**Table of Contents**

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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

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

** **

**For the quarterly period ended September 30, 2008**

** **

**OR**

** **

**o****                                ****TRANSITION REPORT PURSUANTTO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

** **

**For thetransition period from                                 to                                **

 

**CommissionFile Number: 000-50839**

 

**PhaseForward Incorporated**

(Exact name ofregistrant as 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’stelephone number, 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 preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 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 the definitions of “large acceleratedfiler”, “accelerated filer”, and “smaller reporting company” in Rule 12b-2of the Exchange Act.  (Check one):

 

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

 

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 November 03,2008, the registrant had 42,886,565 shares of common stock outstanding.

 

 

 

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Table of Contents

 

**PHASEFORWARD INCORPORATEDQUARTERLY REPORT ON FORM 10-QFor the quarterly period ended September 30, 2008Table of Contents**

 
|                                            | **Page  Number**                                                                                                                                              |
|--------------------------------------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Part I—Financial Information** | 3                                                                                                                                                             |
|                                       |                                                                                                                                                          |
| Item  1.                                   | Condensed  Consolidated Balance Sheets as of December 31, 2007 (unaudited) and  September 30, 2008 (unaudited)                                      | 3 |
|                                       |                                                                                                                                                          |   |
|                                       | Condensed Consolidated Statements of Income for the  three and nine months ended September 30, 2007 (unaudited) and  September 30, 2008 (unaudited) | 4 |
|                                       |                                                                                                                                                          |   |
|                                       | Condensed Consolidated Statements of Cash Flows for  the nine months ended September 30, 2007 (unaudited) and  September 30, 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                                                                   | 20 |
|                                       |                                                                                                                                                          |   |
| Item 3.                                    | Quantitative  and Qualitative Disclosures about Market Risk                                                                                                   | 39 |
|                                       |                                                                                                                                                          |   |
| Item 4.                                    | Controls and Procedures                                                                                                                                       | 40 |
|                                       |                                                                                                                                                          |   |
| **Part II—Other  Information**   | 41                                                                                                                                                            |
|                                       |                                                                                                                                                          |   |
| Item 1.                                    | Legal Proceedings                                                                                                                                             | 41 |
|                                       |                                                                                                                                                          |   |
| Item  1A.                                  | Risk  Factors                                                                                                                                                 | 41 |
|                                       |                                                                                                                                                          |   |
| Item 2.                                    | Unregistered  Sale of Equity Securities and Use of Proceeds                                                                                                   | 43 |
|                                       |                                                                                                                                                          |   |
| Item 5.                                    | Other Information                                                                                                                                             | 43 |
|                                       |                                                                                                                                                          |   |
| Item  6.                                   | Exhibits                                                                                                                                                      | 44 |
|                                       |                                                                                                                                                          |
| Signatures                                 | 45                                                                                                                                                            |
|                                       |                                                                                                                                                          |
| Exhibit Index                         | 46                                                                                                                                                            |

 

2

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Tableof Contents

 

**Part I—Financial Information**

 

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

 

**Phase Forward Incorporated****Condensed Consolidated Balance Sheets****(unaudited)****(in thousands, except per share amounts)**

 
| ** **                                                                                               | ** ** | **As of December 31,** | ** ** | **As of September 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                               | ** ** | **2007**                              | ** ** | **2008**                               | ** ** |
| **Assets**                                                                                               | ** ** | ** **                            | ** ** | ** **                             | ** ** |
| Current assets:                                                                                          |       |                                  |       |                                   |       |
| Cash and cash  equivalents                                                                               |       | $                                     | 133,401    |                                   | $          | 134,401 |   |
| Restricted cash,  current portion                                                                        |       | —                                |       | 500                                    |       |
| Short-term  investments                                                                                  |       | 25,171                                |       | 20,924                                 |       |
| Accounts  receivable, net of allowance of $270 and $324 in 2007 and 2008, respectively                   |       | 35,515                                |       | 34,551                                 |       |
| Acquired future  billings, current portion                                                               |       | —                                |       | 1,170                                  |       |
| Deferred set up  costs, current portion                                                                  |       | 2,062                                 |       | 2,501                                  |       |
| Prepaid  commissions and royalties, current portion                                                      |       | 4,458                                 |       | 4,336                                  |       |
| Prepaid expenses  and other current assets                                                               |       | 4,513                                 |       | 6,266                                  |       |
| Deferred income  taxes, current portion                                                                  |       | 10,061                                |       | 11,058                                 |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Total current  assets                                                                                    |       | 215,181                               |       | 215,707                                |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Long-term  investments                                                                                   |       | 24,050                                |       | 22,795                                 |       |
| Acquired future  billings, net of current portion                                                        |       | —                                |       | 1,081                                  |       |
| Property and  equipment, net                                                                             |       | 15,967                                |       | 26,979                                 |       |
| Deferred set up  costs, net of current portion                                                           |       | 1,347                                 |       | 1,964                                  |       |
| Prepaid commissions  and royalties, net of current portion                                               |       | 3,614                                 |       | 4,032                                  |       |
| Intangible  assets, net of accumulated amortization of $2,044 and $3,119 in 2007 and  2008, respectively |       | 3,356                                 |       | 24,391                                 |       |
| Goodwill                                                                                                 |       | 25,511                                |       | 43,198                                 |       |
| Deferred income  taxes, net of current portion                                                           |       | 16,576                                |       | 10,382                                 |       |
| Restricted cash,  net of current portion                                                                 |       | —                                |       | 962                                    |       |
| Other assets                                                                                             |       | 267                                   |       | 549                                    |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Total assets                                                                                             |       | $                                     | 305,869    |                                   | $          | 352,040 |   |
|                                                                                                     |       |                                  |       |                                   |       |
| **Liabilities  and Stockholders’ Equity**                                                           | ** ** | ** **                            | ** ** | ** **                             | ** ** |
| Current  liabilities:                                                                                    |       |                                  |       |                                   |       |
| Accounts payable                                                                                         |       | $                                     | 1,222      |                                   | $          | 5,249 |   |
| Accrued expenses                                                                                         |       | 19,447                                |       | 20,056                                 |       |
| Deferred rent,  current portion                                                                          |       | 240                                   |       | —                                 |       |
| Leasehold  incentive obligation, current portion                                                         |       | —                                |       | 510                                    |       |
| Deferred  revenues, current portion                                                                      |       | 61,750                                |       | 76,984                                 |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Total current  liabilities                                                                               |       | 82,659                                |       | 102,799                                |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Deferred rent,  net of current portion                                                                   |       | 116                                   |       | —                                 |       |
| Leasehold  incentive obligation, net of current portion                                                  |       | —                                |       | 5,615                                  |       |
| Deferred  revenues, net of current portion                                                               |       | 5,380                                 |       | 9,541                                  |       |
| Other long-term  liabilities                                                                             |       | 1,277                                 |       | 1,336                                  |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Total  liabilities                                                                                       |       | 89,432                                |       | 119,291                                |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Commitments and  contingencies (Note 12)                                                                 |       |                                  |       |                                   |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Stockholders’  equity:                                                                              |       |                                  |       |                                   |       |
| Preferred stock,  $0.01 par value:                                                                       |       |                                  |       |                                   |       |
| Authorized—5,000  shares                                                                            |       |                                  |       |                                   |       |
| Issued—0 shares                                                                                     |       | —                                |       | —                                 |       |
| Common stock,  $0.01 par value:                                                                          |       |                                  |       |                                   |       |
| Authorized—100,000  shares                                                                          |       |                                  |       |                                   |       |
| Issued—42,724  and 42,902 shares in 2007 and 2008, respectively                                     |       | 428                                   |       | 429                                    |       |
| Additional  paid-in capital                                                                              |       | 274,869                               |       | 281,447                                |       |
| Treasury stock,  37 shares at cost                                                                       |       | (111                                  | )          | (111                                   | )          |
| Accumulated  other comprehensive (loss) income                                                           |       | 746                                   |       | (658                                   | )          |
| Accumulated  deficit                                                                                     |       | (59,495                               | )          | (48,358                                | )          |
|                                                                                                     |       |                                  |       |                                   |       |
| Total  stockholders’ equity                                                                         |       | 216,437                               |       | 232,749                                |       |
|                                                                                                     |       |                                  |       |                                   |       |
| Total  liabilities and stockholders’ equity                                                         |       | $                                     | 305,869    |                                   | $          | 352,040 |   |

 

See accompanying notes.

 

3

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Table of Contents

 

**PhaseForward Incorporated****Condensed Consolidated Statements of Income****(unaudited)****(in thousands, except per share amounts)**

 
| ** **                                                                           | ** ** | **Three Months Ended  September 30****,** | ** ** | **Nine Months Ended  September 30****,** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                           | ** ** | **2007**                                                 | ** ** | **2008**                                                | ** ** | **2007** | ** ** | **2008** | ** ** |
| Revenues:                                                                            | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| License                                                                              |       | $                                                        | 12,924     |                                                    | $          | 12,974 |   | $ | 35,429 |   | $ | 38,675 |   |
| Service                                                                              |       | 21,952                                                   |       | 30,017                                                  |       | 61,065 |   | 83,187 |   |
| ** **                                                                           | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total revenues                                                                       |       | 34,876                                                   |       | 42,991                                                  |       | 96,494 |   | 121,862 |   |
| Costs of  revenues:                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| License                                                                              |       | 552                                                      |       | 838                                                     |       | 1,686 |   | 2,119 |   |
| Service(1)                                                                           |       | 13,561                                                   |       | 17,686                                                  |       | 37,447 |   | 50,405 |   |
| ** **                                                                           | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total cost of  revenues                                                              |       | 14,113                                                   |       | 18,524                                                  |       | 39,133 |   | 52,524 |   |
| Gross margin:                                                                        |       |                                                     |       |                                                    |       |   |   |   |   |
| License                                                                              |       | 12,372                                                   |       | 12,136                                                  |       | 33,743 |   | 36,556 |   |
| Service                                                                              |       | 8,391                                                    |       | 12,331                                                  |       | 23,618 |   | 32,782 |   |
| ** **                                                                           | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total gross  margin                                                                  |       | 20,763                                                   |       | 24,467                                                  |       | 57,361 |   | 69,338 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Operating  expenses:                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Sales and  marketing(1)                                                              |       | 6,509                                                    |       | 7,024                                                   |       | 17,731 |   | 19,958 |   |
| Research and  development(1)                                                         |       | 5,066                                                    |       | 6,424                                                   |       | 14,620 |   | 18,003 |   |
| General and  administrative(1)                                                       |       | 5,084                                                    |       | 6,629                                                   |       | 14,509 |   | 18,374 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Total operating  expenses                                                            |       | 16,659                                                   |       | 20,077                                                  |       | 46,860 |   | 56,335 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Income from  operations                                                              |       | 4,104                                                    |       | 4,390                                                   |       | 10,501 |   | 13,003 |   |
| Other income  (expense):                                                             |       |                                                     |       |                                                    |       |   |   |   |   |
| Interest income                                                                      |       | 2,362                                                    |       | 1,483                                                   |       | 4,758 |   | 4,770 |   |
| Other expense                                                                        |       | (91                                                      | )          | (478                                                    | )          | (153 | ) | (229 | ) |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Total other  income                                                                  |       | 2,271                                                    |       | 1,005                                                   |       | 4,605 |   | 4,541 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Income before  provision for income taxes                                            |       | 6,375                                                    |       | 5,395                                                   |       | 15,106 |   | 17,544 |   |
| Provision for  income taxes                                                          |       | 657                                                      |       | 1,954                                                   |       | 1,579 |   | 6,407 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income                                                                           |       | $                                                        | 5,718      |                                                    | $          | 3,441 |   | $ | 13,527 |   | $ | 11,137 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Net income per  share applicable to common stockholders:                             | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic                                                                                |       | $                                                        | 0.14       |                                                    | $          | 0.08 |   | $ | 0.36 |   | $ | 0.27 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Diluted                                                                              |       | $                                                        | 0.13       |                                                    | $          | 0.08 |   | $ | 0.34 |   | $ | 0.25 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Weighted average  number of common shares used in net income per share calculations: |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic                                                                                |       | 41,238                                                   |       | 42,194                                                  |       | 37,643 |   | 42,020 |   |
|                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Diluted                                                                              |       | 43,397                                                   |       | 44,065                                                  |       | 39,659 |   | 43,879 |   |

 

----

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

 
| Costs of service  revenues  |   | $   | 102    |   | $      | 437   |   | $     | 330    |   | $ | 1,278 |   |
|-----------------------------|--------|-----|--------|--------|--------|-------|--------|-------|--------|--------|---|-------|--------|
| Sales and  marketing        |   | 201 |   | 393    |   | 570   |   | 1,075 |   |
| Research and  development   |   | 181 |   | 329    |   | 516   |   | 931   |   |
| General and  administrative |   | 652 |   | 1,133  |   | 1,917 |   | 2,746 |   |

 

See accompanying notes.

 

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**PhaseForward Incorporated****Condensed Consolidated Statements of Cash Flows****(unaudited)****(in thousands)**

 
| ** **                                                                              | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                              | ** ** | **2007**                                            | ** ** | **2008** | ** ** |
| **Operating  activities**                                                               | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Net income                                                                              |       | $                                                   | 13,527     |   | $ | 11,137 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities:      |       |                                                |       |   |   |
| Depreciation and  amortization                                                          |       | 4,930                                               |       | 7,149 |   |
| Stock-based  compensation expense                                                       |       | 3,333                                               |       | 6,030 |   |
| Loss on disposal  of fixed assets                                                       |       | —                                              |       | 303 |   |
| Foreign currency  exchange loss                                                         |       | 160                                                 |       | 444 |   |
| Provision for  allowance for doubtful accounts                                          |       | 75                                                  |       | 55 |   |
| Deferred income  taxes                                                                  |       | (4,554                                              | )          | 5,739 |   |
| Non-cash income  tax expense                                                            |       | 5,410                                               |       | — |   |
| Amortization of  premiums or discounts on investments                                   |       | 57                                                  |       | (178 | ) |
| Changes in  assets and liabilities:                                                     |       |                                                |       |   |   |
| Accounts  receivable and acquired future billings                                       |       | 2,012                                               |       | (502 | ) |
| Deferred costs                                                                          |       | (2,498                                              | )          | (1,524 | ) |
| Prepaid expenses  and other current assets                                              |       | (658                                                | )          | 864 |   |
| Accounts payable                                                                        |       | (437                                                | )          | 3,843 |   |
| Accrued expenses                                                                        |       | 3,337                                               |       | 396 |   |
| Deferred revenues                                                                       |       | 9,359                                               |       | 17,336 |   |
| Deferred rent                                                                           |       | (452                                                | )          | (386 | ) |
|                                                                                    |       |                                                |       |   |   |
| Net cash  provided by operating activities                                              |       | 33,601                                              |       | 50,706 |   |
|                                                                                    |       |                                                |       |   |   |
| **Investing  activities**                                                               | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Increase in  restricted cash                                                            |       | —                                              |       | (1,462 | ) |
| Proceeds from  maturities of short-term and long-term investments                       |       | 60,172                                              |       | 50,325 |   |
| Purchase of  short-term and long-term investments                                       |       | (62,594                                             | )          | (45,901 | ) |
| Purchase of  property and equipment                                                     |       | (7,706                                              | )          | (11,108 | ) |
| Cash paid for  acquisition of Clarix LLC, net of cash acquired (1)                      |       | —                                              |       | (40,869 | ) |
|                                                                                    |       |                                                |       |   |   |
| Net cash used in  investing activities                                                  |       | (10,128                                             | )          | (49,015 | ) |
|                                                                                    |       |                                                |       |   |   |
| **Financing  activities**                                                               | ** ** | ** **                                          | ** ** | ** ** | ** ** |
| Proceeds from  issuance of common stock                                                 |       | 91,369                                              |       | 1,795 |   |
| Withholding  taxes in connection with vesting of restricted stock awards                |       | —                                              |       | (1,247 | ) |
|                                                                                    |       |                                                |       |   |   |
| Net cash  provided by financing activities                                              |       | 91,369                                              |       | 548 |   |
|                                                                                    |       |                                                |       |   |   |
| Effect of  exchange rate changes on cash and cash equivalents                           |       | 123                                                 |       | (1,239 | ) |
|                                                                                    |       |                                                |       |   |   |
| Net change in  cash and cash equivalents                                                |       | 114,965                                             |       | 1,000 |   |
| Cash and cash  equivalents at beginning of period                                       |       | 42,169                                              |       | 133,401 |   |
|                                                                                    |       |                                                |       |   |   |
| Cash and cash  equivalents at end of period                                             |       | 157,134                                             |       | 134,401 |   |
| Short-term and  long-term investments at end of period                                  |       | 29,832                                              |       | 43,719 |   |
| Total cash, cash  equivalents and short-term and long-term investments at end of period |       | $                                                   | 186,966    |   | $ | 178,120 |   |
|                                                                                    |       |                                                |       |   |   |
| **Non-cash  investing activities**                                                      |       |                                                |       |   |   |
| Purchase of  leasehold improvements directly paid by lessor of new facility (Note 13)   |       | $                                                   | —     |   | $ | 6,125 |   |

 

----

| (1) Cash  paid for acquisition of Clarix LLC (Note 5) |   |   |   |   |   |
|------------------------------------------------------------|--------|--------|--------|--------|--------|
| Fair value of  assets acquired                             |   | $      | — |   | $      | 4,420 |   |
| Liabilities  assumed                                       |   | — |   | (3,030 | )      |
| Acquired  intangible assets                                |   | — |   | 22,110 |   |
| Cost in excess  of net assets acquired                     |   | — |   | 17,804 |   |
| Cash paid                                                  |   | — |   | 41,304 |   |
| Less cash  acquired                                        |   | — |   | (435   | )      |
| Cash paid for  acquisition                                 |   | $      | — |   | $      | 40,869 |   |

 

See accompanying notes.

 

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

 

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

 

The accompanyingunaudited condensed consolidated financial statements included herein have beenprepared by Phase Forward Incorporated (the “Company”) pursuant to the rules andregulations of the Securities and Exchange Commission (“SEC”). Certaininformation and footnote disclosures normally included in financial statementsprepared in accordance with generally accepted accounting principles in theUnited States have been condensed or omitted pursuant to such SEC rules andregulations. Management of the Company believes that the disclosures herein areadequate to make the information presented not misleading. In the opinion ofmanagement, the unaudited condensed consolidated financial statements have beenprepared on the same basis as the audited consolidated financial statements andreflect all material adjustments (consisting only of those of a normal andrecurring nature) which are necessary to present fairly the consolidatedfinancial position of the Company as of September 30, 2008, the results ofits operations for the three and nine months ended September 30, 2007 and2008 and its cash flows for the nine months ended September 30, 2007 and2008. These unaudited condensed consolidated financial statements and notesthereto should be read in conjunction with the audited consolidated financialstatements and notes thereto included in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007. The results of operations for theinterim periods are not necessarily indicative of the results of operations tobe expected for the year ending December 31, 2008.

 

As of September 30,2008, 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 19 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.

 

On September 5,2008, the Company acquired all of the outstanding membership interests ofClarix LLC (“Clarix”), a provider of web-integrated interactive responsetechnology (“IRT”) for clinical trial management.  Clarix’s web-integrated IRT is used forsubject randomization, predictive medication inventory management, andoperational management in reporting clinical trials**. **The results of Clarix have beenincluded in the Company’s consolidated financial statements since the date ofacquisition (see Note 5).

 

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

 

The Company derivesrevenues from software licenses and services. License revenues are derivedprincipally from the sale of term licenses for the Company’s software productsincluding: *InFormTM, ClintrialTM,**WebSDMTM*, *Empirica*TM*Trace*(formerly *Clintrace*TM), *Empirica Signal* (formerly *WebVDMETM*)and *CTSDTM*.  Service revenues are derivedprincipally from the Company’s delivery of the hosted solutions of its *InForm, Clarix,Empirica Signal*, *CTSD* and *WebSDM* software products, and consulting services and customer support,including training, for all of the Company’s products

 

The components ofrevenues are as follows:

 
| ** **                    | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                    | ** ** | **2007**                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
| License                       |       | $                                                    | 12,924     |                                                | $          | 12,974 |   | $ | 35,429 |   | $ | 38,675 |   |
| Application hosting  services |       | 14,906                                               |       | 23,553                                              |       | 40,370 |   | 63,974 |   |
| Consulting  services          |       | 3,475                                                |       | 3,488                                               |       | 9,999 |   | 9,703 |   |
| Customer support              |       | 3,571                                                |       | 2,976                                               |       | 10,696 |   | 9,510 |   |
|                          |       |                                                 |       |                                                |       |   |   |   |   |
| Total                         |       | $                                                    | 34,876     |                                                | $          | 42,991 |   | $ | 96,494 |   | $ | 121,862 |   |

 

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The Company recognizessoftware license revenues in accordance with Statement of Position (“SOP”) No. 97-2,*Software Revenue Recognition,* asamended, issued by the American Institute of Certified Public Accountants (“AICPA”),while revenues resulting from application hosting services are recognized inaccordance with Emerging Issues Task Force (“EITF”) Issue No. 00-3, *Application of AICPA Statement of Position 97-2 toArrangements that include the Right to Use Software Stored on Another Entity’sHardware*, SEC Staff Accounting Bulletin (“SAB”) No. 104, *Revenue Recognition* and EITF Issue No. 00-21,*RevenueArrangements with Multiple Deliverables.*

 

Customers generally havethe ability to terminate application hosting, consulting and training serviceagreements upon 30 days notice to the Company. License agreements,multiple element arrangements, including license and service agreements and certainapplication hosting services can generally be terminated by either party formaterial breach of obligations not corrected within 30 days after noticeof the breach.

 

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

 

The Company generally entersinto software term licenses for its *InForm*,*Clintrial* and *Empirica Trace*products with its customersfor 3- to 5-year periods. License agreements for other**productsare generally for annual or multi-year terms. These arrangements typically include multiple elements: softwarelicense, consulting services and customer support. The Company bills itscustomers in accordance with the terms of the underlying contract. Generally,the Company bills license fees annually in advance for each year of the licenseterm. 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 includestraining services, telephone support and software maintenance.  The Company generally bundles customersupport with the software license for the entire term of the arrangement. As aresult, the Company generally recognizes revenues for all elements, includingconsulting services, ratably over the term of the software license and supportarrangement. The Company allocates the revenues recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For its term-based licenses, the Companyallocates to consulting services the anticipated service effort and valuethroughout the term of the arrangement at an amount that would have beenallocated had those services been sold separately to the customer. The value ofthe Company’s consulting services sold within a bundled arrangement is equal tothe value of consulting services sold on a stand-alone basis, as the activitiesperformed under both types of arrangements are similar in nature.  The remaining value is allocated to licenseand support services, with 10% of this amount allocated to support services.The customer support services rate of 10% for multi-year term-based licensesreflects a significant discount from the rate for customer support servicesassociated with perpetual licenses due to the reduction in the time periodduring which the customer can utilize the upgrades and enhancements.  The Company believes this rate is substantiveand represents an amount it believes reasonable to be allocated.  The Company has allocated the estimated fairvalue to its multiple element arrangements to provide meaningful disclosuresabout each of its revenue streams. The costs associated with the consulting andcustomer support services are expensed as incurred. There are instances inwhich the Company sells software licenses based on usage levels. These softwarelicenses can be based on estimated usage, in which case the license fee chargedto the customer is fixed based on this estimate. When the fee is fixed, therevenues are generally recognized ratably over the contractual term of thearrangement. If the fee is based on actual usage, and therefore variable, therevenues are recognized in the period of use. Revenues from certain follow-onconsulting services, which are sold separately to customers with existingsoftware licenses and are not considered part of a multiple elementarrangement, are recognized as the services are performed.

 

The Company may sellincremental perpetual licenses for the *Clintrial* and *Empirica Trace* software products incertain situations to its existing customers with the option to purchasecustomer support. The Company has established vendor specific objective evidenceof fair value for the customer support. Accordingly, license revenues arerecognized upon delivery of the software and when all other revenue recognitioncriteria are met. Customer support revenues are recognized ratably over theterm of the underlying support arrangement. The Company generates customersupport and maintenance revenues from its perpetual license customer base.Training revenues are recognized as earned.

 

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In addition to making itssoftware products available to customers through licenses, the Company offersits *InForm*, *EmpiricaSignal*, *CTSD* and *WebSDM* software solutions through a hosted applicationsolution delivered through a standard web-browser.

 

Revenues resulting from *InForm *and *Clarix*applicationhosting services consist of three stages for each clinical trial: the firststage involves application set up, including design, implementation of thesystem and server configuration; the second stage involves application hostingand related support services; and the third stage involves services required toclose out, or lock, the database for the clinical trial. Services provided forthe first and third stages are provided on a fixed fee basis based upon thecomplexity of the trial and system requirements. Services for the second stageare charged separately as a fixed monthly fee. The Company recognizes revenuesfrom all stages of the *InForm *and *Clarix*hosting service ratably over the hosting period. Fees chargedand costs incurred for the trial system design, set up and implementation aredeferred until the start of the hosting period and are amortized and recognizedratably over the estimated hosting period. The deferred costs includeincremental direct costs with third parties and certain internal direct costsrelated to the trial and application set up, as defined under SFAS No. 91,*Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Indirect Costs of Leases*.These costs include salary and benefits associated with direct labor costsincurred during trial set up, as well as third-party subcontract fees and othercontract labor costs. Work performed outside the original scope of work iscontracted for separately as an additional fee and is generally recognizedratably over the remaining term of the hosting period. Fees for the first andthird stages of the service are billed based upon milestones. Fees forapplication hosting and related services in the second stage are generallybilled quarterly in advance. Bundled into this revenue element are revenuesattributable to the software license used by the customer.

 

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

 

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

 

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

 

One customer,GlaxoSmithKline, accounted for approximately 15% and 12% of the Company’s totalrevenues in the three months ended September 30, 2007 and 2008, and 16%and 12% of the Company’s total revenues in the nine months ended September 30,2007 and 2008, respectively.  The samecustomer accounted for $1,803 and $1,135, or 5% and 3%, of accounts receivableoutstanding as of December 31, 2007 and September 30, 2008,respectively.

 

The Company deferred $976and $1,318 of set up costs and amortized $670 and $858 of set up costs in thethree months ended September 30, 2007 and 2008, respectively, and deferred$2,650 and $3,597 of set up costs and amortized $1,835 and $2,541 of set upcosts in the nine months ended September 30, 2007 and 2008,respectively.  The amortization ofdeferred set up costs is a component of cost of services.

 

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, the Company has not experienced any materiallosses on uncompleted application hosting or consulting contracts.

 

In accordance with EITFIssue No. 01-14, *Income StatementCharacterization of Reimbursements Received for “Out-of-Pocket” ExpensesIncurred,* the Company included $229 and $304 of out-of-pocketexpenses in service revenues and cost of service revenues in the three monthsended September 30, 2007 and 2008, respectively, and included $526 and$647 of out-of-pocket

 

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expenses in servicerevenues and cost of service revenues in the nine months ended September 30,2007 and 2008, respectively.

 

**3.****    ****Prepaid Sales Commissions andRoyalties**

 

For arrangements whererevenues are recognized over the relevant contract period, the Company defersrelated commissions paid to its direct sales force and software licenseroyalties paid to third parties, and amortizes these expenses over the periodin 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 commissions paid are recoverable by the Company. TheCompany deferred $3,233 and $1,930 of commissions and amortized to sales andmarketing expense $2,306 and $2,358 in the three months ended September 30,2007 and 2008, respectively, and deferred $6,859 and $6,301 of commissions andamortized to sales and marketing expense $5,211 and $6,167 in the nine monthsended September 30, 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 $526and $605 of royalties and amortized to cost of revenues $617 and $672 in thethree months ended September 30, 2007 and 2008, respectively, and deferred$2,066 and $2,174 of royalties and amortized to cost of revenues $1,884 and$2,012 in the nine months ended September 30, 2007 and 2008, respectively.

 

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

 

The Company’s softwarelicense arrangements and hosting services are typically warranted to perform ina manner consistent with general industry standards that are reasonablyapplicable and substantially in accordance with the Company’s productdocumentation under normal use and circumstances. The Company’s arrangementsalso include certain provisions for indemnifying customers against liabilitiesif its products or services infringe a third party’s intellectual propertyrights.

 

The Company has enteredinto service level agreements with some of its hosted application customerswarranting certain levels of uptime reliability or other service levels andpermits those customers to receive credits against monthly hosting fees orterminate their agreements in the event that the Company fails to meet thoselevels.

 

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

 

**5.      Acquisitions**

 

*Green Mountain Logic*

 

On October 30, 2007, the Company acquired all of theoutstanding capital stock of Green Mountain Logic, Inc. (“Green Mountain”),a process automation software company that provides targeted solutions for thelife sciences industry, including *LabPas* Phase Iclinic automation software.  Theaggregate purchase price was $5,397, of which $3,943 has been recorded asgoodwill.  The company acquired thetechnology and products of Green Mountain which provides a solution targetedfor Phase I clinical trials.  Theacquisition of Green Mountain was accounted for as a purchase under SFAS No. 141,*Business Combinations*.  Accordingly, the results of Green Mountainhave been included in the consolidated financial statements since the date ofacquisition.

 

*Clarix*

 

On September 5, 2008, the Company acquired all of theoutstanding membership interests of Clarix LLC (“Clarix”), a provider ofweb-integrated interactive response technology (“IRT”) for clinical trialmanagement.  Clarix’s web-integrated IRTis used for subject randomization, predictive medication inventory management,and operational management in reporting clinical trials**. **The aggregate purchase price was$41,304 in cash, of which $17,804 has been recorded as goodwill.  The company acquired the technology ofClarix, which will allow the Company to penetrate the IRT market and extend itsElectronic Data Capture solution.  There were no earn-out provisions as aresult of the acquisition.  The acquisition of Clarix was accounted for as a 

 

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purchase under SFAS No. 141, *BusinessCombinations*.  Accordingly,the results of Clarix have been included in the consolidated financialstatements since the date of acquisition.

 

The components of the consideration are as follows:

 
| ** **                 | ** ** | **Amount** | ** ** |
|----------------------------|------------|------------|------------|
| Cash paid                  |       | $          | 40,000     |   |
| Transaction costs incurred |       | 1,304      |       |
| Total purchase price       |       | $          | 41,304     |   |

 

Due to the timing of the acquisition the Company hasnot finalized the purchase price allocation. The purchase price allocation, including an independent appraisal forcertain tangible and intangible assets, has been prepared on a preliminarybasis based on the information that was available to management at the time theconsolidated financial statements were prepared, and revisions to thepreliminary purchase price allocation are expected as additional informationbecomes available.

 

The following table summarizes the preliminaryallocation of the purchase price to the fair value of the assets acquired andliabilities assumed at the date of acquisition:

 
| ** **                                      | ** ** | ** ** | ** ** | **Amount** | ** ** |
|-------------------------------------------------|------------|------------|------------|------------|------------|
| Current assets                                  |       |       |       | $          | 3,071      |   |
| Property, plant and equipment                   |       |       |       | 227        |       |
| Intangible assets subject to amortization:      |       |       |       |       |       |
| Developed technology (five year useful life)    |       | $          | 12,360     |       |       |   |
| Customer base (five year useful life)           |       | 4,670      |       |       |       |
| Trade name (five year useful life)              |       | 4,110      |       |       |       |
| Non-compete agreements (three year useful life) |       | 310        |       |       |       |
| Customer backlog (five year useful life)        |       | 660        |       | 22,110     |       |
| Other assets, long-term                         |       |       |       | 1,122      |       |
| Goodwill                                        |       |       |       | 17,804     |       |
| Total assets acquired                           |       |       |       | 44,334     |       |
| Current liabilities                             |       |       |       | (1,142     | )          |
| Deferred revenue                                |       |       |       | (1,888     | )          |
| Net assets acquired                             |       |       |       | $          | 41,304     |   |
|                                                 |            |            |            |            |            |  |  |

 

The Company has notfurnished proforma financial information relating to the Clarix acquisitionbecause such information is not material to the Company’s financial results.

 

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

 

Basicand diluted net income per share is presented in conformity with SFAS No. 128,*Earnings Per Share*. Basic net income percommon share for all periods presented was determined by dividing net incomeapplicable to common stockholders by the weighted average number of commonshares outstanding during the period. Weighted average shares outstandingexclude unvested restricted common stock. Diluted net income per share includesthe effects of all dilutive, potentially issuable common shares using thetreasury stock method.

 

The calculation of basicand diluted net income per share is as follows:

 

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| ** **                                                            | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                            | ** ** | **2007**                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
| Numerator:                                                            |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                                            |       | $                                                    | 5,718      |                                                | $          | 3,441 |   | $ | 13,527 |   | $ | 11,137 |   |
|                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Denominator:                                                          |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average  common shares outstanding                           |       | 42,173,033                                           |       | 42,823,272                                          |       | 38,580,618 |   | 42,780,615 |   |
| Less  weighted-average unvested restricted common shares outstanding  |       | (934,561                                             | )          | (629,650                                            | )          | (937,702 | ) | (760,272 | ) |
| Basic  weighted-average common shares outstanding                     |       | 41,238,472                                           |       | 42,193,622                                          |       | 37,642,916 |   | 42,020,343 |   |
| Dilutive effect  of common stock options                              |       | 1,702,967                                            |       | 1,334,814                                           |       | 1,671,410 |   | 1,314,622 |   |
| Dilutive effect  of unvested restricted common stock awards and units |       | 455,142                                              |       | 536,779                                             |       | 344,514 |   | 544,115 |   |
| Diluted  weighted-average common shares outstanding                   |       | 43,396,581                                           |       | 44,065,215                                          |       | 39,658,840 |   | 43,879,080 |   |
|                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Net income per  share applicable to common stockholders:              |       |                                                 |       |                                                |       |   |   |   |   |
| Basic                                                                 |       | $                                                    | 0.14       |                                                | $          | 0.08 |   | $ | 0.36 |   | $ | 0.27 |   |
|                                                                  |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted                                                               |       | $                                                    | 0.13       |                                                | $          | 0.08 |   | $ | 0.34 |   | $ | 0.25 |   |

 

In the three months endedSeptember 30, 2008, diluted weighted-average common shares outstanding donot include options outstanding to purchase 13,252 common shares, respectively,as their effect would have been anti-dilutive. In the three months ended September 30,2007, there were no options outstanding which would have been anti-dilutive.

 

In the nine months ended September 30,2007 and 2008, diluted weighted-average common shares outstanding do notinclude options outstanding to purchase 3,734 and 310,299 common shares,respectively, as their effect would have been anti-dilutive.

 

**7.****    ****Foreign CurrencyTranslation**

 

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, Australia and Romania are the local currencies of thosecountries. Accordingly, the assets and liabilities of the Company’s foreignsubsidiaries are translated into U.S. dollars using the exchange rate in effectat each balance sheet date. Revenues and expense accounts are translatedgenerally using an average rate of exchange during the period. Gains and lossesarising from transactions denominated in foreign currencies are primarilyrelated to intercompany accounts that have been determined to be temporary innature and cash and accounts receivable denominated in non-functionalcurrencies.  The Company has recordedforeign currency losses of $98 and $459 in the three months ended September 30,2007 and 2008, respectively, and $160 and $444 in the nine months ended September 30,2007 and 2008, respectively.  Such lossesare included in other expense in the accompanying unaudited condensedconsolidated statements of income.  Fromtime to time, the Company purchases short-term foreign currency forwardcontracts designed to hedge fluctuation in the non-functional currencies of theCompany and its subsidiaries against the U.S. dollar (see Note 16).

 

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

 

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

 

The Company accounts forits investments in accordance with SFAS No. 115, *Accounting for Certain Investments in Debt and EquitySecurities*. Under SFAS No. 115, securities that the Company hasthe intent and ability to hold to maturity are reported at amortized cost,which approximates market value, and are classified as held-to-maturity, whilethose securities 

 

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for which it is not theCompany’s intent to hold to maturity are classified as available-for-sale securitiesand are reported at fair value, with unrealized gains and losses excluded fromearnings and reported as a separate component of stockholders’ equity. TheCompany considers all highly liquid investments with original maturities of90 days or less at the time of purchase to be cash equivalents andinvestments with original maturities of between 91 days and one year to beshort-term investments.  All securities, with the exception of auctionrate securities (“ARS”), are classified as held-to-maturity securities. The ARS are debt instruments issued by various states throughout the UnitedStates and are classified as available-for-sale because it is the Company’sintent not to hold them to maturity.

 

Cash, cash equivalents,short-term and long-term investments as of December 31, 2007 and September 30,2008 consist of the following:

 
| ** **                       | ** ** | **December 31, 2007** | ** ** |
|----------------------------------|------------|---------------------------------|------------|
| ** **                       | ** ** | **Contracted**                  | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per ** | ** ** |
| **Description**                  | ** ** | **Maturity**                    | ** ** | **Cost** | ** ** | **Value** | ** ** | **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 |   |
| 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 |   |

 

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(1)             These ARS were successfully liquidatedsubsequent to December 31, 2007, with no loss.

 
| ** **                       | ** ** | **September 30, 2008** | ** ** |
|----------------------------------|------------|----------------------------------|------------|
| **Description**                  | ** ** | **Contracted  Maturity**         | ** ** | **Amortized   Cost** | ** ** | **Fair Market**

**Value** | ** ** | **Balance Per  Balance Sheet** | ** ** |
| Cash                             |       | Demand                           |       | $ | 15,023 |   | $ | 15,023 |   | $ | 15,023 |   |
| Money market  funds              |       | Demand                           |       | 119,378 |   | 119,378 |   | 119,378 |   |
| Total cash and  cash equivalents |       |                             |       | $ | 134,401 |   | $ | 134,401 |   | $ | 134,401 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| U.S. agency  notes               |       | 3 days                           |       | $ | 1,000 |   | $ | 998 |   | $ | 1,000 |   |
| Municipal bonds                  |       | 92 days                          |       | 1,002 |   | 1,004 |   | 1,002 |   |
| Corporate bonds                  |       | 298 days                         |       | 18,922 |   | 18,457 |   | 18,922 |   |
| Total short-term  investments    |       |                             |       | $ | 20,924 |   | $ | 20,459 |   | $ | 20,924 |   |
|                             |       |                             |       |   |   |   |   |   |   |
| Auction rate  securities         |       | 34 years                         |       | $ | 24,050 |   | $ | 22,795 |   | $ | 22,795 |   |
| Total long-term  investments     |       |                             |       | $ | 24,050 |   | $ | 22,795 |   | $ | 22,795 |   |

 

The Company has had norealized gains or losses from the sale of cash equivalents or short-terminvestments.  The Company recorded anunrealized loss of $1,255 in connection with its ARS as further discussedbelow.

 

As of September 30,2008, 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.

 

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The Company concludedthat the fair value of these ARS at September 30, 2008 was $22,795, adecline of $1,255 from par value. Fair value was determined using a trinomialdiscount model as recent auctions of these securities were not successful,resulting in the Company continuing to hold these securities and issuers payinginterest 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 $1,255 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.

 

In October 2008, the Company received an offer (the “Offer”) from UBSAG (“UBS”).  As a UBS client who holdsARS, if the Company accepts the Offer it will receive certain rights which willentitle the Company to sell ARS to USB affiliates during the period from June 30,2010 to July 2, 2012 for a price equal to par value.  In exchange for the issuance of the ARSRights, the UBS affiliates will have the discretionary right to sell theCompany’s eligible ARS on the Company’s behalf, without prior notification, atany time before the expiration of the related ARS Right, so long as the Companyreceives par value for the sold ARS. The Offer is non-transferable and expireson November 14, 2008.  The Companyis currently evaluating the Offer and its potential financial statement impact.

 

Refer to Note 18 forfurther discussion on the accounting treatment for the ARS as well as adiscussion of the adoption of SFAS No. 157 and SFAS No. 159.

 

**9.****    ****Restricted Cash and Debt**

 

As of December 31, 2007, the Company had aworking capital line of credit with a bank under which the Company could borrowup to $2,000, of which $1,500 was available and $500 reserved under a letter ofcredit associated with the Company’s leased facility. The line of creditexpired on March 31, 2008, and was not renewed.  As of September 30, 2008, the $500collateral obligation for the Company’s leased facility was secured by acertificate of deposit.  The certificateof deposit has been classified as “Restricted cash, current portion” in theaccompanying condensed consolidated balance sheet.

 

Inconnection with the signing of a lease on February 13, 2008 to secureoffice space for the Company’s future corporate headquarters at 77 FourthAvenue, Waltham, Massachusetts, the Company deposited with the landlord anunconditional, irrevocable letter of credit in the landlord’s favor in theamount of $962, secured by a certificate of deposit.  The certificate of deposit has beenclassified as “Restricted cash, net of current portion” in the accompanyingcondensed consolidated balance sheet.

 

**10.**** ****Goodwill and IntangibleAssets**

 

Goodwill and intangibleassets that have indefinite lives are not amortized but are evaluated forimpairment annually or whenever events or changes in circumstances indicate thecarrying value may not be recoverable. Intangible assets that have finite livesare amortized over their useful lives.

 

The goodwill resultingfrom acquisitions is reviewed for impairment on an annual basis in accordancewith SFAS No. 142,*Goodwill andOther Intangible Assets.* Consistent with prior years, the Company conducted its annual impairmenttest of goodwill in the fourth quarter of 2007. Based on the results of the first step of the goodwill impairment test,the Company has determined that no impairment of goodwill existed at December 31,2007, as the carrying amount of goodwill of the reporting unit was less thanits fair value and therefore, the second step of the goodwill impairment testwas not necessary.

 

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

 
| ** **                                                                    | ** ** | **Amount** | ** ** |
|-------------------------------------------------------------------------------|------------|------------|------------|
|                                                                          |       |       |       |
| Balance as of December 31, 2007                                          |       | $          | 25,511     |   |
| Purchase price  adjustments associated with the acquisition of Green Mountain |       | (117       | )          |
| Increase  associated with the acquisition of Clarix (see Note 5)              |       | 17,804     |       |
| Balance as of September 30, 2008                                         |       | $          | 43,198     |   |

 

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In the nine months ended September 30,2008 adjustments totaling $117 were recorded to reduce goodwill associated withthe acquisition of Green Mountain. Goodwill was decreased $49 due to thereversal of accrued vacation and by $68 due to reduction of net operating losscarryforwards.

 

Intangible assets consistof the following:

 
| ** **                         | ** ** | ** **                      | ** ** | **As of December 31, 2007** | ** ** | **As of September 30, 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 |   | $ | 15,460 |   | $ | 1,527 |   |
| Customer  relationships            |       | 5 years                         |       | 1,700                                           |       | 756                                              |       | 6,370 |   | 1,076 |   |
| Non-compete  agreements            |       | 2 years                         |       | 300                                             |       | 300                                              |       | 610 |   | 307 |   |
| Tradename                          |       | 5 years                         |       | 300                                             |       | 98                                               |       | 4,410 |   | 200 |   |
| Customer Backlog                   |       | 5 years                         |       | —                                          |       | —                                           |       | 660 |   | 9 |   |
| Total                              |       |                            |       | $                                               | 5,400      |                                             | $          | 2,044 |   | $ | 27,510 |   | $ | 3,119 |   |

 

Amortization expenserelated to intangible assets in the three months ended September 30, 2007and 2008 was $202 and $565, respectively, and $637 and $1,075 in the ninemonths ended September 30, 2007 and 2008, respectively.

 

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

 
| **Year ended December 31,** | ** ** | **Amount** | ** ** |
|--------------------------------------------|------------|------------|------------|
| 2008 (1)                                   |       | $          | 1,371      |   |
| 2009                                       |       | 5,483      |       |
| 2010                                       |       | 5,230      |       |
| 2011                                       |       | 4,730      |       |
| 2012 and after                             |       | 7,577      |       |
| Total                                      |       | $          | 24,391     |   |

 

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(1) Thisamount reflects amortization expense that the Company anticipates recognizingfrom October 1, 2008 through December 31, 2008.

 

**11.  AccruedExpenses**

 

Accrued expenses consistof the following:

 
| ** **                            | ** ** | **As of  December 31,** | ** ** | **As of  September 30,** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|------------------------------------|------------|
| ** **                            | ** ** | **2007**                          | ** ** | **2008**                           | ** ** |
| Accrued payroll  and related benefits |       | $                                 | 12,084     |                               | $          | 10,917 |   |
| Accrued other  expenses               |       | 5,353                             |       | 7,499                              |       |
| Accrued  royalties                    |       | 2,010                             |       | 1,640                              |       |
|                                  |       |                              |       |                               |       |
| Total                                 |       | $                                 | 19,447     |                               | $          | 20,056 |   |

 

**12.  Commitmentsand Contingencies**

 

From time to time and inthe ordinary course of business, the Company is subject to various claims, chargesand litigation. Intellectual property disputes often have a risk of injunctiverelief which, if imposed against the Company, could materially and adverselyaffect its financial condition or results of operations. From time to time,third parties have asserted 

 

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and may in the futureassert intellectual property rights to technologies that are important to the Company’sbusiness and have demanded and may in the future demand that the Companylicense their technology. Although the outcome of litigation cannot bepredicted 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 alease (“Lease”) with BP Fourth Avenue, L.L.C. (the “Landlord”) to secure officespace for the Company’s future corporate headquarters at 77 Fourth Avenue,Waltham, Massachusetts. The estimated commencement date for occupancy under theLease is December 2008. The lease for the Company’s current corporateheadquarters at 880 Winter Street in Waltham is due to expire in February 2009.  The Lease provides for the rental of 165,129rentable square feet of space and has an initial term of 10 years and threemonths. The Company can, subject to certain conditions, extend this term byexercising up to two consecutive five year options. The Company is not requiredto pay any rent for the first three months of the initial Lease term.  Thereafter, the annual rent under the Leasefor years one through five will be $6,600, or approximately $548 permonth.  For years six through ten, theannual rent will be $7,200, or approximately $603 per month.  The total base rent payable in the initialterm is $69,100.  In connection with thesigning of the Lease, the Company has deposited with the Landlord anunconditional, irrevocable letter of credit in the Landlord’s favor in theamount of $962.

 

**13.**** ****Leasehold IncentiveObligations**

 

In conjunction with the February 2008 leaseagreement for the Company’s future headquarters, the landlord agreed toreimburse the Company up to a specified amount of leasehold improvements.  In accordance with SFAS No. 13, *Accounting For Leases*, and Financial Accounting StandardsBoard Technical Bulletin 88-1, *Issues Relating toAccounting for Leases*, the leasehold improvements are recognized inproperty and equipment on the consolidated balance sheet, with thecorresponding reimbursement recognized as leasehold incentive obligations onthe consolidated balance sheet.  Theamount of the incentive will be amortized on a straight-line basis over thelease term as a reduction of rental expense at the beginning of occupancy.  The leasehold improvements in property, plantand equipment will be amortized over the shorter of the lease term or theestimated useful life of the asset.

 

For additional information regarding the Frebruary 2008lease agreement, see Note 12.

 

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

 

*Common Stock*

 

In the three and nine months ended September 30,2008, the Company issued 70,219 and 238,317 shares of common stock,respectively, in connection with the exercise of stock options resulting inproceeds of $421 and $1,467, respectively. In the nine months ended September 30, 2008, the Company issued19,839 shares of common stock under the 2004 Employee Stock Purchase Planresulting in proceeds of $328.  In thenine months ended September 30, 2008, the Company released 225,350 sharesof common stock in connection with the vesting of restricted stock awards.  The Company retired 74,961 of these shares tocover withholding taxes in the amount of $1,247.

 

*Stock Option Activity*

 

For options accounted forunder SFAS No. 123(R), *Share-Based Payments*,the fair value of each option grant is estimated on the date of grant using theBlack-Scholes pricing model. No options were granted during the three monthsended September 30, 2007 and 2008. For purposes of utilizing theBlack-Scholes option pricing model and because there was a limited tradinghistory for its common stock, the Company determined the expected life and thevolatility for options based on an analysis of reported data for a peer groupof companies that have issued stock options with substantially similar terms.The expected life of options granted by the Company has been determined basedon the average expected life of the options as reported by this peer group ofcompanies during a similar reporting period. The expected volatility of optionsgranted has been determined using an average of the historical volatilitymeasures of this peer group of companies as well as the historical volatilityof the Company’s common stock beginning in January 2005. The risk-freeinterest rate is based on a treasury instrument whose term is consistent withthe expected life of the stock options. The Company has not paid and does notanticipate paying cash dividends on its shares of common stock; therefore, theexpected dividend yield is assumed to be zero. In addition, while SFAS No. 123,*Accounting for Stock-Based Compensation,*permitted companies to record forfeitures

 

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based on actualforfeitures, which was the Company’s historical policy under SFAS No. 123,SFAS No. 123(R) requires companies to utilize an estimated forfeiturerate when calculating stock-based compensation expense for the period.  As a result, the Company has applied aforfeiture rate of 8%, derived from an analysis of its historical data, indetermining the expense recorded in the Company’s consolidated statements ofincome.

 

In the three months endedSeptember 30, 2007 and 2008, the Company recorded $1,136 and $2,292 ofaggregate stock-based compensation expense, respectively, of which $1,107 and$2,292, respectively, was a result of the adoption of SFAS No. 123(R).  In the nine months ended September 30,2007 and 2008, the Company recorded $3,333 and $6,030 of aggregate stock-basedcompensation expense, respectively, of which $3,226 and $6,030, 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 $107 and $0 in the ninemonths ended September 30, 2007 and 2008, respectively.  As of September 30, 2008, there was$22,574 of unrecognized stock-based compensation expense related to stock-basedawards that is expected to be recognized over a weighted average period of 2.82****years.

 

A summary of stock optionactivity under the Phase Forward Incorporated 1997 Stock Option Plan, the PhaseForward Incorporated 2004 Stock Option and Incentive Plan and the 2003Non-Employee Director Stock Option Plan as of September 30, 2008, andchanges during the nine months ended September 30, 2008, is as follows:

 
| ** **                                                   | ** ** | **Number of   Shares** | ** ** | **Weighted  Average  Exercise Price  per Share** | ** ** | **Weighted  Average  Remaining  Contractual  Term (years)** | ** ** | **Aggregate  Intrinsic  Value (2)** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|------------------------------------------------------------|------------|------------------------------------------------------------------|------------|------------------------------------------|------------|
| Outstanding as  of December 31, 2007                    |       | 2,473,717                        |       | $                                                          | 4.99       |                                                             | 5.76       |                                     | $          | 41,468 |   |
| Granted                                                      |       | —                           |       |                                                       |       |                                                             |       |                                     |       |
| Exercised                                                    |       | (238,317                         | )          | 6.16                                                       |       |                                                             |       | $                                        | 2,829      |   |
| Canceled                                                     |       | (11,044                          | )          | 7.26                                                       |       |                                                             |       |                                     |       |
|                                                         |       |                             |       |                                                       |       |                                                             |       |                                     |       |
| Outstanding as  of September 30, 2008                   |       | 2,224,356                        |       | $                                                          | 4.85       |                                                             | 5.03       |                                     | $          | 35,722 |   |
|                                                         |       |                             |       |                                                       |       |                                                             |       |                                     |       |
| Exercisable as  of September 30, 2008                   |       | 2,006,213                        |       | $                                                          | 4.60       |                                                             | 4.86       |                                     | $          | 32,730 |   |
|                                                         |       |                             |       |                                                       |       |                                                             |       |                                     |       |
| Vested or  expected to vest as of September 30, 2008(1) |       | 2,198,792                        |       | $                                                          | 4.83       |                                                             | 5.01       |                                     | $          | 35,357 |   |

 

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(1) The vested or expected to vest options at September 30, 2008 include boththe vested options and the number of options expected to vest calculated afterapplying an estimated forfeiture rate to the unvested options.

 

(2) The aggregate intrinsic value is calculated based on the positive differencebetween the fair value per share of the Company’s common stock on September 30,2008 of $20.91 or as of the date of exercise, as applicable and the exerciseprice of the underlying options.

 

*Restricted Stock Awards and Unit Activity*

 

A summary of activityrelated to restricted common stock awards and unit awards during the ninemonths ended September 30, 2008, is as follows:

 
| ** **                              | ** ** | **Number of  Shares** | ** ** | **Market Price  Per Share** | ** **         | **Weighted  Average  Grant Date  Fair Value  Per Share** | ** ** | **Weighted  Average  Remaining  contractual  Term  (years)** | ** ** | **Aggregate  Intrinsic  Value (2)** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------------------------------|--------------------|-------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|------------------------------------------|------------|
| Unvested at  December 31, 2007     |       | 1,569,469                  |       | $                                     | 12.12 – 23.20 |                                                                    | $          | 16.52                                                        |       | 2.90                                     |       | $ | 25,926 |   |
| Granted                                 |       | 644,262                    |       | 17.45 – 21.13                    |               | 18.17                                                                   |       |                                                         |       |                                     |       |
| Vested                                  |       | (225,350                   | )          | 12.12 – 12.12                    |               | 12.12                                                                   |       |                                                         |       |                                     |       |
| Forfeited                               |       | (62,500                    | )          | 12.12 – 23.20                    |               | 17.61                                                                   |       |                                                         |       |                                     |       |
| Unvested at  September 30, 2008    |       | 1,925,831                  |       | $                                     | 12.12 – 23.20 |                                                                    | $          | 16.30                                                        |       | 2.68                                     |       | $ | 40,269 |   |
| Expected to be  free of restrictions(1) |       | 1,570,524                  |       | $                                     | 12.12 – 23.20 |                                                                    | $          | 16.38                                                        |       | 2.86                                     |       | $ | 32,840 |   |

 

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(1)    The expected to be free of restrictions at September 30,2008 was calculated by applying an estimated forfeiture rate to the unvestedshares.

 

(2)    The aggregate intrinsic value is calculated based onthe fair value per share of the Company’s common stock on September 30,2008 of $20.91.

 

**15.**  **Comprehensive Income**

 

The Company’s othercomprehensive income relates to foreign currency translation adjustments andunrealized losses on our ARS that are classified as available-for-sale.  Comprehensive income is presented separatelyon the balance sheet as required.

 

Comprehensive incomeconsisted of the following:

 
| ** **                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                         | ** ** | **2007**                                             | ** ** | **2008**                                            | ** ** | **2007** | ** ** | **2008** | ** ** |
| Net income                                         |       | $                                                    | 5,718      |                                                | $          | 3,441 |   | $ | 13,527 |   | $ | 11,137 |   |
| Translation  adjustment                            |       | 482                                                  |       | (1,138                                              | )          | 728 |   | (621 | ) |
| Impairment of  auction rate securities, net of tax |       | —                                               |       | 14                                                  |       | — |   | (782 | ) |
|                                               |       |                                                 |       |                                                |       |   |   |   |   |
| Comprehensive  income                              |       | $                                                    | 6,200      |                                                | $          | 2,317 |   | $ | 14,255 |   | $ | 9,734 |   |

 

**16.**** ****Forward Foreign ExchangeContracts**

 

The Company enters intotransactions in currencies other than the U.S. dollar and holds cash in foreigncurrencies which expose the Company to transaction gains and losses as foreigncurrency exchange rates fluctuate against the U.S. dollar. The Company fromtime to time enters into forward foreign exchange contracts to hedge theforeign currency exposure of non-U.S. dollar denominated third-party andintercompany receivables and cash balances. The contracts which relate to theBritish pound, euro, and the Japanese yen, generally have terms of one month.These hedges are deemed fair value hedges and have not been designated forhedge accounting. The gains or losses on the forward foreign exchange contractsalong with the associated losses and gains on the revaluation and settlement ofthe intercompany balances, accounts receivable and cash balances are recordedin current operations.

 

The following tablesummarizes the outstanding forward foreign exchange contracts held by theCompany as of December 31, 2007 and September 30, 2008:

 
| ** **    | ** ** | ** **          | ** ** | **As of December 31, 2007** | ** ** | **As of September 30, 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                                            |       | 1,200 |   | 1,695 |   |
|          |       |                |       |                                            |       | $                                                | 19,826     |   |   |   | $ | 1,695 |   |

 

Theforward foreign exchange contracts are short-term and generally mature withinone month of origination.

 

Due tothe short period of time between entering into the forward foreign exchangecontracts and September 30, 2008, the forward foreign exchange contractsrate approximates the exchange rate as of the end of the reporting period.

 

Realized and unrealizedforeign currency losses, net of hedging, are accounted for in other income(expense). The Company recorded foreign currency losses of $98 and $459 in thethree months ended September 30, 2007 and 2008, respectively, and $160 and$444 in the nine months ended September 30, 2007 and 2008,respectively.   The Company settlesforward foreign exchange contracts in cash.

 

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**17. **Income Taxes

** **

The Company’s effectivetax rates for the three months ended September 30, 2007 and 2008 were 10%and 36%, respectively.  The Company’s effective tax rates for the ninemonths ended September 30, 2007 and 2008 were 10% and 37%,respectively.  In the three and nine months ended September 30, 2007,the Company’s provision for taxes includes foreign and alternative minimum taxas the Company utilized available U.S. net operating losses to offset itsprimary federal obligations resulting in an effective tax rate of 10% for bothperiods.

 

On January 1, 2007,the Company adopted the provisions of Financial Standards Accounting Board(FASB) Interpretation No. 48 *Accountingfor Uncertainty in Income Taxes*, an interpretation of SFAS No. 109,*Accounting for Income Taxes*. As of September 30, 2008, the Company had a liability of $1,214 forunrecognized tax benefits, all of which would favorably impact the Company’seffective tax rate if recognized.  The Company recognizes interest andpenalties related to uncertain tax positions as a component of income taxexpense.  As of September 30, 2008, the Company had approximately$123 of accrued interest and penalties related to unrecognized tax benefits. The Company anticipates a reduction of approximately $144 to the amountof unrecognized tax benefits over the next twelve months associated withlapsing statutes of limitations.  The unrecognized tax liability of $1,214and accrued interest and penalties of $123 are classified as other long-termliabilities on the consolidated balance sheet as of September 30, 2008.

 

**18.  Fair Value Measurements**

 

In September 2006, the FASB issued SFAS No. 157,which defines fair value, establishes a framework for measuring fair value inaccordance with generally accepted accounting principles and expandsdisclosures about fair value measurements. SFAS No. 157 does not requireany new fair value measurements, but its provisions apply to all other accountingpronouncements that require or permit fair value measurement. SFAS No. 157is effective for the Company’s fiscal year beginning January 1, 2008 andfor interim periods within that year. In February 2008, the FASB issuedFASB Staff Position (FSP) No. 157-2, *EffectiveDate of FASB Statement No. 157*, which delayed for one year theeffective date of SFAS No. 157 for nonfinancial assets and nonfinancialliabilities, except for items that are recognized or disclosed at fair value inthe financial statements on a recurring basis (at least annually). As required,the Company adopted SFAS No. 157 for its financial assets on January 1,2008. Adoption did not have a material impact on the Company’s financialposition or results of operations. The Company has not yet determined theimpact on its financial statements of the January 1, 2009 adoption of SFASNo. 157 as it pertains to non-financial assets and liabilities.

 

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 pricesfor identical assets or liabilities in active markets;

·                  *Level 2*: Inputs, other than the quoted prices inactive markets, that are observable either directly or indirectly such asquoted prices for similar assets or liabilities or market-corroborated inputs;and

·                  *Level 3*: Unobservable inputs for which there islittle or no market data, which require the reporting entity to develop its ownassumptions about how market participants would price the assets orliabilities.

 

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

 
| A. | *Market approach* - Uses prices and other relevant  information generated by market transactions involving identical or comparable  assets or liabilities                                                                                                   |
|----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| B. | *Income approach* - Uses valuation techniques to convert  future amounts to a single present amount based on current market  expectations about those future amounts, including present value techniques,  option-pricing models and excess earnings method |
| C. | *Cost approach* - Based on the amount that currently  would be required to replace the service capacity of an asset (replacement  cost)                                                                                                                     |

 

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The following table sets forth the Company’s financialinstruments carried at fair value within the SFAS No. 157 hierarchy andusing the lowest level of input as of September 30, 2008:

 
| ** **                                  | ** ** | **Quoted Prices**            | ** ** | **Significant Other** | ** ** | **Significant**    | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|-----------------------------------|------------|----------------------------|------------|--------------------|------------|------------|------------|
| ** **                                  | ** ** | **in Active Markets**   | ** ** | **Observable**             | ** ** | **Unobservable**   | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **for Identical Items** | ** ** | **Inputs**                 | ** ** | **Inputs**         | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **(Level 1)**                | ** ** | **(Level 2)**         | ** ** | **(Level 3)** | ** ** | **Total**  | ** ** |
|                                        |       |                              |       |                       |       |               |       |       |       |
| Assets:                                     |       |                              |       |                       |       |               |       |       |       |
|                                        |       |                              |       |                       |       |               |       |       |       |
| Money market  funds                         |       | $                                 | 119,378    |                       | $          | —             |       | $          | —     |   | $ | 119,378 |   |
| Restricted cash                             |       | 1,462                             |       | —                     |       | —             |       | 1,462      |       |
| Total cash  equivalents and restricted cash |       | 120,840                           |       | —                     |       |               |       | 120,840    |       |
|                                        |       |                              |       |                       |       |               |       |       |       |
| U.S. agency  notes                          |       | $                                 | —     |                       | $          | 998                |       | $          | —     |   | $ | 998 |   |
| Municipal bonds                             |       | —                            |       | 1,004                      |       | —             |       | 1,004      |       |
| Corporate bonds                             |       | —                            |       | 18,457                     |       | —             |       | 18,457     |       |
| Total short-term  investments               |       | $                                 | —     |                       | $          | 20,459             |       | $          | —     |   | $ | 20,459 |   |
|                                        |       |                              |       |                       |       |               |       |       |       |
| Auction rate  securities (1)                |       | $                                 | —     |                       | $          | —             |       | $          | 22,795     |   | $ | 22,795 |   |
| Total long-term  investments                |       | $                                 | —     |                       | $          | —             |       | $          | 22,795     |   | $ | 22,795 |   |
|                                        |       |                              |       |                       |       |               |       |       |       |
| Total assets                                |       | $                                 | 120,840    |                       | $          | 20,459             |       | $          | 22,795     |   | $ | 164,094 |   |

 

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(1)      The Company’s investments in ARS are classified withinLevel 3 because there are currently no active markets for ARS and theCompany is unable to obtain independent valuations from market sources.Therefore, the ARS were primarily valued based on an income approach using anestimate of future cash flows.  Foradditional information regarding ARS, see Note 8.

 

The following table setsforth a summary of changes in the fair value of the Company’s Level 3financial assets for the nine months ended September 30, 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 |       | (1,255                          | )          |
| Balance, end of  period                                     |       | $                               | 22,795     |   |

 

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

 

The Company also adoptedthe provisions of SFAS No. 159 in the first quarter of 2008. SFAS No. 159allows companies to choose to measure eligible assets and liabilities at fairvalue with changes in value recognized in earnings. Fair value 

 

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treatment may be electedeither upon initial recognition of an eligible asset or liability or, for anexisting asset or liability, if an event triggers a new basis of accounting.The Company did not elect to re-measure any of its existing financial assets orliabilities under the provisions of this Statement.

 

**19.  RecentlyIssued Accounting Pronouncements**

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), *Business Combinations*(“SFAS No. 141(R)”). SFAS No. 141(R) retains thefundamental requirements in SFAS No. 141 that the acquisition method ofaccounting (which SFAS No. 141 called the purchase method) be used for allbusiness combinations and for an acquirer to be identified for each businesscombination. SFAS No. 141(R) requires an acquirer to recognizethe assets acquired, the liabilities assumed, and any noncontrolling interestin the acquiree at the acquisition date, measured at their fair values as ofthat date, 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.

 

In March 2008, theFASB issued SFAS No. 161,*Disclosuresabout Derivative Instruments and Hedging Activities, an amendment of FASBStatement No. 133* (“SFASNo. 161”)*.*  SFAS No. 161 requires disclosure 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 theCompany’s consolidated financial position and results of operations.

 

In May 2008, theFASB issued SFAS No. 162, *The Hierarchy of GenerallyAccepted Accounting Principles* (“SFAS No. 162”). SFAS No. 162identifies the sources of generally accepted accounting principles in theUnited States. SFAS No. 162 is effective sixty days following the SEC’sapproval of the Public Company Accounting Oversight Board amendments to AU Section 411,*The Meaning of Present Fairly in Conformity WithGenerally Accepted Accounting Principles*.  The adoption of SFAS No. 162 is notexpected to have a material effect on the Company’s consolidated financialposition and results of operations.

 

**Item 2.  *Management’s Discussion andAnalysis of Financial Condition and Results of Operations.***

** **

*Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with our unaudited condensedconsolidated financial statements and related notes thereto that appearelsewhere in this Quarterly Report on Form 10-Q and the audited financialstatements and related notes thereto and Management’s Discussion and Analysisof Financial Condition and Results of Operations included in our Annual Reporton Form 10-K for the year ended December 31, 2007, which has beenfiled with the Securities and Exchange Commission (“SEC”).*

 

**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 Form 10-Q regardingour strategy, 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 

 

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forward-lookingstatements are reasonable, these expectations may prove to be incorrect, andall of these statements are subject to risks and uncertainties. We discuss manyof the risks that we believe could cause actual results or events to differmaterially from these forward-looking statements in greater detail in thesection entitled “Risk Factors” 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, and as otherwise set forth in this Quarterly Report on Form 10-Q,**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.**

 

**Overview**

 

PhaseForward Incorporated is a provider of integrated enterprise-level softwareproducts, services and hosted solutions for use in our customers’ globalclinical trial and drug safety monitoring activities. Our customers includepharmaceutical, biotechnology and medical device companies, as well as academicinstitutions, governmental regulatory agencies, contract researchorganizations, or CRO’s, and other entities engaged in clinical trial and drugsafety monitoring activities. By automating essential elements of the clinicaltrial and drug safety monitoring processes, we believe our products allow ourcustomers to accelerate the market introduction of new medical therapies andcorresponding revenues, reduce overall research and development expenditures,enhance existing data quality control efforts, increase drug safety complianceand reduce clinical and economic risk.

 

**Acquisitions**

 

From time to time we haveexpanded our product and service offerings through the acquisition of otherbusinesses or technologies. These transactions include the acquisitions ofClinsoft Corporation (“Clinsoft”) in 2001, Lincoln Technologies, Inc. (“Lincoln”)in 2005 and the more recent acquisitions of Green Mountain Logic, Inc. (“GreenMountain”) and Clarix LLC (“Clarix”), which are described below.

 

*Clarix*

 

On September 5, 2008, we acquired all of theoutstanding membership interests of Clarix LLC (“Clarix”), a provider ofweb-integrated interactive response technology (“IRT”) for clinical trialmanagement.  Clarix’s web-integrated IRTis used for subject randomization, predictive medication inventory management,and operational management in reporting clinical trials**.**  Theaggregate purchase price was $41,304. There were no earn-out provisions as a result of the acquisition.  The acquisition of Clarix was accounted foras a purchase under Statement of Financial Accounting Standards (“SFAS”) No. 141, *Business Combinations*.  Accordingly, the results of Clarix have beenincluded in our consolidated financial statements since the date ofacquisition.

 

*GreenMountain 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 SFAS No. 141, *Business Combinations*. Accordingly, the results of GreenMountain have been included in our consolidated financial statements since thedate of acquisition.

 

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**Sourcesof Revenues**

 

We derive our revenuesfrom software licenses and services.  Our product line iscomprised of four 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 for Phase Iclinic automation.

 

·*ClinicalData Management*

 

·       *Clintrial*, our clinical datamanagement solution; and

 

·       *WebSDM*, our system for validating and reviewing clinicaltrial data represented in formats meeting industry standards, such as thoseestablished by the Clinical Data Interchange Standards Consortium, or CDISC.

 

·*Safety*

 

·       *EmpiricaTrace*(formerly*Clintrace*), our adverse event managementsolution for monitoring drug safety and reporting adverse events that occurduring and after conclusion of the clinical trial process;

 

·       *EmpiricaSignal (*formerly *WebVDME)*, our data mining and signal detection solution forpost-marketing data; and

 

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

 

·*Interactive Responsive Technology (IRT)*

 

·                  *Clarix*, our Web-integratedinteractive response technology.

 

License revenues arederived principally from the sale of term licenses for our softwareproducts.  Service revenues are derivedprincipally from our delivery of the hosted solution of our *InForm,**EmpiricaSignal*, *CTSD* and *WebSDM* software products, and consulting services and customer support,including training, for all of our products. We generally recognize revenues ratably over the life of a license orservice contract. This allows us to maintain a backlog that provides multi-yearvisibility in revenues.

 

One customer,GlaxoSmithKline, accounted for approximately 15% and 12% of our total revenuesin the three months ended September 30, 2007 and 2008, respectively, and16% and 12% of our total revenues in the nine months ended September 30,2007 and 2008, respectively.  This samecustomer accounted for $1.8 million and $1.1 million, or 5% and 3%, of accountsreceivable outstanding as of December 31, 2007 and September 30,2008, respectively.  Our top 20 customersaccounted for approximately 69% and 62% of our total revenues, net ofreimbursable out-of-pocket expenses, in the three months ended September 30,2007 and 2008, respectively, and 68% and 63% of our total revenues, net ofreimbursable out-of-pocket expenses, in the nine months ended September 30,2007 and 2008, respectively.

 

* License Revenues*

 

We derive our licenserevenues principally from the sale of term licenses for the following softwareproducts: *InForm*, ourInternet-based electronic data capture, or EDC, solution; *Clintrial* and *WebSDM*, ourclinical data management solutions; our drug safety solutions, including our *Empirica Trace*, *Empirica Signal*and *CTSD* products; and our *LabPas* Phase I clinic automationsolution.  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 *electronic data capturesoftware solution, either on a stand-alone or integrated basis, are determinedprimarily by the number, complexity and duration of the clinical trials and thenumber of participants in each 

 

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clinical trial. Licenserevenues for our *Clintrial,**WebSDM, Empirica Trace,**Empirica Signal*, *CTSD* and *LabPas* software solutions are determined primarily by the number of usersaccessing the software solution. Except as discussed below, we enter intosoftware license 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.

 

Followingour acquisition of Clinsoft in August 2001, we began converting holders ofClinsoft perpetual software licenses to our software term license arrangements.We continue to sell additional perpetual licenses of these products in certainsituations to our existing customers with the option to purchase customersupport, and may in the future do so for new customers based on customerrequirements or market conditions. We recognize revenues on the perpetuallicenses upon delivery of the software when all other revenue recognitioncriteria are met. We continue to provide and charge for maintenance and supporton our products to those customers who do not convert to our software termlicense arrangements.  We will continueour efforts to convert the remaining former Clinsoft customer base to softwareterm license arrangements. However, we anticipate that some customers will notconvert and instead will continue to make annual customer support payments.

 

*ServiceRevenues*

 

*ApplicationHosting Services.*    Inaddition to making our software products available to customers throughlicenses, we offer our *InForm*,*Clarix, Empirica Signal, 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 fromthe *InForm *hosting serviceconsist of three stages for each clinical trial:

 

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

 

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

 

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

 

Revenues resultingfrom the *Clarix* hosting service also consists ofthree stages for each clinical trial:

 

·      *First stage*—trialand application set up, including design and set up of the subjectrandomization and medication inventory management, installation and serverconfiguration of the system;

 

·      *Second stage*—applicationhosting and related support services; and

 

·      *Third stage*—servicesrequired to close out the clinical trial.

 

Services provided for thefirst and third stages of both *InForm*and*Clarix* are provided on a fixed fee basis depending upon thecomplexity of the trial and system requirements. Services for the second stageare charged separately as a fixed monthly fee. We recognize revenues from allstages of the hosting service ratably over the hosting period. Fees charged andcosts incurred for the trial system design, set up and implementation aredeferred until the start of the hosting period and are amortized and recognizedratably over the estimated hosting period. The deferred costs include directcosts related to the trial and application set up. Fees for the first and thirdstages of the services are billed based upon milestones. Fees for applicationhosting and related services in the second stage are generally billed quarterlyin advance. Bundled into this revenue element are the revenues attributable tothe software license used by the customer.

 

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

 

Revenues resulting fromhosting services for our *Empirica Signal*,*CTSD* and *WebSDM* products consist of installationand 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, applicationhosting service revenues include hosting services associated with term licensecustomers and reimbursable out-of-pocket expenses.

 

*ConsultingServices**. *Consulting services include the design anddocumentation of the processes related to our customers’ use of our productsand services in their clinical trials and safety monitoring activities.Consulting services also include project planning and management services,guidance on best practices in using our software products, data management andconfiguration services for data mining and reporting, as well as implementationservices consisting of 

 

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application architecturedesign, 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 theAmerican Institute of Certified Public Accountants’ (“AICPA”) Statement ofPosition No. 81-1 (SOP No. 81-1), *Accountingfor Performance of Construction-Type and Certain Production-Type Contracts,*oneither a time and materials basis or using the proportional performance method.If we are not able to produce reasonably dependable estimates, revenue isrecognized upon completion of the project and final acceptance from the customer.If significant uncertainties exist about project completion or receipt ofpayment, the revenue is deferred until the uncertainty is resolved. Provisionsfor estimated losses on contracts are recorded during the period in which theyare identified.

 

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

 

*Costof Revenues.*    Costof license revenues consists primarily of the amortization of royalties paidfor certain modules within our *Clintrial*software product as well as our *InForm *softwareproduct. In addition, costs of revenues include expense for the amortization ofacquired technologies associated with the 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 customer support for use with the *Clintrial* and *InForm *softwareproducts and reimbursable out-of-pocket expenses. Cost of services alsoincludes hosting costs that primarily consist of hosting facility fees andserver depreciation.

 

The cost of service revenuesvaries based upon the number of employees in the service organization, the typeof work performed, and royalties associated with revenues derived fromproviding customer support, as well as costs associated with the flexible useof outside contractors to support internal resources. We supplement the trialdesign and set up activity for our *InForm *applicationhosting services through the use of outside contractors. This allows us toutilize outside contractors in those periods where trial design and set upactivity is highest while reducing the use of outside contractors in thoseperiods where trial activity lessens, allowing for a more flexible deliverymodel. The percentage of the services workforce represented by outsidecontractors varies from period to period depending on the volume of specificsupport required. The cost of services is significantly higher as a percentageof revenues as compared to our cost of license revenues primarily due to theemployee-related and outside contractor expenses associated with providingservices.

 

*GrossMargin.*    Ourgross margin on license revenues varies based on the mix of royalty- andnon-royalty-bearing license revenues and the amount of amortization of acquiredtechnologies. Our gross margin on service revenues varies primarily due tovariations in the utilization levels of the professional service team and thetiming of expense and revenue recognition under our service arrangements. Insituations where the service revenues are recognized ratably over the software 

 

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license term, our costsassociated with delivery of the services are recognized as the services areperformed, which is typically during the first 6 to 12 months of thecontract period. Accordingly, our gross margin on service revenues will varysignificantly over the life of a contract due to the timing, amount and type ofservice required in delivering certain projects. In addition, consolidatedgross margin will vary depending upon the mix of license and service revenues.

 

*Salesand Marketing.*    Salesand marketing expenses consist primarily of employee-related expenses,including travel, marketing programs which include product marketing expensessuch as trade shows, workshops and seminars, corporate communications, otherbrand building 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.

 

*Researchand Development.*    Researchand development expenses consist primarily of employee-related expenses,allocated overhead and outside contractors. We focus our research anddevelopment efforts on increasing the functionality, performance andintegration of our software products. We expect that in the future, researchand development expenses will increase in absolute dollars as we continue toadd features and functionality to our products, introduce additional integratedsoftware solutions to our product suite and expand our product and serviceoffering.

 

*Generaland Administrative.*    Generaland administrative 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-BasedCompensation Expenses.*    Our cost ofservice revenues, sales and marketing, research and development, and generaland administrative expenses include stock-based compensation expense.  Stock-based compensation expense is the fairvalue of outstanding stock options and restricted stock awards and units, whichare recognized over the respective stock option and award service periods.  It also includes amortization of the excessof the deemed fair market value over the exercise price of stock optionsgranted prior to our July 2004 initial public offering.  During the three months ended September 30,2007 and 2008, we recorded $1.1 million and $2.3 million of stock-basedcompensation expense, respectively. During the nine months ended September 30, 2007 and 2008, werecorded $3.3 million and $6.0 million of stock-based compensation expense,respectively.

 

**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, Indianrupee, Japanese yen and Romanian leu.  Inthe three months ended September 30, 2007 and 2008, approximately 48% and43%, respectively, of our revenues were generated in locations outside theUnited States.  In the nine months ended September 30,2007 and 2008, approximately 50% and 45%, respectively, of our revenues weregenerated in locations outside the United States.  For the three and nine months ending September 30,2008, approximately 30% and 32%, respectively, of revenues are in currenciesother than the U.S. dollar.  In periodswhen the U.S. dollar appreciates in value as compared to the foreign currenciesin which we conduct business, our foreign currency-based revenues and expensesgenerally decrease in value when translated into U.S. dollars.

 

**CriticalAccounting Policies and Estimates**

 

Our unaudited condensedconsolidated financial statements are prepared in accordance with accountingprinciples generally accepted in the United States. The preparation of thesefinancial statements requires us to make estimates and assumptions that affectthe reported amounts of assets, liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting periods. On an ongoingbasis, we evaluate our estimates and assumptions with our audit committee,including those related to revenue recognition, deferred set up costs,commissions and royalties, accounts receivable reserves, stock-basedcompensation expenses, long-lived assets, intangible assets and goodwill,income taxes, restructuring, contingencies and litigation. We base ourestimates on historical experience and on various other assumptions that arebelieved to be reasonable under the circumstances, the results of which formthe 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 this 

 

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Quarterly Report on Form 10-Q. Our actual resultsmay differ from these estimates under different assumptions or conditions.

 

We believe that of oursignificant accounting policies, which are described in Note 2 of thenotes to our consolidated financial statements included in our Annual Report onForm 10-K for the year ended December 31, 2007, the followingaccounting policies involve a greater degree of judgment and complexity.Accordingly, these are the policies we believe are the most critical to aid infully understanding and evaluating our consolidated financial condition andresults of operations.

 

*RevenueRecognition and Deferred Set Up Costs.*    We recognize software licenserevenues in accordance with Statement of Position (SOP) No. 97-2, *Software Revenue Recognition,* as amended,issued by the AICPA, while revenues resulting from application services arerecognized in accordance with Emerging Issues Task Force (EITF) Issue No. 00-3,*Application of AICPA Statement of Position97-2 to Arrangements that Include the Right to Use Software Stored on AnotherEntity’s Hardware*, Securities and Exchange Commission’s (SEC) StaffAccounting Bulletin (SAB) No. 104, *RevenueRecognition* and EITFIssue No. 00-21, *Revenue Arrangementswith Multiple Deliverables.*

 

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

 

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

 

We generally enter intosoftware term licenses for our *InForm*,*Clintrial* and *Empirica Trace* products with our customersfor 3- to 5-year periods. License agreements for our *EmpiricaSignal, 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 no significantmodification or customization subsequent to delivery to the customer.Consulting services, which can also be performed by third-party consultants,are deemed to be non-essential to the functionality of the software andtypically are for trial configuration, implementation planning, loading ofsoftware, building simple interfaces and running test data and documentation ofprocedures.

 

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 recognized for thesearrangements to the different elements based on management’s estimate of therelative fair value of each element. For our term-based licenses, we allocateto consulting services the anticipated service effort and value throughout theterm of the arrangement at an amount that would have been allocated had thoseservices been sold separately to the customer. The value of our 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.

 

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We continue to selladditional perpetual licenses for the *Clintrial*and *Empirica Trace* softwareproducts in certain situations to our existing customers with the option topurchase customer support and may in the future do so for new customers basedon customer requirements or market conditions. We have established vendorspecific objective evidence of fair value for the customer support.Accordingly, license revenues are recognized upon delivery of the software andwhen all other revenue recognition criteria are met.  Customer support revenues are recognizedratably over the term of the underlying support arrangement. We continue togenerate customer support and maintenance revenues from our perpetual licensecustomer base. Training revenues are recognized as earned.

 

In addition to making oursoftware products available to customers through licenses, we offer our *InForm**, Clarix*, *Empirica Signal*, *CTSD* and *WebSDM* software solutions through a hosted applicationsolution delivered through a standard web-browser.

 

Revenues resulting from *InForm*and*Clarix *applicationhosting services consist of three stages for each clinical trial: the firststage involves application set up, including design, implementation of thesystem and server configuration; the second stage involves application hostingand related support services; and the third stage involves services required toclose out the clinical trial. Services provided for the first and third stagesare provided on a fixed fee basis based upon the complexity of the trial andsystem requirements. Services for the second stage are charged separately as afixed monthly fee. We recognize revenues from all stages of the *InForm*and*Clarix *hostingservice ratably over the hosting period. Fees charged and costs incurred forthe trial system design, set up and implementation are deferred as applicable,until the start of the hosting period and then amortized and recognized, asapplicable, ratably over the estimated hosting period. The deferred costsinclude incremental direct costs with third parties and certain internal directcosts related to the trial and application set up, as defined under SFAS No. 91,*Accounting for Nonrefundable Fees and CostsAssociated with Originating or Acquiring Loans and Indirect Costs of Leases*.These costs include salary and benefits associated with direct labor costsincurred during trial set up, as well as third-party subcontract fees and othercontract labor costs. Work performed outside the original scope of work iscontracted for separately as an additional fee and is generally recognizedratably over the remaining term of the hosting period. Fees for the first andthird stages of the 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 fromhosting services for our *Empirica Signal*,*CTSD* and *WebSDM* products consist of installationand 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 anapplication hosting customer cancels a clinical trial and its related statementof work, all deferred revenues are recognized and all deferred set up costs areexpensed.   In addition, certaintermination related fees may be charged and if so, such fees are recognized inthe period of termination.

 

We may also enter intoarrangements to provide consulting services separate from a licensearrangement. In these situations, revenue is recognized in accordance with SOP No. 81-1,*Accounting for Performance ofConstruction-Type and Certain Production-Type Contracts,*on either atime and materials basis or using the proportional performance method. If weare not able to produce reasonably dependable estimates, revenue is recognizedupon completion 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.

 

We deferred $976,000 and$1.3 million of set up costs and amortized $670,000 and $858,000 in the threemonths ended September 30, 2007 and 2008, respectively, and deferred $2.7million and $3.6 million of set up costs and amortized $1.8 million and $2.5million in the nine months ended September 30, 2007 and 2008,respectively.  The amortization ofdeferred set up costs is a component of cost of services.

 

Deferred revenuesrepresent 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.

 

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*Accountingfor Prepaid Sales Commissions and Royalties.*    Forarrangements where we recognize revenue over the relevant contract period, wedefer related commission payments to our direct sales force and softwarelicense royalties paid to third parties and amortize these amounts over thesame period that the related revenues are recognized. This is done to bettermatch commission and royalty expenses with the related revenues. 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 commissions which were paid are recoverable byus.  We deferred $3.2 million and$1.9 million of commissions and amortized to sales and marketing expense $2.3million and $2.4 million of commissions in the three months ended September 30,2007 and 2008, respectively, and deferred $6.9 million and $6.3 million ofcommissions and amortized to sales and marketing expense $5.2 million and $6.2million of commissions in the nine months ended September 30, 2007 and2008, respectively.  Royalties are paidon a percentage of billings basis for certain of our products, and we have theright to recover royalties in the event an arrangement is cancelled.  We deferred $526,000 and $605,000 ofroyalties and amortized to cost of revenues $617,000 and $672,000 of royaltiesin the three months ended September 30, 2007 and 2008, respectively, anddeferred $2.1 million and $2.2 million of royalties and amortized to cost ofrevenues $1.9 million and $2.0 million of royalties in the nine months ended September 30,2007 and 2008, respectively.

 

*AccountsReceivable Reserves.*    We maintainallowances for doubtful accounts for estimated losses resulting from theinability of our customers to make required payments. We regularly evaluate thecollectability of our trade receivables based on a combination of factors,which may include dialogue with the customer to determine the cause ofnon-payment, the use of collection agencies, and/or the use of litigation. Inthe event it is determined that the customer may not be able to meet its fullobligation to us, we record a specific allowance to reduce the relatedreceivable to the amount that we expect to recover given all informationavailable to us. We continuously monitor collections from our customers andmaintain a provision for estimated credit losses based upon our historical experienceand any specific customer collection issues that we have identified. While suchcredit losses have historically been within our expectations and the provisionsestablished, we cannot guarantee that we will continue to experience the samecredit loss rates in the future. If the financial condition of our customerswere to deteriorate, resulting in an impairment of their ability to makepayments, additional allowances may be required.  Our accounts receivable reserves were$270,000 and $324,000 as of December 31, 2007 and September 30, 2008,respectively.

 

*Accountingfor 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*, whichrequires us to recognize expense related to the fair value of stock-basedcompensation awards. We elected to use the modified prospective transitionmethod as permitted by SFAS No. 123(R) and therefore have notrestated our financial results for prior periods. Under this transition method,stock-based compensation expense includes compensation expense for allstock-based compensation awards granted on or after March 15, 2004 (thefiling date for the initial registration statement for our initial publicoffering), based on the grant-date fair value estimated in accordance with theprovisions of SFAS 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 options willnot 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 

 

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stock-based compensationto be reported as a financing activity rather than an operating activity in thestatements of cash flows. This requirement can have the effect of reducing ournet operating cash flows and increasing our net financing cash flows in certainperiods.  To date, we have not recordedthese benefits as they have not been realized.

 

Effective with theadoption of SFAS No. 123(R), we use the Black-Scholes option pricing modelto determine the weighted average fair value of options granted.

 

During the three and ninemonths ended September 30, 2008, we recorded $2.3 million and $6.0 millionof aggregate stock-based compensation expense, respectively, which were aresult of the adoption of SFAS No. 123(R). During the three months ended September 30, 2008, stock-basedcompensation expense included $437,000 in cost of revenues, $329,000 inresearch and development, $393,000 in sales and marketing and $1.1 million ingeneral and administrative expense.  Inthe nine months ended September 30, 2008, stock-based compensation expenseincluded $1.3 million in cost of revenues, $931,000 in research anddevelopment, $1.1 million in sales and marketing and $2.7 million in generaland administrative expense.  In the threemonths ended September 30, 2007 and 2008, stock-based compensation expensereduced basic and diluted earnings per share by $0.02 and $0.03, respectively.  In the nine months ended September 30,2007 and 2008, stock-based compensation expense reduced basic earnings pershare by $0.08 and $0.09, respectively, and diluted earnings per share by $0.08and $0.09, respectively.  As of September 30,2008, we had $22.6 million of unrecognized stock-based compensationexpense related to market-based share awards that we expect to recognize over aweighted average period of 2.82 years.

 

*Goodwilland Intangible Assets Impairment.*    Wereview the carrying value of goodwill and intangible assets periodically basedupon the expected future discounted operating cash flows of our business. Ourcash flow estimates are based on historical results adjusted to reflect ourbest estimate of our operating results in future periods. Actual results maydiffer materially from these estimates. The timing and size of impairmentcharges, if any, involves the application of management’s judgment regardingthe estimates and could significantly affect our operating results.

 

**Overviewof Results of Operations in the Three Months Ended September 30, 2007 and2008**

 

Total revenues increasedby 23%, or $8.1 million, in the three months ended September 30, 2008compared to the same period in 2007, primarily due to an increase in servicerevenues of $8.1 million, or 37%.

 

Our gross marginincreased by 18%, or $3.7 million, in the three months ended September 30,2008 compared to the same period in 2007, primarily due to the increase inservice revenues.  Gross services marginincreased $3.9 million due to increased revenues and increased efficiencies inthe service organization.

 

Operating income in thethree months ended September 30, 2008 of $4.4 million increased 7%, or$286,000, compared to the same period in 2007. The operating income for the three months ended September 30, 2007and 2008 also included $1.1 million and $2.3 million of stock-based compensationexpense, respectively.

 

For the three monthsended September 30, 2008, foreign exchange rate fluctuations resulted inan increase of revenues of approximately 3%. For the three months ended September 30, 2008, foreign exchangerate fluctuations had no impact on expenses.

 

As of September 30,2008, we had $155.3 million of unrestricted cash, cash equivalents andshort-term investments, a decrease of $3.3 million from$158.6 million at December 31, 2007. As of September 30, 2008, we had no outstanding debt.

 

*Revenues*

 
| ** **                                           | ** ** | **Three Months Ended September 30,** | ** ** | ** **                   | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **2007**                                                 | ** ** | **2008**                     | ** ** | **Change** | ** ** |
| **Revenues by Product Line (1)** | ** ** | **Amount**                                               | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                  | ** ** |
| Electronic data capture                              |       | $                                                        | 25,485     |                         | 73         | %          | $          | 32,819 |   | 76 | % | $ | 7,334 |   | 29 | % |
| Clinical data management                             |       | 5,482                                                    |       | 16                           |       | 5,827      |       | 14 |   | 345 |   | 6 |   |
| Safety                                               |       | 3,908                                                    |       | 11                           |       | 4,007      |       | 9 |   | 99 |   | 3 |   |
| Interactive response technology                      |       | —                                                   |       | —                       |       | 338        |       | 1 |   | 338 |   | — |   |
| Total                                                |       | $                                                        | 34,876     |                         | 100        | %          | $          | 42,991 |   | 100 | % | $ | 8,115 |   | 23 | % |

 

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(1)          Revenues byProduct Line include product license revenues and product-related servicerevenues.

 

The increase in electronicdata capture revenues is primarily due to an increase in application hostingservices of $8.2 million.  This increase is partially offset by decreasesin license revenues, consulting services revenues and customer support,totaling $862,000.  The increase in clinical data management can beattributed to increases in consulting services and license revenues of $312,000and $51,000, partially offset by a decrease in customer support revenues of$18,000.  The increase in safety was dueto increases in license revenues, application hosting services and customersupport revenues of $118,000, $115,000 and $71,000 respectively.  These increases are partially offset by adecrease in consulting services revenues of $205,000.  The increase in interactive responsetechnology is due to the introduction of a new offering following theacquisition of Clarix LLC on September 5, 2008.

* *
| ** **                    | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2007**                                                 | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| **Revenues**                  | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                  | ** ** |
| License                       |       | $                                                        | 12,924     |                             | 37         | %          | $          | 12,974 |   | 30 | % | $ | 50 |   | — | % |
| Application  hosting services |       | 14,906                                                   |       | 43                               |       | 23,553     |       | 55 |   | 8,647 |   | 58 |   |
| Consulting  services          |       | 3,475                                                    |       | 10                               |       | 3,488      |       | 8 |   | 13 |   | — |   |
| Customer support              |       | 3,571                                                    |       | 10                               |       | 2,976      |       | 7 |   | (595 | ) | (17 | ) |
| Total                         |       | $                                                        | 34,876     |                             | 100        | %          | $          | 42,991 |   | 100 | % | $ | 8,115 |   | 23 | % |

 

Total revenues increasedin the three months ended September 30, 2008 as compared to the same period in2007, primarily due to increases in application hosting services revenues.  The increase in revenues associated with ourapplication hosting services in the three months ended September 30, 2008 waspartially due to an approximately 16% increase in *InForm*production trials under management from approximately 750 as of September 30,2007 to approximately 870, as of September 30, 2008, which include bothapplication hosting services trials as well as trials hosted for our *InForm* license customers. The increase in *InForm*production trials is primarily from customers who purchase all trial-relatedservices from us and who do not have a separate license to *InForm*,as well as an increase in the average fee per trial.  There were also approximately 65 additionaltrials under management as a result of our recent acquisition of Clarix.  The decrease in customer support revenues inthe three months ended September 30, 2008 was due primarily to decreases inboth training services and software support revenues related to electronic datacapture, primarily *InForm*.  Our revenues were not significantly impactedby price increases or decreases. Inflation had only a nominal impact on our revenues.

 
| ** **                          | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                          | ** ** | **2007**                                                 | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                  | ** ** |
| United States                       |       | $                                                        | 18,126     |                             | 52         | %          | $          | 24,303 |   | 57 | % | $ | 6,177 |   | 34 | % |
|                                |       |                                                     |       |                             |       |       |       |   |   |   |   |   |   |
| United Kingdom                      |       | 11,329                                                   |       | 32                               |       | 12,893     |       | 30 |   | 1,564 |   | 14 |   |
| France                              |       | 3,595                                                    |       | 10                               |       | 3,586      |       | 8 |   | (9 | ) | — |   |
| Asia Pacific                        |       | 1,826                                                    |       | 6                                |       | 2,209      |       | 5 |   | 383 |   | 21 |   |
| International  subtotal             |       | 16,750                                                   |       | 48                               |       | 18,688     |       | 43 |   | 1,938 |   | 12 |   |
| Total                               |       | $                                                        | 34,876     |                             | 100        | %          | $          | 42,991 |   | 100 | % | $ | 8,115 |   | 23 | % |

 

The increase in revenuesworldwide was primarily due to an increase in electronic data capture revenuesof $7.3 million, as well as increases in clinical data management, interactiveresponse technology and safety revenues. The increase in U.S. revenues isprimarily due to an increase in electronic data capture of $5.6 million, aswell as increases in interactive response technology ,safety and clinical datamanagement revenues of $338,000, $149,000 and $76,000, respectively. Theincrease in international revenues is primarily due to an increase inelectronic data capture and clinical data management revenues of $1.7 million and$269,000, respectively, partially offset by a decrease in safety revenues of$49,000.

 

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*Cost ofRevenues*

 
| ** **                     | ** ** | **Three Months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|--------------------------------|------------|----------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                     | ** ** | **2007**                                                 | ** ** | **2008**                                  | ** ** | **Change** | ** ** |
| **Cost of Revenues** | ** ** | **Amount**                                               | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                     | ** ** | **(in thousands)**                                  | ** ** |
| License                        |       | $                                                        | 552        |                                      | 4          | %          | $          | 838 |   | 6 | % | $ | 286 |   | 52 | % |
| Services                       |       | 13,561                                                   |       | 62                                        |       | 17,686     |       | 59 |   | 4,125 |   | 30 |   |
| Total                          |       | $                                                        | 14,113     |                                      | 40         | %          | $          | 18,524 |   | 43 | % | $ | 4,411 |   | 31 | % |

 

Thecost of license revenues increased in the three months ended September 30,2008 primarily due to a $237,000 increase in amortization of intangibleassets, of which $172,000 relates to the acquisition of Clarix.  The increase in cost of services in the threemonths ended September 30, 2008 was due primarily to increases in salaryand benefits and outside contractor expense of $1.9 million and $955,000,respectively, primarily relating to a headcount increase of 126 people, ofwhich 66 came from the Clarix acquisition. Other increases include depreciation and stock-based compensationexpense of $414,000 and $334,000, respectively. In addition, we had increases in hosting fees, computer fees and passthrough expenses of $285,000, $167,000 and $100,000, respectively.  Computer-related expenses include hardwareand software support agreements as well as computer accessories.

 

*GrossMargin*

 
| ** **            | ** ** | **Three Months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|-----------------------|------------|----------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **            | ** ** | **2007**                                                 | ** ** | **2008**                                  | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                               | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                                  | ** ** |
| License               |       | $                                                        | 12,372     |                                      | 96         | %          | $          | 12,136 |   | 94 | % | $ | (236 | ) | (2 | )% |
| Services              |       | 8,391                                                    |       | 38                                        |       | 12,331     |       | 41 |   | 3,940 |   | 47 |   |
| Total                 |       | $                                                        | 20,763     |                                      | 60         | %          | $          | 24,467 |   | 57 | % | $ | 3,704 |   | 18 | % |

 

The net gross marginpercentage in the three months ended September 30, 2008 declined 3% fromthe three months ended September 30, 2007 primarily due to an increase of7% in the lower margin service revenues as a percentage of total revenues.  It is likely that gross margin, as apercentage of revenues, will fluctuate quarter by quarter due to the timing andmix of license and service revenues, and the type, amount and timing of servicerequired in delivering certain projects. For example, when services are performed on a time and materials basis,the timing of expense and revenue recognition is more closely aligned than whenservices are performed under bundled arrangements, where the revenues arerecognized ratably over the license period and the expenses are recognized asincurred.

 

*OperatingExpenses*

 
| ** **                  | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2007**                                                 | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                  | ** ** |
| Sales and  marketing        |       | $                                                        | 6,509      |                             | 19         | %          | $          | 7,024 |   | 16 | % | $ | 515 |   | 8 | % |
| Research and  development   |       | 5,066                                                    |       | 14                               |       | 6,424      |       | 15 |   | 1,358 |   | 27 |   |
| General and  administrative |       | 5,084                                                    |       | 15                               |       | 6,629      |       | 15 |   | 1,545 |   | 30 |   |
| Total                       |       | $                                                        | 16,659     |                             | 48         | %          | $          | 20,077 |   | 46 | % | $ | 3,418 |   | 21 | % |

 

*Salesand Marketing.*    Sales and marketingexpenses increased in the three months ended September 30, 2008 primarilydue to increases in stock-based compensation expense and employee-relatedexpenses of $193,000 and $154,000, respectively, related to a headcountincrease of 6 people.  In addition, wehad increases in amortization, travel and outside contractor expenses of$119,000, $31,000 and $25,000, respectively. We expect that our sales and marketing expense will continue to increasein absolute dollars as commission expense increases with our revenues and as wecontinue to expand sales coverage and to build brand awareness through what webelieve are the most cost effective channels available, but may fluctuate quarterover quarter due to the timing of marketing programs.

 

*Researchand Development.*    Research anddevelopment expenses increased in the three months ended September 30,2008 primarily due to an increase in employee-related expenses of $673,000related to a headcount increase of 52 people, of 

 

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which 32 came from theClarix acquisition.  We also experiencedadditional expenses related to outside contractor, stock-based compensation andrecruiting expenses of $399,000, $148,000 and $68,000, 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 and expand our product and serviceofferings.

 

*Generaland Administrative.*    General andadministrative expenses increased in the three months ended September 30,2008 primarily due to an increase in employee-related expenses and stock-basedcompensation expense of $633,000 and $482,000, respectively, primarily relatedto a headcount increase of 25 people, of which 15 came from the Clarixacquisition.  In addition, professionalfees, depreciation expense and computer fees increased $237,000, $81,000 and$68,000, respectively.  We expect that inthe future our general and administrative expenses will increase in absolutedollars as we add personnel and incur additional costs related to the growth ofour business and operations.

 

*OperatingIncome*

 
| ** **       | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **       | ** ** | **2007**                                                 | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| ** **       | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **       | ** ** | **(in thousands)**                                  | ** ** |
| Operating income |       | $                                                        | 4,104      |                             | 12         | %          | $          | 4,390 |   | 10 | % | $ | 286 |   | 7 | % |
|                  |            |                                                          |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

The increase in operatingincome in the three months ended September 30, 2008 was due to an increasein gross margin, partially offset by an increase in operating expenses.

 

*OtherIncome (Expense)*

 
| ** **               | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|--------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **               | ** ** | **2007**                                                 | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| ** **               | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **               | ** ** | **(in thousands)**                                  | ** ** |
| Other income  (expense): |       |                                                     |       |                             |       |       |       |   |   |   |   |   |   |
| Interest income          |       | $                                                        | 2,362      |                             | 7          | %          | $          | 1,483 |   | 3 | % | $ | (879 | ) | (37 | )% |
| Other expense            |       | (91                                                      | )          | —                           |       | (478       | )          | 1 |   | (387 | ) | (425 | ) |
| Total other  income      |       | $                                                        | 2,271      |                             | 7          | %          | $          | 1,005 |   | 2 | % | $ | (1,266 | ) | (56 | )% |

 

Thedecrease in interest income in the three months ended September 30, 2008was primarily due to a decrease in interest rates. The increase in otherexpense is primarily attributable to foreign exchange losses of $459,000associated with exchange rate fluctuations.

 

*Provisionfor Income Taxes*

 
| ** **                  | ** ** | **Three Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-----------------------------|------------|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2007**                                                 | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **Amount**                                               | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                  | ** ** |
| Provision for  income taxes |       | $                                                        | 657        |                             | 2          | %          | $          | 1,954 |   | 5 | % | $ | 1,297 |   | 197 | % |
|                             |            |                                                          |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

**Oureffective tax rates for the three months ended September 30, 2007 and 2008were 10% and 36%, respectively.  In the three months ended September 30,2007, our provision for taxes includes foreign and alternative minimum tax aswe utilized available U.S. net operating losses to offset our primary federalincome tax obligations resulting in an effective tax rate of 10%.  In thethree months ended September 30, 2008, our effective tax rate was lowerthan our statutory rate of 38% primarily due to the utilization of stateresearch and development tax credits.**

 

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**Overviewof Results of Operations in the Nine Months Ended September 30, 2007 and2008**

 

Total revenues increasedby 26%, or $25.4 million, in the nine months ended September 30, 2008compared to the same period in 2007 due primarily to an increase in servicerevenues of 36%.  Additionally, licenserevenues increased by 9%, or $3.2 million, in the nine months ended September 30,2008 compared to the same period in 2007.

 

Our gross marginincreased by 21% or $12.0 million in the nine months ended September 30,2008 compared to the same period in 2007, primarily due to the increase inservices revenues and the combination of additional license revenues thatgenerate a higher gross margin.

 

Operating income in thenine months ended September 30, 2008 of $13.0 million increased 24% or$2.5 million compared to the same period in 2007.  The operating income in the nine months endedSeptember 30, 2007 and 2008 also included $3.3 million and $6.0 million ofstock-based compensation expense, respectively.

 

The results in the ninemonths ended September 30, 2008 were affected by foreign exchange ratefluctuations, resulting in increases of approximately 3% and 1% in revenues andexpenses, respectively, for the period.

 

*Revenues*

 
| ** **                                           | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                   | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **2007**                                                | ** ** | **2008**                     | ** ** | **Change** | ** ** |
| **Revenues by Product Line (1)** | ** ** | **Amount**                                              | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                                           | ** ** | **(in thousands)**                                 | ** ** |
| Electronic data capture                              |       | $                                                       | 69,738     |                         | 72         | %          | $          | 93,173 |   | 77 | % | $ | 23,435 |   | 34 | % |
| Clinical data management                             |       | 15,641                                                  |       | 16                           |       | 16,999     |       | 14 |   | 1,358 |   | 9 |   |
| Safety                                               |       | 11,115                                                  |       | 12                           |       | 11,352     |       | 9 |   | 237 |   | — |   |
| Interactive response technology                      |       | —                                                  |       | —                       |       | 338        |       | — |   | 338 |   | — |   |
| Total                                                |       | $                                                       | 96,494     |                         | 100        | %          | $          | 121,862 |   | 100 | % | $ | 25,368 |   | 26 | % |

 

----

(1) Revenuesby Product Line include product license revenues and product-related servicerevenues.

 

The increase in electronic data capture revenues isprimarily due to an increase in application hosting services of $23.0 million,as well as an increase in license revenues of $2.2 million.  These increases are partially offset bydecreases in customer support and consulting services revenues of $1.5 millionand $215,000, respectively.  The increase in clinical data management canbe attributed to increases in license revenues and consulting services of$776,000 and $598,000, respectively, partially offset by a decrease in customersupport revenues of $16,000.  Theincrease in safety was primarily due to increases in customer support, licenserevenues and application hosting services revenues of $379,000, $272,000 and$266,000, respectively.  These increaseswere partially offset by a decrease in consulting services of $679,000.

 
| ** **                    | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-------------------------------|------------|---------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                    | ** ** | **2007**                                                | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| **Revenues**                  | ** ** | **Amount**                                              | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                    | ** ** | **(in thousands)**                                 | ** ** |
| License                       |       | $                                                       | 35,429     |                             | 37         | %          | $          | 38,675 |   | 32 | % | $ | 3,246 |   | 9 | % |
| Application  hosting services |       | 40,370                                                  |       | 42                               |       | 63,974     |       | 52 |   | 23,604 |   | 58 |   |
| Consulting  services          |       | 9,999                                                   |       | 10                               |       | 9,703      |       | 8 |   | (296 | ) | (3 | ) |
| Customer support              |       | 10,696                                                  |       | 11                               |       | 9,510      |       | 8 |   | (1,186 | ) | (11 | ) |
| Total                         |       | $                                                       | 96,494     |                             | 100        | %          | $          | 121,862 |   | 100 | % | $ | 25,368 |   | 26 | % |

 

Total revenues increased in the nine months endedSeptember 30, 2008 as compared to the same period in 2007, primarily due toincreases in application hosting services revenues.  The increase in revenues associated with ourapplication hosting services in the nine months ended September 30, 2008 waspartially due to an approximately 16% increase in *InForm*production trials under management from approximately 750 as of September 30,2007 to approximately 870, as of September 30, 2008, which include bothapplication hosting services trials as well as trials hosted for our *InForm* license customers. The increase in InForm production trials is primarily from customers whopurchase all trial-related services from us and who do not have a separatelicense to *InForm*, as well as an increase in theaverage fee per trial.  There were alsoapproximately 65 additional trials under management as a result of our recentacquisition of Clarix.  The increase inlicense revenues was primarily the result of additional electronic data capturerevenues, and to a lesser extent, growth in sales relating to our clinical datamanagement and safety products.  Theincrease in consulting services was primarily attributable to additionalelectronic data capture revenues.  Thedecrease in customer support revenues in the nine months ended September 30,2008 was due primarily to decreases in both training services and softwaresupport revenues related to electronic data capture, primarily *InForm*.  Thesedecreases are partially offset by increases in clinical data management softwaresupport revenues, related to our acquisition of Green Mountain in the fourthquarter of 2007. Our revenues were not significantly impacted by priceincreases or decreases.  Inflation hadonly a nominal impact on our revenues.

 

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primarily attributable toadditional electronic data capture revenues which were related to both new andexisting customers.  The decrease incustomer support revenues in the nine months ended September 30, 2008 wasdue primarily to decreases in electronic data capture revenues.  Our revenues were not significantly impactedby price increases or decreases. Inflation had only a nominal impact on our revenues.

 
| ** **                          | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-------------------------------------|------------|---------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                          | ** ** | **2007**                                                | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| **Revenues by Geography** | ** ** | **Amount**                                              | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                          | ** ** | **(in thousands)**                                 | ** ** |
| United States                       |       | $                                                       | 47,852     |                             | 50         | %          | $          | 66,812 |   | 55 | % | $ | 18,960 |   | 40 | % |
|                                |       |                                                    |       |                             |       |       |       |   |   |   |   |   |   |
| United Kingdom                      |       | 34,249                                                  |       | 35                               |       | 37,721     |       | 31 |   | 3,472 |   | 10 |   |
| France                              |       | 8,957                                                   |       | 9                                |       | 10,601     |       | 9 |   | 1,644 |   | 18 |   |
| Asia Pacific                        |       | 5,436                                                   |       | 6                                |       | 6,728      |       | 5 |   | 1,292 |   | 24 |   |
| International  subtotal             |       | 48,642                                                  |       | 50                               |       | 55,050     |       | 45 |   | 6,408 |   | 13 |   |
| Total                               |       | $                                                       | 96,494     |                             | 100        | %          | $          | 121,862 |   | 100 | % | $ | 25,368 |   | 26 | % |

 

The increase in revenuesworldwide was primarily due to an increase in electronic data capture revenuesof $23.6 million.  In addition there wasan increase in clinical data management revenues of $1.4 million, as well asincreases in interactive response technology and safety revenues totaling$421,000.  The increase in U.S. revenuesis primarily related to an increase in electronic data capture revenues of$17.9 million.  The increase ininternational revenues is primarily the result of electronic data capturerevenues of $1.8 million, as well as an increase in clinical data managementand safety revenues totaling $445,000.

 

*Costsof Revenues*

 
| ** **                      | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|---------------------------------|------------|---------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                      | ** ** | **2007**                                                | ** ** | **2008**                                  | ** ** | **Change** | ** ** |
| **Costs of Revenues** | ** ** | **Amount**                                              | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                      | ** ** | **(in thousands)**                                 | ** ** |
| License                         |       | $                                                       | 1,686      |                                      | 5          | %          | $          | 2,119 |   | 5 | % | $ | 433 |   | 26 | % |
| Services                        |       | 37,447                                                  |       | 61                                        |       | 50,405     |       | 61 |   | 12,958 |   | 35 |   |
| Total                           |       | $                                                       | 39,133     |                                      | 41         | %          | $          | 52,524 |   | 43 | % | $ | 13,391 |   | 34 | % |

 

The costs of license revenues increased in the nine monthsended September 30, 2008 primarily due to a $375,000 increasein the amortization of intangible assets, of which $172,000 relates to theacquisition of Clarix.  The increase in cost of services in the ninemonths ended September 30, 2008 was primarily due to increases inemployee-related expenses of $6.0 million, relating to a headcount increase of126 people.  In addition, outsidecontractor, depreciation expense, and stock-based compensation expense increased$3.5 million, $1.5 million and $947,000, respectively.  We also had expense increases for hosting,phone and internet and facilities expenses of $592,000, $200,000 and $180,000,respectively.

 

*GrossMargin*

 
| ** **            | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|-----------------------|------------|---------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **            | ** ** | **2007**                                                | ** ** | **2008**                                  | ** ** | **Change** | ** ** |
| **Gross Margin** | ** ** | **Amount**                                              | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **            | ** ** | **(in thousands)**                                 | ** ** |
| License               |       | $                                                       | 33,743     |                                      | 95         | %          | $          | 36,556 |   | 95 | % | $ | 2,813 |   | 8 | % |
| Services              |       | 23,618                                                  |       | 39                                        |       | 32,782     |       | 39 |   | 9,164 |   | 39 |   |
| Total                 |       | $                                                       | 57,361     |                                      | 59         | %          | $          | 69,338 |   | 57 | % | $ | 11,977 |   | 21 | % |

 

The overall net grossmargin decreased 2% in the nine months ended September 30, 2008 due to thedecline in higher margin license revenues as a percentage of total revenues.

 

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*Operating Expenses*

 
| ** **                  | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2007**                                                | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| **Operating Expenses** | ** ** | **Amount**                                              | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                 | ** ** |
| Sales  and marketing        |       | $                                                       | 17,731     |                             | 18         | %          | $          | 19,958 |   | 16 | % | $ | 2,227 |   | 13 | % |
| Research  and development   |       | 14,620                                                  |       | 15                               |       | 18,003     |       | 15 |   | 3,383 |   | 23 |   |
| General  and administrative |       | 14,509                                                  |       | 15                               |       | 18,374     |       | 15 |   | 3,865 |   | 27 |   |
| Total                       |       | $                                                       | 46,860     |                             | 48         | %          | $          | 56,335 |   | 46 | % | $ | 9,475 |   | 20 | % |

 

*Sales andMarketing.*    Sales andmarketing expenses increased in the nine months ended September 30, 2008primarily due to a $904,000 increase in commission expense due to an increasein revenues, as well as increases in employee-related expenses and stock-basedcompensation expense of $577,000 and $505,000. We also experienced increases in marketing programs which includeproduct marketing expenses such as trade shows, workshops and seminars,amortization of acquired technologies associated with the acquisition of Clarixand travel expenses of $71,000, $64,000 and $55,000, respectively.  

 

*Researchand Development.*    Research anddevelopment expenses increased in the nine months ended September 30, 2008primarily due to employee-related expenses of $1.7 million related to aheadcount increase of 52 people.  Inaddition, outside contractor, stock-based compensation and recruiting expensesincreased $815,000, $416,000 and $164,000 respectively.  Further, there were increases in travel anddepreciation expense of $84,000 and $77,000, respectively.

 

*Generaland Administrative.*    General andadministrative expenses increased in the nine months ended September 30,2008 primarily due to an increase in employee-related expenses of $1.5 millionrelated to a headcount increase of 25 people. Further, stock-based compensation,depreciation and professional expenses increased $829,000, $571,000 and $409,000, respectively.  Additionally, we experienced expenseincreases in computer-related expense, recruiting fees and travel expenses of$177,000, $95,000 and $74,000, respectively.

 

*OperatingIncome*

 
| ** **       | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|------------------|------------|---------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **       | ** ** | **2007**                                                | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| ** **       | ** ** | **Amount**                                              | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenue** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **       | ** ** | **(in thousands)**                                 | ** ** |
| Operating income |       | $                                                       | 10,501     |                             | 11         | %          | $          | 13,003 |   | 11 | % | $ | 2,502 |   | 24 | % |
|                  |            |                                                         |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

The increase in operatingincome in the nine months ended September 30, 2008 was due to an increasein gross margin, partially offset by an increase in operating expenses.

 

*OtherIncome (Expense)*

 
| ** **               | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|--------------------------|------------|---------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **               | ** ** | **2007**                                                | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| ** **               | ** ** | **Amount**                                              | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **               | ** ** | **(in thousands)**                                 | ** ** |
| Other income  (expense): |       |                                                    |       |                             |       |       |       |   |   |   |   |   |   |
| Interest income          |       | $                                                       | 4,758      |                             | 5          | %          | $          | 4,770 |   | 4 | % | $ | 12 |   | — | % |
| Other expense            |       | (153                                                    | )          | —                           |       | (229       | )          | — |   | (76 | ) | 50 |   |
| Total other  income      |       | $                                                       | 4,605      |                             | 5          | %          | $          | 4,541 |   | 4 | % | $ | (64 | ) | (1 | )% |

 

Interest income increasedin the nine months ended September 30, 2008 primarily due to increases in cashequivalents available for investment and marketable securities offset by adecrease in interest rates. The increase in other expense is primarilyattributable to foreign exchange losses associated with exchange rate fluctuations.

 

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*Provisionfor Income Taxes*

 
| ** **                  | ** ** | **Nine Months Ended September 30,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-----------------------------|------------|---------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                  | ** ** | **2007**                                                | ** ** | **2008**                         | ** ** | **Change** | ** ** |
| ** **                  | ** ** | **Amount**                                              | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
| ** **                  | ** ** | **(in thousands)**                                 | ** ** |
| Provision for  income taxes |       | $                                                       | 1,579      |                             | 2          | %          | $          | 6,407 |   | 5 | % | $ | 4,828 |   | 306 | % |
|                             |            |                                                         |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

Our effective tax ratesfor the nine months ended September 30, 2007 and 2008 were 10% and 37%,respectively.  In the nine months ended September 30, 2007, ourprovision for taxes includes foreign and alternative minimum tax as we utilizedavailable U.S. net operating losses to offset our primary federal obligationsresulting in an effective tax rate of 10%.  In the nine months ended September 30,2008, our effective tax rate was lower than our statutory rate of 38% primarilydue to the utilization of state research and development tax credits.

 

**Liquidityand Capital Resources**

 

Our principal sources ofliquidity were unrestricted cash, cash equivalents, short-term and long-terminvestments totaling $182.6 million and $178.1 million at December 31,2007 and September 30, 2008, respectively, and accounts receivable of$35.5 million and $34.6 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 $50.7 million in the nine months ended September 30,2008, which was greater than net income of $11.1 million.  This difference was primarily due to anincrease in deferred revenue of $17.3 million, non-cash depreciation andamortization expense of $7.1 million and non-cash stock-based compensationexpense of $6.0 million.  In addition,over the same period there was $5.7 million of deferred income tax expense andan increase in accounts payable of $3.8 million.  These increases are partially offset bydecreases in deferred set up costs and accounts receivable and acquired futurebillings of $1.5 million and $502,000, respectively.

 

Net cash used ininvesting activities was $49.0 million in the nine months ended September 30,2008, which was primarily due to the purchase of short-term and long-terminvestments of $45.9 million, the acquisition of Clarix for $40.9 million,capital expenditures of $11.1 million and an increase in restricted cashassociated with our leases of $1.5 million. These decreases in cash were partially offset by $50.3 million ofproceeds from maturities of short-term and long-term investments.

 

Net cash providedby financing activities was $548,000 in the nine months ended September 30,2008, consisting of proceeds from the exercise of stock options of $1.8million, partially offset by the payment of withholding taxes associated withthe vesting of restricted stock awards of $1.2 million.

 

Substantially all of ourlong-lived assets at December 31, 2007 and September 30, 2008 arelocated in the United States.

 

We generally do not enterinto long-term binding purchase commitments. Our principal commitments consist of obligations under non-cancelableoperating leases for office space.

 

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:

 

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| ** **                       | ** ** | **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 |   | $ | 38,341 |   |
| Total                            |       | $                                         | 7,872      |   | $ | 3,902 |   | $ | 2,779 |   | $ | 1,153 |   | $ | 38,341 |   |

 

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 the rental of 165,129 rentablesquare feet of space and has an initial term of 10 years and three months. Wecan, subject to certain conditions, extend this term by exercising up to twoconsecutive five year options. We are not required to pay any rent for thefirst three months of the initial Lease term. Thereafter, the annual rent on the Lease for years one through five willbe $6.6 million, or approximately $548,000 per month.  For years six through ten, the annual rentwill be $7.2 million, or approximately $603,000 per month.  The total base rent payable in the initialterm is $69.1 million.

 

As of December 31, 2007, we had a working capitalline of credit with a bank under which we could borrow up to $2.0 million, ofwhich $1.5 million was available and $500,000 reserved under a letter of creditassociated with our leased facility. The line of credit expired on March 31,2008, and was not renewed.  As of September 30,2008, the $500,000 collateral obligation for our leased facility was secured bya certificate of deposit.

 

Inconnection with the signing of the Lease, we deposited with the Landlord anunconditional, irrevocable letter of credit in the Landlord’s favor in theamount of $962,000 secured by a certificate of deposit.

 

At December 31,2007, we had $54.8 million of net operating loss carryforwards that may be usedto offset future U.S. federal taxable income.  These attributes may reduceour future cash tax liability.  In addition, we had $15.6 million of netoperating losses resulting from excess tax deductions related to stock-basedcompensation expense.  We will realize the benefit of these excess taxdeductions through increases to stockholders’ equity in the periods in whichthe losses are utilized to reduce tax payments.  In addition, we had $1.7million of federal research and development tax credit carryforwards that maybe utilized to offset future U.S. taxes.  The net operating loss and taxcredit carryforward periods extend through 2026 and 2027, respectively. In addition, we had $3.6 million of foreign net operating loss carryforwardsthat may be used to offset future foreign taxable income. These foreign netoperating loss carryforwards have an unlimited carryforward period. We also had$3.1 million of research and development tax credit carryforwards that may beutilized to offset future Massachusetts state taxable income.  TheMassachusetts tax credit carryforward period extends through 2022.  Thefederal and state net operating loss carryforwards and research and developmenttax credits are subject to review and possible adjustment by the taxingauthorities.  Also, the Internal Revenue Code contains provisions that maylimit the net operating loss and tax credit carryforwards available in anygiven year in the event of certain changes in the ownership interests ofsignificant stockholders.  We currently expect to realize the benefit ofrecorded deferred tax assets as of September 30, 2008 of $21.4 million. Our conclusion that such assets will be recovered is based upon ourexpectation that our future earnings combined with tax planning strategiesavailable to us will provide sufficient taxable income to realize recorded taxassets.

 

We may be required tomake cash outlays related to our unrecognized 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, unrecognized tax benefits of $1.2 million as ofDecember 31, 2007 have been excluded from the contractual obligationstable above.  For further information on unrecognized tax benefits, seeNote 7 in the notes to our 2007 consolidated financial statements included inour Annual Report on Form 10-K for the year ended December 31, 2007filed with the SEC.

 

We believe our existingunrestricted cash, cash equivalents, short-term investments and cash providedby operating activities will be sufficient to meet our working capital andcapital expenditure needs over at least the next 12 months. Our futurecapital requirements will depend on many factors, including our rate of revenuegrowth, the expansion of our marketing and sales activities, the timing and extentof spending to support product development efforts, the timing of introductionsof new products and services and enhancements to existing products and servicesand the continuing market acceptance of our products and services.  From time to time, we may also enter intoagreements with respect to potential investments in, or acquisitions of,businesses, services or technologies, which could also require us to seekadditional equity

 

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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 September 30, 2008 were $24.1 million of auctionrate securities (“ARS”) at par value, which are classified asavailable-for-sale securities and non-current 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 thefair value of these ARS at September 30, 2008 was $22.8 million, a declineof $1.3 million from par value. Fair value was determined using a discountedcash flow model as recent auctions of these securities were not successful,resulting in our continuing to hold these securities and issuers payinginterest at the maximum contractual rate. This valuation technique considers the complexity and transparency ofthe structure of each ARS and cash flows within each structure; the quality ofthe collateral; and liquidity determinants affecting each ARS.  The decline in fair value is deemed temporaryas we believe the decline in fair value of these investments is due to currentmarket conditions as well as the fact that we have the ability and intent tohold these securities until market conditions improve. Accordingly, we recordedan unrealized loss on these securities of $1.3 million in other comprehensiveincome.  Depending on future marketconditions, the ARS may result in future fair value adjustments.   If in the future we determine that anydecline in value of the ARS is other-than-temporary, we would be required torecognize the loss in our statement of income, which could have a materialimpact on our operating results in the period it is recognized.

 

In October 2008, we received an offer (the “Offer”) from UBS AG (“UBS”).  As a UBS client who holds ARS, if we acceptthe Offer we will receive certain rights, which will entitle us to sell ARS toUSB affiliates during the period from June 30, 2010 to July 2, 2012for a price equal to par value.  Inexchange for the issuance of the ARS Rights, the UBS affiliates will have thediscretionary right to sell our eligible ARS on our behalf, without priornotification, at any time before the expiration of the related ARS Right, solong as we receive par value for the sold ARS. The Offer is non-transferableand expires on November 14, 2008. We are currently evaluating the Offer and its potential financialstatement impact.

 

We believe that, based onour unrestricted cash, cash equivalents and short-term investment balances of$155.3 million at September 30, 2008, excluding fair market value of ARSof $22.8 million, the current lack of liquidity in the credit and capitalmarkets will not have a material impact on our liquidity, cash flow or theability to fund our operations.

 

**Recently Issued AccountingPronouncements**

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), *Business Combinations.* SFAS No. 141(R) retains thefundamental requirements in SFAS No. 141 that the acquisition methodof accounting (which SFAS No. 141 called the “purchase method”) be usedfor all business combinations and for an acquirer to be identified for eachbusiness combination. SFAS No. 141(R) requires an acquirer torecognize the assets acquired, the liabilities assumed, and any noncontrollinginterest in the acquiree at the acquisition date, measured at their fair valuesas 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 nowrequire acquisition costs to be expensed as incurred, restructuring costsassociated with a business combination must generally be expensed prior to theacquisition date and changes in deferred tax asset valuation allowances andincome tax uncertainties after the acquisition date generally will affectincome tax expense. 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 FASBissued SFAS No. 161,*Disclosures aboutDerivative Instruments and Hedging Activities 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

 

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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.

 

In May 2008, theFASB issued SFAS No. 162, *The Hierarchy of GenerallyAccepted Accounting Principles* (“SFAS No. 162”). SFAS No. 162identifies the sources of generally accepted accounting principles in the UnitedStates and prioritizes the generally accepted accounting principles thereunder.SFAS No. 162 is effective sixty days following the SEC’s approval of thePublic Company Accounting Oversight Board amendments to AU Section 411, *The Meaning of Present Fairly in Conformity With Generally AcceptedAccounting Principles*. The adoption of SFAS No. 162 is notexpected to have a material effect on our consolidated financial position andresults of operations.

 

**Off-Balance Sheet Arrangements**

 

We do not have any specialpurpose entities or off-balance sheet arrangements.

 

**Item 3. *Quantitative and Qualitative Disclosures about Market Risk***

 

*Foreign Currency 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.  In the ninemonths ended September 30, 2007 and 2008, 50% and 45%, respectively, ofour revenues were generated in locations outside the United States.  For the three and nine months ending September 30,2008, approximately 30% and 32%, of revenues are in currencies other than theU.S. dollar.  Except for revenuetransactions in Japan, we enter into transactions directly with substantiallyall of our foreign customers. This creates a foreign currency exchange risk forus.

 

As of September 30,2008, we had $7.9 million of receivables denominated in currencies other thanthe U.S. dollar.  We also maintain cashaccounts denominated in currencies other than the local currency which exposeus to foreign exchange rate movements.

 

Inaddition, although our foreign subsidiaries have intercompany accounts thateliminate upon consolidation, such accounts expose us to foreign currency ratemovements. Exchange rate fluctuations on short-term intercompany accounts arerecorded in our consolidated statements of operations under “other income(expense)”, while exchange rate fluctuations on long-term intercompany accountsare recorded in our consolidated balance sheets under “accumulated othercomprehensive loss” in stockholders’ equity, as they are considered part of ournet investment and hence 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 purchase short-term foreign currency forward contracts, designed tohedge fluctuation in the non-functional currencies of the Company and its subsidiariesagainst the U.S. dollar. This process is designed to minimize foreign currencytranslation exposures that could otherwise affect consolidated results ofoperations. The terms of these contracts are for periods generally for onemonth. The short-term nature of these contracts has resulted in theseinstruments having insignificant fair values at September 30, 2008.

 

Currently, our largest foreign currency exposure is theeuro.  Relative to foreign currencyexposures existing at December 31, 2007 and September 30, 2008, a 10%unfavorable movement in foreign currency exchange rates may expose us tosignificant losses in earnings or cash flows or significantly diminish the fairvalue of our foreign currency financial instruments. The calculation assumesthat each exchange rate would change in the same direction relative to the U.S.dollar.

 

As of September 30,2007 and 2008,  we entered into contractsto hedge approximately $1.2 million and $1.7 million, respectively, ofreceivables, intercompany accounts and cash balances denominated in currenciesother than the U.S. dollar.

 

*InterestRate Sensitivity*

 

We had unrestricted cash,cash equivalents, short-term and long-term investments totaling $178.1 millionat September 30, 2008.  Investmentsin securities are invested primarily in high quality securities of a shortduration and are not materially affected by fluctuations in interest rates. Thecash and cash equivalents are held for working capital purposes.

 

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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 September 30,2008, we held auction rate securities (“ARS”) totaling $24.1 million at parvalue, which are classified as available-for-sale securities and non-currentassets 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 thefair value of these ARS at September 30, 2008 was $22.8 million, a declineof $1.3 million from par value. Fair value was determined using a trinomialdiscount model as recent auctions of these securities were not successful,resulting in us continuing to hold these securities and issuers paying interestat the estimated maximum contractual rate. This valuation technique considers the complexity and transparency ofthe structure of each ARS and cash flows within each structure; the quality ofthe collateral; and liquidity determinants affecting each ARS.  The decline in fair value is deemed temporaryas we believe the decline in fair value of these investments is due to generalmarket conditions. Accordingly, we have recorded a temporary impairment onthese securities of $1.3 million in other comprehensive income.  Depending on future market conditions, the ARSmay result in future fair market value adjustments.   If in the future we determine that anydecline in value of the ARS is other-than-temporary, we would be required torecognize the loss in our statement of income, which could have a materialimpact on our operating results in the period it is recognized.

 

We believe that, based onour unrestricted cash, cash equivalents and short-term marketable securitiesbalances of $155.3 million at September 30, 2008, excluding fair marketvalue of ARS of $22.8 million, the current lack of liquidity in the credit andcapital markets will not have a material impact on our liquidity, cash flow orour ability to fund our operations.

 

**Item 4. *Controls and Procedures***

** **

We maintain disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in our Securities Exchange Act reports is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives, as ours are designed to do, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship ofpossible controls and procedures.

 

As of September 30,2008, we carried out an evaluation, under the supervision and with theparticipation of our management, including our Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofour 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.

 

There have been nochanges in our internal control over financial reporting that occurred duringthe period covered by this report that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

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**Part II—Other Information**

** **

**Item 1. *Legal Proceedings***

 

From time to time and inthe ordinary course of business, we are subject to various claims, charges andlitigation.  The outcome of litigationcannot be predicted with certainty and some lawsuits, claims or proceedings maybe disposed of unfavorably to us, which could materially affect our financialcondition or results of operations.

 

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

 

**Certain Factors Which May Affect Future Results**

** **

*Fromtime to time we update, revise and supplement the risk factors described underthe title “Risk Factors” in our Annual Report on Form 10-K for the yearended December 31, 2007.  Exceptwith respect to certain changes in the risk factors set forth below, which havebeen updated to reflect recent market events, there are no material changes tothe risk factors described in the “Risk Factors” section in our Annual Reporton Form 10-K for the year ended December 31, 2007.*

* *

*Weoperate in a rapidly changing environment that involves a number of risks, someof which are beyond our control.  The risks and uncertainties that webelieve are most important for you to consider are described under the title “RiskFactors” in our Annual Report on Form 10-K for the year ended December 31,2007.  Additional risks and uncertainties not presently known to us, whichwe currently deem immaterial or which are similar to those faced by othercompanies in our industry or business in general, may also impair our businessoperations.  If any of the foregoing risks or uncertainties actuallyoccurs, our business, financial condition and operating results would likelysuffer.*

* *

***We depend primarily on the pharmaceutical, biotechnology andmedical device industries and are therefore subject to risks relating to changesin these industries.***

 

Our business depends onthe clinical trial, post-approval and safety evaluation and monitoringactivities conducted or sponsored by pharmaceutical, biotechnology and medicaldevice companies and other entities engaged in these activities. Generaleconomic downturns, increased consolidation or decreased competition in theindustries in which these companies operate could result in fewer productsunder development or decreased pressure to accelerate product approval which,in turn, could materially adversely impact our revenues. Recent disruptions inthe world credit and equity markets as well as the related failures of severallarge financial institutions may also result in a global downturn in spendingon clinical trial, post-approval and safety evaluation and monitoringactivities.  Any significant downturn indemand and spending for such solutions could lead to increased pressure on usto reduce prices or offer reduced services, and could adversely affect our business,results of operations, and financial condition. The adverse effects of any sustained downturn in such spending on ouroperating results may be exacerbated by our research and developmentinvestments, strategic investments and merger and acquisition activity, as wellas customer service and support, which may continue despite any such downturn.Our operating results may also be adversely impacted by other developments thataffect these industries generally, including:

 

·the discovery of safety issues with approved productsor products in clinical development;

 

·changes in the purchasing patterns of entitiesconducting clinical research and monitoring safety;

 

·changes in government regulation;

 

·changes in general business conditions;

 

·the assertion of product liability claims;

 

·changes in governmental price controls or third-partyreimbursement practices; and

 

·changes in medical practices.

 

Any decrease in researchand development expenditures or in the size, scope or frequency of clinicaltrial, post approval and safety evaluation and monitoring activities conductedor sponsored by pharmaceutical, biotechnology or medical device companies orother entities as a result of the foregoing or other factors could materiallyadversely affect our operations or financial condition.

*** ***

***We may not be able to obtain capital when desired onfavorable terms, if at all, or without dilution to our stockholders.***

 

We anticipate that ourcurrent cash and cash equivalents will be sufficient to meet our current needsfor general corporate purposes for at least the next twelve months. However, wemay need or desire additional financing to execute on our current or futurebusiness strategies, including to:

 

·develop new or enhance existing software products,services and hosted solutions;

 

·enhance our operating infrastructure;

 

·acquire businesses or technologies; or

 

·otherwise respond to competitive pressures.

 

If we raise additionalfunds through the issuance of equity or convertible debt securities, thepercentage ownership of our stockholders could be significantly diluted, andthese newly issued securities may have rights, preferences or privileges seniorto those of existing stockholders. If we incur additional debt financing, asubstantial portion of our operating cash flow may be dedicated to the paymentof principal and interest on such indebtedness, thus limiting funds availablefor our business activities. We cannot assure you that additional financingwill be available on terms favorable to us, or at all.  In this regard, the availability of suchfinancing may be adversely impacted by current economic conditions, includingthe effects of the recent disruptions to the credit and financial markets inthe U.S. and worldwide.If adequate funds are not available or are not available on acceptableterms, when we desire them, our ability to fund our operations, take advantageof unanticipated opportunities, develop or enhance our software products,services and hosted solutions, or otherwise respond to competitive pressureswould be significantly limited.

 

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***The market price and trading volume of our common stock maybe volatile, which could result in substantial losses for investors purchasingshares in the public markets and subject us to securities class actionlitigation. The current market price of our common stock may not be indicativeof future market prices and we may be unable to sustain or increase the valueof an investment in our common stock.***

 

The stock market ingeneral, and the NASDAQ global market and the market for securities ofsoftware, technology and health care companies, in particular, have recentlyexperienced extreme price and volume fluctuations that may have been unrelatedor disproportionate to the operating performance of such companies.  In recent weeks, the volatility and disruptionhave reached unprecedented levels.  Thetrading price of our common stock may fluctuate significantly and, accordingly,may not be indicative of future trading prices and we may be unable to sustainor increase the value of an investment in our common stock.These price fluctuations may be rapid andsevere and may leave investors with little time to reaction.  Broad market and industry factors mayseriously harm the market price of our common stock, regardless of ouroperating performance.Some of the factors that may cause the market price of our common stockto fluctuate include:

 

·changes in estimates of our financial results orrecommendations by securities analysts;

 

·financial results that are below estimate of suchresults;

 

·sales or transfers of large blocks of stock byexisting investors;

 

·investors’ general perception of us;

 

·changes in general economic, industry and marketconditions;

 

·period-to-period fluctuations in our financial resultsor those of companies that are perceived to be similar to us;

 

·changes in market valuations of similar companies;

 

·announcements by us or our competitors of significantproducts, contracts, acquisitions or strategic alliances;

 

·future issuances of securities or the incurrence of debtby us, or other changes in our capital structure;

 

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·success of competitive products and technologies;

 

·the failure of any of our software products, servicesand hosted solutions to achieve or maintain commercial success;

 

·regulatory developments in the United States andforeign countries;

 

·changes in industry analyst recommendations;

 

·additions or departures of key personnel; and

 

·litigation involving our company or our generalindustry or both.

 

In addition, if themarket for software, technology or health care stocks or the stock market ingeneral experiences a loss of investor confidence, the trading price of ourcommon stock could decline for reasons unrelated to our business, operatingresults or financial condition. If any of the foregoing occurs, it could causeour stock price to fall and may expose us to class action lawsuits that, evenif unsuccessful, could be costly to defend and a distraction to management.

 

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

 

Underthe terms of our 2004 Stock Option and Incentive Plan, or 2004 Plan, we haveissued shares of restricted stock to our employees. On the date that theserestricted shares vest, we withhold, via a net exercise provision pursuant toour applicable restricted stock agreements and the 2004 Plan, the number ofvested shares (based on the closing price of our common stock on such vestingdate) equal to tax withholdings required by us. The shares withheld from thegrantees to settle their tax liability are reallocated to the number of sharesavailable for issuance under the 2004 Plan. For the nine-month period ending September 30,2008, we withheld an aggregate of 74,961 common shares under restrictedstock awards at a price of $16.65 per share.

 

**Item 5. *Other Information***

 

Our policy governingtransactions in our securities by directors, officers and employees permits ourofficers, directors and certain other persons to enter into trading planscomplying with Rule 10b5-1 under the Securities Exchange Act of 1934, asamended. We have been advised that our Senior Vice President and GeneralCounsel, D. Ari Buchler; our Vice President, Corporate Development, MartinYoung; our Vice President, Quality and Regulatory Compliance, Michael P.Owings; our Senior Vice President, Steven Rosenberg; our Senior Vice President,Worldwide Sales, Stephen J. Powell; and our Senior Vice President and ChiefFinancial Officer, Rodger Weismann****have eachentered into a trading plan covering periods after the date of this QuarterlyReport in accordance with Rule 10b5-1 and our policy governingtransactions in our securities. Generally, under these trading plans, the individual relinquishescontrol over the transactions once the trading plan is put into place.  Accordingly, sales under these plans mayoccur at any time, including possibly before, simultaneously with, orimmediately after significant events involving our company.

 

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**Item 6.*****Exhibits*.**

 
| **Exhibit** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                      |
|-------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                 |
| 2.1         |       |       | Unit Purchase Agreement  by and among Clarix LLC, the Member Representative (as defined therein), the  Selling Interest Holders listed therein and Phase Forward Incorporated, dated  as of September 5, 2008 (Incorporated by reference herein to the  exhibits to the Company’s Current Report on Form 8-K on (File 000-50839) |
| 10.1        | +          |       | Form of Management  Retention Agreement (Incorporated by reference herein to the exhibits to the  Company’s Current Report on Form 8-K on (File 000-50839))                                                                                                                                                                      |
| 10.2        | +          |       | Form of Management  Retention Agreement (Incorporated by reference herein to the exhibits to the  Current Report on Form 8-K on (File 000-50839))                                                                                                                                                                                     |
| 10.3        | +          |       | Form of Phase  Forward Incorporated Restricted Stock Unit Award Agreement for Clarix  Founders (Incorporated by reference herein to the exhibits to the Company’s  Registration Statement on Form S-8 (File No. 333-153335))                                                                                           |
| 10.4        | +          |       | Form of Phase  Forward Incorporated Restricted Stock Unit Award Agreement for Clarix  Employees (Incorporated by reference herein to the exhibits to the Company’s  Registration Statement on Form S-8 (File No. 333-153335))                                                                                               |
| 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 anycompensatory plan, contract or arrangement.

*                           Filed herewith.

 

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**Signatures**

** **

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly 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: November 10,  2008 |                            |

 

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** ** | ** **                                                                                                                                                                                                                                                                                                                                      |
|-------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                 |
| 2.1         |       |       | Unit Purchase Agreement by and among Clarix LLC, the  Member Representative (as defined therein), the Selling Interest Holders  listed therein and Phase Forward Incorporated, dated as of September 5,  2008 (Incorporated by reference herein to the exhibits to the Company’s  Current Report on Form 8-K on (File 000-50839) |
| 10.1        | +          |       | Form of Management Retention Agreement  (Incorporated by reference herein to the exhibits to the Company’s Current  Report on Form 8-K on (File 000-50839))                                                                                                                                                                      |
| 10.2        | +          |       | Form of Management Retention Agreement  (Incorporated by reference herein to the exhibits to the Current Report on  Form 8-K on (File 000-50839))                                                                                                                                                                                     |
| 10.3        | +          |       | Form of Phase Forward Incorporated Restricted  Stock Unit Award Agreement for Clarix Founders (Incorporated by  reference herein to the exhibits to the Company’s Registration Statement on  Form S-8 (File No. 333-153335))                                                                                           |
| 10.4        | +          |       | Form of Phase Forward Incorporated Restricted  Stock Unit Award Agreement for Clarix Employees (Incorporated by reference  herein to the exhibits to the Company’s Registration Statement on  Form S-8 (File No. 333-153335))                                                                                               |
| 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 anycompensatory plan, contract or arrangement.

*                           Filed herewith.

 

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