftware
products in certain situations to our existing customers with the option to
purchase customer support. We have established vendor specific objective
evidence of fair value for the customer support. Accordingly the perpetual
license revenue is recognized upon delivery of the software and when all other
revenue recognition criteria are met. Customer support revenues are recognized
ratably over the term of the underlying support arrangement. In addition to making our software products available to customers through
licenses, we offer our InFormelectronic data capture software solution through
a hosted application solution delivered through a standard web-browser. Revenue
resulting from application hosting services consist of three stages for each
clinical trial: the first stage involves application setup, including design of
electronic case report forms and edit checks, implementation of the system and
server configuration; the second stage involves application hosting and related
support services; and the third stage involves services required to close out,
or lock, the database for the clinical trial. Services provided for the first
and third stages are provided on a fixed fee basis based upon the complexity of
the trial and system requirements. Services for the second stage are charged
separately as a fixed monthly fee. We recognize revenue from all stages of the
hosting service over the second and third stages. Fees charged and costs
incurred for the trial system design, setup and implementation are deferred and
capitalized as applicable, until the start of the second stage and then
amortized and recognized, as applicable, ratably over the estimated hosting
period. The capitalized costs include incremental direct costs with third
parties and certain internal direct costs related to the trial and application
setup, as defined under SFAS No. 91, Accounting for Nonrefundable Fees and
Costs Associated with Originating or Acquiring Loans and Indirect Costs of
Leases. These costs include salary and benefits associated with direct labor
costs incurred during trial setup, as well as third-party subcontract fees and
other contract labor costs. Work performed outside the original scope of work
is contracted for separately as an additional fee and is generally recognized
over the remaining term of the hosting period. Fees for the first and third
stages of the services are billed based upon milestones. Fees for application
hosting and related services in the second stage are billed quarterly in
advance. Bundled into this revenue element is the revenue attributable to the
software license used by the customer. We capitalized $719,000 and $849,000 of deferred setup costs and amortized
$946,000 and $880,000 during the six months ended June 30 2003 and 2004,
respectively. The amortization of deferred setup costs is a component of cost
of services. Deferred revenue represents amounts billed or cash received in advance of
revenue recognition. Accounting for Commission Payments and Royalties.For arrangements where
we recognize revenue over the relevant contract period, we defer related
commission payments to our direct sales force and software license royalties
paid to third parties and amortize these amounts over the same period that the
related revenues are recognized. This is done to better match commission and
royalty expenses with the related revenues. During the six months ended June
30, 2003 and 2004, respectively, we deferred $1.3 million and $1.6 million,
respectively, of commissions and amortized $703,000 and $1.2 million,
respectively, to sales and marketing expenses. Royalties are paid on a
percentage of billings basis for certain of our products. During the six months
ended June 30, 2003 and 2004, we deferred $828,000 and $2.2 million,
respectively, of royalty expenditures and amortized $815,000 and $1.2 million,
respectively, to cost of license and service revenue. Accounting for Stock-Based Awards.We record deferred stock-based
compensation charges in the amount by which the exercise price of an option is
less than the deemed fair value of our common stock at the date of grant.
Because there had been no public market for our stock prior to the July 2004
initial public offering of our common stock, our board of directors had
determined the fair value of our common stock based upon several factors,
including, but not limited to, our 24




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operating and financial performance, sales of convertible preferred stock
to third parties, the rights and preferences of securities senior to common
stock and the anticipated offering price of our common stock in connection with
our July 2004 initial public offering. We have not historically engaged unrelated third parties to prepare
valuations of our common stock. In connection with our July 2004 initial public
offering, management and the board of directors retroactively assessed the fair
value of our common stock during 2003 and the six months ended June 30, 2004. During 2003, all stock options were granted with an exercise price of
$3.00 per share, while the estimated per share fair value of our common stock
ranged from $3.00 to $4.00 in the first quarter of 2003, $4.00 to $5.00 in the
second quarter of 2003, $5.00 to $7.50 in the third quarter of 2003 and $7.50
to $9.00 in the fourth quarter of 2003. At the beginning of 2003, we determined the value of our common stock
based principally on the per share amounts that would have been distributed to
the common stockholders, after all required distributions to the preferred
stockholders, in the event of a sale of the Company at the value established in
our January 2002 preferred stock financing. We chose this valuation methodology
based on our operating performance during 2002 and the limited, if any, access
we had to the public equity markets at the time. The increase in our estimated per share fair value of common stock since
the beginning of 2003 reflects a number of significant factors, including an
improvement in our operating results, especially in the second half of the
year, changes to our management team throughout 2003, additions to our board of
directors in the second half of 2003 and an overall improvement in stock market
indices and increasing volume of initial public offerings of common stock
throughout 2003. We improved our operating results during each of the four quarters of
2003. In the first, second and third quarters, we incurred operating losses of
$1.4 million, $1.1 million and $31,000, respectively. In the fourth quarter, we
had an operating profit of $432,000, excluding a restructuring charge in the
fourth quarter. Our increasing per share fair value of common stock throughout
2003 reflects this positive trend in operating results. In addition, in the
second half of 2003, because of our improved operating performance and the
improving equity markets, we began to contemplate an initial public offering of
our common stock. During the six months ended June 30, 2004, options were granted at
exercise prices ranging from $4.50 to $6.00 per share while the estimated fair
value of our common stock was $10.00 per share. The fair value of our common
stock in the six months ended June 30, 2004 was based on the high end of the
range of estimated offering prices of common stock as contemplated in the
preliminary prospectus for our initial public offering that was filed with the
Securities and Exchange Commission. As of June 30, 2004, there was an aggregate of $2.9 million of deferred
stock-based compensation remaining to be amortized approximately as follows:
$870,000 in the year ending December 31, 2004; $1.0 million in the year ending
December 31, 2005; $583,000 in the year ending December 31, 2006; $270,000 in
the year ending December 31, 2007 and $157,000 through December 31, 2011. We
have elected not to record the fair value of employee stock-based awards. The
impact of recording employee stock-based awards at fair value, using the
Black-Scholes option-pricing model, is further described in Note 2 of the notes
to our 2003 consolidated financial statements contained in our Registration
Statement No. 333-113594 on Form S-1 filed with the Securities and Exchange
Commission. In the six months ended June 30, 2004, we granted options to purchase
205,000 shares of common stock that vest upon the earlier of 7 years from date
of grant or the attainment of specified milestones. Upon completion of our July
2004 initial public offering, 61,250 options automatically 25




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vested, which accelerated $264,000 in stock-based compensation in the six
months ended June 30, 2004. In the past, we have awarded a limited number of stock options to
non-employees. For these options, we recognize the stock-based compensation
over the vesting periods of the underlying awards, based on an estimate of
their fair value on the vesting dates using the Black-Scholes option-pricing
model. Other Significant Estimates Goodwill Impairment.We review the carrying value of goodwill periodically
based upon the expected future discounted operating cash flows of our business.
Our cash flow estimates are based on historical results adjusted to reflect our
best estimate of future markets and operating conditions. Actual results may
differ materially from these estimates. The timing and size of impairment
charges involves the application of managements judgment and could
significantly affect our operating results. Accounting for Income Taxes.In connection with preparing our financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves the assessment of our
net operating loss carryforwards and credits, as well as estimating the actual
current tax liability together with assessing temporary differences resulting
from differing treatment of items, such as reserves and accrued liabilities,
for tax and accounting purposes. We then assess the likelihood that deferred
tax assets will be recovered from future taxable income, and to the extent we
believe that recovery is not likely, we must establish a valuation allowance.
Based on historical results, we do not believe that it is more likely than not
that we will realize the value of our deferred tax assets and therefore have
provided a full valuation allowance against our net deferred tax assets. Restructuring
Expenses.In December 2003, we recorded a $4.5 million
restructuring charge related to the relocation of our corporate headquarters.
Approximately $2.5 million of this charge represents the estimated future
obligation under a non-cancelable lease and approximately $2.0 million related
to the write-off of the related abandoned leasehold improvements and fixed
assets. These estimates are reviewed annually and, if revised, may result in
changes to our restructuring expense should different conditions prevail than
were anticipated in our original estimates. Overview of Results of Operations for the Three Months Ended June 30, 2003 and
2004 License revenue increased by approximately 23% in the three months ended
June 30, 2004 as compared to the three months ended June 30, 2003. Service
revenue increased by approximately 19% in the three months ended June 30, 2004
as compared to the three months ended June 30, 2003. Our gross margin increased by approximately 45% or $3.2 million in the
quarter ended June 30, 2004 to $10.4 million, compared to $7.2 million for the
same period in 2003, primarily due to the increase in license and application
hosting services revenues. Operating income increased by $2.1 million from an operating loss of $1.1
million in the three months ended June 30, 2003 to an operating income of
$946,000 for the three months ended June 30, 2004. The operating income (loss)
in the three months ended June 30, 2003 and 2004 included approximately $62,000
and $473,000 of stock-based compensation. As of June 30, 2004, we had $26.4
million of cash and cash equivalents, an increase of $7.3 million from $19.0
million at December 31, 2003. 26




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Revenues For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageRevenues
    
    Amount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)License
    
    $
    5,164
    
    
    
    35
    %
    
    $
    6,357
    
    
    
    36
    %
    
    $
    1,193
    
    
    
    23
    %Application hosting services
    
    
    4,899
    
    
    
    33
    
    
    
    6,689
    
    
    
    38
    
    
    
    1,790
    
    
    
    37
    %Professional services
    
    
    1,147
    
    
    
    8
    
    
    
    1,215
    
    
    
    7
    
    
    
    68
    
    
    
    6
    %Customer support
    
    
    3,466
    
    
    
    24
    
    
    
    3,432
    
    
    
    19
    
    
    
    (34
    )
    
    
    (1
    %)Total
    
    $
    14,676
    
    
    
    100
    %
    
    $
    17,693
    
    
    
    100
    %
    
    $
    3,017
    
    
    
    21
    %
 Total revenues increased in the three months ended June 30, 2004 as
compared to the same period in 2003 due to an increase in license revenue
across all products, primarily Clintrialas well as an increase in InForm
application hosting services. The increase in license revenue in the three
months ended June 30, 2004 was primarily due to an increase in sales of
Clintrialinto our existing InFormcustomer base. This increase was a result of
our continued strategy to expand the usage of our software products by cross
selling the InForm, Clintrialand Clintraceproducts to our existing customer
base, additional utilization of our products within our customer base and sales
to new customers. The increase in revenue associated with the
hosted-application version of our InFormproduct in the three months ended June
30, 2004 was due to an increase in clinical trials under management. Consulting
services revenue for the three months ended June 30, 2004 was relatively
unchanged compared to the same period in 2003. The decrease in customer
support revenue for the three months ended June 30, 2004 was due primarily to a
reduction in the Clintrialand Clintracemaintenance renewal base as a result
of the conversion of the former Clinsoft customers to term-based licenses that
have a lower customer support fee. In the future, we anticipate that license
revenue will become a more significant component of total revenues. For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageRevenues by Geography
    
    Amount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)North America
    
    $
    8,975
    
    
    
    61
    %
    
    $
    10,433
    
    
    
    59
    %
    
    $
    1,458
    
    
    
    16
    %United Kingdom
    
    
    3,140
    
    
    
    21
    
    
    
    3,807
    
    
    
    22
    
    
    
    667
    
    
    
    21
    %France
    
    
    1,932
    
    
    
    13
    
    
    
    2,119
    
    
    
    12
    
    
    
    187
    
    
    
    10
    %Asia-Pacific
    
    
    629
    
    
    
    5
    
    
    
    1,334
    
    
    
    7
    
    
    
    705
    
    
    
    112
    %International subtotal
    
    
    5,701
    
    
    
    39
    
    
    
    7,260
    
    
    
    41
    
    
    
    1,559
    
    
    
    27
    %Total
    
    $
    14,676
    
    
    
    100
    %
    
    $
    17,693
    
    
    
    100
    %
    
    $
    3,017
    
    
    
    21
    %
 The increase in revenues worldwide was due primarily to the increase in
sales of our Clintrialproducts and InFormapplication hosting services, which
we believe reflects a continued increase in the worldwide adoption of our
products. 27




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Cost of Revenues For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    Percentageof Related
    
    
    
    
    
    of RelatedCost of Revenues
    
    Amount
    
    Revenue
    
    Amount
    
    Revenue
    
    Amount
    
    %(in thousands)License
    
    $
    681
    
    
    
    13
    %
    
    $
    448
    
    
    
    7
    %
    
    $
    (233
    )
    
    
    (34
    %)Services
    
    
    6,837
    
    
    
    72
    
    
    
    6,842
    
    
    
    60
    
    
    
    5
    
    
    
    0
    %Total
    
    $
    7,518
    
    
    
    51
    %
    
    $
    7,290
    
    
    
    41
    %
    
    $
    (228
    )
    
    
    (3
    %)
 The cost of license revenue decreased in the three months ended June 30,
2004 primarily due to a $400,000 decrease in amortization expense from acquired
technologies partially offset by an increase in royalty expense of $181,000 as
revenue increased on certain modules of the Clintrialsoftware product. Cost of
services for the three months ended June 30, 2004 remained relatively constant
but included a $268,000 increase in employee and related expenses, while
headcount remained relatively unchanged. This increase was offset by decreases
in reimbursable out-of-pocket expenses of $149,000 and facilities expense of
$104,000. Gross Margin For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    Percentageof Related
    
    
    
    
    
    of RelatedGross Margin
    
    Amount
    
    Revenue
    
    Amount
    
    Revenue
    
    Amount
    
    %(in thousands)License
    
    $
    4,483
    
    
    
    87
    %
    
    $
    5,909
    
    
    
    93
    %
    
    $
    1,426
    
    
    
    32
    %Services
    
    
    2,675
    
    
    
    28
    
    
    
    4,494
    
    
    
    40
    
    
    
    1,819
    
    
    
    68
    %Total
    
    $
    7,158
    
    
    
    49
    %
    
    $
    10,403
    
    
    
    59
    %
    
    $
    3,245
    
    
    
    45
    %
 The license gross margin percentage increased in the three months ended
June 30, 2004 primarily due to an increase in Clintriallicense revenue and a
reduction in amortization expense associated with acquired technology,
partially offset by an increase in royalty expense as revenue grew for certain
modules of the Clintrialsoftware product. The services gross margin percentage
increased for the three months ended June 30, 2004 due to the increase in
InFormapplication hosting revenues while the overall cost base remained
relatively constant with an increase in employee and related expenses which was
offset by decreases in reimbursable out-of-pocket expenses and facilities
expense. 28




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Operating Expenses For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageOperating Expenses
    
    Amount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)Sales and marketing
    
    $
    3,258
    
    
    
    22
    %
    
    $
    3,536
    
    
    
    20
    %
    
    $
    278
    
    
    
    8
    %Research and development
    
    
    2,609
    
    
    
    18
    
    
    
    3,018
    
    
    
    17
    
    
    
    409
    
    
    
    16
    %General and administrative
    
    
    2,424
    
    
    
    16
    
    
    
    2,903
    
    
    
    16
    
    
    
    479
    
    
    
    20
    %Total
    
    $
    8,291
    
    
    
    56
    %
    
    $
    9,457
    
    
    
    53
    %
    
    $
    1,166
    
    
    
    14
    %
 Sales and Marketing.Sales and marketing expenses increased for the three
months ended June 30, 2004 primarily due to a $338,000 increase in commission
expense due to an increase in revenues and an increase in the effective
commission rate and a $21,000 increase in both stock-based compensation, which
was partially offset by a $52,000 reduction in travel expense and a $41,000
decrease in outside consultant expense. We expect that our sales and marketing
expenses will continue to increase in absolute dollars as commission expense
increases with our revenues and we continue to build our brand awareness
through what we believe are the most cost-effective channels available.
However, sales and marketing expenses may fluctuate, quarter by quarter, due to
the timing of marketing programs. Research and Development.Research and development expenses increased in
the three months ended June 30, 2004 primarily due to an increase in employee
related expenses of $642,000 as we hired 21 additional people to improve our
quality assurance and product development team, and $42,000 of stock-based
compensation. This was partially offset by a $279,000 decrease in outside
consultant expense as we brought certain research and development activities
in-house. We expect that our research and development costs will continue to
increase in absolute dollars as we continue to add features and functionality
to our products and expand our product and service offerings. General and Administrative.General and administrative expenses increased
in the three months ended June 30, 2004 primarily due to a $326,000 increase in
stock-based compensation and an increase in employee related expenses of
$205,000, while headcount remained the same during these periods. We expect our
general and administrative expenses to increase in absolute dollars as we incur
additional costs associated with being a public company. 29




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##### Table of Contents



Operating Income (Loss), Other Income (Expense) For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageAmount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)Operating Income (Loss)
    
    $
    (1,133
    )
    
    
    (8
    %)
    
    $
    946
    
    
    
    5
    %
    
    $
    2,079
    
    
    NMOther Income (Expense)Interest income
    
    $
    31
    
    
    
    0
    %
    
    $
    67
    
    
    
    0
    %
    
    $
    36
    
    
    NMInterest expense
    
    
    (93
    )
    
    
    0
    
    
    
    (128
    )
    
    
    0
    
    
    
    (35
    )
    
    NMOther income (expense)
    
    
    306
    
    
    
    2
    
    
    
    87
    
    
    
    0
    
    
    
    (219
    )
    
    NMTotal
    
    $
    244
    
    
    
    2
    %
    
    $
    26
    
    
    
    0
    %
    
    $
    (218
    )
    
    NM
 Operating Income (Loss).The increase in operating income in the three
months ended June 30, 2004 was primarily due to an increase in gross margins
from both license and services, partially offset by increased operating
expenses. Other Income (Expense).The increase in interest income in the three
months ended June 30, 2004 was primarily due to an increase in cash and cash
equivalents available for investment. The increase in interest expense in the
three months ended June 30, 2004 was primarily due to an increase in
outstanding borrowings. Other income (expense) decreased due to a decrease in
the foreign exchange gain as a result of a reduction in the outstanding
non-U.S. dollar denominated accounts receivable and intercompany balances. Provision for Income Taxes For the Three Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageAmount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)Provision for income taxes
    
    $
    33
    
    
    
    0
    %
    
    $
    542
    
    
    
    3
    %
    
    $
    (509
    )
    
    NM
 Provision for Income Taxes.The effective tax rate for 2003 was
approximately 7% and represents foreign withholding taxes and income taxes
payable in certain foreign locations that could not be offset through loss
carryforwards. The effective tax rate for 2004 is approximately 37% before
stock-based compensation and represents income tax expense that cannot be
offset through the use of acquired net operating losses for financial statement
purposes. The increase in the effective tax rate is primarily due to the
profitability of our U.S. operations. In utilizing our net operating loss
carryforwards, we are required to use our oldest net operating losses first. As
a result we will first use the net operating losses acquired in the Clinsoft
acquisition. The utilization of the acquired net operating losses will reduce
the amount of income taxes payable to local tax authorities. This cash benefit
will be reflected as a reduction of goodwill. Additionally, our effective tax
rate exceeds our statutory tax rate due to the current non-deductibility of our
stock-based compensation expense. 30




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##### Table of Contents



Overview of Results of Operations for the Six Months Ended June 30, 2003 and
2004 License revenue increased by approximately 26% in the six months ended
June 30, 2004 as compared to the six months ended June 30, 2003. Service
revenue increased by approximately 12% in the six months ended June 30, 2004 as
compared to the six months ended June 30, 2003. Our gross margin increased by approximately 43% or $6.1 million in the
quarter ended June 30, 2004 to $20.2 million, as compared to $14.1 million for
the same period in 2003, primarily due to the increase in license and
application hosting services revenues. Operating income increased by $4.4 million from an operating loss of $2.6
million in the six months ended June 30, 2003 to an operating income of $1.8
million for the six months ended June 30, 2004. The operating income (loss) in
the six months ended June 30, 2003 and 2004 included $68,000 and $919,000 of
stock-based compensation. Revenues For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageRevenues
    
    Amount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)License
    
    $
    9,930
    
    
    
    33
    %
    
    $
    12,523
    
    
    
    36
    %
    
    $
    2,593
    
    
    
    26
    %Application hosting
services
    
    
    10,102
    
    
    
    34
    
    
    
    12,601
    
    
    
    36
    
    
    
    2,499
    
    
    
    25
    %Professional services
    
    
    2,319
    
    
    
    8
    
    
    
    2,779
    
    
    
    8
    
    
    
    460
    
    
    
    20
    %Customer support
    
    
    7,272
    
    
    
    25
    
    
    
    6,752
    
    
    
    20
    
    
    
    (520
    )
    
    
    (7
    %)Total
    
    $
    29,623
    
    
    
    100
    %
    
    $
    34,655
    
    
    
    100
    %
    
    $
    5,032
    
    
    
    17
    %
 Total revenues increased in the six months ended June 30, 2004 as compared
to the same period in 2003 due to an increase in license revenue across all
products, primarily Clintrial, as well as an increase in InFormapplication
hosting services. The increase in license revenue in the six months ended June
30, 2004 was primarily due to an increase in sales of Clintrialinto our
existing InFormcustomer base. This increase was a result of our continued
strategy to expand the usage of our software products by cross selling the
InForm, Clintrialand Clintraceproducts to our existing customer base,
additional utilization of our products within our customer base and sales to
new customers. The increase in revenue associated with the Inform application hosting services in the six months ended June 30, 2004 was due an
increase in clinical trials under management. The increase in consulting
services revenue for the six months ended June 30, 2004 was due primarily to an
increase in consulting services associated with integrated enterprise solutions
of our products to our existing InForm customer base compared to the same
period in 2003. The decrease in customer support revenue for the six months
ended June 30, 2004 was due primarily to a reduction in the Clintrialand
Clintracemaintenance renewal base as a result of the conversion of the former
Clinsoft customers to term-based licenses that have a lower customer support
fee. In the future, we anticipate that license revenue will become a more
significant component of total revenues. 31




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##### Table of Contents



For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageRevenues by Geography
    
    Amount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)North America
    
    $
    18,149
    
    
    
    61
    %
    
    $
    20,958
    
    
    
    60
    %
    
    $
    2,809
    
    
    
    15
    %United Kingdom
    
    
    6,262
    
    
    
    21
    
    
    
    7,212
    
    
    
    21
    
    
    
    950
    
    
    
    15
    %France
    
    
    3,852
    
    
    
    13
    
    
    
    4,265
    
    
    
    12
    
    
    
    413
    
    
    
    11
    %Asia-Pacific
    
    
    1,360
    
    
    
    5
    
    
    
    2,220
    
    
    
    7
    
    
    
    860
    
    
    
    63
    %International subtotal
    
    
    11,474
    
    
    
    39
    
    
    
    13,697
    
    
    
    40
    
    
    
    2,223
    
    
    
    19
    %Total
    
    $
    29,623
    
    
    
    100
    %
    
    $
    34,655
    
    
    
    100
    %
    
    $
    5,032
    
    
    
    17
    %
 The increase in revenues worldwide was due primarily to the increase in
sales of our Clintrialproducts and InFormapplication hosting services, which
we believe reflects a continued increase in the worldwide adoption of our
products. Cost of Revenues For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    Percentageof Related
    
    
    
    
    
    of RelatedCost of Revenues
    
    Amount
    
    Revenue
    
    Amount
    
    Revenue
    
    Amount
    
    %(in thousands)License
    
    
    
    
    
    $
    1,329
    
    
    
    13
    %
    
    $
    870
    
    
    
    7
    %
    
    $
    (459
    )
    
    
    (34
    %)Services
    
    
    
    
    
    
    14,187
    
    
    
    72
    
    
    
    13,623
    
    
    
    62
    
    
    
    (564
    )
    
    
    (4
    %)Total
    
    $
    15,516
    
    
    
    52
    %
    
    $
    14,493
    
    
    
    42
    %
    
    $
    (1,023
    )
    
    
    (7
    %)
 The cost of license revenue decreased in the six months ended June 30,
2004 primarily due to an $800,000 decrease in amortization expense from
acquired technologies partially offset by an increase in royalty expense of
$378,000 as revenue increased on certain modules of the Clintrialsoftware
product, and to a lesser extent, the Japanese version of our InFormsoftware
product. The decrease in the cost of services for the six months ended June 30,
2004 was due primarily to a $196,000 reduction in expense resulting from the
incremental capitalization of deferred setup costs related to an increase in
the number of new clinical trials in the trial design, setup and implementation
phase. This increase was associated with an increase in new clinical trial
activity from both existing and new customers. Additionally, cost of services
decreased for the six months ended June 30, 2004 due to a decrease in
depreciation and facilities expense of $201,000 and $205,000, respectively,
primarily resulting from cost savings associated with the relocation of our
corporate headquarters in the fourth quarter of 2003. This was partially
offset by a $175,000 increase in employee and related expenses and an increase
of $48,000 in stock-based compensation. 32




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##### Table of Contents



Gross Margin For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    Percentageof Related
    
    
    
    
    
    of RelatedGross Margin
    
    Amount
    
    Revenue
    
    Amount
    
    Revenue
    
    Amount
    
    %(in thousands)License
    
    $
    8,601
    
    
    
    87
    %
    
    $
    11,653
    
    
    
    93
    %
    
    $
    3,052
    
    
    
    35
    %Services
    
    
    5,506
    
    
    
    28
    
    
    
    8,509
    
    
    
    38
    
    
    
    3,003
    
    
    
    55
    %Total
    
    $
    14,107
    
    
    
    48
    %
    
    $
    20,162
    
    
    
    58
    %
    
    $
    6,055
    
    
    
    43
    %
 The license gross margin percentage increased in the six months ended June
30, 2004 primarily due to an increase in Clintriallicense revenue and a
reduction in amortization expense associated with acquired technology,
partially offset by an increase in royalty expense as revenue increased for
certain modules of the Clintrialsoftware product as well as the Japanese
version of our InFormsoftware product. The services gross margin percentage
increased for the six months ended June 30, 2004 due to the increase in InForm
application hosting revenues. Operating Expenses For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageOperating Expenses
    
    Amount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)Sales and marketing
    
    $
    6,431
    
    
    
    22
    %
    
    $
    6,841
    
    
    
    20
    %
    
    $
    410
    
    
    
    6
    %Research and development
    
    
    5,192
    
    
    
    17
    
    
    
    5,954
    
    
    
    17
    
    
    
    762
    
    
    
    15
    %General and administrative
    
    
    5,042
    
    
    
    17
    
    
    
    5,546
    
    
    
    16
    
    
    
    504
    
    
    
    10
    %Total
    
    $
    16,665
    
    
    
    56
    %
    
    $
    18,341
    
    
    
    53
    %
    
    $
    1,676
    
    
    
    10
    %
 Sales and Marketing.Sales and marketing expenses increased for the six
months ended June 30, 2004 primarily due to a $136,000 increase in employee
related expenses as we increased headcount by 5 people, $560,000 increase in
commission expense due to both an increase in revenues and an increase in the
effective commission rate, and a $55,000 increase in stock-based compensation,
which was partially offset by a $104,000 decrease in marketing programs, a
$86,000 decrease in travel expense and a $64,000 decrease in outside consultant
expense. The decline in marketing programs reflects the transition from the
participation in trade shows to more cost-effective workshops and seminars, as
well as a reduction in advertising expense. Research and Development.Research and development expenses increased in
the six months ended June 30, 2004 primarily due to an increase in employee
related expenses of $1.1 million as we hired 21 additional people to improve
our quality assurance and product development team and a $137,000 increase in
stock-based compensation. This was partially offset by a $316,000 decrease in
outside consultant expense as we brought certain research and development
activities in-house and a $145,000 decrease in depreciation expense from cost
savings associated with the relocation of our corporate headquarters in the
fourth quarter of 2003. General and Administrative.General and administrative expenses increased
for the six months ended June 30, 2004 primarily due to a $611,000 increase in
stock-based compensation and an increase in employee related expenses of
$194,000, while the headcount remained stable during 33




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##### Table of Contents



these periods. This was partially offset by a $130,000 decrease in
depreciation expense from cost savings associated with the relocation of our
corporate headquarters in the fourth quarter of 2003 and a $99,000 decrease in
outside consultant expense. Operating Income (Loss), Other Income (Expense) For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageAmount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)Operating Income (Loss)
    
    $
    (2,558
    )
    
    
    (9
    %)
    
    $
    1,821
    
    
    
    5
    %
    
    $
    4,379
    
    
    NMOther Income (Expense)Interest income
    
    $
    59
    
    
    
    0
    %
    
    $
    172
    
    
    
    0
    %
    
    $
    113
    
    
    
    192
    %Interest expense
    
    
    (185
    )
    
    
    0
    
    
    
    (210
    )
    
    
    0
    
    
    
    (25
    )
    
    
    (13
    %)Other income (expense)
    
    
    143
    
    
    
    0
    
    
    
    71
    
    
    
    0
    
    
    
    (72
    )
    
    
    (50
    )%Total
    
    $
    17
    
    
    
    0
    %
    
    $
    33
    
    
    
    0
    %
    
    $
    16
    
    
    
    94
    %
 Operating Income (Loss).The increase in operating income in the six
months ended June 30, 2004 was primarily due to an increase in gross margins
from both software and services, partially offset by increased operating
expenses. Other Income (Expense).The increase in interest income in the six months
ended 2004 was primarily due to $84,000 of interest received in connection with
the repayment of a subscription receivable during the period and an increase in
cash and cash equivalents available for investment. The increase in interest
expense in the six months ended June 30, 2004 was primarily due to an increase
in outstanding borrowings. Other income (expense) decreased due to a decrease
in the foreign exchange gain as a result of a reduction in the outstanding
non-U.S. dollar denominated accounts receivable and intercompany balances. Provision for Income Taxes For the Six Months Ended June 30,2003
    
    2004
    
    ChangePercentage
    
    
    
    
    
    PercentageAmount
    
    of Revenue
    
    Amount
    
    of Revenue
    
    Amount
    
    %(in thousands)Provision for
income taxes
    
    $
    136
    
    
    
    0
    %
    
    $
    1,041
    
    
    
    3
    %
    
    $
    905
    
    
    NM
 Provision for Income Taxes.The effective tax rate for 2003 was
approximately 7% and represents foreign withholding taxes and income taxes
payable in certain foreign locations that could not be offset through loss
carryforwards. The effective tax rate for 2004 is approximately 37% before
stock-based compensation and represents income tax expense that cannot be
offset through the use of acquired net operating losses for financial statement
purposes. The increase in the effective tax rate is primarily due to the
profitability of our U.S. operations. In utilizing our net operating loss
carryforwards, we are required to use our oldest net operating losses first. As
a result we will first use the net operating losses acquired in the Clinsoft
acquisition. The utilization of the acquired net operating losses will reduce
the amount of income taxes payable to local tax 34




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##### Table of Contents



authorities. This cash benefit will be reflected as a reduction of
goodwill. Additionally, our effective tax rate exceeds our statutory tax rate
due to the current non-deductibility of our stock-based compensation expense. Liquidity and Capital Resources At December 31, 2003 and June 30, 2004, our principal sources of liquidity
were cash, cash equivalents and restricted cash totaling $20.7 million and
$26.4 million and accounts receivable of $22.9 million and $15.3 million,
respectively. From our inception, we funded our operations primarily through issuances
of convertible preferred stock for aggregate net cash proceeds of $79.7
million, including net cash acquired in our Clinsoft acquisition, the issuance
of notes payable for an aggregate of $16.3 million and borrowings under a
secured line of credit of $2.5 million. Net cash generated from operating activities was $6.8 million for the six
months ended June 30, 2004, which was greater than the net income of $813,000.
This difference is primarily due to $4.1 million of non-cash depreciation,
amortization, deferred rent, stock based compensation and non-cash income tax
expense and changes in working capital, which primarily consisted of a $7.5
million decrease in accounts receivable offset partially by an increase in
deferred costs of $1.3 million and decreases in deferred revenue of $2.6
million and accrued expenses of $1.5 million. Cash provided by and used in operating activities has historically been
affected by changes in working capital accounts, primarily deferred revenue,
accounts receivable and accrued expenses, and add-backs of non-cash expense
items such as depreciation and amortization and stock-based compensation.
Fluctuations within accounts receivable and deferred revenue are primarily
related to the timing of billings of our term license customers and the
associated revenue recognition. Movements in deferred costs are related to the
volume and stages of hosted clinical trials and movements in accrued expenses
and accounts payable are due to the timing of certain transactions. Net cash provided by investing activities was $358,000 for the six months
ended June 30, 2004, consisting primarily of a reduction of restricted cash of
$1.6 million partially offset by $1.2 million of capital expenditures
associated with computer equipment and furniture and fixtures in support of
expanding our infrastructure and work force. Net cash provided by financing activities was $195,000 for the six months
ended June 30, 2004, consisting primarily of borrowings under a line of credit
and the repayment of notes payable. At December 31, 2003, we had approximately $1.6 million of restricted cash held
in certificates of deposits as collateral for letters of credit related to our
facilities. The certificates of deposit matured and the collateral for the
letters of credit is now reflected as a reduction in the amount available under
the line of credit. Substantially all of our long-lived assets as of December 31, 2003 and
June 30, 2004 are located in the United States. We do not have any special purpose entities or any other off balance sheet
financing arrangements. We have operating leases for office space and computer
equipment, which are described below. We generally do not enter into binding purchase commitments. Our principal
commitments consist of obligations under our lines of credit and leases for
office space. Between April 2000 and March 2004 we entered into several equipment lines
of credit with a bank. All advances under these equipment lines of credit are
payable in 30 to 36 equal monthly 35




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##### Table of Contents



installments of principal, plus accrued interest. The interest that
accrues under these credit lines ranges from prime to prime plus 1%. At
December 31, 2003 and June 30, 2004, respectively, we had $4.2 million and $4.9
million outstanding under all of our equipment lines of credit. As of June 30,
2004, there was $4.1 million available under the equipment line of credit. On March 31, 2004 we amended our working capital line of credit with a
bank under which we can borrow up to $5.0 million. Interest accrues at the
prime rate. The line expires March 31, 2006 at which time all advances will be
immediately due and payable. As of each of December 31, 2003 and June 30, 2004
we had $2.5 million outstanding under the working capital line of credit. As of
June 30, 2004, there was $889,000 available under the working capital line of
credit. Subsequent to June 30, 2004, we paid the $2.5 million outstanding
under the working capital line of credit. Borrowings are secured by substantially all of our assets other than our
intellectual property. We have also entered into a negative pledge agreement
that, subject to certain exceptions, generally prohibits us from pledging our
intellectual property to others. Under the terms of these credit lines, we are
required to comply with certain financial covenants. At December 31, 2003, we
were in violation of the financial covenant requiring $16.0 million for fourth
quarter 2003 revenue, net of reimbursable out-of-pocket expenses, for which we
received a waiver from the bank. That waiver, however, did not remove or limit
the financial covenants we must satisfy under the credit agreement in the
future. At June 30, 2004, we were in compliance with all financial covenants.
To the extent we are unable to satisfy those covenants in the future, we will
need to obtain additional waivers to avoid being in default of the terms of
these credit lines. If an unwaived default occurs, the bank may require that we
repay all amounts then outstanding. We currently expect that we will have
sufficient resources to fund any amounts which may become due under these
credit lines as a result of a default by us or otherwise. However, any amounts
which we may be required to repay prior to a scheduled repayment date would
reduce funds that we could otherwise allocate to other opportunities that we
consider desirable. At December 31, 2003, we had net operating loss carryforwards of
approximately $82.6 million, which may be used to offset future U.S. federal
taxable income, if any, and $4.0 million of federal tax credit carryforwards.
In addition, we had $6.9 million of net operating losses relating to our
non-U.S. jurisdictions. Of these amounts, approximately $29.2 million and $2.7
million of net operating loss carryforwards and tax credit carryforwards,
respectively, relate to amounts acquired as part of our Clinsoft acquisition.
These tax carryforwards may reduce our future cash payments to the taxing
authorities. Our carryforwards expire through 2022 and are subject to review
and possible adjustment by tax authorities. Due to our history of operating
losses, there is significant uncertainty surrounding our ability to utilize our
net operating loss and tax credit carryforwards and other deferred tax assets.
Accordingly, we have provided a full valuation allowance against our net
deferred tax assets as of December 31, 2003 and June 30, 2004. We believe our existing cash, cash equivalents and cash provided by
operating activities and our various debt facilities will be sufficient to meet
our working capital and capital expenditure needs over the next 12 months. Our
future capital requirements will depend on many factors, including our rate of
revenue growth, the expansion of our marketing and sales activities, the timing
and extent of spending to support product development efforts, the timing of
introductions of new services and enhancements to existing services, and the
continuing market acceptance of our services. For 2004, we intend to spend
approximately $3.8 million for the purchase of computer equipment for our
hosting services and for general corporate purposes, and approximately $4.7
million as a special cash distribution, representing a return of capital,
payable on our series B, C and D preferred stock in September 2004. To the
extent that existing cash and securities and cash from operations are
insufficient to fund our future activities, we may need to raise additional
funds through public or private equity or debt financing. Although we are
currently not a party to any agreement or letter of intent with respect to
potential investments in, or acquisitions of, businesses, services or
technologies, we may enter into these types of arrangements in the future,
which could also require 36




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us to seek additional equity or debt financing. Additional funds may not
be available on terms favorable to us or at all. Certain Factors Which May Affect Future Results Our operating results and financial condition have varied in the past and
may in the future vary significantly depending on a number of factors. Except
for the historical information in this report, the matters contained in this
report include forward-looking statements that involve risks and uncertainties.
The following factors, among others, could cause actual results to differ
materially from those contained in forward-looking statements made in this
report and presented elsewhere by management from time to time. Such factors,
among others, may have a material adverse effect upon our business, results of
operations and financial condition. Risks Related to Our Industry We depend primarily on the pharmaceutical, biotechnology and medical device
industries and are therefore subject to risks relating to changes in these
industries. Our business depends on the clinical trials conducted or sponsored by
pharmaceutical, biotechnology and medical device companies and other entities
conducting clinical research. General economic downturns, increased
consolidation or decreased competition in the industries in which these
companies operate could result in fewer products under development or decreased
pressure to accelerate product approval which, in turn, could materially
adversely impact our revenues. Our operating results may also be adversely
impacted by other developments that affect these industries generally,
including:  
    
    the introduction or adoption of new technologies or products;  
    
    changes in third-party reimbursement practices;  
    
    changes in government regulation or governmental price controls;  
    
    changes in medical practices;  
    
    the assertion of product liability claims; and  
    
    changes in general business conditions. Any decrease in research and development expenditures or in the size,
scope or frequency of clinical trials conducted or sponsored by pharmaceutical,
biotechnology or medical device companies or other entities as a result of the
foregoing or other factors could materially adversely affect our operations or
financial condition. Changes in regulations and regulatory guidance applicable to our customers or
potential customers and the approval process for their products may result in
our inability to continue to do business. Demand for our software products, services and hosted solutions is largely
a function of regulation and regulatory guidance associated with the approval
of new drugs, biological products and medical devices imposed upon the clinical
trial process by the U.S. federal government and related regulatory authorities
such as the U.S. Food and Drug Administration, or FDA, and by foreign
governments. In recent years, efforts have been made to streamline the FDA
approval process and coordinate U.S. standards with those of other developed
countries. Any change in the scope of applicable regulations and regulatory
guidance could alter the type or amount of clinical trial spending or
negatively impact interest in our software products, services and hosted
solutions. 37




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Any regulatory reform that limits or reduces the research and development
spending of entities conducting clinical research upon which our business
depends could have a material adverse effect on our revenues or gross margins. In addition, any failure to conform our software products, services and
hosted solutions to domestic or international changes in regulations and
regulatory guidance applicable to our customers or potential customers and the
approval process for their products may result in our inability to continue to
do business. Changing our software products, services and hosted solutions to
allow our customers to comply with future changes in regulation or regulatory
guidance, either domestically or internationally, could cause us to incur
substantial costs. We cannot assure you that our product and service offerings
will allow our customers and potential customers to stay in compliance with
regulations and regulatory guidance as they develop. If our product and service
offerings fail to allow our customers and potential customers to operate in a
manner that is compliant with applicable regulations and regulatory guidance,
clinical trial sponsors and other entities conducting clinical research may be
unwilling to use our software products, services and hosted solutions. If entities engaged in clinical trials do not shift from traditional
paper-based methods of collecting clinical trial data to electronic systems, we
may not achieve the market penetration necessary to obtain or maintain
profitability. If entities engaged in clinical trials are unwilling to use our electronic
data capture solutions or to change the way of collecting clinical trial data,
our future growth and market share may be limited. Most clinical trials today
rely on pre-printed, three-part paper case report forms for data collection.
Our efforts to establish an electronic process to capture clinical trial data
are a significant departure from the traditional paper-based methods of
collecting clinical trial data. As is typical for new and rapidly evolving
industries, customer demand for recently introduced technology is highly
uncertain. We may not be successful in persuading entities engaged in clinical
trials to change the manner in which they have traditionally collected clinical
trial data and to accept our software products, services and hosted solutions.
If we fail to convince entities engaged in clinical trials to use our methods
of capturing clinical trial data, our revenues may be limited and we may fail
to be profitable. We operate in a highly competitive industry and if we are not able to compete
effectively, our business and operating results will be harmed. The market for our software products, services and hosted solutions is
characterized by rapidly changing technologies, evolving industry standards and
frequent new product and service introductions and enhancements that may render
existing products and services obsolete. Accordingly, we are susceptible to
rapid and significant declines in market share due to unforeseen changes in the
features, functions or pricing of competing products. Barriers to entry are
relatively low and, with the introduction of new technologies and new market
entrants, we expect that competition will increase. Increased competition is
likely to result in pricing pressures, which could negatively impact our sales,
gross margins or market share. Our failure to compete effectively could
materially adversely affect our business, financial condition or results of
operations. Some of our current competitors, as well as many of our potential
competitors, have greater name recognition, longer operating histories and
significantly greater resources. As a result, our competitors may be able to
respond more quickly and effectively than we can to new or changing
opportunities, technologies, standards or customer requirements. In addition,
current and potential competitors have established, and may in the future
establish, cooperative relationships with vendors of complementary products,
technologies or services to increase the availability of their products to the
marketplace. Accordingly, new competitors or alliances may emerge that have
greater market share, larger customer bases, more widely adopted proprietary
technologies, greater marketing expertise and larger sales forces than we have,
which could put us at a competitive 38




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disadvantage. Further, in light of these advantages, even if our products and
services are more effective than the product or service offerings of our
competitors, current or potential customers might accept competitive products
and services in lieu of purchasing our software products, services and hosted
solutions. We cannot assure you that we can maintain or enhance our competitive
position against current and future competitors. Changing customer or prospective customer requirements could decrease the
demand for our products and services, which would adversely affect our revenues
and operating results. Our future success will depend in large part on our ability to enhance and
broaden our software products, services and hosted solutions to meet the
evolving needs of our customers and prospective customers. To achieve our
goals, we need to effectively respond to our customers and prospective
customers needs, technological changes and new industry standards and
developments in a timely manner. If we are unable to enhance our existing
product and service offerings or develop new products and services to meet
changing requirements, demand for our software products, services and hosted
solutions could suffer and our revenues and operating results could be
materially adversely affected. We could also incur substantial costs if we need
to modify our products or services, or information technology infrastructure,
to adapt to technological changes or new industry standards or developments. Risks Related to Our Company We have incurred substantial losses in the past and may not be profitable in
the future. We have incurred significant losses in each fiscal year since our
inception in June 1997, and we may incur significant operating losses in the
future. As a result of our operating losses and accretion of preferred
dividends, we had an accumulated deficit of $105.0 million at June 30, 2004.
You should not consider recent quarterly revenue growth as indicative of our
future performance as our operating results may fluctuate significantly from
quarter to quarter. In addition, we expect our development, sales and other
operating expenses to increase in the future as we expand our business. If our
revenue does not grow to offset these expected increased expenses, we may not
be profitable. In fact, in future quarters we may not have any revenue growth
and our revenue could decline. Furthermore, if our operating expenses exceed
our expectations, our financial performance will be adversely affected. We operate in an emerging market, which makes it difficult to evaluate our
business and future prospects. We were incorporated in June 1997 and operate in an emerging market.
Accordingly, our business and future prospects are difficult to evaluate. You
should consider the challenges, risks and uncertainties frequently encountered
by companies using new and unproven business models in rapidly evolving
markets. These challenges include our ability to:  
    
    generate sufficient revenues to achieve and maintain profitability;  
    
    manage growth in our operations;  
    
    attract and retain customers;  
    
    attract and retain key personnel;  
    
    develop and renew strategic relationships; and  
    
    access additional capital when required and on reasonable terms. 39




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We cannot be certain that we will successfully address these and other
challenges, risks and uncertainties or that our business model will be
successful. Failure to do so could adversely affect our business, results of
operations or financial condition. Our software products and hosted solutions are at varying stages of market
acceptance and the failure of any of our products to achieve wide acceptance
would harm our operating results. We began offering our InFormelectronic data capture software solution for
clinical trials in December 1998. Although the Clintrialand Clintraceproducts
were introduced over 10 years ago, we did not begin offering these products
until after our acquisition of Clinsoft Corporation in 2001. Continued use of
our Clintrialand Clintracesoftware products, and broad and timely acceptance
of our InFormproduct, as well as integrated solutions combining one or more of
our software products, is critical to our future success and is subject to a
number of significant risks, some of which are outside our control. These risks
include:  
    
    our customers and prospective customers desire for and acceptance
of our electronic data capture, management and adverse event reporting
software solutions;  
    
    our software products and hosted solutions ability to support
large numbers of users and manage vast amounts of data;  
    
    our customers ability to use our software products and hosted
solutions, train their employees and successfully deploy our technology
in their clinical trials; and  
    
    our ability to significantly expand our internal resources and
increase our capital and operating expenses to support the anticipated
growth and continued integration of our software products, services and
hosted solutions. Our failure to address, mitigate or manage these risks would seriously
harm our business, particularly if the failure of any or all of our software
products or hosted solutions to achieve market acceptance negatively affects
our sales of our other products and services. Our operating results may fluctuate significantly and could cause the market
price of our common stock to fall rapidly and without notice. Our revenues and operating results are difficult to predict and may
fluctuate significantly from quarter to quarter, particularly because of the
rapidly evolving market in which we operate and our term license model. For
instance, our quarterly results ranged from an operating loss of $4.1 million
for the quarter ended December 31, 2003 to operating income of $946,000 for the
quarter ended June 30, 2004. Our results of operations in any given quarter
will be based on a number of factors, including:  
    
    the extent to which our software products, services and hosted
solutions achieve or maintain market acceptance;  
    
    our ability to introduce new products and services and enhancements
to our existing products and services on a timely basis;  
    
    the competitive environment in which we operate;  
    
    the timing of our product sales and the length of our sales and implementation cycles;  
    
    changes in our operating expenses; 40




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
    
    our ability to hire and retain qualified personnel;  
    
    changes in the regulatory environment related to the clinical trial market;  
    
    the financial condition of our current and potential customers; and  
    
    the timing, size and integration success of potential future acquisitions. A significant portion of our operating expense is relatively fixed in
nature and planned expenditures are based in part on expectations regarding
future revenues. Accordingly, unexpected revenue shortfalls may decrease our
gross margins and could cause significant changes in our operating results from
quarter to quarter. Results of operations in any quarterly period should not be
considered indicative of the results to be expected for any future period. In
addition, our future quarterly operating results may fluctuate and may not meet
the expectations of securities analysts or investors. If this occurs, the
trading price of our common stock could fall substantially either suddenly or
over time. We may be required to spend substantial time and expense before we recognize a
significant portion of the revenues, if any, attributable to our customer
contracts. The sales cycle for some of our software solutions frequently takes in
excess of nine months from initial customer contact to contract execution.
During this time, we may expend substantial time, effort and financial
resources without realizing any revenue with respect to the potential sale. In
addition, in the case of our hosted electronic data capture solutions, we do
not begin recognizing revenue until implementation cycles are complete.
Moreover, while we begin recognizing revenue upon the execution of our software
term licenses, it may be difficult for us to rapidly increase our revenue
through additional sales in any period, as revenue from new customers is
recognized over the applicable license term, typically three to five years. As
a result, we may not recognize significant revenues, if any, from some
customers despite incurring considerable expense related to our sales and
implementation process. Even if we do realize revenues from a contract, our
term license pricing model may keep us from recognizing a significant portion
of these revenues during the same period in which sales and implementation
expenses were incurred. Those timing differences could cause our gross margins
and profitability to fluctuate significantly from quarter to quarter.
Similarly, a decline in new or renewed software term licenses in any one
quarter will not necessarily be fully reflected in the revenue in that quarter
and may negatively affect our revenue in future quarters. This could cause our
operating results to fluctuate significantly from quarter to quarter. The loss of one or more major customers could materially and adversely affect
our results of operations and financial condition. Our top five customers accounted for approximately 37% of our revenues
during 2002, approximately 32% of our revenues during 2003 and approximately
34% of our revenues during the three months ended June 30, 2004. Moreover,
sales to one customer, Eli Lilly and Company, a holder of approximately one
percent of our outstanding capital stock, accounted for approximately 10% of
our revenues for the fiscal year ended December 31, 2003 and 12% for the three
months ended June 30, 2004. The loss of any of our major customers could have a
material adverse effect on our results of operations or financial condition. We
may not be able to maintain our customer relationships, and our customers may
not renew their agreements with us, which could adversely affect our results of
operations or financial condition. A significant change in the liquidity or
financial position of any of these customers could also have a material adverse
effect on the collectibility of our accounts receivables, our liquidity and our
future operating results. 41




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Interruptions or delays in service from our third party providers could impair
the delivery of our hosted InForm electronic data capture solution and harm our
business. We host our InFormelectronic data capture software solution at
third-party facilities. Consequently, the occurrence of a natural disaster or
other unanticipated problems at the facilities of our third-party provider
could result in unanticipated interruptions in our customers access to our
InFormelectronic data capture software solution. Our hosted services may also
be subject to sabotage, intentional acts of malfeasance and similar misconduct
due to the nature of the Internet. In the past, Internet users have
occasionally experienced difficulties with Internet and online services due to
system or security failures. We cannot assure you that our business
interruption insurance will adequately compensate our customers or us for
losses that may occur. Even if covered by insurance, any failure or breach of
security of our systems could damage our reputation and cause us to lose
customers. Further, certain of our hosted InFormelectronic data capture
solutions, representing approximately 38% of our total revenues for the three
months ended June 30, 2004, are subject to service level agreements that
guarantee certain levels of uptime reliability. These agreements provide for
95% to 99% server availability. In the event that we fail to meet those levels,
whether resulting from an interruption in service caused by our technology or
that of a third-party provider, we could be subject to customer credits or
termination of these customer contracts. Failure of our technology and products could harm our business and operating
results. The technology underlying our software products and hosted solutions
processes vast amounts of clinical trial data. Customers relying on our
products to collect, manage and report clinical trial information may have a
greater sensitivity to product errors and security vulnerabilities than
customers of software products in general. In the past, failures of our
technology and human error have negatively impacted the data capture,
management or reporting capabilities of our products, and new errors may be
detected in the future. Any delay or failure of our technology may result in
the disruption of the clinical trial process and could harm our business and
operating results. Product or service errors could materially and adversely
affect our reputation, result in significant costs to us and impair our ability
to sell our products and services in the future. The costs incurred in
correcting any defects or errors may be substantial and could adversely affect
our operating margins. In addition, security breaches, whether intentional or
accidental, could expose us to a risk of loss of data, litigation and possible
liability. The global nature of our business exposes us to multiple risks. For the year ended December 31, 2003 and the three months ended June 30,
2004, approximately 39% and 41%, respectively, of our revenues were derived
from international operations. We expect that our international operations will
continue to account for a significant portion of our revenues. As a result of
our international operations, we are exposed to many risks and uncertainties,
including:  
    
    difficulties in staffing, managing and supporting operations in multiple countries;  
    
    tariff and international trade barriers;  
    
    fewer legal protections for intellectual property and contract rights abroad;  
    
    different and changing legal and regulatory requirements in the
jurisdictions in which we currently operate or may operate in the
future;  
    
    government currency control and restrictions on repatriation of earnings;  
    
    fluctuations in foreign currency exchange and interest rates; and 42




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
    
    political and economic changes, hostilities and other disruptions
in regions where we currently operate or may operate in the future. Negative developments in any of these areas in one or more countries could
result in a reduction in demand for our software products, services and hosted
solutions, the cancellation or delay of orders already placed, threats to our
intellectual property, difficulty in collecting receivables, and a higher cost
of doing business, any of which could adversely affect our business, results of
operations or financial condition. Moreover, with regard to our international
operations, we frequently enter into transactions in currencies other than the
U.S. dollar. This creates a foreign currency exchange risk for us that could
have a material adverse effect on our results of operations and financial
condition. We may lose or delay revenues related to our hosted solutions if our customers
terminate or delay their contracts with us. Certain of our hosted electronic data capture and other service and
consulting contracts are subject to cancellation by our customers at any time
with limited notice. Entities engaged in clinical trials may terminate or delay
a clinical trial for various reasons including the failure of the tested
product to satisfy safety or efficacy requirements, unexpected or undesired
clinical results, decisions to de-emphasize a particular product or forego a
particular clinical trial, decisions to downsize clinical development programs,
insufficient patient enrollment or investigator recruitment and production
problems resulting in shortages of required clinical supplies. In the case of
our hosted solutions, any termination or delay in the clinical trials would
likely result in a consequential delay or termination in those customers
service contracts. We have experienced terminations and delays of our customer
service contracts in the past and expect to experience additional terminations
and delays in the future. Because we do not recognize any portion of a hosted
service contracts revenue until the implementation cycle is complete, the
termination or delay of our customers clinical trials could result in
decreased or delayed revenues under these contracts which could materially harm
our business. We may be unable to adequately protect, and we may incur significant costs in
defending, our intellectual property and other proprietary rights. Our success depends on our ability to protect our intellectual property
and other proprietary rights. We rely upon a combination of trademark, trade
secret, copyright, patent and unfair competition laws, as well as license
agreements and other contractual provisions, to protect our intellectual
property and other proprietary rights. In addition, we attempt to protect our
intellectual property and proprietary information by requiring our employees
and consultants to enter into confidentiality, noncompetition and assignment of
inventions agreements. To the extent that our intellectual property and other
proprietary rights are not adequately protected, third parties might gain
access to our proprietary information, develop and market products or services
similar to ours, or use trademarks similar to ours, each of which could
materially harm our business. Existing U.S. federal and state intellectual
property laws offer only limited protection. Moreover, the laws of other
countries in which we market our software products, services and hosted
solutions may afford little or no effective protection of our intellectual
property. If we resort to legal proceedings to enforce our intellectual
property rights or to determine the validity and scope of the intellectual
property or other proprietary rights of others, the proceedings could be
burdensome and expensive, even if we were to prevail. The failure to adequately
protect our intellectual property and other proprietary rights may have a
material adverse effect on our business, results of operations or financial
condition. 43




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Claims that we or our technologies infringe upon the intellectual property or
other proprietary rights of a third party may require us to incur significant
costs, to enter into royalty or licensing agreements or to develop or license
substitute technology. We are, and may in the future be, subject to claims that our technologies
infringe upon the intellectual property or other proprietary rights of a third
party. For instance, Dr. Mark L. Kozam, doing business under the name MLK
Software, has filed a complaint against us and one of our customers alleging
that we infringe a patent claimed to be owned by Dr. Kozam. This case is still
in the initial pleading stage. In addition, the vendors who provide us with
technology that we use in our technology could become subject to similar
infringement claims. Although we believe that our software solutions do not
infringe the patents of any third party, we cannot assure you that our
technology does not infringe patents held by others or that they will not in
the future. Any claims of infringement could cause us to incur substantial
costs defending against the claim, even if the claim is without merit, and
could distract our management from our business. Moreover, any settlement or
adverse judgment resulting from the claim could require us to pay substantial
amounts or obtain a license to continue to use the technology that is the
subject of the claim, or otherwise restrict or prohibit our use of the
technology. There can be no assurance that we would be able to obtain a license
from the third party asserting the claim on commercially reasonable terms, if
at all, that we would be able to successfully develop alternative technology on
a timely basis, if at all, or that we would be able to obtain a license from
another provider of suitable alternative technology to permit us to continue
offering, and our customers to continue using, the applicable technology. In
addition, we generally provide in our customer agreements, including our
agreement with the customer that is the subject of the Kozam claim referenced
above, that we will indemnify our customers, against third party infringement
claims relating to our technology provided to the customer, which could
obligate us to fund significant amounts. Infringement claims asserted against
us or our vendors may have a material adverse effect on our business, results
of operations or financial condition. Our business could be seriously harmed by our dependence on a limited number of
suppliers. We depend upon a limited number of suppliers for specific components of
our software products and hosted solutions. We may increase our dependence on
certain suppliers as we continue to develop and enhance our software and
service solutions. Our dependence on a limited number of suppliers leaves us
vulnerable to having an inadequate supply of required components, price
increases, delayed supplier performance and poor component quality. For
instance, we rely on Oracle Corporation to supply the database component of our
software solutions and on IBM Corporation to provide the server facilities for
our hosting services. Oracle Corporation also offers a software package that is
competitive with our products and services. If we are unable to obtain
components for our software solutions from third-party suppliers in the
quantities and of the quality that we need, on a timely basis or at acceptable
prices, we may not be able to deliver our software products, services and
hosted solutions on a timely or cost-effective basis to our customers, and our
business, results of operations and financial condition could be seriously
harmed. Moreover, delays or interruptions in our service may reduce our
revenue, cause customers to terminate their contracts and adversely affect our
customer renewals. We could incur substantial costs resulting from product liability claims
relating to our products or services or our customers use of our products or
services. Any failure or errors in a customers clinical trial or adverse event
reporting obligations caused or allegedly caused by our products or services
could result in a claim for substantial damages against us by our customers or
the clinical trial participants, regardless of our responsibility for the
failure. Although we are entitled to indemnification under our customer
contracts against claims brought against us by third parties arising out of our
customers use of our products, we might find ourselves entangled in lawsuits
against us that, even if unsuccessful, divert our resources and energy and
adversely affect our business. Further, in the event we seek indemnification
from a customer, we cannot assure you that a court will enforce our
indemnification right if challenged by the customer obligated to indemnify us
or that the customer will be able to fund any amounts for indemnification owed
to us. We also cannot assure you that our existing general liability insurance
coverage will continue to be available on reasonable terms or will be available
in amounts sufficient 44




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to cover one or more large claims, or that the insurer will not disclaim
coverage as to any future claim. We and our products and services could be subjected to governmental regulation,
requiring us to incur significant compliance costs or to cease offering our
products and services. The clinical trial process is subject to extensive and strict regulation
by the FDA, as well as other regulatory authorities worldwide. Our electronic
data capture, management and adverse event reporting products and services
could be subjected to state, federal and foreign regulations. We cannot assure
you that our products and service offerings will comply with applicable
regulations and regulatory guidelines as they develop. If our products or
services fail to comply with any applicable government regulations or
guidelines, we could incur significant liability or be forced to cease offering
our applicable products or services. Also, conforming our products and services
to any applicable regulations and guidelines could substantially increase our
operating expenses. We may acquire or make investments in companies or technologies that could
cause disruption of our business and loss of value or dilution to our
stockholders. We have made in the past, and may make in the future, acquisitions or
significant investments in other businesses. Entering into an acquisition
entails many risks, any of which could harm our business, including:  
    
    difficulties in integrating the operations, technologies, products,
existing contracts and personnel of the target company and realizing
the anticipated synergies of the combined businesses;  
    
    the price we pay or other resources that we devote may exceed the
value we eventually realize or the value we could have realized if we
had allocated the purchase price or other resources to another
opportunity;  
    
    potential loss of key employees, customers and strategic alliances
from either our current business or the target companys business;  
    
    managing the risks of entering markets or types of businesses in
which we have limited or no direct experience;  
    
    the diversion of managements attention from other business
concerns; and  
    
    assumption of unanticipated problems or latent liabilities, such as
problems with the quality of the target companys products. In addition, if we finance any future acquisitions by issuing equity
securities or convertible debt, our existing stockholders may be diluted or the
market price of our stock may be adversely affected. The failure to
successfully evaluate and execute acquisitions or investments or otherwise
adequately address these risks could materially harm our business and financial
results. If we are unable to retain our personnel and hire additional skilled personnel,
we may be unable to achieve our goals. Our future success depends upon our ability to attract, train and retain
highly skilled employees and contract workers, particularly our management
team, sales and marketing personnel, professional services personnel and
software engineers. Each of our executive officers and other employees could
terminate his or her relationship with us at any time. The loss of any member
of our management team might significantly delay or prevent the achievement of
our business or 45




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development objectives and could materially harm our business. In addition,
because of the technical nature of our software products, services and hosted
solutions and the dynamic market in which we compete, any failure to attract
and retain qualified direct sales, professional services and product
development personnel, as well as our contract workers, could have a material
adverse affect on our ability to generate sales or successfully develop new
software products, services and hosted solutions or software enhancements. Failure to manage our rapid growth effectively could harm our business. We have been experiencing a period of rapid growth that has placed a
significant strain on our operational and financial resources and our
personnel. From January 1, 1999 to June 30, 2004, the number of our employees
increased from 35 to approximately 359. To manage our anticipated future growth
effectively, we must continue to maintain and may need to enhance our
information technology infrastructure, financial and accounting systems and
controls and manage expanded operations in geographically distributed
locations. We also must attract, integrate, train and retain a significant
number of qualified sales and marketing personnel, professional services
personnel, software engineers and other management personnel. Our failure to
manage our rapid growth effectively could have a material adverse effect on our
business, operating results or financial condition. We may not be able to obtain capital when desired on favorable terms, if at
all, or without dilution to our stockholders. We anticipate that our current cash and cash equivalents will be
sufficient to meet our current needs for general corporate purposes. However,
we may need additional financing to execute on our current or future business
strategies, including to:  
    
    hire additional personnel;  
    
    develop new or enhance existing software products, services and hosted solutions;  
    
    enhance our operating infrastructure;  
    
    acquire businesses or technologies; or  
    
    otherwise respond to competitive pressures. If we raise additional funds through the issuance of equity or convertible
debt securities, the percentage ownership of our stockholders could be
significantly diluted, and these newly issued securities may have rights,
preferences or privileges senior to those of existing stockholders. We cannot
assure you that additional financing will be available on terms favorable to
us, or at all. If adequate funds are not available or are not available on
acceptable terms, when we desire them, our ability to fund our operations, take
advantage of unanticipated opportunities, develop or enhance our software
products, services and hosted solutions, or otherwise respond to competitive
pressures would be significantly limited. Our loan agreement contains operating and financial covenants that may restrict
our business and financing activities. We have a loan agreement with a bank that provides for a $5.0 million
working capital credit line. Our loan agreement restricts our ability to:  
    
    redeem subordinated indebtedness; 46




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
    
    incur additional indebtedness;  
    
    create liens;  
    
    enter into transactions with affiliates;  
    
    make investments;  
    
    sell assets;  
    
    pay dividends or make distributions on, or repurchase, our stock; or  
    
    consolidate or merge with other entities. In addition, our credit facilities require us to meet specified revenue
thresholds and maintain specified financial ratios and tests. The operating and
financial restrictions and covenants in these credit facilities, as well as any
future financing agreements that we may enter into, may restrict our ability to
finance our operations, engage in business activities or expand or fully pursue
our business strategies. Our ability to comply with these covenants may be
affected by events beyond our control, and we may not be able to meet those
covenants. A breach of any of these covenants could result in a default under
the loan agreement, which could cause all of the outstanding indebtedness under
both credit facilities to become immediately due and payable and terminate all
commitments to extend further credit. At December 31, 2003, we were in violation of a financial covenant
requiring us to achieve quarterly revenues of $16.0 million, net of
reimbursable out-of-pocket expenses, for which we received a waiver from the
bank. That waiver, however, did not remove or limit the financial covenants we
must satisfy under the loan agreement in the future. Although we believe we are
currently in compliance under this agreement, we cannot assure you that if a
future violation occurs we will receive a waiver or that our indebtedness will
not be accelerated. While we believe that we will have sufficient resources to
fund any amounts which may become due under these credit facilities, we cannot
assure you that we will have sufficient assets to repay our credit facilities
upon any default or that the bank will not seek to enforce its remedies against
us. If we were unable to repay those amounts, the bank could proceed against
the collateral granted to them to secure that indebtedness. We have pledged
substantially all of our assets, other than our intellectual property, as
collateral under the loan agreement. We have also entered into a negative
pledge agreement that, subject to certain exceptions, generally prohibits us
from pledging our intellectual property to others. In the course of conducting our business, we possess or could be deemed to
possess personal medical information in connection with the conduct of clinical
trials, which if we fail to keep properly protected, could subject us to
significant liability. Our software solutions are used to collect, manage and report information
in connection with the conduct of clinical trails. This information is or could
be considered to be personal medical information of the clinical trial
participants. Regulation of the use and disclosure of personal medical
information is complex and growing. Increased focus on individuals rights to
confidentiality of their personal information, including personal medical
information, could lead to an increase of existing and future legislative or
regulatory initiatives giving direct legal remedies to individuals, including
rights to damages, against entities deemed responsible for not adequately
securing such personal information. In addition, courts may look to regulatory
standards in identifying or applying a common law theory of liability, whether
or not that law affords a private right of action. Since we receive and process
personal information of clinical trial participants from our customers, there
is a risk that we could be liable if there were a breach of any obligation to a 47




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protected person under contract, standard of practice or regulatory
requirement. If we fail to properly protect this personal information that is
in our possession or deemed to be in our possession, we could be subjected to
significant liability. Risks Related to our Common Stock The market price of our common stock may be volatile, which could result in
substantial losses for investors purchasing shares in the public markets and
subject us to securities class action litigation. We only recently completed our initial public offering. Prior to our
initial public offering, you could not buy or sell our common stock publicly.
An active public market for our common stock may not continue to develop or be
sustained. Market prices for securities of software, technology and health
care companies have been particularly volatile. The trading price of our common
stock may fluctuate significantly and, accordingly, may not be indicative of
future trading prices and we may be unable to sustain or increase the value of
an investment in our common stock . Some of the factors that may cause the
market price of our common stock to fluctuate include:  
    
    period-to-period fluctuations in our financial results or those of
companies that are perceived to be similar to us;  
    
    changes in estimates of our financial results or recommendations by
securities analysts;  
    
    the failure of any of our software products, services and hosted
solutions to achieve or maintain commercial success;  
    
    changes in market valuations of similar companies;  
    
    success of competitive products and technologies;  
    
    future issuances of securities or the incurrence of debt by us, or
other changes in our capital structure;  
    
    announcements by us or our competitors of significant products,
contracts, acquisitions or strategic alliances;  
    
    regulatory developments in the United States and foreign countries;  
    
    litigation involving our company or our general industry or both;  
    
    additions or departures of key personnel;  
    
    investors general perception of us; and  
    
    changes in general economic, industry and market conditions. In addition, if the market for software, technology or health care stocks
or the stock market in general experiences a loss of investor confidence, the
trading price of our common stock could decline for reasons unrelated to our
business, operating results or financial condition. If any of the foregoing
occurs, it could cause our stock price to fall and may expose us to class
action lawsuits that, even if unsuccessful, could be costly to defend and a
distraction to management. 48




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A significant portion of our total outstanding shares are restricted from
immediate resale but may be sold into the market in the near future. This could
cause the market price of our common stock to drop significantly, even if our
business is doing well. Sales of a substantial number of shares of our common stock in the public
market could occur at any time after the expiration of lock-up agreements
applicable to some of our stockholders 180 days following our July 2004 initial
public offering. These sales, or the perception in the market that the holders
of a large number of shares intend to sell shares, could reduce the market
price of our common stock. As of July 20, 2004, we had 31,760,044 shares of
common stock outstanding. Approximately 26,510,044 shares, or 84% of our
outstanding shares, are currently restricted as a result of securities laws or
lock-up agreements but will be able to be sold, subject to any applicable
volume limitations under federal securities laws, in the near future as set
forth below. Number of Shares and
    
    Date Available for Sale% of Total Outstanding
    
    Into Public Market361,475 shares, or 1.1%
    
    On or after October 13, 2004.25,485,503 shares, or 80.2%
    
    On or after January 11, 2005, subject to
extension in specified instances, due to
lock-up agreements between the holders of
these shares and the underwriters. However,
Thomas Weisel Partners LLC, the managing
underwriter in our initial public offering,
can waive the provisions of these lock-up
agreements and allow these stockholders to
sell their shares at any time.400,118 shares, or 1.3%
    
    On or after January 11, 2005 due to a lock-up
agreement between the holders of these shares
and us. However, the managing underwriter of
our July 2004 initial public offering can
waive the provisions of these lock-up
agreements and allow these stockholders to
sell their shares at any time.
 In addition, as of June 30, 2004, there were 34,330 shares subject to an
outstanding warrant that will become eligible for sale in the public market to
the extent permitted by the lock-up agreement and the applicable requirements
of the federal securities laws. We have also registered, on Form S-8,
4,474,349 shares that we may issue pursuant to outstanding options and an
additional 1,920,000 shares reserved for future issuance under our stock option
and stock purchase plans that will be eligible for sale in the public market to
the extent permitted by any applicable vesting requirements and the lock-up
agreements. Moreover, holders of an aggregate of 25,093,840 shares of our
common stock as of June 30, 2004, will have rights, subject to some conditions,
to require us to file registration statements covering their shares or to
include their shares in registration statements that we may file for ourselves
or other stockholders. Our directors and management exercise significant control over our company. Our directors and executive officers and their affiliates collectively
control approximately 35% of our outstanding common stock. As a result, these
stockholders, if they act together, are able to influence our management and
affairs and all matters requiring stockholder approval, including the election
of directors and approval of significant corporate transactions. This
concentration of ownership may have the effect of delaying or preventing a
change in control of our company and might affect the market price of our
common stock. 49




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Delaware law and our corporate documents may prevent or frustrate a change in
control or a change in management that stockholders believe is desirable. Provisions of our certificate of incorporation and bylaws and Delaware law
may discourage, delay or prevent a merger, acquisition or other change in
control that stockholders may consider favorable, including transactions in
which you might otherwise receive a premium for your shares. These provisions
may also prevent or frustrate attempts by our stockholders to replace or remove
our management. These provisions include:  
    
    limitations on the removal of directors;  
    
    advance notice requirements for stockholder proposals and nominations;  
    
    the inability of stockholders to act by written consent or to call special meetings; and  
    
    the ability of our board of directors to designate the terms of and
issue new series of preferred stock without stockholder approval, which
could be used to institute a rights plan, or a poison pill, that would
work to dilute the stock ownership of a potential hostile acquirer,
likely preventing acquisitions that have not been approved by our board
of directors. The affirmative vote of the holders of at least 75% of our shares of
capital stock entitled to vote is necessary to amend or repeal the above
provisions of our certificate of incorporation. In addition, absent approval of
our board of directors, our bylaws may only be amended or repealed by the
affirmative vote of the holders of at least 75% of our shares of capital stock
entitled to vote. In addition, Section 203 of the Delaware General Corporation Law prohibits
a publicly held Delaware corporation from engaging in a business combination
with an interested stockholder, generally a person which together with its
affiliates owns, or within the last three years has owned, 15% of our voting
stock, for a period of three years after the date of the transaction in which
the person became an interested stockholder, unless the business combination is
approved in a prescribed manner. The existence of the foregoing provisions could limit the price that
investors might be willing to pay in the future for shares of our common stock. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk Foreign Currency Exchange
Risk Our results of operations and cash flows are subject to fluctuations due
to changes in foreign currency exchange rates, particularly changes in the
Euro, British pound sterling, Australian dollar and Japanese yen. In the six
months ended June 30, 2003 and 2004, 39% and 40%, respectively of our revenues
were generated in locations outside the United States. The majority of these
revenues are denominated in currencies other than U.S. dollars. Except for
revenue transactions in Japan, we enter into transactions directly with
substantially all of our foreign customers. This creates a foreign currency
exchange risk for us. As of June 30, 2004, we had $3.7 million of receivables denominated in
currencies other than the U.S. dollar. If the foreign exchange rates fluctuated
by 10% as of June 30, 2004, our foreign exchange exposure would have fluctuated
by approximately $300,000. In addition, our subsidiaries have intercompany
accounts that eliminate upon consolidation, however, such accounts expose us to
foreign currency exchange rate exposure. Exchange rate fluctuations on
short-term intercompany accounts are reported in other income (expense), while
exchange rate fluctuations on long-term intercompany accounts are recorded in
other comprehensive income or loss in stockholders deficit. We have recently
implemented a risk management process that monitors monthly activity through 50




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the use of various internal controls. This process is designed to minimize
foreign currency exposures. To date, we have not entered into any hedging
contracts. Interest Rate
Sensitivity We had unrestricted cash and cash equivalents totaling $26.4 million at
June 30, 2004. These amounts were invested primarily in money market funds. The
unrestricted cash and cash equivalents are held for working capital purposes.
We do not enter into investments for trading or speculative purposes. Due to
the short-term nature of these investments, we believe that we do not have any
material exposure to changes in the fair value of our investment portfolio as a
result of changes in interest rates. Declines in interest rates, however, would
reduce future investment income. We have lines of credit which bear interest based upon the prime rate. At
June 30, 2004, there was $2.5 million outstanding under our working capital
line of credit. If the prime rate fluctuated by 10% as of June 30, 2004,
interest expense would have fluctuated by approximately $5,000. 
 Item 4. Controls and Procedures (a) Evaluation of Disclosure Controls and Procedures. As required by Rules 13a-15 and 15d-15 of the Securities Exchange Act of
1934, we have evaluated, with the participation of management, including the
Chief Executive Officer and the Chief Financial Officer, the effectiveness of
our disclosure controls and procedures as of the end of the period covered by
this report. Based on such evaluation, the Chief Executive Officer and Chief
Financial Officer have concluded that such disclosure controls and procedures
are effective in are effective in enabling us to record, process, summarize
and report information required to be included in the reports that we file or
submit under the Securities Exchange Act of 1934 within the applicable time
period prescribed by the Securities and Exchange Commission. From time to time,
we review the disclosure controls and procedures, and may from time to time
make changes aimed at enhancing their effectiveness and to ensure that our
systems evolve with our business. (b) Changes in Internal Controls There was no change in our internal control over financial reporting that
occurred during the quarter ended June 30, 2004 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting. 51




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Part II  Other Information 
 Item 1. Legal Proceedings From time to time and in the ordinary course of business, we may be subject to
various claims, charges and litigation. The outcome of litigation cannot be
predicted with certainty and some lawsuits, claims or proceedings may be
disposed of unfavorably to us, which could materially and adversely affect our
financial condition or results of operations. On April 26, 2004, Datasci, LLC (Datasci) filed suit (Civil Action No.
04-1328 (MJG)) in the United States District Court for the District of Maryland
(Greenbelt Division) against Phase Forward Incorporated and Quintiles Inc., one
of our customers. Datasci had asserted that our InForm, Clintrial and Clintrial
Integration Solution products and our services, and the products and services
of Quintiles, infringe a United States patent claimed to be owned by Datasci
(Patent No. 6,496,827). Datasci sought an injunction and unspecified damages
from each of us and Quintiles. On May 4, 2004, we filed an Answer and Counterclaim to Datascis complaint
denying that it infringes the patent which Datasci claimed to own. The Answer
also challenged the validity of the patent and asserted numerous affirmative
defenses. Our Counterclaim sought a declaratory judgment that we do not
infringe the patent claimed to be owned by Datasci. Datasci responded by
denying all the allegations in our Counterclaim. On or about June 7, 2004,
Datasci filed a motion to dismiss its complaint against Phase Forward and
Quintiles. In its filing, Datasci disclosed that it did not exist when its
complaint against Phase Forward and Quintiles was filed. That motion was
granted and, thus, the entire action was dismissed on August 5, 2004. Also on
or about June 7, 2004, Dr. Mark L. Kozam, doing business under the name MLK
Software and claiming to be the owner of the patent, filed suit (Civil Action
No. 04-CV-1787 (PJM)) in the same court where Datasci filed its initial
complaint against us and Quintiles. Dr. Kozams complaint contains the same
allegations and seeks the same remedies that were contained in the Datasci
complaint. On June 22, 2004, we filed an Answer and Counterclaim to Dr.
Kozams complaint denying that we infringes the patent, challenging the
validity of the patent, asserting numerous affirmative defenses, and
counterclaiming for a declaratory judgment that we do does not infringe any
valid claim of the patent. Dr. Kozam responded by denying all the allegations
in our Counterclaim. Although this action is in the initial pleading stage, we are prepared to
vigorously defend the claims and pursue our Counterclaims and any other
remedies available to us. Due to the preliminary nature of this action, we are
unable to assess whether its outcome will have a material adverse effect on our
results of operations. 
 Item 2. Changes in Securities, Use of Proceeds and Issuer Repurchases of Equity
Securities During the quarter ended June 30, 2004, we granted options to purchase an
aggregate of 20,555 shares of our common stock to employees under our Amended
and Restated 1997 Stock Option Plan, at a weighted average exercise price of
$6.00 per share. In addition, we issued 50,658 shares of common stock during
the quarter ended June 30, 2004 in connection with the exercise of outstanding
options under our 1997 Stock Option Plan by 17 of our employees, at a weighted
exercise price of $0.92 per share. These option exercises resulted in aggregate
proceeds to us of approximately $46, 827. No underwriters were involved in the
foregoing stock or option issuances. The foregoing stock and option issuances
were exempt from registration under the Securities Act of 1933, as amended,
either pursuant to Rule 701 under the Act, as transactions pursuant to a
compensatory benefit plan, or pursuant to Section 4(2) under the Act, as a
transaction by an issuer not involving a public offering. On July 20, 2004, we closed the sale of an aggregate of 5,250,000 shares
of our common stock, $0.01 par value, in our initial public offering at a price
to the public of $7.50 per share. The managing underwriters in the offering
were Thomas Weisel Partners LLC, Piper Jaffray & Co. and Raymond James &
Associates, Inc. All of the shares of common stock sold in the offering were
registered under the Securities Act of 1933 on a Registration Statement on Form
S-1 (Reg. No. 333-113594) that was declared effective by the SEC on July 13, as
amended by Post-Effective Amendment No. 1 and No. 2 to Form S-1 Registration
Statement (Reg. No. 333-113594) declared effective by the SEC on July 14, 2004
and a Registration Statement filed pursuant to Rule 424(b) under the Securities
Act of 1933 that was filed on July 15, 2004 (Reg. No. 333-113594). The offering
commenced on July 15, 2004 and did not terminate until after the sale of all of
the securities registered in the Registration Statement. As part of the initial
public offering, we granted the several underwriters an overallotment option to
purchase up to an additional 787,500 shares of our common stock from us within
30 days of the offering. As of the date hereof, the underwriters have not
exercised the overallotment option. There were no selling stockholders in the
offering. The aggregate price of the offering amount registered on our behalf was
approximately $39.4 million. In connection with the offering, we paid
approximately $2.8 million in underwriting discounts and commissions to the
underwriters and incurred an estimated $2.0 million in other 52




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offering-related expenses. Entities affiliated with Thomas Weisel Partners
LLC, a managing underwriter in the offering, beneficially own in the aggregate
more than ten percent of our outstanding common stock. Accordingly, Thomas
Weisel Partners LLC may be deemed to be an affiliate of ours. We paid
approximately $1.2 million in underwriting discounts and commissions to Thomas
Weisel Partners LLC in connection with the offering. Except as described in
the preceding sentence, none of the underwriting discounts and commissions or
offering expenses were incurred or paid to directors or officers of ours or
their associates or to persons owning ten percent or more of our common stock
or to any affiliates of ours. After deducting the underwriting discounts and
commissions and offering expenses, we received net proceeds from the offering
of approximately $34.6 million. We currently expect to use the proceeds to us
in conformity with our intended use outlined in the prospectus related to the
offering. To date, other than the repayment of our $2.5 million equipment line
of credit as disclosed in the prospectus, none of the net proceeds from the
initial public offering has been applied. Pending such application, we have
invested or plan to invest the remaining net proceeds of the offering in cash
and cash equivalent assets in accordance with our investment policy in one or
more of the following fixed income instruments: money-market mutual funds,
U.S. Government agencies and direct and guaranteed obligations of the United
States, as well as corporate bonds. None of the net proceeds were paid,
directly or indirectly, to directors, officers, persons owning ten percent or
more of our equity securities, or our affiliates. During the quarter ended June 30, 2004, there were no repurchases made by
us or on our behalf, or by any affiliated purchaser, of shares of our common
stock registered pursuant to Section 12 of the Securities Exchange Act of 1934,
as amended. 
 Item 3. Defaults upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders On April 20, 2004, we obtained the approval by written consent, in lieu of
a special meeting of stockholders, of the holders of our capital stock to:  
    
    approve an amendment to our fifth restated certificate of
incorporation to temporarily reduce to $9.50 per share (i) the initial
public offering price of our common stock at or above which would cause
the automatic conversion of our preferred stock into common stock upon
closing of our initial public offering and (ii) the initial public
offering price of our common stock at or below which the holders of our
series C preferred stock and series D preferred stock would be entitled
to receive their respective liquidation payments in an initial public
offering;  
    
    approve the amendment and restatement of our by-laws effective upon
the closing of our initial public offering;  
    
    approve the amendment and restatement of our fifth restated
certificate of incorporation, as amended, to take effect immediately
prior to the effectiveness of the registration statement for our
initial public offering;  
    
    adopt our 2004 Stock Option and Incentive Plan and approve the
reservation of 1,500,000 shares of our common stock thereunder;  
    
    approve certain amendments to our Amended and Restated 2003
Non-Employee Director Stock Option Plan;  
    
    adopt our 2004 Employee Stock Purchase Plan and approve the
reservation of 320,000 shares of our common stock thereunder; and  
    
    approve the further amendment and restatement of our amended and
restated certificate of incorporation to be filed with the Delaware
Secretary of State upon the closing of our initial public offering. 53




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All such actions were effected pursuant to an action by written consent of our
stockholders in compliance with Section 228 of the Delaware General Corporation
Law. Stockholders holding an aggregate of 20,593,922 shares of capital stock
signed the action by written consent. On June 4, 2004, we obtained the approval by written consent, in lieu of a
special meeting of stockholders, of the holders of our capital stock to:  
    
    approve the payment of a special cash dividend on each issued and
outstanding share of our series B preferred stock, series C preferred
stock and series D preferred stock equal to five percent (5%) of the
applicable original issue price of such shares; and  
    
    approve an amendment to our fifth restated certificate of
incorporation, as then amended to date, to temporarily reduce to $7.50
per share (i) the initial public offering price of our common stock at
or above which would cause the automatic conversion of our preferred
stock into common stock upon closing of our initial public offering and
(ii) the initial public offering price of our common stock at or below
which the holders of our series B preferred stock, would be entitled to
receive their respective liquidation payments in an initial public
offering. All such actions were effected pursuant to an action by written consent of our
stockholders in compliance with Section 228 of the Delaware General Corporation
Law. Stockholders holding an aggregate of 20,329,082 shares of capital stock
signed the action by written consent. 
 Item 5. Other Information Our policy governing transactions in our securities by directors, officers
and employees permits our officers, directors and certain other persons to
enter into trading plans complying with Rule 10b5-1 under the Securities
Exchange Act of 1934, as amended. We anticipate that, as permitted by Rule
10b5-1 and our policy governing transactions in our securities, some or all of
our officers, directors and employees may establish trading plans in the
future. We intend to disclose the names of executive officers and directors who
establish a trading plan in compliance with Rule 10b5-1 and the requirements of
our policy governing transactions in our securities in our future quarterly and
annual reports on Form 10-Q and 10-K filed with the SEC. However, we undertake
no obligation to update or revise the information provided herein, including
for revision or termination of an established trading plan, other than in such
quarterly and annual reports. 
 Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. Exhibit No.
    
    Exhibit31.1*
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities Exchange Act of 193431.2*
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities Exchange Act of 193432.1*
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 200232.2*
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
  *
    
    Filed herewith. (b) Reports on Form 8-K. No Reports on Form 8-K were filed or furnished by us during the fiscal
quarter ended June 30, 2004. 54




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Signature Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. Phase Forward IncorporatedBy:
    /s/   Robert K. WeilerRobert K. WeilerChief Executive Officer

(Duly authorized officer) By:
    /s/   John J. SchicklingJohn J. SchicklingChief Financial Officer

(Duly authorized officer and
principal financial officer) Date: August 13, 2004 55




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Exhibit Index Exhibit No.
    
    Exhibit31.1*
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities Exchange Act of 193431.2*
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) under the Securities Exchange Act of 193432.1*
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 200232.2*
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002
  *
    
    Filed herewith. 56