**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 
| **x**                                                  | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**       |
|--------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|
|                                                   |       |                                                                                                    |
| **For the quarterly period ended March 31, 2008** |
| ** **                                             | ** ** | ** **                                                                                              |
| **OR**                                                 |
| ** **                                             | ** ** | ** **                                                                                              |
| **o**                                                  | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from                               to                              **

 

**CommissionFile Number: 000-50839**

 

**PhaseForward Incorporated**

(Exact name of registrantas specified in its charter)

 

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

** **

**(888) 703-1122**

(Registrant’s telephonenumber, including area code)

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 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 suchreports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes    x    No o

 

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

 

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

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

 

Yes    o     No    x

 

As of May 1, 2008,the registrant had 42,783,441 shares of common stock outstanding.

 

 

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**PHASE FORWARD INCORPORATEDQUARTERLY REPORT ON FORM 10-QFor the quarterly period ended March 31, 2008Table of Contents**

 
|                                             | ** ** | ** **                                                                                                                                       | ** ** | **Page  Number** |
|---------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|
| **Part I—Financial  Information** |       |                                                                                                                                             |
| ** **                                  |       |                                                                                                                                             |
| Item 1.                                     |       | Condensed Consolidated  Balance Sheets as of December 31, 2007 (unaudited) and  March 31, 2008 (unaudited)                             |       | 3                |
|                                        |       |                                                                                                                                             |       |             |
|                                        |       | Condensed  Consolidated Statements of Income for the three months ended  March 31, 2007 (unaudited) and March 31, 2008 (unaudited)     |       | 4                |
|                                        |       |                                                                                                                                             |       |             |
|                                        |       | Condensed  Consolidated Statements of Cash Flows for the three months ended  March 31, 2007 (unaudited) and March 31, 2008 (unaudited) |       | 5                |
|                                        |       |                                                                                                                                             |       |             |
|                                        |       | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                                |       | 6                |
|                                        |       |                                                                                                                                             |       |             |
| Item 2.                                     |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                      |       | 17               |
|                                        |       |                                                                                                                                             |       |             |
| Item 3.                                     |       | Quantitative  and Qualitative Disclosures about Market Risk                                                                                      |       | 30               |
|                                        |       |                                                                                                                                             |       |             |
| Item 4.                                     |       | Controls and  Procedures                                                                                                                         |       | 31               |
|                                        |       |                                                                                                                                             |       |             |
| **Part II—Other  Information**    |       |                                                                                                                                             |
| ** **                                  |       |                                                                                                                                             |
| Item 1.                                     |       | Legal Proceedings                                                                                                                                |       | 32               |
|                                        |       |                                                                                                                                             |       |             |
| Item 1A.                                    |       | Risk Factors                                                                                                                                     |       | 32               |
|                                        |       |                                                                                                                                             |       |             |
| Item 5.                                     |       | Other Information                                                                                                                                |       | 32               |
|                                        |       |                                                                                                                                             |       |             |
| Item 6.                                     |       | Exhibits                                                                                                                                         |       | 33               |
|                                        |       |                                                                                                                                             |       |             |
| Signatures                                  |       | 34                                                                                                                                               |
|                                        |       |                                                                                                                                             |
| Exhibit Index                          |       | 35                                                                                                                                               |

 

2

----

 

**Part I—Financial Information**

 

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

 

**PhaseForward Incorporated**

**Condensed Consolidated Balance Sheets**

**(unaudited)**

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

** **
| ** **                                                                                              | ** ** | **As of December 31,** | ** ** | **As of March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                              | ** ** | **2007**                              | ** ** | **2008**                           | ** ** |
| **Assets**                                                                                              |       |                                  |       |                               |       |
| Current assets:                                                                                         |       |                                  |       |                               |       |
| Cash and cash  equivalents                                                                              |       | $                                     | 133,401    |                               | $          | 153,790 |   |
| Short-term  investments                                                                                 |       | 25,171                                |       | 22,059                             |       |
| Accounts  receivable, net of allowance of $270 and $340 in 2007 and 2008, respectively                  |       | 35,515                                |       | 40,997                             |       |
| Deferred set up  costs, current portion                                                                 |       | 2,062                                 |       | 1,607                              |       |
| Prepaid commissions  and royalties, current portion                                                     |       | 4,458                                 |       | 4,840                              |       |
| Prepaid expenses  and other current assets                                                              |       | 4,513                                 |       | 3,930                              |       |
| Deferred income  taxes, current portion                                                                 |       | 10,061                                |       | 11,263                             |       |
|                                                                                                    |       |                                  |       |                               |       |
| Total current  assets                                                                                   |       | 215,181                               |       | 238,486                            |       |
|                                                                                                    |       |                                  |       |                               |       |
| Long-term investments                                                                                   |       | 24,050                                |       | 23,413                             |       |
| Property and  equipment, net                                                                            |       | 15,967                                |       | 15,177                             |       |
| Deferred set up  costs, net of current portion                                                          |       | 1,347                                 |       | 2,202                              |       |
| Prepaid  commissions and royalties, net of current portion                                              |       | 3,614                                 |       | 3,824                              |       |
| Intangible  assets, net of accumulated amortization of $2,044 and $2,299 in 2007 and  2008,respectively |       | 3,356                                 |       | 3,101                              |       |
| Goodwill                                                                                                |       | 25,511                                |       | 25,511                             |       |
| Deferred income  taxes, net of current portion                                                          |       | 16,576                                |       | 13,530                             |       |
| Other assets                                                                                            |       | 267                                   |       | 298                                |       |
|                                                                                                    |       |                                  |       |                               |       |
| Total assets                                                                                            |       | $                                     | 305,869    |                               | $          | 325,542 |   |
|                                                                                                    |       |                                  |       |                               |       |
| **Liabilities  and Stockholders’ Equity**                                                          |       |                                  |       |                               |       |
| Current  liabilities:                                                                                   |       |                                  |       |                               |       |
| Accounts payable                                                                                        |       | $                                     | 1,222      |                               | $          | 2,969 |   |
| Accrued expenses                                                                                        |       | 19,447                                |       | 14,750                             |       |
| Deferred  revenues, current portion                                                                     |       | 61,750                                |       | 71,053                             |       |
| Deferred rent,  current portion                                                                         |       | 240                                   |       | 207                                |       |
|                                                                                                    |       |                                  |       |                               |       |
| Total current  liabilities                                                                              |       | 82,659                                |       | 88,979                             |       |
|                                                                                                    |       |                                  |       |                               |       |
| Deferred  revenues, net of current portion                                                              |       | 5,380                                 |       | 12,830                             |       |
| Deferred rent,  net of current portion                                                                  |       | 116                                   |       | —                             |       |
| Other long-term  liabilities                                                                            |       | 1,277                                 |       | 1,277                              |       |
|                                                                                                    |       |                                  |       |                               |       |
| Total  liabilities                                                                                      |       | 89,432                                |       | 103,086                            |       |
|                                                                                                    |       |                                  |       |                               |       |
| Commitments and contingencies  (Note 12)                                                                |       |                                  |       |                               |       |
|                                                                                                    |       |                                  |       |                               |       |
| Stockholders’  equity:                                                                             |       |                                  |       |                               |       |
| Preferred stock,  $.01 par value:                                                                       |       |                                  |       |                               |       |
| Authorized—5,000 shares  Issued—0 shares                                                      |       | —                                |       | —                             |       |
| Common stock,  $.01 par value:                                                                          |       |                                  |       |                               |       |
| Authorized—100,000  shares  Issued—42,724 and 42,794 shares in 2007 and 2008, respectively    |       | 428                                   |       | 428                                |       |
| Additional  paid-in capital                                                                             |       | 274,869                               |       | 277,064                            |       |
| Treasury stock,  37 shares at cost                                                                      |       | (111                                  | )          | (111                               | )          |
| Accumulated  other comprehensive income                                                                 |       | 746                                   |       | 568                                |       |
| Accumulated  deficit                                                                                    |       | (59,495                               | )          | (55,493                            | )          |
|                                                                                                    |       |                                  |       |                               |       |
| Total  stockholders’ equity                                                                        |       | 216,437                               |       | 222,456                            |       |
|                                                                                                    |       |                                  |       |                               |       |
| Total  liabilities and stockholders’ equity                                                        |       | $                                     | 305,869    |                               | $          | 325,542 |   |

 

See accompanying notes.

 

3

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**PhaseForward Incorporated**

**Condensed Consolidated Statements of Income**

**(unaudited)**

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

** **
| ** **                                                                           | ** ** | **Three Months Ended  March 31****,** | ** ** |
|--------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2007**                                             | ** ** | **2008** | ** ** |
| Revenues:                                                                            |       |                                                 |       |   |   |
| License                                                                              |       | $                                                    | 11,036     |   | $ | 12,614 |   |
| Service                                                                              |       | 19,048                                               |       | 25,406 |   |
|                                                                                 |       |                                                 |       |   |   |
| Total revenues                                                                       |       | 30,084                                               |       | 38,020 |   |
| Costs of  revenues:                                                                  |       |                                                 |       |   |   |
| License                                                                              |       | 605                                                  |       | 655 |   |
| Service(1)                                                                           |       | 11,527                                               |       | 15,528 |   |
|                                                                                 |       |                                                 |       |   |   |
| Total cost of  revenues                                                              |       | 12,132                                               |       | 16,183 |   |
| Gross margin:                                                                        |       |                                                 |       |   |   |
| License                                                                              |       | 10,431                                               |       | 11,959 |   |
| Service                                                                              |       | 7,521                                                |       | 9,878 |   |
|                                                                                 |       |                                                 |       |   |   |
| Total gross  margin                                                                  |       | 17,952                                               |       | 21,837 |   |
| Operating  expenses:                                                                 |       |                                                 |       |   |   |
| Sales and  marketing(1)                                                              |       | 5,447                                                |       | 6,151 |   |
| Research and  development(1)                                                         |       | 4,632                                                |       | 5,558 |   |
| General and  administrative(1)                                                       |       | 4,638                                                |       | 5,700 |   |
|                                                                                 |       |                                                 |       |   |   |
| Total operating  expenses                                                            |       | 14,717                                               |       | 17,409 |   |
|                                                                                 |       |                                                 |       |   |   |
| Income from  operations                                                              |       | 3,235                                                |       | 4,428 |   |
| Other income  (expense):                                                             |       |                                                 |       |   |   |
| Interest income                                                                      |       | 864                                                  |       | 1,901 |   |
| Other expense                                                                        |       | (66                                                  | )          | 134 |   |
|                                                                                 |       |                                                 |       |   |   |
| Total other  income                                                                  |       | 798                                                  |       | 2,035 |   |
|                                                                                 |       |                                                 |       |   |   |
| Income before  provision for income taxes                                            |       | 4,033                                                |       | 6,463 |   |
| Provision for  income taxes                                                          |       | 552                                                  |       | 2,461 |   |
|                                                                                 |       |                                                 |       |   |   |
| Net income                                                                           |       | $                                                    | 3,481      |   | $ | 4,002 |   |
|                                                                                 |       |                                                 |       |   |   |
| Net income per  share applicable to common stockholders:                             |       |                                                 |       |   |   |
| Basic                                                                                |       | $                                                    | 0.10       |   | $ | 0.10 |   |
|                                                                                 |       |                                                 |       |   |   |
| Diluted                                                                              |       | $                                                    | 0.10       |   | $ | 0.09 |   |
|                                                                                 |       |                                                 |       |   |   |
| Weighted average  number of common shares used in net income per share calculations: |       |                                                 |       |   |   |
| Basic                                                                                |       | 34,627                                               |       | 41,859 |   |
|                                                                                 |       |                                                 |       |   |   |
| Diluted                                                                              |       | 36,417                                               |       | 43,738 |   |

 

----

(1)Amounts include stock-basedcompensation expense, as follows:

 
| Costs of service  revenues  |   | $   | 110    |   | $      | 393 |   |
|-----------------------------|--------|-----|--------|--------|--------|-----|--------|
| Sales and  marketing        |   | 166 |   | 314    |   |
| Research and development    |   | 156 |   | 279    |   |
| General and  administrative |   | 600 |   | 760    |   |

 

See accompanying notes.

 

4

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**PhaseForward Incorporated**

**Condensed Consolidated Statements of Cash Flows**

**(unaudited)**

**(inthousands)**

** **
| ** **                                                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| **Operating  activities**                                                          |       |                                             |       |   |   |
| Net income                                                                         |       | $                                                | 3,481      |   | $ | 4,002 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities: |       |                                             |       |   |   |
| Depreciation and  amortization                                                     |       | 1,458                                            |       | 2,160 |   |
| Stock-based  compensation expense                                                  |       | 1,032                                            |       | 1,746 |   |
| Loss on disposal  of fixed assets                                                  |       | —                                           |       | 316 |   |
| Foreign currency  exchange loss                                                    |       | 65                                               |       | — |   |
| Provision for  allowance for doubtful accounts                                     |       | 107                                              |       | 46 |   |
| Deferred income  taxes                                                             | ** ** | (1,078                                           | )          | 2,272 |   |
| Non-cash income  tax expense                                                       |       | 1,401                                            |       | — |   |
| Amortization of  premiums or discounts on investments                              |       | 11                                               |       | (88 | ) |
| Changes in  assets and liabilities:                                                |       |                                             |       |   |   |
| Accounts  receivable                                                               |       | 1,026                                            |       | (4,664 | ) |
| Deferred costs                                                                     |       | (564                                             | )          | (865 | ) |
| Prepaid expenses  and other current assets                                         |       | 58                                               |       | 609 |   |
| Accounts payable                                                                   |       | (1,514                                           | )          | 1,705 |   |
| Accrued expenses                                                                   |       | (2,019                                           | )          | (4,900 | ) |
| Deferred revenue                                                                   |       | 11,370                                           |       | 16,366 |   |
| Deferred rent                                                                      |       | (73                                              | )          | (149 | ) |
|                                                                               |       |                                             |       |   |   |
| Net cash  provided by operating activities                                         |       | 14,761                                           |       | 18,556 |   |
|                                                                               |       |                                             |       |   |   |
| **Investing  activities**                                                          |       |                                             |       |   |   |
| Proceeds from  maturities of short-term investments                                |       | 18,310                                           |       | 28,325 |   |
| Purchase of  short-term investments                                                |       | (17,119                                          | )          | (25,625 | ) |
| Purchase of  property and equipment                                                |       | (3,068                                           | )          | (1,403 | ) |
|                                                                               |       |                                             |       |   |   |
| Net cash (used  in) provided by investing activities                               |       | (1,877                                           | )          | 1,297 |   |
|                                                                               |       |                                             |       |   |   |
| **Financing  activities**                                                          |       |                                             |       |   |   |
| Proceeds from  issuance of common stock                                            |       | 496                                              |       | 446 |   |
|                                                                               |       |                                             |       |   |   |
| Net cash  provided by financing activities                                         |       | 496                                              |       | 446 |   |
|                                                                               |       |                                             |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                      |       | 3                                                |       | 90 |   |
|                                                                               |       |                                             |       |   |   |
| Net increase in  cash and cash equivalents                                         |       | 13,383                                           |       | 20,389 |   |
| Cash and cash  equivalents at beginning of period                                  |       | 42,169                                           |       | 133,401 |   |
|                                                                               |       |                                             |       |   |   |
| Cash and cash  equivalents at end of period                                        |       | 55,552                                           |       | 153,790 |   |
| Short and  long-term investments at end of period                                  |       | 26,264                                           |       | 45,472 |   |
| Total cash, cash  equivalents and short and long-term investments at end of period |       | $                                                | 81,816     |   | $ | 199,262 |   |

 

See accompanying notes.

 

5

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**Phase Forward Incorporated Notes to Condensed Consolidated Financial Statements(unaudited)(in thousands, except share and per share amounts)**

 

**1.****              Basis ofPresentation**

 

The accompanyingunaudited condensed consolidated financial statements included herein have beenprepared by Phase Forward Incorporated (the “Company”) pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”). Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles in theUnited States have been condensed or omitted pursuant to such SEC rules andregulations. Management of the Company believes that the disclosures herein areadequate to make the information presented not misleading. In the opinion ofmanagement, the unaudited condensed consolidated financial statements have beenprepared on the same basis as the audited consolidated financial statements andreflect all material adjustments (consisting only of those of a normal andrecurring nature) which are necessary to present fairly the consolidatedfinancial position of the Company as of March 31, 2008, the results of itsoperations for the three months ended March 31, 2007 and 2008 and its cashflows for the three months ended March 31, 2007 and 2008. These unauditedcondensed consolidated financial statements and notes thereto should be read inconjunction with the audited consolidated financial statements and notesthereto included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2007. The results of operations for the interim periodsare not necessarily indicative of the results of operations to be expected forthe year ending December 31, 2008.

 

As of March 31,2008, the Company’s significant accounting policies and estimates, which aredetailed in the Company’s Annual Report on Form 10-K for the year ended December 31,2007, have not changed except for the adoption of Statement of FinancialAccounting Standards (“SFAS”) No. 157, *Fair Value Measurements*and SFAS No. 159, *The Fair Value Option forFinancial Assets and Liabilities*. See Note 17 for additional information regarding the Company’sadoption of these pronouncements.

 

Certain amounts inthe prior year’s financial statements have been reclassified to conform to thecurrent year’s presentation.

 

**2.****             ****Revenue Recognition and DeferredSet Up Costs**

 

The Company derives revenues from software licensesand services. License revenues are derived principally from the sale of termlicenses for the Company’s software products including: *InFormTM, ClintrialTM,**WebSDMTM*, *Empirica*TM*Trace*(formerly *Clintrace*TM), *WebVDMETM* and *CTSDTM*.  Service revenues are derivedprincipally from the Company’s delivery of the hosted solutions of its *InForm, WebVDME*, *CTSD*and *WebSDM* softwareproducts, and consulting services and customer support, including training, forall of the Company’s products.

 

The components of revenue are as follows:

 

| ** **                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------|------------|--------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| License                       |       | $                                                | 11,036     |   | $ | 12,614 |   |
| Application  hosting services |       | 12,052                                           |       | 19,185 |   |
| Consulting  services          |       | 3,426                                            |       | 3,099 |   |
| Customer support              |       | 3,570                                            |       | 3,122 |   |
|                          |       |                                             |       |   |   |
| Total                         |       | $                                                | 30,084     |   | $ | 38,020 |   |

 

The Company recognizes software license revenues in accordance withStatement of Position (“SOP”) No. 97-2, *SoftwareRevenue Recognition,* as amended, issued by the American Institute ofCertified Public Accountants (“AICPA”), while revenues resulting fromapplication hosting services are recognized in accordance with Emerging IssuesTask Force (“EITF”) Issue No. 00-3, *Applicationof AICPA Statement of Position 97-2 to Arrangements that include the Right toUse Software Stored on Another Entity’s Hardware*, SEC StaffAccounting Bulletin (“SAB”) No. 104, *RevenueRecognition* and EITF Issue No. 00-21, *Revenue Arrangements with MultipleDeliverables.*

 

Customers generally have the ability to terminate application hosting,consulting and training service agreements upon 30 days notice to theCompany. License agreements, multiple element arrangements, including licenseand service agreements and certain application hosting services can generallybe terminated by either party for material breach of obligations not correctedwithin 30 days after notice of the breach.

 

6

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The Company recognizes revenues when all of the following conditionsare satisfied: (1) there is persuasive evidence of an arrangement; (2) theproduct or service has been provided to the customer; (3) the collectionof fees is probable; and (4) the amount of fees to be paid by the customeris fixed or determinable.

 

The Company generally enters into software term licenses for its *InForm*, *Clintrial*and *Empirica Trace*products withits customers for 3- to 5-year periods. License agreements for other**products are generally for annual or multi-year terms.  These arrangements typically include multipleelements: software license, consulting services and customer support. TheCompany bills its customers in accordance with the terms of the underlyingcontract. Generally, the Company bills license fees annually in advance foreach year of the license term. Payment terms are generally net 30 days.

 

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

 

Customer support includes training services, telephone support andsoftware maintenance.  The Companygenerally bundles customer support with the software license for the entireterm of the arrangement. As a result, the Company generally recognizes revenuesfor all elements, including consulting services, ratably over the term of thesoftware license and support arrangement. The Company allocates the revenuesrecognized for these arrangements to the different elements based on management’sestimate of the relative fair value of each element. For its term-basedlicenses, the Company allocates to consulting services the anticipated serviceeffort and value throughout the term of the arrangement at an amount that wouldhave been allocated had those services been sold separately to the customer.The value of the Company’s consulting services sold within a bundled arrangementis equal to the value of consulting services sold on a stand-alone basis, asthe activities performed under both types of arrangements are similar innature.  The remaining value is allocatedto license and support services, with 10% of this amount allocated to supportservices. The customer support services rate of 10% for multi-year term-basedlicenses reflects a significant discount from the rate for customer supportservices associated with perpetual licenses due to the reduction in the timeperiod during which the customer can utilize the upgrades andenhancements.  The Company believes thisrate is substantive and represents an amount it believes reasonable to beallocated.  The Company has allocated theestimated fair value to its multiple element arrangements to provide meaningfuldisclosures about each of its revenue streams. The costs associated with theconsulting and customer support services are expensed as incurred. There areinstances in which the Company sells software licenses based on usage levels.These software licenses can be based on estimated usage, in which case thelicense fee charged to the customer is fixed based on this estimate. When thefee is fixed, the revenues are generally recognized ratably over thecontractual term of the arrangement. If the fee is based on actual usage, andtherefore variable, the revenues are recognized in the period of use. Revenuesfrom certain follow-on consulting services, which are sold separately tocustomers with existing software licenses and are not considered part of amultiple element arrangement, are recognized as the services are performed.

 

The Company may sell incremental perpetual licenses for the *Clintrial*and *Empirica Trace* softwareproducts in certain situations to its existing customers with the option topurchase customer support. The Company has established vendor specificobjective evidence of fair value for the customer support. Accordingly, licenserevenues are recognized upon delivery of the software and when all otherrevenue recognition criteria are met. Customer support revenues are recognizedratably over the term of the underlying support arrangement. The Companygenerates customer support and maintenance revenues from its perpetual licensecustomer base. Training revenues are recognized as earned.

 

In addition to making its software products available to customersthrough licenses, the Company offers its *InForm*,*WebVDME*, *CTSD* and *WebSDM* softwaresolutions through a hosted application solution delivered through a standardweb-browser.

 

Revenues resulting from *InForm *applicationhosting services consists of three stages for each clinical trial: the firststage involves application set up, including design of electronic case reportforms and edit checks, implementation of the system and server configuration;the second stage involves application hosting and related support services; andthe third stage involves services required to close out, or lock, the databasefor the clinical trial. Services provided for the first and third stages areprovided on a fixed fee basis based upon the complexity of the trial and systemrequirements. Services for the second stage are charged separately as a fixedmonthly fee. The Company recognizes revenues from all stages of the *InForm *hosting service ratably overthe hosting period. Fees charged and costs incurred for the trial systemdesign, set up and implementation are deferred until the start of the hostingperiod and are amortized and recognized ratably over the estimated hostingperiod. The deferred costs include incremental direct costs with third partiesand certain internal direct costs related to the trial and application set up,as defined under SFAS No. 91, *Accountingfor Nonrefundable Fees and Costs Associated with Originating or Acquiring Loansand Indirect Costs of Leases*. These costs include salary andbenefits associated with direct labor costs incurred during trial set up, aswell as third-party subcontract fees and other contract labor costs. Workperformed outside the original scope of work is contracted for separately as anadditional fee and is generally recognized ratably over the remaining term ofthe hosting period. Fees for the first and third stages of the service arebilled 

 

7

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based upon milestones.Fees for application hosting and related services in the second stage aregenerally billed quarterly in advance. Bundled into this revenue element arerevenues attributable to the software license used by the customer.

 

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

 

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

 

The Company may also enter into arrangements to provide consultingservices separate from a license arrangement. In these situations, revenue isrecognized in accordance with SOP 81-1, *Accounting for Performance of Construction-Type andCertain Production-Type Contracts,*on either a time andmaterials basis or using the proportional performance method. If the Company isnot able to produce reasonably dependable estimates, revenue is recognized uponcompletion of the project and final acceptance from the customer. Ifsignificant uncertainties exist about project completion or receipt of payment,the revenue is deferred until the uncertainty is resolved. Provisions forestimated losses on contracts are recorded during the period in which they areidentified.

 

One customer,GlaxoSmithKline, accounted for approximately 17% and 13% of the Company’s totalrevenues in the three months ended March 31, 2007 and 2008, respectively,and $1,803 and $1,805 of accounts receivable outstanding as of December 31,2007 and March 31, 2008, respectively.

 

The Company deferred $942and $1,205 of set up costs and amortized $560 and $805 during the three monthsended March 31, 2007 and 2008, respectively. The amortization of deferredset up costs is a component of cost of service revenues.

 

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

 

Provisions for estimated losses on uncompleted contracts are made on acontract-by-contract basis and are recognized in the period in which suchlosses become probable and can be reasonably estimated. To date, the Companyhas not experienced any material losses on uncompleted application hosting orconsulting contracts.

 

In accordance with EITFIssue No. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred,* the Company included $119 and $156 of out-of-pocketexpenses in service revenue and cost of service revenue in the three monthsended March 31, 2007 and 2008, respectively.

 

**3.****              Prepaid SalesCommissions and Royalties**

 

For arrangements where revenues are recognized over the relevantcontract period, the Company defers related commissions paid to its directsales force and software license royalties paid to third parties, and amortizesthese expenses over the period in which the related revenues are recognized.

 

Commission payments arenonrefundable unless amounts due from a customer are determined to beuncollectible or if the customer subsequently changes or terminates the levelof service, in which case the commissions paid are recoverable by the Company.The Company deferred $1,663 and $2,020 of commissions and amortized to salesand marketing expense $1,515 and $1,784 during the three months ended March 31,2007 and 2008, respectively.

 

The Company’s royaltyobligation is based upon the license and customer support revenues earned forcertain products in an arrangement. The Company has the right to recover theroyalties in the event the arrangement is cancelled. The Company deferred $744and $1,047 of royalties and amortized to cost of revenues $688 and $691 duringthe three months ended March 31, 2007 and 2008, respectively.

 

**4.****              Warranties andIndemnification**

 

TheCompany’s software license arrangements and hosting services are typicallywarranted to perform in a manner consistent with general industry standardsthat are reasonably applicable and substantially in accordance with the Company’sproduct documentation under normal use and circumstances. The Company’sarrangements also include certain provisions for indemnifying customers againstliabilities if its products or services infringe a third party’s intellectualproperty rights.

 

8

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TheCompany has entered into service level agreements with some of its hostedapplication customers warranting certain levels of uptime reliability or otherservice levels and permits those customers to receive credits against monthlyhosting fees or terminate their agreements in the event that the Company failsto meet those levels.

 

Todate, the Company has not incurred any material costs as a result of suchindemnifications and has not accrued any liabilities related to suchobligations in the accompanying consolidated financial statements.

 

**5.****              Acquisitions**

 

On October 30,2007, the Company acquired all of the outstanding capital stock of GreenMountain Logic, Inc. (“Green Mountain”), a process automation softwarecompany that provides targeted solutions for the life sciences industry,including *LabPas* Phase I clinic automationsoftware.  The Company paid a premium toacquire the technology and products of Green Mountain which provide the Companywith a solution targeted for Phase I clinical trials.  The aggregate purchase price was $5,397.  The acquisition of Green Mountain wasaccounted for as a purchase under SFAS No. 141, *BusinessCombinations*.  Accordingly,the results of Green Mountain have been included in the audited consolidatedfinancial statements since the date of acquisition.

 

**6.****              Net Income Per Share**

 

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

 

The calculation of basic and diluted net income per share is asfollows:

 

| ** **                                                            | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                             | ** ** | **2008** | ** ** |
| Numerator:                                                            |       |                                                 |       |   |   |
| Net income                                                            |       | $                                                    | 3,481      |   | $ | 4,002 |   |
|                                                                  |       |                                                 |       |   |   |
| Denominator:                                                          |       |                                                 |       |   |   |
| Weighted average  common shares outstanding                           |       | 35,561,344                                           |       | 42,718,775 |   |
| Less weighted  average unvested restricted common shares outstanding  |       | (934,733                                             | )          | (860,087 | ) |
|                                                                  |       |                                                 |       |   |   |
| Basic weighted  average common shares outstanding                     |       | 34,626,611                                           |       | 41,858,688 |   |
| Dilutive effect  of common stock options                              |       | 1,574,939                                            |       | 1,363,374 |   |
| Dilutive effect  of unvested restricted common stock Awards and units |       | 215,350                                              |       | 516,117 |   |
| Diluted weighted  average common shares outstanding                   |       | 36,416,900                                           |       | 43,738,179 |   |
|                                                                  |       |                                                 |       |   |   |
| Net income per  share applicable to common stockholders:              |       |                                                 |       |   |   |
| Basic                                                                 |       | $                                                    | 0.10       |   | $ | 0.10 |   |
|                                                                  |       |                                                 |       |   |   |
| Diluted                                                               |       | $                                                    | 0.10       |   | $ | 0.09 |   |

 

Diluted weighted averagecommon shares outstanding do not include options and awards outstanding topurchase 25,000 and 350,876, respectively, common equivalent shares for thethree months ended March 31, 2007 and 2008, respectively, as their effectwould have been anti-dilutive.

 

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

 

The financial statementsof the Company’s foreign subsidiaries are translated in accordance with SFAS No. 52,*Foreign Currency Translation.* Thereporting currency for the Company is the U.S. dollar. The functional currencyof the Company’s subsidiaries in the United Kingdom, France, Belgium, Germany,Japan, India and Australia are the local currencies of those countries.Accordingly, the assets and liabilities of the Company’s foreign subsidiariesare translated into U.S. dollars using the exchange rate in effect at each balancesheet date. Revenues and expense accounts are translated generally using anaverage rate of exchange during the period. Gains and losses arising fromtransactions denominated in foreign currencies are primarily related tointercompany accounts that have been determined to be temporary in nature andcash and accounts receivable denominated in non-functional currencies.  The Company recorded a foreign currency lossof $65 for the three months ended March 31, 2007, and is included in otherincome (expense) in the accompanying unaudited condensed consolidatedstatements of income.  There were noforeign currency gains or 

 

9

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losses for the threemonths ended March 31, 2008.

 

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

 

**8.****              Cash, Cash Equivalents, Short-term andLong-term Investments**

 

The Company accounts for its investments in accordance with SFAS No. 115,*Accounting for Certain Investments in Debtand Equity Securities*. Under SFAS No. 115, securities that theCompany has the intent and ability to hold to maturity are reported atamortized cost, which approximates market value, and are classified as held-to-maturity,while those securities for which it is not the Company’s intent to hold tomaturity are classified as available-for-sale securities and are reported atfair value, with unrealized gains and losses excluded from earnings andreported in a separate component of stockholders’ equity. The Company considersall highly liquid investments with original maturities of 90 days or lessat the time of purchase to be cash equivalents and investments with originalmaturities of between 91 days and one year to be short-terminvestments.  All securities, with the exception of auction ratesecurities (“ARS”), are classified as held-to-maturity securities.  TheARS are debt instruments issued by various states throughout the United Statesand are classified as available-for-sale because it is the Company’s intent notto hold them to maturity.

 

Cash, cash equivalents,short-term and long-term investments as of December 31, 2007 and March 31,2008 consist of the following:

 
| ** **                                  | ** ** | **December 31, 2007** | ** ** |
|---------------------------------------------|------------|---------------------------------|------------|
| **Description**                             | ** ** | **Contracted********Maturity**  | ** ** | **Amortized********Cost** | ** ** | **Fair Market********Value** | ** ** | **Balance Per********Balance Sheet** | ** ** |
| Cash                                        |       | Demand                          |       | $ | 8,718 |   | $ | 8,718 |   | $ | 8,718 |   |
| Certificate of  deposit                     |       | 50 Days                         |       | 3,100 |   | 3,100 |   | 3,100 |   |
| Money market funds                          |       | Demand                          |       | 121,583 |   | 121,583 |   | 121,583 |   |
|   Total cash and cash equivalents |       |                            |       | $ | 133,401 |   | $ | 133,401 |   | $ | 133,401 |   |
|                                        |       |                            |       |   |   |   |   |   |   |
| Auction rate  securities (1)                |       | 26 years                        |       | $ | 10,450 |   | $ | 10,450 |   | $ | 10,450 |   |
| U.S. agency notes                           |       | 173 days                        |       | 1,502 |   | 1,501 |   | 1,502 |   |
| Municipal bonds                             |       | —                          |       | — |   | — |   | — |   |
| Corporate bonds                             |       | 210 days                        |       | 13,219 |   | 13,222 |   | 13,219 |   |
| Total short-term investments                |       |                            |       | $ | 25,171 |   | $ | 25,173 |   | $ | 25,171 |   |
|                                        |       |                            |       |   |   |   |   |   |   |
| Auction rate securities                     |       | 34 years                        |       | $ | 24,050 |   | $ | 24,050 |   | $ | 24,050 |   |
| Total long-term investments                 |       |                            |       | $ | 24,050 |   | $ | 24,050 |   | $ | 24,050 |   |

 

----

(1)          TheseARS were successfully liquidated subsequent to December 31, 2007, with noloss.

 
| ** **                                  | ** ** | **March 31, 2008**   | ** ** |
|---------------------------------------------|------------|--------------------------------|------------|
| **Description**                             | ** ** | **Contracted********Maturity** | ** ** | **Amortized********Cost** | ** ** | **Fair Market********Value** | ** ** | **Balance Per********Balance Sheet** | ** ** |
| Cash                                        |       | Demand                         |       | $ | 15,690 |   | $ | 15,690 |   | $ | 15,690 |   |
| Money market funds                          |       | Demand                         |       | 138,100 |   | 138,100 |   | 138,100 |   |
|   Total cash and cash equivalents |       |                           |       | $ | 153,790 |   | $ | 153,790 |   | $ | 153,790 |   |
|                                        |       |                           |       |   |   |   |   |   |   |
| U.S. agency notes                           |       | 320 days                       |       | $ | 7,002 |   | $ | 7,016 |   | $ | 7,002 |   |
| Municipal bonds                             |       | 262 days                       |       | 2,002 |   | 2,012 |   | 2,002 |   |
| Corporate bonds                             |       | 276 days                       |       | 13,055 |   | 13,178 |   | 13,055 |   |
| Total short-term investments                |       |                           |       | $ | 22,059 |   | $ | 22,206 |   | $ | 22,059 |   |
|                                        |       |                           |       |   |   |   |   |   |   |
| Auction rate securities                     |       | 34 years                       |       | $ | 24,050 |   | $ | 22,913 |   | $ | 22,913 |   |
| Corporate bonds                             |       | 490 days                       |       | 500 |   | 505 |   | 500 |   |
| Total long-term investments                 |       |                           |       | $ | 24,550 |   | $ | 23,418 |   | $ | 23,413 |   |

 

The Company has had no realized gains or losses from the sale of cashequivalents or short-term investments. The Company recorded an unrealized loss of $1,137 in connection with itsARS as further discussed below.

 

10

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As of March 31,2008, the Company held ARS totaling $24,050 at par value, which were consideredas available-for-sale securities and classified as long term investments in theaccompanying condensed consolidated balance sheet, and recorded at fair value.These ARS are debt instruments issued by various states throughout the UnitedStates to finance student loans.  Thetypes of ARS that the Company owns are backed by student loans, 95% of whichare guaranteed under the Federal Family Education Loan Program, and all havecredit ratings of AAA (or equivalent) from a recognized rating agency.  Historically, the carrying value of ARSapproximated fair value due to the frequent resetting of the interest rates.With the liquidity issues experienced in the global credit and capital markets,the Company’s ARS have experienced multiple failed auctions. While the Companycontinues to earn and receive interest on these investments at the maximumcontractual rate, the estimated fair value of these ARS no longer approximatespar value.

 

The Company concluded that the fair value of these ARS at March 31,2008 was $22,913, a decline of $1,137 from par value. Fair value was determinedusing a trinomial discount model as recent auctions of these securities werenot successful, resulting in the Company continuing to hold these securitiesand issuers paying interest at the estimated maximum contractual rate.  This valuation technique considers the complexityand transparency of the structure of each ARS and cash flows within eachstructure; the quality of the collateral; and liquidity determinants affectingeach ARS.  The decline in fair value wasdeemed temporary as the Company believes the decline in fair value of theseinvestments is due to general market conditions as well as the fact that theCompany has the ability and intent to hold these securities until marketconditions improve. Accordingly, the Company has recorded a temporaryimpairment on these securities of $1,137 in other comprehensive income.  Depending on future market conditions, futurefair value adjustments to the ARS may be required.   If in the future the Company determines thatany decline in fair value of the ARS is other-than-temporary, the Company wouldbe required to recognize the loss in its statement of income, which could havea material impact on the Company’s operating results in the period it isrecognized.

 

TheCompany believes that, based on its cash, cash equivalents and short termmarketable securities balances of $175,849 at March 31, 2008, whichexcludes the fair value of its ARS of $22,913, the current lack of liquidity inits ARS will not have a material impact on the Company’s liquidity, cash flowor the Company’s ability to fund its operations.

 

Referto Note 17 for further discussion on the accounting treatment for the ARS aswell as a discussion of the adoption of SFAS No. 157 and SFAS No. 159.

 

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

 

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

 

The goodwill resulting from acquisitions is reviewed for impairment onan annual basis in accordance with SFAS No. 142,*Goodwill and Other Intangible Assets.*  Consistent with prior years, the Companyconducted its annual impairment test of goodwill during the fourth quarter of2007.  Based on the results of the firststep of the goodwill impairment test, the Company determined that no impairmentof goodwill existed at December 31, 2007, as the carrying amount ofgoodwill of the reporting unit was less than its fair value and therefore, thesecond step of the goodwill impairment test was not necessary. The net carryingamount of goodwill was $25,511 at December 31, 2007 and March 31,2008.

 

Intangible assets consistof the following:

 
| ** **                         | ** ** | ** **                      | ** ** | **As of December 31, 2007** | ** ** | **As of March 31, 2008** | ** ** |
|------------------------------------|------------|---------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------|------------|
| **Description**                    | ** ** | **Estimated  Useful Life** | ** ** | **Gross  Carrying  Value**                      | ** ** | **Accumulated  Amortization**                | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed  technology and know-how |       | 5 years                         |       | $                                               | 3,100      |                                         | $          | 890 |   | $ | 3,100 |   | $ | 1,045 |   |
| Customer  relationships            |       | 5 years                         |       | 1,700                                           |       | 756                                          |       | 1,700 |   | 841 |   |
| Non-compete  agreements            |       | 2 years                         |       | 300                                             |       | 300                                          |       | 300 |   | 300 |   |
| Trade-name                         |       | 5 years                         |       | 300                                             |       | 98                                           |       | 300 |   | 113 |   |
| Total                              |       |                            |       | $                                               | 5,400      |                                         | $          | 2,044 |   | $ | 5,400 |   | $ | 2,299 |   |

 

Amortization expenserelated to intangible assets for the three months ended March 31, 2007 and2008 was $218 and $255, respectively.

 

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

 
| **Year ended December 31,**   | ** ** | **Amount** | ** ** |
|----------------------------------------------|------------|------------|------------|
| 2008 (nine  months ended December, 31, 2008) |       | $          | 765        |   |
| 2009                                         |       | 1,020      |       |
| 2010                                         |       | 766        |       |
| 2011                                         |       | 300        |       |
| 2012                                         |       | 250        |       |
| Total                                        |       | $          | 3,101      |   |

 

11

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

 

Accrued expenses consistof the following:

 
| ** **                            | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| ** **                            | ** ** | **2007**                          | ** ** | **2008**                       | ** ** |
| Accrued payroll  and related benefits |       | $                                 | 12,084     |                           | $          | 9,230 |   |
| Accrued other  expenses               |       | 4,922                             |       | 3,776                          |       |
| Accrued  royalties                    |       | 2,010                             |       | 1,033                          |       |
| Accrued income  taxes                 |       | 431                               |       | 711                            |       |
|                                  |       |                              |       |                           |       |
| Total                                 |       | $                                 | 19,447     |                           | $          | 14,750 |   |

 

**11.****       Debt**

 

 As of December 31, 2007, the Company had a working capital line of creditwith a bank under which it could borrow up to $2,000, of which $1,500 wasavailable and $500 reserved under a letter of credit associated with theCompany’s leased facility. The line of credit expired on March 31, 2008,and was not renewed.  As of March 31,2008, the $500 collateral obligation for the Company’s leased facility wassecured by a certificate of deposit.

 

In connection with the signing of a lease on February 13,2008 to secure office space for the Company’s future corporate headquarters at77 Fourth Avenue, Waltham, Massachusetts, the Company deposited with thelandlord an unconditional, irrevocable letter of credit in the landlord’s favorin the amount of $962, secured by a certificate of deposit.  See Note 12 for further discussion regardingthis lease.

 

**12.****       Commitments andContingencies**

 

From time to time and in the ordinary course of business, the Companyis subject to various claims, charges and litigation. Intellectual property disputesoften have a risk of injunctive relief which, if imposed against the Company,could materially and adversely affect its financial condition, or results ofoperations. From time to time, third parties have asserted and may in thefuture assert intellectual property rights to technologies that are importantto the Company’s business and have demanded and may in the future demand thatthe Company license their technology. Although the outcome of litigation cannotbe predicted with certainty and some lawsuits, claims or proceedings may bedisposed of unfavorably to the Company, which could materially and adverselyaffect its financial condition or results of operations, the Company does notbelieve that it is currently a party to any material legal proceedings.

 

On February 13, 2008,the Company entered into a lease (“Lease”) with BP Fourth Avenue, L.L.C. (the “Landlord”)to secure office space for the Company’s future corporate headquarters at 77Fourth Avenue, Waltham, Massachusetts. The estimated commencement date foroccupancy under the Lease is December 2008. The lease for the Company’scurrent corporate headquarters at 880 Winter Street in Waltham is due to expirein February 2009.  The Leaseprovides for the rental of 165,129 rentable square feet of space and has aninitial term of 10 years and three months. The Company can, subject to certainconditions, extend this term by exercising up to two consecutive five yearoptions. The Company is not required to pay any rent for the first three monthsof the initial Lease term.  Thereafter,the annual rent under the Lease for years one through five will be $6.6million, or approximately $548 per month. For years six through ten, the annual rent will be $7.2 million, orapproximately $603 per month.  The totalbase rent payable in the initial term is $69.1 million.  In connection with the signing of the Lease,the Company has deposited with the Landlord an unconditional, irrevocableletter of credit in Landlord’s favor in the amount of $962.

 

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

** **

*Common Stock*

 

In the three months ended March 31,2008, the company issued 74,655 shares of common stock in connection with theexercise of stock options resulting in proceeds of $446.

 

12

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*Stock Option Activity*

 

For options accounted for under SFAS No. 123(R),*Share-Based Payments*, the fair value ofeach option grant is estimated on the date of grant using the Black-Scholespricing model. No options were granted during the three months ended March 31,2007 and 2008. For purposes of utilizing the Black-Scholes option pricing modeland because there was a limited trading history for its common stock, theCompany determined the expected life and the volatility for options based on ananalysis of reported data for a peer group of companies that have issued stockoptions with substantially similar terms. The expected life of options grantedby the Company has been determined based on the average expected life of theoptions as reported by this peer group of companies during a similar reportingperiod. The expected volatility of options granted has been determined using anaverage of the historical volatility measures of this peer group of companiesas well as the historical volatility of the Company’s common stock beginning inJanuary 2005. The risk-free interest rate is based on a treasuryinstrument whose term is consistent with the expected life of the stockoptions. The Company has not paid and does not anticipate paying cash dividendson its shares of common stock; therefore, the expected dividend yield isassumed to be zero. In addition, while SFAS No. 123, *Accountingfor Stock-Based Compensation,* permitted companies to recordforfeitures based on actual forfeitures, which was the Company’s historicalpolicy under SFAS No. 123, SFAS No. 123(R) requires companies toutilize an estimated forfeiture rate when calculating stock-based compensationexpense for the period.  As a result, theCompany has applied a forfeiture rate of 8%, derived from an analysis of itshistorical data, in determining the expense recorded in the Company’sconsolidated statements of income.

 

Duringthe three months ended March 31, 2007 and 2008, the Company recorded$1,032 and $1,746 of aggregate stock-based compensation expense, respectively,of which $986 and $1,746, respectively, was a result of the adoption of SFAS No. 123(R).  The remaining stock-based compensationexpense is due to the amortization of stock-based compensation associated withpreviously issued stock options which amounted to $46 in 2007.   For the three months ended March 31,2007, stock-based compensation expense was allocated as follows: $110 to costof service revenues, $156 to research and development, $166 to sales andmarketing, and $600 to general and administrative.  For the three months ended March 31,2008, stock-based compensation expense included $393 in cost of revenues, $279in research and development, $314 in sales and marketing and $760 in generaland administrative.  As of March 31,2008, there was $21,246 of unrecognized stock-based compensation expenserelated to stock-based awards that is expected to be recognized over a weightedaverage period of 2.89****years.

 

A summary of stock option activity under the Phase Forward Incorporated1997 Stock Option Plan, the Phase Forward Incorporated 2004 Stock Option andIncentive Plan and the 2003 Non-Employee Director Stock Option Plan as of March 31,2008, and changes during the three months ended March 31, 2008, is asfollows:

 

| ** **                                             | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price per  Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value (2)** | ** ** |
|--------------------------------------------------------|------------|----------------------------|------------|--------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------|------------|
| Outstanding at  December 31, 2007                 |       | 2,473,717                  |       | $                                                      | 4.99       |                                                             | 5.76       |                                     | $          | 41,468 |   |
| Granted                                                |       | —                     |       |                                                   |       |                                                             |       |                                     |       |
| Exercised                                              |       | (74,655                    | )          | 5.98                                                   |       |                                                             |       |                                     |       |
| Canceled                                               |       | (4,658                     | )          | 8.16                                                   |       |                                                             |       |                                     |       |
|                                                   |       |                       |       |                                                   |       |                                                             |       |                                     |       |
| Outstanding at  March 31, 2008                    |       | 2,394,404                  |       | $                                                      | 4.95       |                                                             | 5.57       |                                     | $          | 29,045 |   |
|                                                   |       |                       |       |                                                   |       |                                                             |       |                                     |       |
| Exercisable at  March 31, 2008                    |       | 1,959,451                  |       | $                                                      | 4.48       |                                                             | 5.24       |                                     | $          | 24,699 |   |
|                                                   |       |                       |       |                                                   |       |                                                             |       |                                     |       |
| Vested or expected  to vest at March 31, 2008 (1) |       | 2,321,447                  |       | $                                                      | 4.90       |                                                             | 5.52       |                                     | $          | 28,287 |   |

 

----

(1)    The vested orexpected to vest options at March 31, 2008 include both the vested optionsand the number of options expected to vest calculated after applying anestimated forfeiture rate to the unvested options.

 

(2)    The aggregateintrinsic value is calculated based on the positive difference between the fairvalue per share of the Company’s common stock on March 31, 2008 of $17.08and the exercise price of the underlying options.

 

*Restricted Stock Awards and Unit Activity*

 

A summary of activity related to restricted common stock awards andunit awards during the three months ended March 31, 2008, is as follows:

 

13

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| ** **                              | ** ** | **Number  of Shares** | ** ** | **Market Price  Per Share** | ** **         | **Weighted  Average  Grant Date  Fair Value  Per Share** | ** ** | **Weighted  Average  Remaining  contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value (2)** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------------------------------|--------------------|-------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------------------------|------------|
| Unvested at  December 31, 2007     |       | 1,569,469                  |       | $                                     | 12.12 - 23.20      |                                                                    | $          | 16.52                                                        |       | 2.90                                     |       |   |   |
| Granted                                 |       | 310,750                    |       | 17.45                                 |               | 17.45                                                                   |       |                                                         |       |                                     |       |
| Vested                                  |       | —                     |       |                                  |               |                                                                    |       |                                                         |       |                                     |       |
| Forfeited                               |       | (12,225                    | )          | 12.12 – 23.03                    |               | 17.33                                                                   |       |                                                         |       |                                     |       |
| Unvested at  March 31, 2008        |       | 1,867,994                  |       | $                                     | 12.12 – 23.20 |                                                                    | 15.38      |                                                         | 3.02       |                                     | $          | 31,905 |   |
|                                    |       |                       |       |                                  |               |                                                                    |       |                                                         |       |                                     |       |
| Expected to be  free of restrictions(1) |       | 1,512,485                  |       | $                                     | 12.12 – 23.20 |                                                                    | $          | 15.42                                                        |       | 3.01                                     |       | $ | 25,833 |   |

 

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(1)          Theexpected to be free of restrictions at March 31, 2008 was calculated byapplying an estimated forfeiture rate to the unvested shares.

 

(2)          The aggregate intrinsicvalue is calculated based on the fair value per share of the Company’s commonstock on March 31, 2008 of $17.08.

 

**14.**       ComprehensiveIncome

** **

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

 

Comprehensive incomeconsisted of the following:

 
| ** **                                         | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                         | ** ** | **2008** | ** ** |
| Net income                                         |       | $                                                | 3,481      |   | $ | 4,002 |   |
| Cumulative translation  adjustment                 |       | 132                                              |       | 532 |   |
| Impairment of  auction rate securities, net of tax |       | —                                           |       | (709 | ) |
| Comprehensive  income                              |       | $                                                | 3,613      |   | $ | 3,825 |   |

 

**15.****       Forward Foreign ExchangeContracts**

 

The Company enters into transactions in currencies other than the U.S.dollar and holds cash in foreign currencies which expose the Company totransaction gains and losses as foreign currency exchange rates fluctuateagainst the U.S. dollar. The Company from time to time enters into forwardforeign exchange contracts to hedge the foreign currency exposure of non-U.S.dollar denominated third-party and intercompany receivables and cash balances.The contracts which relate to the British pound, euro and the Japanese yen,generally have terms of one month. These hedges are deemed fair value hedgesand have not been designated for hedge accounting. The gains or losses on theforward foreign exchange contracts along with the associated losses and gainson the revaluation and settlement of the intercompany balances, accountsreceivable and cash balances are recorded in current operations.

 

The following table summarizes the outstanding forward foreign exchangecontracts held by the Company as of December 31, 2007 and March 31,2008:

 

| ** **    | ** ** | ** **          | ** ** | **As of December 31, 2007** | ** ** | **As of March 31, 2008**  | ** ** |
|---------------|------------|---------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| **Currency**  | ** ** | **Hedge Type** | ** ** | **Local  Currency  Amount**                     | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** | **Local  Currency  Amount** | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** |
| British pound |       | Sale                |       | 7,500                                           |       | $                                             | 14,861     |   | — |   | $ | — |   |
| Euro          |       | Sale                |       | 3,400                                           |       | 4,965                                         |       | 3,000 |   | 4,729 |   |
|          |       |                |       |                                            |       | $                                             | 19,826     |   |   |   | $ | 4,729 |   |

 

The forward foreign exchange contracts are short-termand generally mature within one month of origination.

 

Due to the short periodof time between entering into the forward foreign exchange contracts and March 31,2008, the forward foreign exchange contracts rate approximates the exchangerate as of the end of the reporting period.

 

Realized and unrealizedforeign currency losses, net of hedging, are accounted for in non-operatingincome. Foreign currency losses, net of hedging, were $65 for the three monthsended March 31, 2007.  There were noforeign currency gains or losses for the three months ended March 31,2008.  The Company settles forwardforeign exchange contracts in cash.

 

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** **

**16.**       Income Taxes

** **

**The Company’s effective tax rates forthe three months ended March 31, 2007 and 2008 were 14% and 38%,respectively.  In the three months ended March 31,2007,**theCompany’s provision for taxes includes foreign and alternative minimum tax asthe Company utilized available U.S. net operating losses to offset its primaryfederal obligations resulting in an effective tax rate of 14%.  In the three months ended March 31,2008, the Company’s effective tax rate was higher than its statutory rate of37% due to non-deductible stock-based compensation expense.

** **

On January 1, 2007,the Company adopted the provisions of Financial Standards Accounting Board(FASB) Interpretation No. 48 *Accounting for Uncertaintyin Income Taxes*, an interpretation of SFAS No. 109, *Accounting for Income Taxes*.  As of March 31,2008, the Company had a liability of $1,154 for unrecognized tax benefits, allof which would favorably impact the company’s effective tax rate ifrecognized.  The Company recognizesinterest and penalties related to uncertain tax positions as a component ofincome tax expense.  As of March 31,2008, the Company had approximately $107 and $123, respectively, of accruedinterest and penalties related to unrecognized tax benefits.  The Companyanticipates a reduction of approximately $144 to the amount of unrecognized taxbenefits over the next twelve months associated with lapsing statutes oflimitations.  The unrecognized taxliability of $1,154 and accrued interest and penalties of $123 are classifiedas other long-term liabilities on the consolidated balance sheet as of December 31,2007 and March 31, 2008.

 

**17.  Fair Value Measurements**

 

InSeptember 2006, the FASB issued SFAS No. 157, *FairValue Measurements*, which defines fair value, establishes a frameworkfor measuring fair value in accordance with generally accepted accountingprinciples and expands disclosures about fair value measurements. SFAS No. 157does not require any new fair value measurements, but its provisions apply toall other accounting pronouncements that require or permit fair valuemeasurement. SFAS No. 157 is effective for the Company’s fiscal yearbeginning January 1, 2008 and for interim periods within that year. In February 2008,the FASB issued FASB Staff Position (FSP) No. 157-2, *Effective Date of FASB Statement No. 157*,which delayed for one year the effective date of SFAS No. 157 fornonfinancial assets and nonfinancial liabilities, except for items that arerecognized or disclosed at fair value in the financial statements on arecurring basis (at least annually). As required, the Company adopted SFAS No. 157for its financial assets on January 1, 2008. Adoption did not have amaterial impact on the Company’s financial position or results of operations.The Company has not yet determined the impact on its financial statements ofthe January 1, 2009 adoption of SFAS No. 157 as it pertains tonon-financial assets and liabilities.

 

SFAS No. 157requires expanded disclosures about fair value measurements. SFAS No. 157applies to other accounting pronouncements that require or permit fair valuemeasurements, but does not require any new fair value measurements. SFAS No. 157clarifies that fair value is an exit price, representing the price that wouldbe received to sell an asset or paid to transfer a liability in an orderlytransaction between market participants based on the highest and best use ofthe asset or liability. As such, fair value is a market-based measurement thatshould be determined based on assumptions that market participants would use inpricing an asset or liability. SFAS No. 157 requires the Company to usevaluation techniques to measure fair value that maximize the use of observableinputs and minimize the use of unobservable inputs. These inputs areprioritized as follows:

 

·      *Level 1*:Observable inputs such as quoted prices for identical assets or liabilities inactive markets;

·      *Level 2*.Inputs, other than the quoted prices in active markets, that are observableeither directly or indirectly such as quoted prices for similar assets orliabilities or market-corroborated inputs; and

·      *Level 3*.Unobservable inputs for which there is little or no market data, which requirethe reporting entity to develop its own assumptions about how marketparticipants would price the assets or liabilities.

 

Thevaluation techniques that may be used to measure fair value are as follows:

 

A.    *Market approach* - Uses prices andother relevant information generated by market transactions involving identicalor comparable assets or liabilities

B.    *Income approach* - Uses valuationtechniques to convert future amounts to a single present amount based oncurrent market expectations about those future amounts, including present valuetechniques, option-pricing models and excess earnings method

C.    *Cost approach* - Based on theamount that currently would be required to replace the service capacity of anasset (replacement cost)

 

 

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The following table setsforth the Company’s financial instruments carried at fair value within the SFASNo. 157 hierarchy and using the lowest level of input as of March 31,2008:

 
| ** **                              | ** ** | **Quoted Prices  in Active Markets  for Identical Items  (Level 1)** | ** ** | **Significant Other  Observable  Inputs  (Level 2)** | ** ** | **Significant  Unobservable  Inputs  (Level 3)** | ** ** | **Total** | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|-----------|------------|
|                                    |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| Assets:                                 |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| Money market funds                      |       | $                                                                    | 138,100    |                                                 | $          | —                                           |       | $         | —     |   | $ | 138,100 |   |
|                                    |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| U.S. agency notes                       |       | —                                                               |       | 7,016                                                |       | —                                           |       | 7,016     |       |
| Municipal bonds                         |       | —                                                               |       | 2,012                                                |       | —                                           |       | 2,012     |       |
| Corporate bonds                         |       | —                                                               |       | 13,178                                               |       | —                                           |       | 13,178    |       |
| Total short-term investments            |       | —                                                               |       | 22,206                                               |       | —                                           |       | 22,206    |       |
|                                    |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| Auction rate securities  (1)            |       | —                                                               |       | —                                               |       | 22,913                                           |       | 22,913    |       |
| Corporate bonds                         |       | —                                                               |       | 505                                                  |       | —                                           |       | 505       |       |
| Long-term investments                   |       | —                                                               |       | 505                                                  |       | 22,913                                           |       | 23,418    |       |
|                                    |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| Total Assets                            |       | $                                                                    | 138,100    |                                                 | $          | 22,711                                           |       | $         | 22,913     |   | $ | 183,724 |   |
|                                    |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| Liabilities:                            |       |                                                                 |       |                                                 |       |                                             |       |      |       |
| Forward foreign currency  contracts (2) |       | $                                                                    | —     |                                                 | $          | 4,729                                            |       | $         | —     |   | $ | 4,729 |   |
| Total Liabilities                       |       | $                                                                    | —     |                                                 | $          | 4,729                                            |       | $         | —     |   | $ | 4,729 |   |

 

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(1)   For additional information regarding auction rate securities, seeNote 8.

(2)   Foradditional information regarding forward foreign exchange contracts, see Note 15.

 

The following table setsforth a summary of changes in the fair value of the Company’s Level 3financial assets for the three months ended March 31, 2008:

 

| ** **                                                  | ** ** | **Level 3 Financial  Assets** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------|------------|
| Balance, beginning of  period                               |       | $                             | —     |   |
| Transfers in (out) of  Level 3                              |       | 24,050                        |       |
| Sales                                                       |       | —                        |       |
| Realized gains (losses)                                     |       | —                        |       |
| Unrealized gains (losses)  on securities held at period end |       | (1,137                        | )          |
| Balance, end of period                                      |       | $                             | 22,913     |   |

 

Realized gains and lossesfrom sales of the Company’s investments are included in “Other income(expense), net” and unrealized gains and losses are included as a separatecomponent of equity, net of tax, unless the loss is determined to beother-than-temporary.

 

The Company also adoptedthe provisions of SFAS No. 159, *The Fair Value Option forFinancial Assets and Financial Liabilities — Including an Amendment of FASBStatement No. 115*, in the first quarter of 2008. This Statementallows companies to choose to measure eligible assets and liabilities at fairvalue with changes in value recognized in earnings. Fair value treatment may beelected either upon initial recognition of an eligible asset or liability or,for an existing asset or liability, if an event triggers a new basis ofaccounting. The Company did not elect to re-measure any of its existingfinancial assets or liabilities under the provisions of this Statement.

 

**18.****               ****Recently Issued AccountingPronouncements**

 

In December 2007, the FASB issued SFAS No. 141 (Revised 2007),*Business Combinations* (“SFAS No. 141(R)”). SFAS No. 141(R) retainsthe fundamental requirements in SFAS No. 141 that the acquisition methodof accounting (which SFAS No. 141 called the purchase method) be used forall business combinations and for an acquirer to be identified for each businesscombination. SFAS No. 141(R) requires an acquirer to recognize theassets acquired, the liabilities assumed, and any noncontrolling interest inthe acquiree at the acquisition date, measured at their fair values as of thatdate, with limited exceptions specified in SFAS No. 141(R).  That replaces SFAS No. 141’scost-allocation method, which required the cost of an acquisition to beallocated to the individual assets acquired and liabilities assumed based ontheir estimated fair values.  SFAS No. 141(R) retainsthe guidance in SFAS No. 141 for identifying and recognizing intangibleassets separately from goodwill. SFAS No. 141(R) will now require the following:acquisition costs to be expensed as incurred, restructuring costs associatedwith a business combination must be expensed prior to the acquisition date andchanges in deferred tax asset valuation allowances and income tax uncertaintiesafter the acquisition date generally will affect income tax expense.  SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter the beginning of the first annual reporting period beginning on or after December 15,2008, which is the Company’s 2009 fiscal year. Earlier adoption is prohibited.

 

 

16

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

 

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

 

*The following discussion and analysis of ourfinancial condition and results of operations should be read in conjunctionwith our unaudited condensed consolidated financial statements and relatednotes thereto that appear elsewhere in this Quarterly Report on Form 10-Qand the audited financial statements and related notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded in our Annual Report on Form 10-K for the year ended December 31,2007, which has been filed with the Securities and Exchange Commission (“SEC”).*

 

**Overview**

 

Phase ForwardIncorporated is a provider of integrated enterprise-level software products,services and hosted solutions for use in our customers’ global clinical trialand drug safety monitoring activities. Our customers include pharmaceutical,biotechnology and medical device companies, as well as academic institutions,governmental regulatory agencies, contract research organizations, or CRO’s,and other entities engaged in clinical trial and drug safety monitoringactivities. By automating essential elements of the clinical trial and drugsafety monitoring processes, we believe our products allow our customers toaccelerate the market introduction of new medical therapies and correspondingrevenues, reduce overall research and development expenditures, enhanceexisting data quality control efforts, increase drug safety compliance andreduce clinical and economic risk.

 

**Acquisitions**

 

From time to time we have expanded our product andservice offerings through the acquisition of other businesses or technologies.The most significant of these transactions are the acquisitions of ClinsoftCorporation (“Clinsoft”) in 2001 and Lincoln Technologies, Inc. (“Lincoln”)in 2005. We also recently completed the acquisition of Green Mountain Logic, Inc.(“Green Mountain”), which is described below.

 

*Green Mountain Logic*

 

On October 30,2007, we acquired all of the outstanding capital stock of Green Mountain, aprocess automation software company that provides targeted solutions for thelife sciences industry, including the *LabPas*Phase Iclinic automation software.  The acquiredtechnology and products of Green Mountain provide us with a solution targetedfor Phase I clinical trials. The aggregate purchase price was $5.4million.  The acquisition of GreenMountain was accounted for as a purchase under Statement of FinancialAccounting Standards (“SFAS”) No. 141, *Business Combinations*.Accordingly, the results of Green Mountain have been included in ourconsolidated financial statements since the date of acquisition.

 

**Sourcesof Revenues**

 

We derive our revenuesfrom software licenses and services.  Our product line iscomprised of three general categories that include the following softwareproducts:

 

·*ElectronicData Capture (EDC)*

 

·       *InForm*, our Internet-basedelectronic data capture solution for collection and transmission of patientinformation in clinical trials; and

 

·       *LabPas*, our system forPhase I clinic automation.

 

·*ClinicalData Management*

 

·       *Clintrial*, our clinical datamanagement solution; and

 

·      *WebSDM*, our system for validatingand reviewing clinical trial data represented in formats meeting industrystandards, such as those established by the Clinical Data Interchange StandardsConsortium, or CDISC.

 

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·*Safety*

 

·       *EmpiricaTrace*(formerly *Clintrace*), ouradverse event management solution for monitoring drug safety and reportingadverse events that occur during and after conclusion of the clinical trialprocess;

 

·       *WebVDME*, our data mining andsignal detection solution for post-marketing data; and

 

·       *CTSD*, our signaldetection solution for data from clinical trials.

 

License revenues are derived principally from the sale of term licensesfor our software products.  Servicerevenues are derived principally from our delivery of the hosted solution ofour *InForm,**WebVDME*, *CTSD* and *WebSDM* software products, andconsulting services and customer support, including training, for all of ourproducts.  We generally recognizerevenues ratably over the life of a license or service contract. This allows usto maintain a backlog that provides multi-year visibility in revenues.

 

One customer,GlaxoSmithKline, accounted for approximately 17% and 13% of our total revenuesin the three months ended March 31, 2007 and 2008, respectively, and $1.8million of accounts receivable outstanding as of December 31, 2007 and March 31,2008.  Our top 20 customers accounted forapproximately 67% and 64% of our total revenues, net of reimbursableout-of-pocket expenses, in the three months ended March 31, 2007 and 2008,respectively, net of reimbursable out-of-pocket expenses.

 

*LicenseRevenues*

 

We derive our license revenues principally from the sale of termlicenses for the following software products: *InForm*,our Internet-based electronic data capture, or EDC, solution; *Clintrial* and *WebSDM*, ourclinical data management solutions; our drug safety solutions, including our *Empirica Trace*, *WebVDME* and *CTSD* products; and our *LabPas* Phase I clinic automation solution.  Although each of our software solutions is availableas a stand-alone enterprise application, we offer integrated enterprisesolutions incorporating certain of our electronic data capture, data managementand drug safety products.

 

License revenues for our *InForm *electronicdata capture software solution, either on a stand-alone or integrated basis,are determined primarily by the number, complexity and duration of the clinicaltrials and the number of participants in each clinical trial. License revenuesfor our *Clintrial,**WebSDM, Empirica Trace,**WebVDME*, *CTSD* and *LabPas* software solutions are determined primarily by the number of usersaccessing the software solution. Except as discussed below, we enter into softwarelicense agreements for our *InForm*,*Clintrial* and *Empirica Trace* products**withterms generally of three to five years with payment terms generally annually inadvance. License agreements for our other products are generally annual ormulti-year with payment terms generally annually in advance.  License revenues are recognized ratably overthe duration of the software term license agreement, to the extent that amountsare fixed or determinable and collectable.

 

Following our acquisition of Clinsoft in August 2001,we began converting holders of Clinsoft perpetual software licenses to oursoftware term license arrangements. We continue to sell additional perpetuallicenses of these products in certain situations to our existing customers withthe option to purchase customer support, and may in the future do so for newcustomers based on customer requirements or market conditions. We recognizerevenues on the perpetual licenses upon delivery of the software when all otherrevenue recognition criteria are met. We continue to provide and charge formaintenance and support on our products to those customers who do not convertto our software term license arrangements. We will continue our efforts to convert the remaining former Clinsoftcustomer base to software term license arrangements. However, we anticipatethat some customers will not convert and instead will continue to make annualcustomer support payments.

 

*ServiceRevenues*

 

*Application Hosting Services.*    In addition tomaking our software products available to customers through licenses, we offerour *InForm*,*WebVDME, CTSD*and*WebSDM* software as hosted applicationsolutions delivered through a standard web-browser, with customer support andtraining services.  Service revenues fromapplication hosting services are derived principally from our *InForm *hosted solution.

 

Revenues resulting from the *InForm *hostingservice consist of three stages for each clinical trial:

 

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

 

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

 

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

 

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Services provided for the first and third stages are provided on afixed fee basis depending upon the complexity of the trial and systemrequirements. Services for the second stage are charged separately as a fixedmonthly fee. We recognize revenues from all stages of the hosting serviceratably over the hosting period. Fees charged and costs incurred for the trialsystem design, set up and implementation are deferred until the start of thehosting period and are amortized and recognized ratably over the estimatedhosting period. The deferred costs include direct costs related to the trialand application set up. Fees for the first and third stages of the services arebilled based upon milestones. Fees for application hosting and related servicesin the second stage are generally billed quarterly in advance. Bundled intothis revenue element are the revenues attributable to the software license usedby the customer.

 

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

 

Revenues resulting from hosting services for our *WebVDME*, *CTSD*and *WebSDM* products consist ofinstallation and server configuration, application hosting and related supportservices.  Services for this offering arecharged monthly as a fixed fee.  Revenuesare recognized ratably over the period of the service.

 

In addition, application hosting service revenues include hostingservices associated with term license customers and reimbursable out-of-pocketexpenses.

 

* Consulting Services**.*    Consultingservices include the design and documentation of the processes related to ourcustomers’ use of our products and services in their clinical trials and safetymonitoring activities. Consulting services also include project planning andmanagement services, guidance on best practices in using our software products,data management and configuration services for data mining and reporting, aswell as implementation services consisting of application architecture design,systems integration, installation and validation.  Consulting services can be sold on astand-alone basis or as part of a bundled arrangement.  In some circumstances, we sell additionalfollow on consulting services to a customer at a later date even if thecustomer purchased consulting services at the time of the initial licensepurchase under a bundled arrangement. Revenues from consulting services included in either a multiple elementsoftware license agreement or in an application hosting agreement arerecognized ratably over the term of the arrangement. The value of ourconsulting services sold within a bundled arrangement is equal to the value ofconsulting services sold on a stand-alone basis, as the activities performedunder both types of arrangements are similar in nature.  The associated costs are expensed asincurred.  We may also enter intoarrangements to provide consulting services separate from a licensearrangement. In these situations, revenue is recognized in accordance with The American Institute of Certified Public Accountants’(“AICPA”) Statement of Position No. 81-1 (SOP No. 81-1), *Accounting for Performance of Construction-Type andCertain Production-Type Contracts,*on either a time and materials basis or using theproportional performance method. If we are not able to produce reasonablydependable estimates, revenue is recognized upon completion of the project andfinal acceptance from the customer. If significant uncertainties exist about projectcompletion or receipt of payment, the revenue is deferred until the uncertaintyis resolved. Provisions for estimated losses on contracts are recorded duringthe period in which they are identified.

 

*Customer Support.*    We have amultinational services organization to support our software products and hostedsolutions worldwide. Customer support includes training services, telephonesupport and software maintenance. We bundle customer support in our softwareterm licenses and allocate 10% of the value of the license to customer supportrevenues. The customer support services rate of 10% for multi-year term-basedlicenses reflects a significant discount from the rate for customer supportservices associated with perpetual licenses due to the reduction in the timeperiod during which the customer can utilize the upgrades and enhancements. We believe this rate is substantive andrepresents an amount we believe reasonable to be allocated.  Our customer support revenuesalso consist of customer support fees paid by perpetual license customers.Customer support revenues are recognized ratably over theperiod of the customer support or term license agreement, with payment termsgenerally annually in advance.

 

**Cost ofRevenues and Operating Expenses**

 

We allocate overhead expenses such as rent and occupancy charges andemployee benefit costs to all departments based on headcount. As such, generaloverhead expenses are reflected in cost of service revenues and in the salesand marketing, research and development, and general and administrative expensecategories.

 

*Cost of Revenues.*    Cost of licenserevenues consists primarily of the amortization of royalties paid for certainmodules within our *Clintrial*software product as well as our *InForm *softwareproduct. In addition, costs of revenues include expense for the amortization ofacquired technologies associated with the acquisition of Lincoln. The cost oflicense revenues vary based upon the mix of revenues from software licenses forour products. We operate our service organization on a global basis as onedistinct unit, and do not segment costs for our various service revenueelements. These services include performing application hosting, consulting andcustomer support services. Costs for these services consist primarily ofemployee-related costs associated with these services, amortization of thedeferred clinical trial set up costs, allocated overhead, outside contractors,royalties associated with providing 

 

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customer support for usewith the *Clintrial* and *InForm *software products and reimbursable out-of-pocketexpenses. Cost of services also includes hosting costs that primarily consistof hosting facility fees and server depreciation.

 

The cost of service revenues varies based upon the number of employeesin the service organization, the type of work performed, and royaltiesassociated with revenues derived from providing customer support, as well ascosts associated with the flexible use of outside contractors to supportinternal resources. We supplement the trial design and set up activity for our *InForm *application hosting servicesthrough the use of outside contractors. This allows us to utilize outsidecontractors in those periods where trial design and set up activity is highestwhile reducing the use of outside contractors in those periods where trialactivity lessens, allowing for a more flexible delivery model. The percentageof the services workforce represented by outside contractors varies from periodto period depending on the volume of specific support required. The cost ofservices is significantly higher as a percentage of revenues as compared to ourcost of license revenues primarily due to the employee-related and outsidecontractor expenses associated with providing services.

 

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

 

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

 

*Research and Development.*    Research anddevelopment expenses consist primarily of employee-related expenses, allocatedoverhead and outside contractors. We focus our research and development effortson increasing the functionality, performance and integration of our softwareproducts. We expect that in the future, research and development expenses willincrease in absolute dollars as we continue to add features and functionalityto our products, introduce additional integrated software solutions to ourproduct suite and expand our product and service offering.

 

*General and Administrative.*    General andadministrative expenses consist primarily of employee-related expenses,professional fees, primarily consisting of expenses for accounting, compliancewith the Sarbanes-Oxley Act of 2002, and legal services, including litigation,information technology and other corporate expenses and allocated overhead. Weexpect that in the future our general and administrative expenses will increasein absolute dollars as we add personnel and incur additional costs related tothe growth of our business and operations.

 

*Stock-Based Compensation Expenses.*    Ourcost of service revenues, sales and marketing, research and development, andgeneral and administrative expenses include stock-based compensationexpense.  Stock-based compensationexpense is the fair value of outstanding stock options and restricted stockawards and units, which are recognized over the respective stock option andaward service periods.  It also includesamortization of the excess of the deemed fair market value over the exerciseprice of stock options granted prior to our July 2004 initial public offering.  During the three months ended March 31,2007 and 2008, we recorded $1.0 and $1.7 million of stock-based compensationexpense, respectively.

 

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**ForeignCurrency Translation**

 

With regard to ourinternational operations, we frequently enter into transactions in currenciesother than the U.S. dollar. As a result, our revenues, expenses and cash flowsare subject to fluctuations due to changes in foreign currency exchange rates,particularly changes in the euro, British pound, Australian dollar and Japaneseyen. In the three months ended March 31, 2007 and 2008, approximately 50%and 47%, respectively, of our revenues were generated in locations outside theUnited States. The majority of these revenues are in currencies other than theU.S. dollar, as are many of the associated expenses. In periods when the U.S.dollar declines in value as compared to the foreign currencies in which weconduct business, our foreign currency-based revenues and expenses generallyincrease in value when translated into U.S. dollars.

 

**CriticalAccounting Policies and Estimates**

 

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

 

Webelieve that of our significant accounting policies, which are described inNote 2 of the notes to our consolidated financial statements included inour Annual Report on Form 10-K for the year ended December 31, 2007,the following accounting policies involve a greater degree of judgment andcomplexity. Accordingly, these are the policies we believe are the mostcritical to aid in fully understanding and evaluating our consolidatedfinancial condition and results of operations.

 

*Revenue Recognition and Deferred SetUp Costs.*    Werecognize software license revenues in accordance with Statement of Position(SOP) No. 97-2, *Software RevenueRecognition,* as amended, issued by the AICPA, while revenuesresulting from application services are recognized in accordance with EmergingIssues Task Force (EITF) Issue No. 00-3, *Applicationof AICPA Statement of Position 97-2 to Arrangements that Include the Right toUse Software Stored on Another Entity’s Hardware*, Securities andExchange Commission’s (SEC) Staff Accounting Bulletin (SAB) No. 104, *Revenue Recognition* and EITF Issue No. 00-21, *RevenueArrangements with Multiple Deliverables.*

 

Customers generally have the ability to terminate application hosting,consulting and training service agreements upon 30 days notice. Licenseagreements, multiple element arrangements, including license and servicesagreements and certain application hosting services can generally be terminatedby either party for material breach of obligations not corrected within30 days after notice of the breach.

 

We recognize revenues when all of the following conditions aresatisfied: (1) there is persuasive evidence of an arrangement; (2) theproduct or service has been provided to the customer; (3) the collectionof our fees is probable; and (4) the amount of fees to be paid by thecustomer is fixed or determinable.

 

We generally enter into software term licenses for our *InForm*, *Clintrial*and *Empirica Trace* products withour customers for 3- to 5-year periods. License agreements for our *WebVDME, CTSD*and*WebSDM*products are generally annual or multi-year terms.  These arrangements typically include multipleelements: software license, consulting services and customer support. We billour customers in accordance with the terms of the underlying contract.Generally, we bill license fees annually in advance for each year of thelicense term. Our payment terms are generally net 30 days.

 

Our software licenserevenues are earned from the sale of off-the-shelf software requiring nosignificant modification or customization subsequent to delivery to thecustomer. Consulting services, which can also be performed by third-party consultants,are deemed to be non-essential to the functionality of the software andtypically are for trial configuration, implementation planning, loading ofsoftware, building simple interfaces and running test data and documentation ofprocedures.

 

Customer support includes training services, telephonesupport and software maintenance.  Wegenerally bundle customer support with the software license for the entire termof the arrangement. As a result, we generally recognize revenues for allelements, including consulting services, ratably over the term of the softwarelicense and support arrangement. We allocate the revenues 

 

21

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recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For our term-based licenses, we allocateto consulting services the anticipated service effort and value throughout theterm of the arrangement at an amount that would have been allocated had those servicesbeen sold separately to the customer. The value of our consulting services sold withina bundled arrangement is equal to the value of consulting services sold on astand-alone basis, as the activities performed under both types of arrangementsare similar in nature.  Theremaining value is allocated to license and support services, with 10% of thisamount allocated to support services. The customer support services rate of 10% formulti-year term-based licenses reflects a significant discount from the ratefor customer support services associated with perpetual licenses due to thereduction in the time period during which the customer can utilize the upgradesand enhancements. We believe this rateis substantive and represents a reasonable basis of allocation. We haveallocated the estimated fair value to our multiple element arrangements toprovide meaningful disclosures about each of our revenue streams. The costsassociated with the consulting and customer support services are expensed asincurred. There are instances in which we sell software licenses based on usagelevels. These software licenses can be based on estimated usage, in which casethe license fee charged to the customer is fixed based on this estimate. Whenthe fee is fixed, the revenues are generally recognized ratably over thecontractual term of the arrangement. If the fee is based on actual usage, andtherefore variable, the revenues are recognized in the period of use. Revenuesfrom certain follow-on consulting services, which are sold separately tocustomers with existing software licenses and are not considered part of amultiple element arrangement, are recognized as the services are performed.

 

We continue to sell additional perpetual licenses for the *Clintrial* and *Empirica Trace* software products in certain situations toour existing customers with the option to purchase customer support and may inthe future do so for new customers based on customer requirements or marketconditions. We have established vendor specific objective evidence of fairvalue for the customer support. Accordingly, license revenues are recognizedupon delivery of the software and when all other revenue recognition criteriaare met.  Customer support revenues arerecognized ratably over the term of the underlying support arrangement. Wecontinue to generate customer support and maintenance revenues from ourperpetual license customer base. Training revenues are recognized as earned.

 

In addition to making our software products available to customersthrough licenses, we offer our *InForm*,*WebVDME*, *CTSD* and *WebSDM* softwaresolutions through a hosted application solution delivered through a standardweb-browser.

 

Revenues resulting from *InForm *applicationhosting services consist of three stages for each clinical trial: the firststage involves application set up, including design of electronic case reportforms and edit checks, implementation of the system and server configuration;the second stage involves application hosting and related support services; andthe third stage involves services required to close out, or lock, the databasefor the clinical trial. Services provided for the first and third stages areprovided on a fixed fee basis based upon the complexity of the trial and systemrequirements. Services for the second stage are charged separately as a fixedmonthly fee. We recognize revenues from all stages of the *InForm *hosting service ratably overthe hosting period. Fees charged and costs incurred for the trial systemdesign, set up and implementation are deferred as applicable, until the startof the hosting period and then amortized and recognized, as applicable, ratablyover the estimated hosting period. The deferred costs include incrementaldirect costs with third parties and certain internal direct costs related tothe trial and application set up, as defined under SFAS No. 91, *Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Indirect Costs of Leases*.These costs include salary and benefits associated with direct labor costsincurred during trial set up, as well as third-party subcontract fees and othercontract labor costs. Work performed outside the original scope of work iscontracted for separately as an additional fee and is generally recognizedratably over the remaining term of the hosting period. Fees for the first andthird stages of the services are billed based upon milestones. Fees forapplication hosting and related services in the second stage are billedquarterly in advance. Bundled into this revenue element are the revenuesattributable to the software license used by the customer.

 

Revenues resulting from hosting services for our *WebVDME*, *CTSD*and *WebSDM* products consist ofinstallation and server configuration, application hosting and related supportservices.  Services for this offering arecharged monthly as a fixed fee.  Revenuesare recognized ratably over the period of the service.

 

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

 

We may also enter into arrangements to provide consulting servicesseparate from a license arrangement. In these situations, revenue is recognizedin accordance with SOP No. 81-1,*Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts,*on either a time and materials basis orusing the proportional performance method. If we are not able to producereasonably dependable estimates, revenue is recognized upon completion of theproject and final acceptance from the customer. If significant uncertaintiesexist about project completion or receipt of payment, the revenue is deferreduntil the uncertainty is resolved. Provisions for estimated losses on contractsare recorded during the period in which they are identified.

 

We deferred $942,000 and$1.2 million of set up costs and amortized $560,000****and$805,000 during the three months ended March 31, 2007 and 2008,respectively. The amortization of deferred set up costs is a component of costof services.

 

22

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

 

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

 

*Accountingfor Prepaid Sales Commissions and Royalties.*    For arrangements where werecognize revenue over the relevant contract period, we defer relatedcommission payments to our direct sales force and software license royaltiespaid to third parties and amortize these amounts over the same period that therelated revenues are recognized. This is done to better match commission androyalty expenses with the related revenues. Commissionpayments are nonrefundable unless amounts due from a customer are determined tobe uncollectible or if the customer subsequently changes or terminates thelevel of service, in which case commissions which were paid are recoverable byus.  During the three months ended March 31, 2007 and2008, we deferred $1.7 million and $2.0 million, respectively, ofcommissions and amortized $1.5 million and $1.8 million, respectively, to salesand marketing expense. Royalties are paid on a percentage of billings basis forcertain of our products, and we have the right to recover royalties in theevent an arrangement is cancelled. During the three months ended March 31,2007 and 2008, we deferred $744,000 and $1.0 million, respectively, of royaltyexpenditures and amortized $688,000 and $691,000 respectively, to cost oflicense and service revenues.

 

        *Accounts ReceivableReserve.*    We maintain allowances for doubtfulaccounts for estimated losses resulting from the inability of our customers tomake required payments. We regularly evaluate the collectability of our tradereceivables based on a combination of factors, which may include dialogue withthe customer to determine the cause of non-payment, the use of collectionagencies, and/or the use of litigation. In the event it is determined that thecustomer may not be able to meet its full obligation to us, we record aspecific allowance to reduce the related receivable to the amount that weexpect to recover given all information available to us. We continuouslymonitor collections from our customers and maintain a provision for estimatedcredit losses based upon our historical experience and any specific customercollection issues that we have identified. While such credit losses havehistorically been within our expectations and the provisions established, wecannot guarantee that we will continue to experience the same credit loss ratesin the future. If the financial condition of our customers were to deteriorate,resulting in an impairment of their ability to make payments, additionalallowances may be required. Our accounts receivable reserves were $270,000 and$340,000 as of December 31, 2007 and March 31, 2008, respectively.

 

*Accounting for Income Taxes.*   We are subject toincome taxes in both the United States and foreign jurisdictions, and we useestimates in determining our provision for income taxes.  We account for income taxes in accordancewith SFAS No. 109, *Accounting forIncome Taxes*, which is the asset and liability method for accountingand reporting for income taxes.  Weadopted the provisions of FASB Interpretation No. (FIN) 48, *Accounting for Uncertainty in Income Taxes—aninterpretation of FASB Statement No. 109*, on January 1,2007.  Under SFAS No. 109, deferredtax assets and liabilities are recognized based on temporary differencesbetween the financial reporting and income tax bases of assets and liabilitiesusing statutory rates. This process requires that we project our current taxliability and estimate our deferred tax assets and liabilities, including netoperating loss and tax credit carryforwards. In assessing the need for avaluation allowance, we have considered our recent operating results, futuretaxable income projections and all prudent and feasible tax planningstrategies. In 2007, we determined that it was more likely than not that wewould realize the full value of our deferred tax assets and eliminated theremaining balance of our valuation allowance.

 

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

 

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

 

For service-basedoptions, accounted for under SFAS No. 123(R), we recognizecompensation expense on a straight-line basis over the requisite service periodof the award.  For performance-basedoptions, we recognize expense over the estimated performance period. Inaddition, SFAS 123(R) requires the benefits of tax deductions inexcess of recognized stock-based compensation to be reported as a financingactivity rather than an operating activity in the statements of cash flows.This requirement can have the effect of reducing our net operating cash flowsand increasing our net financing cash flows in certain periods.  To date, we have not recorded these benefitsas they have not been realized.

 

23

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

 

During the three months ending March 31, 2007 and 2008, werecorded $1,032,000 and $1,746,000 of aggregate stock-based compensationexpense, respectively, of which $986,000 and $1,746,000, respectively, was aresult of the adoption of SFAS No. 123(R). The remaining stock-basedcompensation expense is due to the amortization of stock-based compensationassociated with previously issued stock options which amounted to $46,000 and$0 in 2007 and 2008, respectively. For 2007, we allocated stock-basedcompensation expense as follows: $110,000 to cost of service revenues, $156,000to research and development, $166,000 to sales and marketing, and $600,000 togeneral and administrative.  For 2008, weallocated stock-based compensation expense as follows: $393,000 to cost ofrevenues, $279,000 to research and development, $314,000 to sales and marketingand $760,000 to general and administrative. For the three months ending March 31, 2007 and 2008, stock-basedcompensation expense reduced basic earnings per share by $0.03 and $0.02,respectively, and diluted earnings per share by $0.02 and $0.03,respectively.  As of March 31, 2008,we had $21.2 million of unrecognized stock-based compensation expense relatedto market-based share awards that we expect to recognize over a weightedaverage period of 2.89 years.

 

*Goodwilland Intangible Assets Impairment.*    We review the carrying valueof goodwill and intangible assets periodically based upon the expected futurediscounted operating cash flows of our business. Our cash flow estimates arebased on historical results adjusted to reflect our best estimate of ouroperating results in future periods. Actual results may differ materially fromthese estimates. The timing and size of impairment charges, if any, involvesthe application of management’s judgment regarding the estimates and couldsignificantly affect our operating results.

 

**Overviewof Results of Operations for the Three Months Ended March 31, 2007 and2008**

 

Total revenues increasedby 26%, or $7.9 million, in the three months ended March 31, 2008 comparedto the same period in 2007 due to increases in both service and licenserevenues of 36% and 14%, respectively.

 

Our gross marginincreased by 22%, or $3.9 million, in the three months ended March 31,2008 compared to the same period in 2007, primarily due to the increase inrevenues.

 

Operating income for thethree months ended March 31, 2008 of $4.4 million increased 37%, or $1.2million, compared to the same period in 2007. The operating income for the three months ended March 31, 2007 and2008 also included $1.0 million and $1.7 of stock-based compensation expense,respectively.

 

The results for the threemonths ended March 31, 2008 were impacted by foreign exchange ratefluctuations, resulting in increases of approximately 4% and 2% in revenues andexpenses, respectively, for the period.

 

As of March 31,2008, we had $199.3 million of cash, cash equivalents and short andlong-term investments, an increase of $16.7 million from$182.6 million at December 31, 2007. As of March 31, 2008, we had no outstanding debt.

 

*Revenues*

 

| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** | ** **                   | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|------------------------------|------------|
| ** **                                           | ** ** | **2007**                                             | ** ** | **2008**                     | ** ** | **Change** | ** ** |
| **Revenues by Product Line (1)** | ** ** | **Amount**                                           | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                              | ** ** |
| Electronic data capture                              |       | $                                                    | 21,275     |                         | 71         | % | $ | 28,950 |   | 76 | % | $ | 7,675 |   | 36 | % |
| Clinical data management                             |       | 5,036                                                |       | 17                           |       | 5,529 |   | 15 |   | 493 |   | 10 |   |
| Safety                                               |       | 3,773                                                |       | 12                           |       | 3,541 |   | 9 |   | (232 | ) | (6 | ) |
| Total                                                |       | $                                                    | 30,084     |                         | 100        | % | $ | 38,020 |   | 100 | % | $ | 7,936 |   | 26 | % |

 

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

 

The increase inelectronic data capture revenues is primarily due to increases in applicationhosting services and license revenues of $7.1 million and $1.2 million,respectively.  The increases are partially offset by decreases inconsulting services and customer support, totaling $592,000.  The increasein clinical data management can be attributed to an increase in licenserevenues and consulting services revenues of $394,000 and $134,000,respectively.  These increases arepartially offset by decrease in customer support revenues of $35,000.  The decrease in safety was due to a decreasein consulting services revenues of $322,000 and license revenues of $18,000,offset by increases in application hosting services and customer supportrevenues, totaling $108,000.

 

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|                           |   | **Three Months Ended March 31,** |   |                         |   |       |   |
|--------------------------------|--------|------------------------------------------------------|--------|------------------------------|--------|------------|--------|
|                           |   | **2007**                                             |   | **2008**                     |   | **Change** |   |
| **Revenues by Type** |   | **Amount**                                           |   | **Percentage  of  Revenues** |   | **Amount** |   | **Percentage  of  Revenues** |   | **Amount** |   | **%** |   |
|                           |   | **(in thousands)**                              |   |
| License                        |   | $                                                    | 11,036 |                         | 37     | %          | $      | 12,614 |   | 33 | % | $ | 1,578 |   | 14 | % |
| Application hosting services   |   | 12,045                                               |   | 40                           |   | 19,185     |   | 51 |   | 7,140 |   | 59 |   |
| Consulting services            |   | 3,430                                                |   | 11                           |   | 3,099      |   | 8 |   | (331 | ) | (10 | ) |
| Customer support               |   | 3,573                                                |   | 12                           |   | 3,122      |   | 8 |   | (451 | ) | (13 | ) |
| Total                          |   | $                                                    | 30,084 |                         | 100    | %          | $      | 38,020 |   | 100 | % | $ | 7,936 |   | 26 | % |
|                                |        |                                                      |        |                              |        |            |        |  |  |  |  |  |  |  |  |  |  |

 

Total revenues increased in the three months ended March 31,2008 as compared to the same period in 2007, primarily due to increases inapplication hosting and license revenues. The increase in revenues associated with our application hostingservices in the three months ended March 31, 2008 was primarily due to anapproximately 15% increase in production trials under management fromapproximately 660 as of March 31, 2007 to approximately 760 as of March 31,2008, primarily from customers who purchase all trial-related services from usand who do not have a separate license to *InForm*, and toan increase in the average fee per trial. The increase in license revenues was primarily the result of additional *InForm *and *Clintrial*revenues from both new and existing customers. The decrease in consulting revenues was primarily attributable todecreases in *WebVDME* and *InForm *consultingservices revenues.  The decrease incustomer support revenues in the three months ended March 31, 2008 was dueprimarily to decreases in *InForm *revenues.  Our revenues were not significantly impactedby price increases or decreases. Inflation had only a nominal impact on our revenues.  Revenues were impacted by foreign exchangerate fluctuations, resulting in an increase in revenues for the period ofapproximately 4%.

 

| ** **                          | ** ** | **Three Months Ended March 31,** | ** ** | ** **                      | ** ** | ** ** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **                          | ** ** | **2007**                                             | ** ** | **2008**                        | ** ** | **Change** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                              | ** ** |
| United States                       |       | $                                                    | 14,979     |                            | 50         | %          | $          | 20,194 |   | 53 | % | $ | 5,215 |   | 35 | % |
|                                |       |                                                 |       |                            |       |       |       |   |   |   |   |   |   |
| United Kingdom                      |       | 10,910                                               |       | 36                              |       | 12,094     |       | 32 |   | 1,184 |   | 11 |   |
| France                              |       | 2,487                                                |       | 8                               |       | 3,586      |       | 9 |   | 1,099 |   | 44 |   |
| Asia Pacific                        |       | 1,708                                                |       | 6                               |       | 2,146      |       | 6 |   | 438 |   | 26 |   |
|                                |       |                                                 |       |                            |       |       |       |   |   |   |   |   |   |
| International  subtotal             |       | 15,105                                               |       | 50                              |       | 17,826     |       | 47 |   | 2,721 |   | 18 |   |
|                                |       |                                                 |       |                            |       |       |       |   |   |   |   |   |   |
| Total                               |       | $                                                    | 30,084     |                            | 100        | %          | $          | 38,020 |   | 100 | % | $ | 7,936 |   | 26 | % |
|                                     |            |                                                      |            |                                 |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The increase in revenues worldwide wasprimarily related to an increase inelectronic data capture**and clinical data management revenues, offsetpartially by decreases in safety revenues. The increase in U.S. revenues is primarily due to increases inapplication hosting and license revenues of $4.6 million and $1.5 million.  These increases are offset by decreases inconsulting services and customer support revenues of $637,000 and $177,000,respectively.  The growth ininternational revenues is primarily due to increases in hosting, consultingservices, and license revenues of $2.6 million, $305,000, and $113,000,respectively.  These increases are offsetby decreases in customer support revenues of $276,000.

 

*Cost ofRevenues*

 

| ** **                      | ** ** | **Three Months Ended March 31,** | ** ** | ** **                               | ** ** | ** ** | ** ** |
|---------------------------------|------------|------------------------------------------------------|------------|------------------------------------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                             | ** ** | **2008**                                 | ** ** | **Change** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                                           | ** ** | **Percentage  of Related  Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                      | ** ** | **(in thousands)**                              | ** ** |
| License                         |       | $                                                    | 605        |                                     | 5          | %          | $          | 655 |   | 5 | % | $ | 50 |   | 8 | % |
| Services                        |       | 11,527                                               |       | 61                                       |       | 15,528     |       | 61 |   | 4,001 |   | 35 |   |
|                            |       |                                                 |       |                                     |       |       |       |   |   |   |   |   |   |
| Total                           |       | $                                                    | 12,132     |                                     | 40         | %          | $          | 16,183 |   | 43 | % | $ | 4,051 |   | 33 | % |
|                                 |            |                                                      |            |                                          |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

The increase in cost ofservices in the three months ended March 31, 2008 was due primarily toincreases in employee-related and 

contractor expense of $2.0 million and $1.0 million, respectively.  In addition, our headcount increased by 68people.  Depreciation expense andstock-based compensation expense increased by $575,000 and $283,000,respectively.  We also had expenseincreases for facilities and application management of $157,000 and $137,000,respectively.  Phone and recruitmentexpenses increased by $69,000 and $40,000, respectively.  These increases were partially offset by adecrease in computer-related expense of $209,000.

 

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Computer-related expenses include hardware and software supportagreements as well as computer accessories.

 

*GrossMargin*

 

| ** **            | ** ** | **Three Months Ended March 31,** | ** ** | ** **                               | ** ** | ** ** | ** ** |
|-----------------------|------------|------------------------------------------------------|------------|------------------------------------------|------------|------------|------------|
| ** **            | ** ** | **2007**                                             | ** ** | **2008**                                 | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                           | ** ** | **Percentage  of Related  Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                              | ** ** |
| License               |       | $                                                    | 10,431     |                                     | 95         | %          | $          | 11,959 |   | 95 | % | $ | 1,528 |   | 15 | % |
| Services              |       | 7,521                                                |       | 39                                       |       | 9,878      |       | 39 |   | 2,357 |   | 31 |   |
|                  |       |                                                 |       |                                     |       |       |       |   |   |   |   |   |   |
| Total                 |       | $                                                    | 17,952     |                                     | 60         | %          | $          | 21,837 |   | 57 | % | $ | 3,885 |   | 22 | % |
|                       |            |                                                      |            |                                          |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

The net gross marginpercentage in the three months ended March 31, 2008 declined 3% from thethree months ended March 31, 2007 primarily due to an increase in lowermargin service revenues as a percentage of total revenues.  We expect that gross margin, as a percentageof revenue, will fluctuate quarter by quarter due to the timing and mix oflicense and service revenues, and the type, amount and timing of servicerequired in delivering certain projects.

 

*Operating Expenses*

 

| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** | ** **                      | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2007**                                             | ** ** | **2008**                        | ** ** | **Change** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                              | ** ** |
| Sales and  marketing        |       | $                                                    | 5,447      |                            | 18         | %          | $          | 6,151 |   | 16 | % | $ | 704 |   | 13 | % |
| Research and  development   |       | 4,632                                                |       | 15                              |       | 5,558      |       | 15 |   | 926 |   | 20 |   |
| General and  administrative |       | 4,638                                                |       | 16                              |       | 5,700      |       | 15 |   | 1,062 |   | 23 |   |
|                        |       |                                                 |       |                            |       |       |       |   |   |   |   |   |   |
| Total                       |       | $                                                    | 14,717     |                            | 49         | %          | $          | 17,409 |   | 46 | % | $ | 2,692 |   | 18 | % |
|                             |            |                                                      |            |                                 |            |            |            |  |  |  |  |  |  |  |  |  |  |  |

 

*Salesand Marketing.*    Sales and marketingexpenses increased in the three months ended March 31, 2008 primarily dueto a $275,000 increase in commission expense due to an increase in orders andrevenues.  In addition, there wereexpense increases in employee-related, stock-based compensation and outsidecontractor expenses of $220,000, $148,000 and $71,000, respectively.  We expect that our sales and marketingexpense will continue to increase in absolute dollars as commission expenseincreases with our revenues and as we continue to expand sales coverage and tobuild brand awareness through what we believe are the most cost effectivechannels available, but may fluctuate quarter over quarter due to the timing ofmarketing programs.

 

*Researchand Development.*    Research anddevelopment expenses increased in the three months ended March 31, 2008primarily due to employee-related expenses of $536,000 related to a headcountincrease of 14 people.  We also hadexpense increases related to stock-based compensation, outside contractors andrecruiting expenses of $123,000, $98,000 and $66,000, respectively.  We expect that our research and developmentcosts will continue to increase in absolute dollars as we continue to addfeatures and functionality to our products, introduce additional integratedsoftware solutions to our product site and expand our product and serviceofferings.

 

*Generaland Administrative.*    General andadministrative expenses increased in the three months ended March 31, 2008primarily due to increases in depreciation of $381,000 and employee-relatedexpenses of $367,000 related to a headcount increase of 8 people and thewrite-off of an abandaned asset of $316,000. We expect that in the future our general and administrative expenseswill increase in absolute dollars as we add personnel and incur additionalcosts related to the growth of our business and operations.

 

*OperatingIncome*

 

| ** **       | ** ** | **Three Months Ended March 31,** | ** ** | ** **                      | ** ** | ** ** | ** ** |
|------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **       | ** ** | **2007**                                             | ** ** | **2008**                        | ** ** | **Change** | ** ** |
| ** **       | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **       | ** ** | **(in thousands)**                              | ** ** |
| Operating income |       | $                                                    | 3,235      |                            | 11         | %          | $          | 4,428 |   | 12 | % | $ | 1,193 |   | 37 | % |
|                  |            |                                                      |            |                                 |            |            |            |  |  |  |  |  |  |  |  |  |

 

*OperatingIncome.*   The increase in operating income inthe three months ended March 31, 2008 was primarily due to the increase intotal gross margin and a reduction in operating expenses as a percentage ofrevenues.

 

26

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*OtherIncome (Expense)*

 

| ** **               | ** ** | **Three Months Ended March 31,** | ** ** | ** **                      | ** ** | ** ** | ** ** |
|--------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **               | ** ** | **2007**                                             | ** ** | **2008**                        | ** ** | **Change** | ** ** |
| ** **               | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **               | ** ** | **(in thousands)**                              | ** ** |
| Other income  (expense): |       |                                                 |       |                            |       |       |       |   |   |   |   |   |   |
| Interest income          |       | $                                                    | 864        |                            | 3          | %          | $          | 1,901 |   | 5 | % | $ | 1,037 |   | 120 | % |
| Other expense            |       | (66                                                  | )          | —                          |       | 134        |       | — |   | 200 |   | 303 |   |
|                     |       |                                                 |       |                            |       |       |       |   |   |   |   |   |   |
| Total other  income      |       | $                                                    | 798        |                            | 3          | %          | $          | 2,035 |   | 5 | % | $ | 1,237 |   | 155 | % |
|                          |            |                                                      |            |                                 |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

*OtherIncome.*    The increase in interestincome in the three months ended March 31, 2008 was primarily due to anincrease in cash, cash equivalents, short and long-term investments availablefor investment, partially offset by a decline in return on investments.

 

*Provision for Income Taxes*

 

| ** **                  | ** ** | **Three Months Ended March 31,** | ** ** | ** **                      | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------------------------------------------------|------------|---------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2007**                                             | ** ** | **2008**                        | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                              | ** ** |
| Provision for  income taxes |       | $                                                    | 552        |                            | 2          | %          | $          | 2,461 |   | 6 | % | $ | 1,909 |   | 346 | % |
|                             |            |                                                      |            |                                 |            |            |            |  |  |  |  |  |  |  |  |  |

 

***Provision forIncome Taxes.***  Our effective tax rates for the three months ended March 31,2007 and 2008 were 14% and 38%, respectively. In the three months ended March 31, 2007, the provision for taxes includes foreign and alternative minimum tax aswe utilized available U.S. net operating losses to offset our primary federalobligations resulting in an effective tax rate of 14%.  In the three months ended March 31,2008, our effective rate was higher than our statutory rate of 37% due tonon-deductible stock-based compensation expense.

** **

**Liquidityand Capital Resources**

 

Our principal sources ofliquidity were cash, cash equivalents, short and long-term investments totaling$182.6 million and $199.3 million at December 31, 2007 and March 31,2008, respectively, and accounts receivable of $35.5 million and$41.0 million, respectively.

 

Cash provided by and usedin operating activities has historically been affected by changes in workingcapital accounts, primarily deferred revenue, accounts receivable and accruedexpenses, and add-backs of non-cash expense items such as depreciation andamortization and stock-based compensation expense. Fluctuations within accountsreceivable and deferred revenue are primarily related to the timing of billingsto our term license customers and the associated revenue recognition. Movementsin deferred costs are related to the volume and stages of hosted clinicaltrials and movements in accrued expenses and accounts payable are due to thetiming of certain transactions.

 

Net cash provided byoperating activities was $18.6 million in the three months ended March 31,2008, which was greater than net income of $4.0 million. This differenceis primarily due to $2.2 million of non-cash charges of depreciation andamortization, increases in deferred revenue of $16.4 million and deferredincome taxes of $2.3 million, stock based compensation expense of $1.7 million,and an increase in accounts payable of $1.7 million.  These increases were partially offset bydecreases in accrued expenses of $4.9 million and an increase in accountsreceivable of $4.7 million.

 

Net cash provided byinvesting activities was $1.3 million during the three months ending March 31,2008, which was primarily due to proceeds from maturities of short-terminvestments of $28.3 million, offset by purchases of short-term investments of$25.6 million and capital expenditures of $1.4 million.

 

Net cash provided byfinancing activities was $446,000 in the three months ended March 31,2008, consisting of proceeds from the exercise of stock options.

 

Substantially all of ourlong-lived assets at December 31, 2007 and March 31, 2008 are locatedin the United States.

 

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

 

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The following table ofour material contractual obligations as of December 31, 2007 summarizesthe aggregate effect that these obligations are expected to have on our cashflows in the periods indicated:

 
| ** **                       | ** ** | **Payments Due by Period** | ** ** |
|----------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations** | ** ** | **Total**                                 | ** ** | **1 year or  less** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **More  than 5  years** | ** ** |
| ** **                       | ** ** | **(in thousands)**                   | ** ** |
| Operating lease  obligations     |       | $                                         | 7,872      |   | $ | 3,902 |   | $ | 2,779 |   | $ | 1,153 |   | $ | 38 |   |
| Total                            |       | $                                         | 7,872      |   | $ | 3,902 |   | $ | 2,779 |   | $ | 1,153 |   | $ | 38 |   |

 

The above table does not include the new lease we enteredinto subsequent to December 31, 2007. On February 13, 2008, we entered into a lease (“Lease”) with BPFourth Avenue, L.L.C. (the “Landlord”) to secure office space for our futurecorporate headquarters at 77 Fourth Avenue, Waltham, Massachusetts. Theestimated commencement date for occupancy under the Lease is December 2008.The Lease for our current corporate headquarters at 880 Winter Street inWaltham is due to expire in February 2009.

 

The Lease provides for therental of 165,129 rentable square feet of space and has an initial term of 10years and three months. We can, subject to certain conditions, extend this termby exercising up to two consecutive five year options. We are not required topay any rent for the first three months of the initial Lease term.  Thereafter, the annual rent on the Lease foryears one through five will be $6.6 million, or approximately $548,000 permonth.  For years six through ten, theannual rent will be $7.2 million, or approximately $603,000 per month.  The total base rent payable in the initialterm is $69.1 million.

 

As of December 31, 2007, we had aworking capital line of credit with a bank under which we could borrow up to$2,000, of which $1,500 was available and $500 reserved under a letter ofcredit associated with our leased facility. The line of credit expired on March 31,2008, and was not renewed.  As of March 31,2008, the $500 collateral obligation for our leased facility was secured by acertificate of deposit.

 

In connection with the signing of a lease on February 13,2008 to secure office space for our future corporate headquarters at 77 FourthAvenue, Waltham, Massachusetts, we deposited with the Landlord anunconditional, irrevocable letter of credit in the Landlord’s favor in theamount of $962, secured by a certificate of deposit.

 

At December 31, 2007, we had $54.8 million of netoperating loss carryforwards that may be used to offset future U.S. federaltaxable income.  These attributes mayreduce our future cash tax liability.  Inaddition, we had $15.6 million of net operating losses resulting from excesstax deductions related to stock-based compensation expense.  We will realize the benefit of these excesstax deductions through increases to stockholders’ equity in the periods inwhich the losses are utilized to reduce tax payments.  In addition, we had $1.7 million of federalresearch and development tax credit carryforwards that may be utilized tooffset future U.S. taxes.  The netoperating loss and tax credit carryforward periods extend through 2026 and2027, respectively.  In addition, we had$3.6 million of foreign net operating loss carryforwards that may be used tooffset future foreign taxable income. These foreign net operating losscarryforwards have an unlimited carryforward period. We also had $3.1 millionof research and development tax credit carryforwards that may be utilized tooffset future Massachusetts state taxable income.  The Massachusetts tax credit carryforwardperiod extends through 2022.  The federaland state net operating loss carryforwards and research and development taxcredits are subject to review and possible adjustment by the taxingauthorities.  Also, the Internal RevenueCode contains provisions that may limit the net operating loss and tax creditcarryforwards available in any given year in the event of certain changes inthe ownership interests of significant stockholders.  

 

We currently expect to realize the benefit of recordeddeferred tax assets as of March 31, 2008 of $24.8 million.  Our conclusion that such assets will berecovered is based upon our expectation that our future earnings combined withtax planning strategies available to us will provide sufficient taxable incometo realize recorded tax assets.

 

We may be required to make cash outlays related to ourunrecognized tax benefits.  However, dueto the uncertainty of the timing of future cash flows associated with ourunrecognized tax benefits, we are unable to make reasonably reliable estimatesof the period of cash settlement, if any, with the respective taxingauthorities.  Accordingly, unrecognizedtax benefits of $1.2 million as of December 31, 2007 have been excludedfrom the contractual obligations table above. For further information on unrecognized tax benefits, see Note 7 in thenotes to our 2007 consolidated financial statements included in our AnnualReport on Form 10-K for the year ended December 31, 2007 filed withthe SEC.

 

We believe our existing cash, cash equivalents, short-term investmentsand cash provided by operating activities will be sufficient to meet ourworking capital and capital expenditure needs over at least the next12 months. Our future capital requirements will depend on many factors,including our rate of revenue growth, the expansion of our marketing and salesactivities, the timing and extent of spending to support product developmentefforts, the timing of introductions of new products and services andenhancements to existing products and services and the continuing marketacceptance of our products and services. From time to time, we may also enter into agreements with respect topotential investments in, or acquisitions of, businesses, services ortechnologies, which could 

 

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also require us to seek additional equity or debt financing.  To the extent that existing cash andsecurities and cash from operations are insufficient to fund our futureactivities, we may need to raise additional funds through public or privateequity or debt financing.

 

Included within ourinvestment portfolio at March 31, 2008, were $24.1 million of auction ratesecurities (“ARS”) totaling at par value, which are classified asavailable-for-sale securities and noncurrent assets on our condensedconsolidated balance sheets, and recorded at fair market value. These ARS aredebt instruments issued by various states throughout the United States tofinance student loans.  The types of ARSthat we own are backed by student loans, 95% of which are guaranteed under theFederal Family Education Loan Program, and all have credit ratings of AAA (orequivalent) from a recognized rating agency. Historically, the carrying value of ARS approximated fair value due tothe frequent resetting of the interest rates. With the liquidity issuesexperienced in the global credit and capital markets, our ARS have experiencedmultiple failed auctions. While we continue to earn and receive interest onthese investments at the maximum contractual rate, the estimated fair value ofthese ARS no longer approximates par value.

 

We concluded that the fair value of these ARS at March 31, 2008was $22.9 million, a decline of $1.1 million from par value. Fair value wasdetermined using a discounted cash flow model as recent auctions of thesesecurities were not successful, resulting in our continuing to hold thesesecurities and issuers paying interest at the maximum contractual rate.  This valuation technique considers thecomplexity and transparency of the structure of each ARS and cash flows withineach structure; the quality of the collateral; and liquidity determinantsaffecting each ARS.  The decline in fairvalue is deemed temporary as we believe the decline in fair value of theseinvestments is due to current market conditions as well as the fact that wehave the ability and intent to hold these securities until market conditionsimprove. Accordingly, we recorded an unrealized loss on these securities of$1.1 million in other comprehensive income. Depending on future market conditions, the ARS may result in future fairvalue adjustments.   If in the future wedetermine that any decline in value of the ARS is other-than-temporary, wewould be required to recognize the loss in its statement of income, which couldhave a material impact on our operating results in the period it is recognized.

 

Webelieve that, based on our cash equivalents and short term marketablesecurities balances of $175.8 million at March 31, 2008, excluding fairmarket value of ARS of $22.9 million, the current lack of liquidity in thecredit and capital markets will not have a material impact on our liquidity,cash flow or the ability to fund our operations.

 

**Recently Issued Accounting Pronouncements**

 

In December 2007, the FASB issued SFAS No. 141 (Revised2007), *Business Combinations.*SFAS No. 141(R) retains the fundamental requirements in SFAS No. 141that the acquisition method of accounting (which SFAS No. 141 called the “purchasemethod”) be used for all business combinations and for an acquirer to beidentified for each business combination. SFAS No. 141(R) requiresan acquirer to recognize the assets acquired, the liabilities assumed, and anynoncontrolling interest in the acquiree at the acquisition date, measured attheir fair values as of that date, with limited exceptions specified in SFAS No. 141(R).This approach replaces SFAS No. 141’s cost-allocation process, whichrequired the cost of an acquisition to be allocated to the individual assetsacquired and liabilities assumed based on their estimated fair values. SFAS No. 141(R) retainsthe guidance in SFAS No. 141 for identifying and recognizing intangibleassets separately from goodwill. SFAS No. 141(R) will now requireacquisition costs to be expensed as incurred, restructuring costs associatedwith a business combination must generally be expensed prior to the acquisitiondate and changes in deferred tax asset valuation allowances and income taxuncertainties after the acquisition date generally will affect income taxexpense. SFAS No. 141(R) applies prospectively to businesscombinations for which the acquisition date is on or after the beginning of thefirst annual reporting period beginning on or after December 15, 2008,which is our 2009 fiscal year. Earlier adoption is prohibited.

 

In March 2008, the FASB issued SFAS No. 161,*Disclosures about Derivative Instruments and HedgingActivities an amendment of FASB Statement No. 133.*  SFAS No. 161 requires disclosures of howand why an entity uses derivative instruments, how derivative instruments andrelated hedged items are accounted for and how derivative instruments andrelated hedged items affect an entity’s financial position, financialperformance, and cash flows. SFAS No. 161 is effective for fiscal yearsbeginning after November 15, 2008, with early adoption permitted. Theadoption of SFAS No. 161 is not expected to have a material effect on ourconsolidated financial position and results of operations.

 

**Off-Balance Sheet Arrangements**

 

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

 

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**SpecialNote Regarding Forward-Looking Statements**

 

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

 

We maynot actually achieve the plans, intentions or expectations disclosed in ourforward-looking statements and you should not place undue reliance on ourforward-looking statements. We have based these forward-looking statements onour current expectations and projections about future events. Although webelieve that the expectations underlying any of our forward-looking statementsare reasonable, these expectations may prove to be incorrect, and all of thesestatements are subject to risks and uncertainties. We discuss many of the risksthat we believe could cause actual results or events to differ materially fromthese forward-looking statements in greater detail in the section entitled “RiskFactors” in **ourAnnual**Report on**Form 10-Kfor the year ended December 31, 2007. **We urge you to considerthe risks and uncertainties described in Item 1A of our Annual**Reporton**Form 10-K for the year ended December 31,2007**in evaluating ourforward-looking statements.**Should one or more of theserisks and uncertainties materialize, or should underlying assumptions,projections or expectations prove incorrect, actual results, performance orfinancial condition may vary materially and adversely from those anticipated,estimated or expected. Our forward-looking statements do not reflect thepotential impact of any future acquisitions, mergers, dispositions, jointventures or investments we may make.

 

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

 

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

 

*ForeignCurrency Exchange Risk*

 

Our results of operationsand cash flows are subject to fluctuations due to changes in foreign currencyexchange rates, particularly changes in the euro, British pound, Australiandollar and Japanese yen. During the three months ended March 31, 2007 and2008, 50% and 47%, respectively, of our revenues were generated in locationsoutside the United States. The majority of these revenues are denominated incurrencies other than the U.S. dollar, as are many of the associated expenses.Except for revenue transactions in Japan, we enter into transactions directlywith substantially all of our foreign customers. This creates a foreigncurrency exchange risk for us.

 

As of March 31,2008, we had $11.3 million of receivables denominated in currencies other thanthe U.S. dollar.  We also maintain cashaccounts denominated in currencies other that the local currency which exposesus to foreign exchange rate movements.

 

In addition,although our foreign subsidiaries have intercompany accounts that eliminateupon consolidation, such accounts expose us to foreign currency rate movements.Exchange rate fluctuations on short-term intercompany accounts are recorded inour consolidated statements of operations under “other income (expense)”, whileexchange rate fluctuations on long-term intercompany accounts are recorded inour consolidated balance sheets under “accumulated other comprehensive loss” instockholders’ equity, as they are considered part of our net investment andhence do not give rise to gains or losses.

 

Wehave implemented a risk management program under which we measure foreigncurrency exchange risk monthly and manage those exposures through the use ofvarious operating strategies.  Weregularly hedge our non-U.S. dollar-based exposures by entering into short-termforward foreign exchange contracts. This process is designed to minimizeforeign currency translation exposures that could otherwise affect consolidatedresults of operations. The terms of these contracts are for periods generallyfor one month. The short-term nature of these contracts has resulted in theseinstruments having insignificant fair values at March 31, 2008.

 

Currently, our largest foreign currency exposure is theeuro.  Relative to foreign currencyexposures existing at December 31, 2006 and 2007, a 10% unfavorablemovement in foreign currency exchange rates would not expose us to significantlosses in earnings or cash flows or significantly diminish the fair value ofour foreign currency financial instruments. This is primarily due to the shortlives of the affected financial instruments that effectively hedgesubstantially all of our year-end exposures against fluctuations in foreigncurrency exchange rates. The calculation assumes that each exchange rate wouldchange in the same direction relative to the U.S. dollar.

 

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Asof March 31, 2008, we entered into forward foreign exchange contracts tohedge approximately $3.0 million of receivables, intercompany accounts and cashbalances denominated in currencies other than the U.S. dollar.

 

*InterestRate Sensitivity*

 

We had cash, cashequivalents, short and long-term investments totaling $199.3 million at March 31,2008.  Investments in securities areinvested primarily in high quality securities of a short duration and are notmaterially affected by fluctuations in interest rates. The cash and cashequivalents are held for working capital purposes. We do not enter intoinvestments for trading or speculative purposes. Due to the short-term natureof these investments, we believe that we do not have any material exposure tochanges in the fair value of our investment portfolio as a result of changes ininterest rates. Declines in interest rates, however, would reduce futureinvestment income.

 

As of March 31,2008, we held auction rate securities (“ARS”) totaling $24.1 million at parvalue, which are classified as available-for-sale securities and noncurrentassets on our condensed consolidated balance sheets, and recorded at fairvalue. These ARS are debt instruments issued by various states throughout theUnited States to finance student loans. The types of ARS that we own are backed by student loans, 95% of whichare guaranteed under the Federal Family Education Loan Program, and all havecredit ratings of AAA (or equivalent) from a recognized rating agency.  Historically, the carrying value of ARSapproximated fair value due to the frequent resetting of the interest rates.With the liquidity issues experienced in the global credit and capital markets,our ARS have experienced multiple failed auctions. While we continue to earnand receive interest on these investments at the maximum contractual rate, theestimated fair value of these ARS no longer approximates par value.

 

We concluded that the fair value of these ARS at March 31, 2008was $22.9 million, a decline of $1.1 million from par value. Fair value wasdetermined using a trinomial discount model as recent auctions of thesesecurities were not successful, resulting in us continuing to hold thesesecurities and issuers paying interest at the estimated maximum contractualrate.  This valuation technique considersthe complexity and transparency of the structure of each ARS and cash flowswithin each structure; the quality of the collateral; and liquiditydeterminants affecting each ARS.  Thedecline in fair value is deemed temporary as we believe the decline in fairvalue of these investments is due to general market conditions. Accordingly, wehave recorded a temporary impairment on these securities of $1.1 million inother comprehensive income.  Depending onfuture market conditions, the ARS may result in future fair market valueadjustments.   If in the future wedetermine that any decline in value of the ARS is other-than-temporary, wewould be required to recognize the loss in our statement of income, which couldhave a material impact on our operating results in the period it is recognized.

 

Webelieve that, based on our cash, cash equivalents and short term marketablesecurities balances of $175.8 million at March 31, 2008, excluding fairmarket value of ARS of $22.9 million, the current lack of liquidity in thecredit and capital markets will not have a material impact on our liquidity,cash flow or our ability to fund our operations.

 

**Item4.**                          *Controls and Procedures*

** **

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

 

Asof March 31, 2008, we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934. Based upon thatevaluation, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures are effective at that reasonableassurance level in (i) enabling us to record, process, summarize andreport information required to be included in our periodic SEC filings withinthe required time period and (ii) ensuring that information required to bedisclosed in the reports that we file or submit under the Securities ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officers and Chief Financial Officer, to allow timely decisionsregarding required disclosure.

 

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

 

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**Part II—OtherInformation**

** **

**Item 1.****                             *****LegalProceedings***

 

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

 

**Item 1A.****                    *****RiskFactors***

 

**Certain Factors Which May AffectFuture Results**

** **

*We operate in a rapidly changing environment thatinvolves a number of risks, some of which are beyond our control.  Therisks and uncertainties that we believe are most important for you to considerare described under the title “Risk Factors” in our Annual Report on Form 10-Kfor the year ended December 31, 2007.  There are no material changesto the risk factors described in the “Risk Factors” section in our AnnualReport on Form 10-K for the year ended December 31, 2007.  Additional risks and uncertainties notpresently known to us, which we currently deem immaterial or which are similarto those faced by other companies in our industry or business in general, mayalso impair our business operations.  If any of the foregoing risks oruncertainties actually occurs, our business, financial condition and operatingresults would likely suffer.*

* *

**Item 5.****                             *****OtherInformation***

 

Our policy governingtransactions in our securities by directors, officers and employees permits ourofficers, directors and certain other persons to enter into trading planscomplying with Rule 10b5-1 under the Securities Exchange Act of 1934, asamended. We have been advised that our Senior Vice President and GeneralCounsel, D. Ari Buchler; our Vice President of Quality and RegulatoryCompliance, Michael Owings; our Senior Vice President, Worldwide Sales, StephenJ. Powell; and our Senior Vice President and Chief Financial Officer, RodgerWeismann****have each entered into a trading plancovering periods after the date of this Quarterly Report in accordance with Rule 10b5-1and our policy governing transactions in our securities.  Generally, under these trading plans, 

the individual relinquishes control over the transactions once thetrading plan is put into place. Accordingly, sales under these plans may occur at any time, includingpossibly before, simultaneously with, or immediately after significant eventsinvolving our company.

 

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

 

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**Item 6.            Exhibits.**

 
| **Exhibit** |       |       |                                                                                                                                                                                                                                                                                                         |
|-------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                              |
| 10.1        |       | +          | Phase Forward 2008  Management Incentive Compensation Plan (Incorporated by reference herein to  Exhibit 10.13 to the Company’s Annual Report on Form 10-K filed  with the SEC on March 17, 2008).                                                                                       |
| 10.2        |       | +          | Phase Forward 2008  Global Sales Executive Incentive Compensation Plan (Incorporated by reference  herein to Exhibit 10.14 to the Company’s Annual Report on Form 10-K  filed with the SEC on March 17, 2008).                                                                           |
| 10.3        |       | +          | Form of Executive  Agreement between the Registrant and its officers, as amended June 6,  2006 and restated on February 28, 2008. (Incorporated by reference  herein to Exhibit 10.18 to the Company’s Annual Report on Form 10-K  filed with the SEC on March 17, 2008). |
| 10.4        |       |       | Lease dated  February 13, 2008 between Phase Forward Incorporated and BP Fourth  Avenue, L.L.C. (Incorporated by reference herein to Exhibit 10.1 to the  Company’s Current Report on Form 8-K filed with the SEC on  February 19, 2008).                                           |
| 31.1        |       | *          | Certification of CEO  pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                                                                                                                    |
| 31.2        |       | *          | Certification of CFO pursuant  to rules 13a-14(a) and 15d-14(a) under the Securities Exchange  Act of 1934.                                                                                                                                                                                   |
| 32.1        |       | *          | Certification of CEO  pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                |
| 32.2        |       | *          | Certification of CFO  pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                |

 

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+     Indicates a management contract or any compensatory plan, contract orarrangement.

*     Filed herewith.

 

33

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** **

**Signatures**

** **

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

 

 
|                          | **PHASE  FORWARD INCORPORATED** |
|--------------------------|---------------------------------|
| ** **               | ** **                      |
|                     | By:                             | /s/ ROBERT  K. WEILER |
|                     |                            | Robert  K. Weiler |
|                     |                            | *Chief  Executive Officer* |
|                     |                            | *(Duly  authorized officer)* |
|                     |                            | * * |
|                     | By:                             | /s/ RODGER  WEISMANN |
|                     |                            | Rodger  Weismann * * |
|                     |                            | *Chief  Financial Officer* |
|                     |                            | *(Duly  authorized officer and* |
|                     |                            | *principal  financial officer)* |
|                     |                            | * * |
| Date:  May 12, 2008 |                            | * * |

 

34

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**EXHIBIT INDEX**

 
| **Exhibit** |       |       |                                                                                                                                                                                                                                                                                                         |
|-------------|------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                              |
| 10.1        |       | +          | Phase Forward 2008  Management Incentive Compensation Plan (Incorporated by reference herein to  Exhibit 10.13 to the Company’s Annual Report on Form 10-K filed  with the SEC on March 17, 2008).                                                                                       |
| 10.2        |       | +          | Phase Forward 2008  Global Sales Executive Incentive Compensation Plan (Incorporated by reference  herein to Exhibit 10.14 to the Company’s Annual Report on Form 10-K  filed with the SEC on March 17, 2008).                                                                           |
| 10.3        |       | +          | Form of Executive  Agreement between the Registrant and its officers, as amended June 6,  2006 and restated on February 28, 2008. (Incorporated by reference  herein to Exhibit 10.18 to the Company’s Annual Report on Form 10-K  filed with the SEC on March 17, 2008). |
| 10.4        |       |       | Lease dated  February 13, 2008 between Phase Forward Incorporated and BP Fourth  Avenue, L.L.C. (Incorporated by reference herein to Exhibit 10.1 to the  Company’s Current Report on Form 8-K filed with the SEC on February 19,  2008).                                           |
| 31.1        |       | *          | Certification of CEO  pursuant to Rule 13a-14(a) and 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                                                                                                                    |
| 31.2        |       | *          | Certification of CFO  pursuant to rules 13a-14(a) and 15d-14(a) under the Securities  Exchange Act of 1934.                                                                                                                                                                                   |
| 32.1        |       | *          | Certification of CEO  pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                |
| 32.2        |       | *          | Certification of CFO  pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002.                                                                                                                                                                                |

 

----

+     Indicates a management contract or any compensatory plan, contract orarrangement.

*     Filed herewith.

 

35

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