Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**

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

 

**For the quarterly period ended March 31,2010**

 

**OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|----------------------------------------------------------------------------------------------------------|

 

**For the transition period from                    to                    **

 

**CommissionFile Number: 000-50839**

 

**Phase Forward Incorporated**

(Exact name of registrant asspecified in its charter)

 

| **Delaware**                              | ** ** | **04-3386549**      |
|-------------------------------------------|------------|---------------------|
| (State or other  jurisdiction of          |       | (I.R.S. Employer    |
| incorporation or  organization)           |       | Identification No.) |
|                                      |       |                |
| **77 Fourth  Avenue**                     | ** ** | ** **          |
| **Waltham, Massachusetts**                | ** ** | **02451**           |
| (Address of principal  executive offices) |       | (Zip Code)          |

 

**(888)703-1122**

(Registrant’s telephone number, includingarea code)

 

Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o  No o

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, a non-accelerated filer or a smallerreporting company.  See the definitionsof “large accelerated filer”, “accelerated filer”, and “smaller reportingcompany” in Rule 12b-2 of the Exchange Act.  (Check one):

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

 

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

 

As of April 26, 2010, the registrant had43,744,864 shares of common stock outstanding.

 

 

 

----

Table of Contents

 

**PHASEFORWARD INCORPORATED**

**QUARTERLYREPORT ON FORM 10-Q**

**Forthe quarterly period ended March 31, 2010**

**Table of Contents**

 
| ** **                                  | ** **                                                                                                                                       | **Page  Number** |
|---------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|------------------|
| **Part I—Financial  Information** |                                                                                                                                             |
|                                        |                                                                                                                                             |             |
| Item  1.                                    | Condensed  Consolidated Balance Sheets as of December 31, 2009 (unaudited) and  March 31, 2010 (unaudited)                             | 3                |
|                                        |                                                                                                                                             |             |
|                                        | Condensed Consolidated Statements of Income for the  three months ended March 31, 2009 (unaudited) and March 31, 2010  (unaudited)     | 4                |
|                                        |                                                                                                                                             |             |
|                                        | Condensed Consolidated Statements of Cash Flows for  the three months ended March 31, 2009 (unaudited) and March 31,  2010 (unaudited) | 5                |
|                                        |                                                                                                                                             |             |
|                                        | Notes to Condensed Consolidated Financial Statements  (unaudited)                                                                                | 6                |
|                                        |                                                                                                                                             |             |
| Item  2.                                    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                      | 19               |
|                                        |                                                                                                                                             |             |
| Item  3.                                    | Quantitative and Qualitative Disclosures about Market  Risk                                                                                      | 33               |
|                                        |                                                                                                                                             |             |
| Item 4.                                     | Controls  and Procedures                                                                                                                         | 35               |
|                                        |                                                                                                                                             |             |
| **Part II—Other  Information**    |                                                                                                                                             |
|                                        |                                                                                                                                             |             |
| Item 1.                                     | Legal Proceedings                                                                                                                                | 36               |
|                                        |                                                                                                                                             |             |
| Item 1A.                                    | Risk Factors                                                                                                                                     | 36               |
|                                        |                                                                                                                                             |             |
| Item  2.                                    | Unregistered  Sale of Equity Securities and Use of Proceeds                                                                                      | 36               |
|                                        |                                                                                                                                             |             |
| Item 5.                                     | Other Information                                                                                                                                | 37               |
|                                        |                                                                                                                                             |             |
| Item 6.                                     | Exhibits                                                                                                                                         | 38               |
|                                        |                                                                                                                                             |
| Signatures                                  | 39                                                                                                                                               |
|                                        |                                                                                                                                             |
| Exhibit Index                          | 40                                                                                                                                               |

 

2

----

Table of Contents

 

**Part I—FinancialInformation**

 

**Item 1. *Condensed Consolidated Financial Statements***

 

**Phase Forward Incorporated**

**Condensed Consolidated BalanceSheets**

**(unaudited)**

**(in thousands, except pershare amounts)**

 
| ** **                                                                                        | ** ** | **December 31, 2009** | ** ** | **March 31, 2010** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------|------------|-------------------------|------------|
| **Assets**                                                                                        | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Current assets:                                                                                   |       |                       |       |                    |       |
| Cash and cash equivalents                                                                         |       | $                          | 41,862     |                    | $          | 53,290 |   |
| Short-term investments                                                                            |       | 67,241                     |       | 76,449                  |       |
| Securities settlement  agreement                                                                  |       | 4,345                      |       | 3,280                   |       |
| Accounts receivable, net of  allowance of $781 and $769, respectively                             |       | 56,034                     |       | 44,660                  |       |
| Deferred income taxes                                                                             |       | 9,521                      |       | 9,521                   |       |
| Other current assets                                                                              |       | 14,694                     |       | 15,564                  |       |
|                                                                                              |       |                       |       |                    |       |
| Total current assets                                                                              |       | 193,697                    |       | 202,764                 |       |
|                                                                                              |       |                       |       |                    |       |
| Property and equipment, net                                                                       |       | 52,840                     |       | 52,015                  |       |
| Intangible assets, net of  accumulated amortization of $7,332 and $8,782, respectively            |       | 41,661                     |       | 40,211                  |       |
| Goodwill                                                                                          |       | 59,027                     |       | 59,027                  |       |
| Deferred income taxes                                                                             |       | 5,465                      |       | 5,465                   |       |
| Restricted cash                                                                                   |       | 962                        |       | 982                     |       |
| Long-term investments                                                                             |       | 26,439                     |       | —                  |       |
| Other assets                                                                                      |       | 9,865                      |       | 9,213                   |       |
|                                                                                              |       |                       |       |                    |       |
| Total assets                                                                                      |       | $                          | 389,956    |                    | $          | 369,677 |   |
|                                                                                              |       |                       |       |                    |       |
| **Liabilities and Stockholders’  Equity**                                                    | ** ** | ** **                 | ** ** | ** **              | ** ** |
| Current liabilities:                                                                              |       |                       |       |                    |       |
| Accounts payable                                                                                  |       | $                          | 5,909      |                    | $          | 3,649 |   |
| Accrued expenses and other  current liabilities                                                   |       | 28,006                     |       | 19,136                  |       |
| Deferred revenues                                                                                 |       | 85,896                     |       | 95,394                  |       |
|                                                                                              |       |                       |       |                    |       |
| Total current liabilities                                                                         |       | 119,811                    |       | 118,179                 |       |
|                                                                                              |       |                       |       |                    |       |
| Deferred rent, net of  current portion                                                            |       | 2,115                      |       | 2,489                   |       |
| Deferred revenue, net of  current portion                                                         |       | 12,478                     |       | 15,055                  |       |
| Other long-term liabilities                                                                       |       | 10,224                     |       | 10,177                  |       |
|                                                                                              |       |                       |       |                    |       |
| Total liabilities                                                                                 |       | 144,628                    |       | 145,900                 |       |
|                                                                                              |       |                       |       |                    |       |
| Commitments and  contingencies (Note 10)                                                          |       |                       |       |                    |       |
|                                                                                              |       |                       |       |                    |       |
| **Stockholders’ equity:**                                                                    |       |                       |       |                    |       |
| Preferred stock, $0.01 par  value; 5,000 shares authorized, none issued                           |       | —                     |       | —                  |       |
| Common stock, $0.01 par  value; 100,000 shares authorized: 43,577 and 43,732 issued, respectively |       | 436                        |       | 438                     |       |
| Additional paid-in capital                                                                        |       | 296,572                    |       | 299,478                 |       |
| Treasury stock, 980 and  2,915 shares at cost, respectively                                       |       | (14,147                    | )          | (40,111                 | )          |
| Accumulated other  comprehensive income (loss)                                                    |       | 71                         |       | (357                    | )          |
| Accumulated deficit                                                                               |       | (37,604                    | )          | (35,671                 | )          |
| Total stockholders’ equity                                                                   |       | 245,328                    |       | 223,777                 |       |
|                                                                                              |       |                       |       |                    |       |
| Total liabilities and  stockholders’ equity                                                  |       | $                          | 389,956    |                    | $          | 369,677 |   |

 

See accompanyingnotes.

 

3

----

Table of Contents

 

**PhaseForward Incorporated**

**CondensedConsolidated Statements of Income**

**(unaudited)**

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

 
| ** **                                                                           | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                           | ** ** | **2009**                               | ** ** | **2010** | ** ** |
| ** **                                                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Revenues:                                                                            | ** ** | ** **                             | ** ** | ** ** | ** ** |
| License                                                                              |       | $                                      | 14,116     |   | $ | 15,141 |   |
| Service                                                                              |       | 34,700                                 |       | 42,059 |   |
| Total revenues                                                                       |       | 48,816                                 |       | 57,200 |   |
|                                                                                 |       |                                   |       |   |   |
| Costs of revenues:                                                                   |       |                                   |       |   |   |
| License (2)                                                                          |       | 566                                    |       | 566 |   |
| Service (1), (2)                                                                     |       | 19,899                                 |       | 25,716 |   |
| Total cost of revenues                                                               |       | 20,465                                 |       | 26,282 |   |
|                                                                                 |       |                                   |       |   |   |
| Gross margin:                                                                        |       |                                   |       |   |   |
| License                                                                              |       | 13,550                                 |       | 14,575 |   |
| Service                                                                              |       | 14,801                                 |       | 16,343 |   |
| Total gross margin                                                                   |       | 28,351                                 |       | 30,918 |   |
|                                                                                 |       |                                   |       |   |   |
| Operating expenses:                                                                  |       |                                   |       |   |   |
| Sales and marketing (1),  (2)                                                        |       | 7,206                                  |       | 8,986 |   |
| Research and development  (1)                                                        |       | 8,180                                  |       | 9,698 |   |
| General and administrative  (1), (2)                                                 |       | 7,804                                  |       | 9,184 |   |
| Total operating expenses                                                             |       | 23,190                                 |       | 27,868 |   |
|                                                                                 |       |                                   |       |   |   |
| Income from operations                                                               |       | 5,161                                  |       | 3,050 |   |
|                                                                                 |       |                                   |       |   |   |
| Other income:                                                                        |       |                                   |       |   |   |
| Interest income                                                                      |       | 640                                    |       | 316 |   |
| Other income (expense), net                                                          |       | 409                                    |       | (184 | ) |
| Total other income                                                                   |       | 1,049                                  |       | 132 |   |
|                                                                                 |       |                                   |       |   |   |
| Income before provision for  income taxes                                            |       | 6,210                                  |       | 3,182 |   |
| Provision for income taxes                                                           |       | 2,132                                  |       | 1,249 |   |
|                                                                                 |       |                                   |       |   |   |
| Net income                                                                           |       | $                                      | 4,078      |   | $ | 1,933 |   |
|                                                                                 |       |                                   |       |   |   |
| Net income per share  applicable to common stockholders:                             | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Basic                                                                                |       | $                                      | 0.10       |   | $ | 0.05 |   |
|                                                                                 |       |                                   |       |   |   |
| Diluted                                                                              |       | $                                      | 0.09       |   | $ | 0.05 |   |
|                                                                                 |       |                                   |       |   |   |
| Weighted average number of  common shares used in net income per share calculations: |       |                                   |       |   |   |
| Basic                                                                                |       | 42,430                                 |       | 41,085 |   |
|                                                                                 |       |                                   |       |   |   |
| Diluted                                                                              |       | 43,998                                 |       | 42,764 |   |

----

| (1) Amounts include  stock-based compensation expense, as follows:                   |   |   |   |   |   |
|-------------------------------------------------------------------------------------------|--------|--------|--------|--------|--------|
|                                                                                      |   |   |   |   |   |
| Costs of service revenues                                                                 |   | $      | 476    |   | $      | 636 |   |
| Sales and marketing                                                                       |   | 415    |   | 468    |   |
| Research and development                                                                  |   | 621    |   | 1,036  |   |
| General and administrative                                                                |   | 1,057  |   | 1,361  |   |
|                                                                                      |   |   |   |   |   |
| (2) Amounts include  amortization expense of acquired intangible assets, as follows: |   |   |   |   |   |
|                                                                                      |   |   |   |   |   |
| Costs of license revenues                                                                 |   | $      | 155    |   | $      | 237 |   |
| Cost of service revenues                                                                  |   | 261    |   | 447    |   |
| Sales and marketing                                                                       |   | 320    |   | 740    |   |
| General and administrative                                                                |   | 25     |   | 26     |   |

 

See accompanyingnotes.

 

4

----

Table of Contents

 

**PhaseForward Incorporated**

**CondensedConsolidated Statements of Cash Flows**

**(unaudited)**

**(inthousands)**

 
| ** **                                                                              | ** ** | **Three  Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                                                              | ** ** | **2009**                                | ** ** | **2010** | ** ** |
| ** **                                                                              | ** ** | ** **                              | ** ** | ** ** | ** ** |
| **Operating activities**                                                                | ** ** | ** **                              | ** ** | ** ** | ** ** |
|                                                                                    |       |                                    |       |   |   |
| Net income                                                                              |       | $                                       | 4,078      |   | $ | 1,933 |   |
|                                                                                    |       |                                    |       |   |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:      |       |                                    |       |   |   |
| Depreciation and amortization                                                           |       | 3,713                                   |       | 5,806 |   |
| Stock-based compensation expense                                                        |       | 2,569                                   |       | 3,501 |   |
| Amortization of leasehold incentive obligation                                          |       | (198                                    | )          | (247 | ) |
| Provision for allowance for doubtful accounts                                           |       | 13                                      |       | 12 |   |
| Deferred income taxes                                                                   |       | 2,444                                   |       | — |   |
| Amortization of premiums or discounts on  investments                                   |       | (3                                      | )          | 254 |   |
| Change in fair value of investments                                                     |       | (437                                    | )          | (1,112 | ) |
| Change in fair value of securities settlement  agreement                                |       | 185                                     |       | 1,065 |   |
| Changes in assets and liabilities:                                                      |       |                                    |       |   |   |
| Accounts receivable                                                                     |       | (2,210                                  | )          | 11,406 |   |
| Other assets                                                                            |       | (1,881                                  | )          | (670 | ) |
| Accounts payable                                                                        |       | (4,125                                  | )          | (2,254 | ) |
| Accrued expenses                                                                        |       | (6,715                                  | )          | (8,756 | ) |
| Deferred revenues                                                                       |       | 7,465                                   |       | 12,137 |   |
| Deferred rent                                                                           |       | 1,135                                   |       | 374 |   |
|                                                                                    |       |                                    |       |   |   |
| Net cash provided by operating activities                                               |       | 6,033                                   |       | 23,449 |   |
|                                                                                    |       |                                    |       |   |   |
| **Investing activities**                                                                | ** ** | ** **                              | ** ** | ** ** | ** ** |
|                                                                                    |       |                                    |       |   |   |
| Increase in restricted cash                                                             |       | —                                  |       | (20 | ) |
| Proceeds from maturities of short-term and  long-term investments                       |       | 12,000                                  |       | 29,125 |   |
| Purchase of short-term and long-term investments                                        |       | (9,536                                  | )          | (10,750 | ) |
| Purchase of property and equipment                                                      |       | (5,174                                  | )          | (3,049 | ) |
|                                                                                    |       |                                    |       |   |   |
| Net cash (used in) provided by investing activities                                     |       | (2,710                                  | )          | 15,306 |   |
|                                                                                    |       |                                    |       |   |   |
| **Financing activities**                                                                | ** ** | ** **                              | ** ** | ** ** | ** ** |
|                                                                                    |       |                                    |       |   |   |
| Proceeds from issuance of common stock                                                  |       | 342                                     |       | 134 |   |
| Purchase of treasury stock                                                              |       | —                                  |       | (25,964 | ) |
| Withholding taxes in connection with vesting of  restricted stock awards                |       | (459                                    | )          | (727 | ) |
|                                                                                    |       |                                    |       |   |   |
| Net cash used in financing activities                                                   |       | (117                                    | )          | (26,557 | ) |
|                                                                                    |       |                                    |       |   |   |
| Effect of exchange rate changes on cash and cash equivalents                            |       | (547                                    | )          | (770 | ) |
|                                                                                    |       |                                    |       |   |   |
| Net increase in cash and cash equivalents                                               |       | 2,659                                   |       | 11,428 |   |
| Cash and cash equivalents at beginning of period                                        |       | 131,550                                 |       | 41,862 |   |
|                                                                                    |       |                                    |       |   |   |
| Cash and cash equivalents at end of period                                              |       | 134,209                                 |       | 53,290 |   |
| Short-term and long-term investments at end of  period                                  |       | 43,891                                  |       | 76,449 |   |
| Total cash, cash equivalents and short-term and  long-term investments at end of period |       | $                                       | 178,100    |   | $ | 129,739 |   |

 

See accompanyingnotes.

 

5

----

Table of Contents

 

**Phase Forward Incorporated**

**Notes to Condensed ConsolidatedFinancial Statements**

**(unaudited)**

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

 

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

 

Theaccompanying unaudited condensed consolidated financial statements includedherein have been prepared by Phase Forward Incorporated (the “Company”)pursuant to the rules and regulations of the Securities and ExchangeCommission (“SEC”). Certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles in the United States have been condensed or omittedpursuant to such SEC rules and regulations. Management of the Companybelieves that the disclosures herein are adequate to make the informationpresented not misleading. In the opinion of management, the unaudited condensedconsolidated financial statements have been prepared on the same basis as theaudited consolidated financial statements and reflect all material adjustments(consisting only of those of a normal and recurring nature) which are necessaryto present fairly the consolidated financial position of the Company as of March 31,2010, the results of its operations for the three months ended March 31,2009 and 2010 and its cash flows for the three months ended March 31, 2009and 2010. 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, 2009. The results of operations for theinterim periods are not necessarily indicative of the results of operations tobe expected for the year ending December 31, 2010.

 

Asof March 31, 2010, the Company’s significant accounting policies andestimates, which are detailed in the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009, have not changed except for theadoption or application of the accounting pronouncements applicable forsubsequent periods as set forth in Note 16.

 

**2.****      Revenue Recognition**

 

The Companyderives revenues from software licenses and services of its IntegratedClinical Research Suite (“ICRS”) products which can be purchased on a stand-alone basis orbundled together. License revenues are derived principally from the sale ofterm licenses of its software products and service revenues are derivedprincipally from the Company’s delivery of the hosted solutions of its softwareproducts, consulting services and customer support including training, for allof the Company’s products. Revenue arrangements may include one of thesesingle elements, or may incorporate one or more elements in a single transactionor combination of related transactions. In the first quarter of 2010, theCompany adopted the guidance of Accounting Standards Update (“ASU”) No. 2009-13,*Revenue Recognition* (Topic 605): *Multiple-Deliverable Revenue Arrangements,* which wasratified by the Financial Accounting Standards Board (“FASB”) Emerging IssuesTask Force on September 23, 2009. ASU No. 2009-13 affects accountingand reporting for all multiple-deliverable arrangements.

 

ASU No. 2009-13establishes a selling price hierarchy for determining the selling price of adeliverable in a sale arrangement. The selling price for each deliverable isbased on vendor-specific objective evidence (“VSOE”) if available, third-partyevidence (“TPE”) if VSOE is not available, or estimated selling price ifneither VSOE or TPE is available. The amendments in this ASU eliminate theresidual method of allocation and require that arrangement consideration beallocated at the inception of the arrangement to all deliverables using therelative selling price method. The relative selling price method allocates anydiscount in the arrangement proportionately to each deliverable on the basis ofthe deliverable’s selling price. The Company adopted these standards in thefirst quarter of 2010, effective as of January 1, 2010 and on aprospective basis thereafter. The adoption of this standard did not materiallyaffect the results of operations for three months ended March 31, 2010.  See Note 16 for further discussion on theadoption of this standard.

 

Thecomponents of revenue are as follows:

 
| ** **                   | ** ** | **Three Months Ended  March 31,** | ** ** |
|------------------------------|------------|---------------------------------------------|------------|
| ** **                   | ** ** | **2009**                                    | ** ** | **2010** | ** ** |
| License                      |       | $                                           | 14,116     |   | $ | 15,141 |   |
| Application hosting services |       | 26,626                                      |       | 33,782 |   |
| Consulting services          |       | 4,861                                       |       | 5,207 |   |
| Customer support             |       | 3,213                                       |       | 3,070 |   |
| Total                        |       | $                                           | 48,816     |   | $ | 57,200 |   |

 

6

----

Table of Contents

 

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

 

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

 

The Company generally enters into software term licenses for itssoftware products with its customers for 1 to 5 year periods. Thesearrangements typically include multiple elements: software license, consultingservices and customer support. The Company bills its customers in accordancewith the terms of the underlying contract. Generally, the Company bills licensefees annually in advance for each year of the license term. Payment terms aregenerally net 30 days.

 

The Company’s software license revenues are earned from the sale ofoff-the-shelf software requiring no significant modification or customizationsubsequent to delivery to the customer. Consulting services, which can also beperformed by third-party consultants, are deemed to be non-essential to thefunctionality of the software and typically are for trial configuration,implementation planning, loading of software, building simple interfaces andrunning test data and documentation of procedures.

 

Customer support includes training services, telephone support andsoftware maintenance. The Company generally bundles customer support with thesoftware license for the entire term of the arrangement. As a result, theCompany generally recognizes revenues for all elements, including consultingservices, 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 remainingvalue is allocated to license and support services, with 10% of this amountallocated 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. The Company believes this rate is substantive and representsan amount it believes reasonable to be allocated. The Company has allocated theestimated fair value to its multiple element arrangements to provide meaningfuldisclosures about each of its revenue streams. The costs associated with theconsulting and customer support services are expensed as incurred. There areinstances in which the Company sells software licenses based on usage levels.These software licenses can be based on estimated usage, in which case thelicense fee charged to the customer is fixed based on this estimate. When thefee is fixed, the revenues are generally recognized ratably over thecontractual term of the arrangement. If the fee is based on actual usage, andtherefore variable, the revenues are recognized in the period of use. Revenuesfrom certain follow-on consulting services, which are sold separately tocustomers with existing software licenses and are not considered part of amultiple element arrangement, are recognized as the services are performed.

 

The Company continues to sell additional perpetual licenses forsoftware products in certain situations to existing customers with the optionto purchase customer support, and may in the future do so for new customersbased on customer requirements or market conditions. For the *Clintrial* and *Empirica Trace* products, the Company has 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 revenuesare recognized ratably over the term of the underlying support arrangement. For*Clinical Development Center*products, vendor specific objective evidence of fair value for the customersupport has not been established, and therefore, revenue for the entireagreement is recognized ratably over the term of the underlying supportagreement. The Company generates customer support and maintenance revenues fromits perpetual license customer base. Training revenues are recognized asearned.

 

Revenues resulting from *InForm *and*OutcomeLogix* application hostingservices consist of three stages for each clinical trial: the first stageinvolves application set up, including design of electronic case report formsand edit checks, installation and server configuration of the system; thesecond stage involves application hosting and related support services; and thethird stage involves services required to close out, or lock, the database forthe clinical trial. Revenues resulting from *PhaseForward IRT* and *Covance IVRS/IWRS*application hosting services also consist of three stages for each clinicaltrial: the first stage involves application set up, including design and set upfor the subject randomization and medication inventory management, installationand server configuration of the system; the second stage involves applicationhosting and related support services; and the third stage involves servicesrequired to close out, or lock, the database for the clinical trial. Servicesprovided for the *InForm, Phase Forward IRT,OutcomeLogix* and *CovanceIVRS/IWRS* products for the first and third stages are provided on afixed-fee basis based upon the complexity of the trial and

 

7

----

Table of Contents

 

systemrequirements. Services for the second stage are charged separately as a fixedmonthly fee. The Company recognizes revenues from all stages of the *InForm, Phase Forward IRT, OutcomeLogix*and *Covance IVRS/IWRS* hostingservices ratably over the hosting period. Work performed outside the originalscope of work is contracted for separately as an additional fee and isgenerally recognized ratably over the remaining term of the hosting period.Fees for the first and third stages of the service are billed based uponmilestones. Fees for application hosting and related services in the secondstage are generally billed quarterly in advance. Bundled into this revenueelement are revenues attributable to the software license used by the customer.

 

Revenues resulting from hosting services for the *Empirica Signal*, *Empirica Study* and *WebSDM* products consist of installationand server configuration, application hosting and related support services.Services for this offering are generally charged a monthly fixed fee. Revenuesare recognized ratably over the period of the service.

 

In the event that an application hosting customer cancels its relatedstatement of work, all deferred revenues are recognized. In addition, certaintermination related fees may be charged and if so, such fees are recognized inthe period of termination.

 

Provisionsfor estimated losses on uncompleted contracts are made on a contract-by-contractbasis and are recognized in the period in which such losses become probable andcan be reasonably estimated. To date, the Company has not experienced anymaterial losses on uncompleted application hosting or consulting contracts.

 

Inthe three months ended March 31, 2009 and 2010, no customer accounted for10% or more of the Company’s total revenues for the period.

 

TheCompany may also enter into arrangements to provide consulting servicesseparate from a license arrangement. In these situations, revenue is recognizedon either a time-and-materials basis or using the proportional performancemethod. If the Company is not able to produce reasonably dependable estimates,revenue is recognized upon completion of the project and final acceptance from thecustomer. If significant uncertainties exist about project completion orreceipt of payment, the revenue is deferred until the uncertainty is resolved.Provisions for estimated losses on contracts are recorded during the period inwhich they are identified.

 

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

 

**Internal Use Software and WebsiteDevelopment Costs**

 

TheCompany capitalizes qualifying computer software costs which are incurredduring the application development stage, and amortizes them over the software’sestimated useful life. The Company capitalized $206 and $191 during the threemonths ended March 31, 2009 and 2010, respectively, related toCompany-wide financial systems and outside software development costsassociated with the Company’s hosting operation, of which both had certainportions that became operational in 2009 and 2010.  Capitalized amounts include software anddirect external implementation costs and are classified as “Property and Equipment,net” in the accompanying unaudited condensed consolidated balance sheets. The Company-wide financial system is being amortized over five years while theoutside software development costs associated with the Company’s hostingoperation is being amortized over three years. Amortization expense was $9 and $80 during the three months ended March 31,2009 and 2010, respectively.

 

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

 

The Company sells products in a market that issubject to rapid technological change, new product development and changingcustomer needs. Accordingly, the Company has evaluated the establishment oftechnological feasibility of its products and concluded that technologicalfeasibility is not established until the development stage of the product isnearly complete. The Company defines technological feasibility as thecompletion of a working model. The time period during which costs could becapitalized, from the point of reaching technological feasibility until thetime of general product release, is very short, and consequently, the amountsthat could be capitalized are not material to the Company’s financial positionor results of operations. Therefore, the Company has charged all such costs toresearch and development expense in the period incurred.

 

**3.      Prepaid Sales Commissions,Royalties****and Deferred Set Up Costs**

 

*Prepaid Sales Commissions.*   For arrangements where revenuesare recognized over the relevant contract period, the Company defers relatedcommissions paid to its direct sales force and amortizes them over the periodin which the related revenues are recognized.

 

*Royalty Obligations.*   For arrangementswhere revenues are recognized over the relevant contract period, the Companydefers related software license royalties paid to third parties, and amortizesthem over the period in which the related revenues are

 

8

----

Table of Contents

 

recognized. 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.

 

*Deferred Set Up Costs.*   Costs incurred for the trial system design,set up and implementation are deferred until the start of the hosting periodand are amortized and recognized ratably over the estimated hosting period. Thedeferred costs include incremental direct costs with third parties and certaininternal direct costs related to the trial and application set up. These costsinclude salary and benefits associated with direct labor costs incurred duringtrial set up, as well as third-party subcontract fees and other contract laborcosts. In the event that an application hosting customer cancels its relatedstatement of work, all deferred set up costs are expensed.

 

Prepaid salescommissions, royalty obligations and deferred set up costs are included in “othercurrent assets” and “other assets” in the accompanying unaudited condensedconsolidated balance sheets. Commissions, royalty obligations and deferred set up costs are amortizedto sales and marketing, cost of revenues and cost of services, respectively.

 

The Company deferred and amortized the following amountsfor the three months ended March 31, 2009 and 2010:

 
| ** **                | ** ** | **Deferred** | ** ** | **Amortized** | ** ** |
|---------------------------|------------|--------------|------------|---------------|------------|
| **Description**           | ** ** | **2009**     | ** ** | **2010**      | ** ** | **2009** | ** ** | **2010** | ** ** |
| Prepaid Sales Commissions |       | $            | 1,984      |          | $          | 2,325 |   | $ | 1,744 |   | $ | 2,173 |   |
| Royalty Obligations       |       | 1,089        |       | 535           |       | 661 |   | 367 |   |
| Deferred Set Up Costs     |       | 1,295        |       | 2,054         |       | 917 |   | 1,292 |   |
| Total                     |       | $            | 4,368      |          | $          | 4,914 |   | $ | 3,322 |   | $ | 3,832 |   |

 

**4.****                ****Warrantiesand Indemnification**

 

The Company’s software license arrangements and hosting services aretypically warranted to perform in a manner consistent with general industrystandards that are reasonably applicable and substantially in accordance withthe Company’s product documentation under normal use and circumstances. TheCompany’s arrangements also include certain provisions for indemnifyingcustomers against liabilities if its products or services infringe a thirdparty’s intellectual property rights.

 

TheCompany has entered into service level agreements with some of its hostedapplication customers warranting certain levels of uptime reliability andpermitting those customers to receive credits against monthly hosting fees orterminate their agreements in the event that the Company fails to meet thoselevels.

 

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

 

**5.****                ****Acquisitions**

 

From time to time the Company has expanded its product and serviceofferings through the acquisition of other businesses or technologies. The mostrecent transactions include the 2009 acquisitions of Waban Software, Inc.(“Waban”), Maaguzi LLC (“Maaguzi”), and the Interactive Voice and WebResponse Services business (“Covance IVRS/IWRS”) of Covance Inc., all ofwhich are further described below.

 

*Covance IVRS/IWRS.*   In August 2009 theCompany acquired the Interactive Voice and Web Response Services business ofCovance Inc. (“Covance IVRS/IWRS”). The aggregate purchase price was$10,000 in cash,of which $5,280 and $5,610 was recorded as goodwill and intangible assets,respectively, with all of the intangible assets consisting of customer relationships.   All of the goodwill is expected to bedeductible for income tax purposes. While the Company has existing trialsrunning on the Covance IVRS/IWRS system, no new trials or offerings will besold or implemented.

 

*Maaguzi.*   In July 2009 the Companyacquired all of the outstanding membership interests of Maaguzi LLC (“Maaguzi”),a privately-held innovative provider of a Web-based product called *OutcomeLogix*, which is an electronicpatient reported outcomes (“ePRO”) and late phase solution. The acquisition ofMaaguzi extends the Company’s ICRS and marks the Company’s entry into the ePROand observational studies markets. The aggregate purchase price was $11,000 incash, of which $6,301and $5,338 was recorded as goodwill and intangible assets, respectively. All of thegoodwill is expected to be deductible for income tax purposes.

 

*Waban.  *In April 2009 the Company acquired all of the outstandingcommon stock of Waban Software, Inc. (“Waban”), a privately-held providerof platform solutions for the automation and compliance of clinical dataanalysis and reporting. Waban’s software, which the Company has branded as *Clinical Development Center* product,provides automation, traceability and control of the key activities involved inthe integration, analysis and reporting on clinical trial data. The Companyacquired the technology of 

 

9

----

Table of Contents

 

Wabanto allow it to penetrate the market for statistical computing and clinical datarepository solutions. The aggregate purchase price was $13,764 in cash, ofwhich $7,850 and $8,905 was recorded as goodwill and intangible assets, respectively. None of thegoodwill is expected to be deductible for income tax purposes.

 

All of the assets acquired and liabilities assumed in the aboveacquisitions are recognized at their acquisition-date fair values, whiletransaction costs were expensed as incurred. The difference between the aggregate purchase price and the fair valueof assets acquired and liabilities assumed, if any, was allocated to goodwill.Acquired intangible assets were valued using the discounted cash flows andrelief-from royalty approaches. If an allocated asset becomes impaired or isabandoned, the carrying value of the related intangible asset will be writtendown to its fair value and an impairment charge will be taken in the period inwhich the impairment occurs. The acquired intangible assets are subject toreview for impairment as indicators of impairment develop and, otherwise, atleast annually. The results of each acquisition have been included in theunaudited condensed consolidated financial statements since the respectivedates of acquisition.

 

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

 

Basicnet income per common share for all periods presented was determined bydividing net income applicable to common stockholders by the weighted averagenumber of common shares outstanding during the period. Weighted average sharesoutstanding exclude unvested restricted common stock. Diluted net income pershare includes the effects of all dilutive, potentially issuable common sharesusing the treasury stock method.

 

Thecalculation of basic and diluted net income per share is as follows:

 
| ** **                                                                 | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                 | ** ** | **2009**                                    | ** ** | **2010** | ** ** |
| **Numerator:**                                                             |       |                                        |       |   |   |
| Net income                                                                 |       | $                                           | 4,078      |   | $ | 1,933 |   |
|                                                                       |       |                                        |       |   |   |
| **Denominator:**                                                           |       |                                        |       |   |   |
| Weighted-average common shares outstanding                                 |       | 43,022,458                                  |       | 41,459,557 |   |
| Less weighted-average unvested restricted common  stock awards outstanding |       | (592,150                                    | )          | (374,625 | ) |
| Basic weighted-average common shares outstanding                           |       | 42,430,308                                  |       | 41,084,932 |   |
| Dilutive effect of common stock options                                    |       | 1,071,713                                   |       | 917,886 |   |
| Dilutive effect of unvested restricted common  stock awards and units |       | 495,665                                     |       | 760,963 |   |
| Diluted weighted-average common shares outstanding                         |       | 43,997,686                                  |       | 42,763,782 |   |
|                                                                       |       |                                        |       |   |   |
| Net income per share applicable to common  stockholders:                   |       |                                        |       |   |   |
| Basic                                                                      |       | $                                           | 0.10       |   | $ | 0.05 |   |
|                                                                       |       |                                        |       |   |   |
| Diluted                                                                    |       | $                                           | 0.09       |   | $ | 0.05 |   |

 

Dilutedweighted average common shares outstanding do not include options, awards andunits outstanding to purchase 350,011 and 629,678 common equivalent shares forthe three months ended March 31, 2009 and 2010, respectively, as theireffect would have been anti-dilutive.

 

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

 

Securitiesthat the Company has the intent and ability to hold to maturity are reported atamortized cost and are classified as held-to-maturity. Securities for which itis not the Company’s intent to hold to maturity are classified as eitheravailable-for-sale securities or trading securities. Available-for-salesecurities are reported at fair value, with temporary unrealized gains/(losses)excluded from earnings and reported as a separate component of stockholders’equity and other than temporary unrealized losses included in earnings. Tradingsecurities are reported at fair value, with unrealized gains/(losses) includedin earnings.  The Company’s cash equivalents principally consist ofmoney market funds and corporate bonds with maturities of 90 days or less atthe date of purchase. Short-term and long-term investments primarily consist ofinvestment-grade corporate bonds, U.S. government agency notes and auction ratesecurities (“ARS”) with original maturities of greater than 90 days.

 

10

----

Table of Contents

 

Duringthe three-months ended March 31, 2010, the Company elected to sell certaininvestments which were classified as held-to-maturity.  As a result, the Company determined that allinvestments should now be classified as available-for-sale, and accordingly,the Company recorded unrealized gains of $286 through other comprehensiveincome in the period ended March 31, 2010 to properly record theavailable-for-sale securities at fair value.

 

Cash,cash equivalents, short-term and long-term investments as of December 31,2009 and March 31, 2010 consist of the following:

 
| ** **                   | ** ** | **December 31,  2009** | ** ** |
|------------------------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **Contracted**              | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per** | ** ** |
| **Description**              | ** ** | **Maturity**                | ** ** | **Cost** | ** ** | **Value** | ** ** | **Balance Sheet** | ** ** |
| Cash and cash equivalents    |       | Demand                      |       | $ | 41,862 |   | $ | 41,862 |   | $ | 41,862 |   |
|                         |       |                        |       |   |   |   |   |   |   |
| U.S. agency notes            |       | 138 days                    |       | $ | 22,348 |   | $ | 22,413 |   | $ | 22,348 |   |
| Corporate bonds              |       | 177 days                    |       | 25,523 |   | 25,678 |   | 25,523 |   |
| Auction rate securities      |       | 181 days                    |       | 23,800 |   | 19,370 |   | 19,370 |   |
| Total short-term investments |       |                        |       | $ | 71,671 |   | $ | 67,461 |   | $ | 67,241 |   |
|                         |       |                        |       |   |   |   |   |   |   |
| U.S. agency notes            |       | 499 days                    |       | $ | 13,742 |   | $ | 14,577 |   | $ | 13,742 |   |
| Corporate bonds              |       | 460 days                    |       | 12,697 |   | 12,898 |   | 12,697 |   |
| Total long-term investments  |       |                        |       | $ | 26,439 |   | $ | 27,475 |   | $ | 26,439 |   |

 
| ** **                   | ** ** | **March 31, 2010** | ** ** |
|------------------------------|------------|-------------------------|------------|
| ** **                   | ** ** | **Contracted**          | ** ** | **Amortized** | ** ** | **Fair Market** | ** ** | **Balance Per** | ** ** |
| **Description**              | ** ** | **Maturity**            | ** ** | **Cost** | ** ** | **Value** | ** ** | **Balance Sheet** | ** ** |
| Cash and cash equivalents    |       | Demand                  |       | $ | 53,290 |   | $ | 53,290 |   | $ | 53,290 |   |
|                         |       |                    |       |   |   |   |   |   |   |
| U.S. agency notes            |       | 216 days                |       | $ | 27,694 |   | $ | 27,724 |   | $ | 27,724 |   |
| Corporate bonds              |       | 239 days                |       | 30,236 |   | 30,493 |   | 30,493 |   |
| Auction rate securities      |       | 90 days                 |       | 21,550 |   | 18,232 |   | 18,232 |   |
| Total short-term investments |       |                    |       | $ | 79,480 |   | $ | 76,449 |   | $ | 76,449 |   |

 

Asof March 31, 2010 all securities, with the exception of ARS, areclassified as available-for-sale securities. In prior periods and up throughthe execution of the signed settlement agreement with UBS AG (“UBS”) in November 2008as further discussed below, the ARS were classified as available-for-salebecause it was the Company’s intent not to hold them to maturity. Upon theexecution of the settlement agreement with UBS, the Company elected to make aone-time transfer of the ARS from available-for-sale securities to tradingsecurities. Accordingly, on a prospective basis, all unrealized gains/(losses)for these trading securities have been included in earnings.  Interest and dividends on all of the Company’ssecurities are included in interest income in the accompanyingunaudited condensed consolidated statement of income.

 

Asof December 31, 2009 and March 31, 2010, the Company held ARStotaling $23,800 and $21,550, respectively, at par value, which are classifiedas short-term investments in the accompanying unaudited condensed consolidatedbalance sheets, and which are recorded at fair value. These ARS are debtinstruments issued by various states throughout the United States to financestudent loans. The types of ARS that the Company owns are backed by studentloans, 95% of which are guaranteed under the Federal Family Education LoanProgram, and all have credit ratings of AAA (or equivalent) from a recognizedrating agency. Historically, the carrying value of ARS approximated fair valuedue to the frequent resetting of the interest rates. With the liquidity issuesexperienced in the global credit and capital markets, the Company’s ARS haveexperienced multiple failed auctions. While the Company continues to earn andreceive interest on these investments at the maximum contractual rate, theestimated fair value of these ARS no longer approximates par value.

 

InNovember 2008, the Company accepted an offer from and entered into anagreement (the “Agreement”) with UBS with respect to all of the Company’s ARSheld at that time. As a UBS client who holds ARS, the Company will receivecertain rights, which will 

 

11

----

Table of Contents

 

entitlethe Company to sell ARS to UBS affiliates during the period from June 30,2010 to July 2, 2012 for a price equal to par value. In accepting theAgreement, the Company granted UBS the authority to sell or auction the ARS atpar at any time up until the expiration date of the Agreement and released UBSfrom any claims relating to the marketing and sale of ARS. UBS obligationsunder the Agreement are not secured by its assets and do not require UBS toobtain any financing to support its performance obligations under theAgreement. UBS has disclaimed any assurance that it will have sufficientfinancial resources to satisfy its obligations under the Agreement. If UBS hasinsufficient funding to buy back the ARS and the auction process continues tofail, the Company may incur further losses on the carrying value of the ARS.

 

TheCompany performed a fair value calculation of these ARS as of March 31,2010.  Fair value was determined using a secondary market indicationsmethod (direct discounts) and a discounted cash flow method as recent auctionsof these securities were not successful, resulting in the Company continuing tohold these securities and issuers paying interest at the maximum contractualrate. This valuation technique considers the following: time left to maturity,the rate of interest paid on the securities, the amount of principal to berepaid to the holders of the securities; the credit worthiness of the issuerand guarantors (if any) and the sufficiency of the collateral; tradingcharacteristics of the securities; ability to borrow against the ARS; evidencefrom secondary market sales; and the market-clearing yield for the securities.

 

Basedupon the valuation performed, the Company concluded that the fair value ofthese ARS at December 31, 2009 was $19,370, a decline of $4,430 from parvalue. As of March 31, 2010, the Company concluded that the fair value ofthese ARS was $18,232, and therefore, recorded the change in fair value of$1,112 in the accompanying unaudited condensed consolidated statement of incomefor the three months ended March 31, 2010. During the three months ended March 31, 2010, $2,250 of the Company’sARS were called by the respective issuers at par value.  As of March 31, 2010, it remained theCompany’s intent to sell the ARS on June 30, 2010 in accordance with itsrights under the Agreement.  Accordingly,the ARS are classified as short-term investments in the accompanying unauditedcondensed consolidated balance sheets.

 

Fairvalue of the Company’s put option was determined using a discounted cash flowmethod, which considered the following factors: term of the agreement, theavailability to borrow against the ARS, the creditworthiness of UBS and currentmarket interest rates. Based on the valuation performed, the Company concluded thatthe fair value of the put option as of December 31, 2009 and March 31,2010 was $4,345 and $3,280, respectively.  Accordingly, the decrease infair value of $1,065 for the three months ended March 31, 2010 wasrecorded in the Company’s accompanying unaudited condensed consolidatedstatements of income. As of March 31, 2010, it remained the Company’sintent to sell the ARS on June 30, 2010 in accordance with its rightsunder the settlement agreement and, accordingly, the Company classifies thefair value of the “securities settlement agreement” as current assets in theaccompanying unaudited condensed consolidated balance sheets.

 

Referto Note 15 for further discussion on Fair Value Measurements.

 

**8.****                   ****Goodwilland Intangible Assets**

 

Intangible assets that have indefinite lives are notamortized while intangible assets that have finite lives are amortized overtheir useful lives.  Both goodwill andintangible assets are evaluated for impairment annually or whenever events orchanges in circumstances indicate the carrying value may not be recoverable.

 

Thegoodwill resulting from acquisitions is reviewed for impairment on an annualbasis*.*  Consistent with prior years, the Company willconduct its annual impairment test of goodwill during the fourth quarter of2010.  For the three months ended March 31,2010, there have been no changes to the goodwill balance and there have been noimpairment indicators that would lead the Company to write down an asset.

 

Intangibleassets consist of the following:

 
| ** **                          | ** ** | ** **                      | ** ** | **As of December 31, 2009** | ** ** | **As of March 31, 2010** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------|------------|
| **Description**                     | ** ** | **Estimated  Useful Life** | ** ** | **Gross  Carrying  Value**                      | ** ** | **Accumulated  Amortization**           | ** ** | **Gross  Carrying  Value** | ** ** | **Accumulated  Amortization** | ** ** |
| Developed technology and know-how   |       | 5-15 years                      |       | $                                               | 21,447     |                                    | $          | 3,604 |   | $ | 21,447 |   | $ | 4,288 |   |
| Customer relationships              |       | 5-18 years                      |       | 22,190                                          |       | 2,574                                   |       | 22,190 |   | 3,087 |   |
| Non-compete agreements              |       | 2-3 years                       |       | 610                                             |       | 438                                     |       | 610 |   | 464 |   |
| Trade name                          |       | 1-8 years                       |       | 3,140                                           |       | 396                                     |       | 3,140 |   | 563 |   |
| In process research and development |       | 8 years                         |       | 886                                             |       | —                                  |       | 886 |   | — |   |
| Customer backlog                    |       | 3 years                         |       | 720                                             |       | 320                                     |       | 720 |   | 380 |   |
| Total                               |       |                            |       | $                                               | 48,993     |                                    | $          | 7,332 |   | $ | 48,993 |   | $ | 8,782 |   |

 

12

----

Table of Contents

 

Amortizationexpense related to intangible assets for the three months ended March 31,2009 and 2010 was $761 and $1,450, respectively.

 

Theestimated remaining amortization expense for each of the five succeeding yearsis as follows:

 
| **Year ended December 31,**       | ** ** | **Amount** | ** ** |
|--------------------------------------------------|------------|------------|------------|
| 2010 (nine months ended  December 31, 2010) |       | $          | 4,158      |   |
| 2011                                             |       | 4,987      |       |
| 2012                                             |       | 4,914      |       |
| 2013                                             |       | 4,543      |       |
| 2014                                             |       | 4,039      |       |
| 2015 and thereafter                              |       | 17,570     |       |
| Total                                            |       | $          | 40,211     |   |

 

**9.****             ****AccruedExpenses and Other Current Liabilities**

 

Accruedexpenses and other current liabilities consist of the following:

 
| ** **                           | ** ** | **As of  December 31,** | ** ** | **As of  March 31,** | ** ** |
|--------------------------------------|------------|-----------------------------------|------------|--------------------------------|------------|
| ** **                           | ** ** | **2009**                          | ** ** | **2010**                       | ** ** |
| Accrued payroll and related benefits |       | $                                 | 17,278     |                           | $          | 10,244 |   |
| Accrued royalties                    |       | 1,867                             |       | 748                            |       |
| Accrued outside contractors          |       | 2,013                             |       | 1,621                          |       |
| Leasehold incentive obligation (1)   |       | 956                               |       | 1,002                          |       |
| Accrued other expenses               |       | 5,892                             |       | 5,521                          |       |
|                                 |       |                              |       |                           |       |
| Total                                |       | $                                 | 28,006     |                           | $          | 19,136 |   |

 

----

(1)          In conjunction with the February 2008lease agreement (see Note 10) the Company was reimbursed for leaseholdimprovements totaling $8,104.  Inconjunction with the August 2009 lease agreement (see Note 10), theCompany was reimbursed for leasehold improvements totaling $2,163, of which$1,640 was received in 2009 and $523 received in 2010. Both leaseholdimprovements are recognized in property and equipment in the accompanying condensedconsolidated balance sheets, with the corresponding reimbursement recognized as“accrued expenses and other current liabilities” and “other long-termliabilities” on the unaudited condensed consolidated balance sheets. The amountof the incentive is being amortized on a straight-line basis over the leaseterm as a reduction of rental expense and commenced at the beginning ofoccupancy. The leasehold improvements in property and equipment will beamortized over the shorter of the lease term or the estimated useful life ofthe asset.  The Company amortized the leasehold incentive obligation as areduction to rent expense of $198 and $247 in the three months ended March 31,2009 and 2010, respectively.

 

**10.****          ****Commitments, Contingenciesand Restricted Cash**

 

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

 

OnApril 20, 2010, a lawsuit, *Selma Ehrlich**et al. v. Phase Forward Incorporated, et al.,*Civ. A.No. 10-1463, was filed in the Superior Court for Middlesex County,Massachusetts against the Company, the members of the Company’s board ofdirectors, Oracle Corporation, and Pine Acquisition Corporation.  Refer to Note 17 for further discussion.

 

13

----

Table of Contents

 

On August 17, 2009,the Company entered into a lease (“IRT Lease”) with KBS Five Tower Bridge, LLCto secure office space for the Company’s *PhaseForward IRT* business operations at 300 Barr Harbor Drive, WestConshohocken, Pennsylvania. The commencement date for occupancy under the IRTLease was September 2009 with rent payments commencing in June 2010.The IRT Lease provides for the rental of 44,907 square feet of space and has aninitial term of 10 years and one month. The Company can, subject tocertain conditions, extend this term by exercising up to two consecutivefive-year options. The annual rent under the IRT Lease for the first year is$1,325, or approximately $110 per month, with annual escalations in rent foreach subsequent year in the amount of $22, or fifty cents per rentable squarefoot. The total base rent payable in the initial term is $14,258.

 

On February 13, 2008,the Company entered into a lease (“Headquarters Lease”) with BP Fourth Avenue,LLC (the “Landlord”) to secure office space for the Company’s current corporateheadquarters at 77 Fourth Avenue, Waltham, Massachusetts. The commencement datefor occupancy under the Headquarters Lease was December 2008. The leasefor the Company’s previous corporate headquarters at 880 Winter Street inWaltham, Massachusetts expired in February 2009. The Headquarters Leaseprovides for the rental of 165,129 square feet of space and has an initial termof 10 years and three months. The Company can, subject to certainconditions, extend this term by exercising up to two consecutive five yearoptions. The Company was not required to pay any rent for the first three monthsof the initial Headquarters Lease term. After the initial three months, theannual rent under the Headquarters Lease for years one through five is $6,600,or approximately $548 per month. For years six through ten, the annual rentwill be $7,200, or approximately $603 per month. The total base rent payable inthe initial term is $69,100. In connection with the signing of the HeadquartersLease, the Company has deposited with the Landlord an unconditional,irrevocable letter of credit in Landlord’s favor in the amount of $962, securedby a certificate of deposit. The certificate of deposit has been classified as “Restrictedcash” in the accompanying unaudited condensed consolidated balance sheets as ofDecember 31, 2009 and March 31, 2010.

 

**11.****          ****Stockholders’ Equity andStock-Based Compensation**

 

*Stock-basedCompensation Expense*

 

Forstock options issued under the Company’s 2004 Stock Option and Incentive Plan(the “2004 Plan”), the fair value of each option grant is estimated on the dateof grant using the Black-Scholes pricing model, and an estimated forfeiturerate is used when calculating stock-based compensation expense for theperiod.  For restricted stock awards andunits issued under the Company’s 2004 Plan, the fair value of each grant iscalculated based on the Company’s stock price on the date of grant and anestimated forfeiture rate when calculating stock-based compensation expense forthe period.  During the three monthsended March 31, 2009 and 2010, the Company recorded $2,569 and $3,501 ofaggregate stock-based compensation expense, respectively.  As of March 31, 2010, there was $27,675of unrecognized stock-based compensation expense related to stock-based awardsthat is expected to be recognized over a weighted average period of 2.33 years.

 

TheCompany applied forfeiture rates derived from an analysis of its historicaldata in determining the expense recorded in the Company’s unaudited condensedconsolidated statements of income as follows:

 
| ** **                        | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------|------------|--------------------------------------------------|------------|
| ** **                        | ** ** | **2009**                                         | ** ** | **2010** | ** ** |
| Restricted stock units and awards |       | 5.8                                              | %          | 5.8 | % |
| Service-based stock options       |       | 9.0                                              | %          | 9.0 | % |
| Milestone options                 |       | 12.0                                             | %          | 12.0 | % |

 

*Common Stock*

 

In the three months ended March 31,2010, the Company issued 30,899 shares of common stock in connection with theexercise of stock options resulting in proceeds of $132.  In the three months ended March 31,2010, the Company released 190,195 shares of 

 

14

----

Table of Contents

 

common stock in connection with the vesting ofrestricted stock awards and units and retired 65,755 of these shares to coverwithholding taxes in the amount of $727.

 

*Stock Option Activity*

 

Asummary of stock option activity under the Phase Forward Incorporated 1997Stock Option Plan, the Phase Forward Incorporated 2004 Stock Option andIncentive Plan and the 2003 Non-Employee Director Stock Option Plan as of March 31,2010, and changes during the three months ended March 31, 2010, 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, 2009                       |       | 1,816,004                  |       | $                                                          | 4.70       |                                                             | 3.69       |                               |       |   |
| Granted                                                        |       | —                     |       | —                                                     |       |                                                             |       |                               |       |
| Exercised                                                      |       | (30,899                    | )          | 4.27                                                       |       |                                                             |       | $                                  | 275        |   |
| Canceled                                                       |       | (3,600                     | )          | 5.00                                                       |       |                                                             |       |                               |       |
|                                                           |       |                       |       |                                                       |       |                                                             |       |                               |       |
| Outstanding as of March 31, 2010                          |       | 1,781,505                  |       | $                                                          | 4.71       |                                                             | 3.49       |                               | $          | 14,932 |   |
|                                                           |       |                       |       |                                                       |       |                                                             |       |                               |       |
| Exercisable as of March 31, 2010                          |       | 1,701,755                  |       | $                                                          | 4.63       |                                                             | 3.42       |                               | $          | 14,390 |   |
|                                                           |       |                       |       |                                                       |       |                                                             |       |                               |       |
| Vested or expected to vest as of March 31,  2010 (1) |       | 1,776,107                  |       | $                                                          | 4.70       |                                                             | 3.48       |                               | $          | 14,895 |   |

 

----

(1)          The vested or expected tovest options at March 31, 2010 include both the vested options and thenumber of options expected to vest calculated after applying an estimatedforfeiture rate to the unvested options.

 

(2)          The aggregate intrinsicvalue for shares outstanding, exercisable and vested is calculated based on thepositive difference between the fair value per share of the Company’s commonstock on March 31, 2010 of $13.09, or the date of exercise, as applicable,and the exercise price of the underlying options.

 

*Restricted Stock Awards and Unit Activity*

 

Asummary of activity related to restricted common stock awards and unit awardsas of March 31, 2010 and changes during the three months ended March 31,2010, 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, 2009           |       | 2,931,363              |       | $                            | 10.85 - 23.20 |                                                     | $          | 15.21                                                        |       |                              |       |   |   |
| Granted                                      |       | 165,025                |       | 11.93 - 15.34                |          |                                                     |       |                                                         |       |                              |       |
| Vested                                       |       | (190,195               | )          | 13.23 - 23.20                |          |                                                     |       |                                                         |       |                              |       |
| Forfeited                                    |       | (26,268                | )          | 10.85 - 23.20                |          |                                                     |       |                                                         |       |                              |       |
| Unvested at March 31, 2010              |       | 2,879,925              |       | $                            | 10.85 - 23.20 |                                                     | $          | 14.92                                                        |       | 2.46                              |       | $ | 37,698 |   |
|                                         |       |                   |       |                         |          |                                                     |       |                                                         |       |                              |       |
| Expected to be free of restrictions (1) |       | 2,284,312              |       | $                            | 10.85 - 23.20 |                                                     | $          | 14.93                                                        |       | 2.46                              |       | $ | 29,902 |   |

 

----

(1)          The expected to be free ofrestrictions at March 31, 2010 was calculated by applying an estimatedforfeiture rate to the unvested shares.

 

(2)          The aggregate intrinsicvalue is calculated based on the fair value per share of the Company’s commonstock on March 31, 2010 of $13.09.

 

15

----

Table of Contents

 

*Stock Repurchase Program*

 

On November 3,2009, the Company’s Board of Directors authorized the repurchase of up to$40,000 of its common stock, par value $0.01 per share, through a sharerepurchase program. On February 12, 2010, the Company’s Board of Directorsincreased the amount available under the share repurchase program by anadditional $25,000. As authorized by the program, shares may be purchased inthe open market or through privately negotiated transactions in a mannerconsistent with applicable securities laws and regulations, including pursuantto a Rule 10b5-1 plan maintained by the Company.  For the three months ended March 31,2010 1,934,707 shares of the Company’s common stock had been purchased as partof this repurchase program at an average price of $13.42 per share

 

**12.   Comprehensive Income**

 

TheCompany’s other comprehensive income relates to foreign currency translationadjustments and unrealized gains and losses on marketable securities.  Accumulated other comprehensive income ispresented separately on the balance sheet as required.

 

Comprehensiveincome consisted of the following:

 
| ** **                                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                         | ** ** | **2010** | ** ** |
| Net income                                       |       | $                                                | 4,078      |   | $ | 1,933 |   |
| Unrealized  gain/(loss) on marketable securities |       | —                                           |       | 286 |   |
| Cumulative Translation adjustment                |       | 373                                              |       | (712 | ) |
| Comprehensive income                             |       | $                                                | 4,451      |   | $ | 1,507 |   |

 

**13.   ForwardForeign Exchange Contracts and Foreign Currency Translation**

 

TheCompany enters into transactions in currencies other than the U.S. dollar andholds cash in foreign currencies which expose the Company to transaction gainsand losses as foreign currency exchange rates fluctuate against the U.S.dollar. The Company from time to time enters into forward foreign exchangecontracts to hedge the foreign currency exposure of non-U.S. dollar denominatedthird-party and intercompany receivables and cash balances. The contracts,which relate to the British pound, euro, and the Japanese yen, generally haveterms of one month. The Company settles forward foreign exchange contracts incash. These hedges are deemed fair value hedges and have not been designatedfor hedge accounting. The gains or losses on the forward foreign exchangecontracts along with the associated losses and gains on the revaluation andsettlement of the short-term intercompany balances, accounts receivable andcash balances are recorded in current operations in other income.

 

Thefollowing table summarizes the outstanding forward foreign exchange contractsheld by the Company as of December 31, 2009 and March 31, 2010:

 
| ** **    | ** ** | ** **          | ** ** | **As of December 31, 2009** | ** ** | **As of March 31, 2010**             | ** ** |
|---------------|------------|---------------------|------------|-------------------------------------------------|------------|-----------------------------------------------------|------------|
| **Currency**  | ** ** | **Hedge Type** | ** ** | **Local  Currency********Amount**               | ** ** | **Approximate********U.S. Dollar  Equivalent** | ** ** | **Local********Currency********Amount** | ** ** | **Approximate  U.S. Dollar  Equivalent** | ** ** |
| British pound |       | Sale                |       | 1,000                                           |       | $                                                   | 1,612      |   | 560 |   | $ | 847 |   |
| Euro          |       | Sale                |       | 3,200                                           |       | 4,571                                               |       | 3,200 |   | 4,339 |   |
|          |       |                |       |                                            |       | $                                                   | 6,183      |   |   |   | $ | 5,186 |   |

 

Thefinancial statements of the Company’s foreign subsidiaries are translated intoU.S. dollars, which is the Company’s reporting currency. The functionalcurrency of the Company’s subsidiaries in Australia, Belgium, France, India,Japan, Romania and the United Kingdom 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. Revenue and expense accounts are translated usingan average rate of exchange during the period. Gains and losses arising fromtransactions denominated in foreign currencies are primarily related to intercompanyaccounts that have been determined to be temporary in nature and cash accountsand accounts receivable denominated in non-functional currencies.

 

Foreigncurrency translation adjustments are accumulated as a component of othercomprehensive income as a separate component of stockholders’ equity. Realizedand unrealized foreign currency gains and losses, net of hedging, are accountedfor in other income.  The Companyrecorded foreign currency gains/(losses) of $147 and $(236) in the three monthsended March 31, 2009 and 2010. As of March 31, 2009 and 2010, theCompany recorded $(248) and $31, respectively, of foreign exchangegains/(losses)  in other income (expense)as a result of outstanding forward foreign exchange contracts.

 

16

----

Table of Contents

 

**14.**          IncomeTaxes

** **

TheCompany’s effective tax rates for the three months ended March 31, 2009and 2010 were 34% and 39%, respectively. The Company’s effective tax rate for the three monthsended March 31, 2010 is higher than the effective tax rate for the threemonths ended March 31, 2009 principally due to the benefit derived in theprior year from the federal research and development tax credit.  The federal research and development taxcredit expired effective December 31, 2009 and, as such, the Company hasnot forecasted a current tax benefit for this item in 2010.

 

Asof March 31, 2010, the Company had a liability of $1,535 for netunrecognized 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 March 31, 2010, the Company had approximately $12 and$7, respectively, of accrued interest and penalties related to unrecognized taxbenefits.  The Company anticipates a reduction of approximately $81 to theamount of unrecognized tax benefits over the next twelve months associated withlapsing statutes of limitations.  The unrecognized tax liability of $1,535and accrued interest and penalties of $19 are classified as other long-termliabilities on the unaudited condensed consolidated balance sheet.

 

**15.     Fair Value Measurements**

 

Fairvalue is an exit price, representing the price that would be received to sellan asset or paid to transfer a liability in an orderly transaction betweenmarket participants based on the highest and best use of the asset orliability. As such, fair value is a market-based measurement that should bedetermined based on assumptions that market participants would use in pricingan asset or liability. The Company uses valuation techniques to measure fairvalue that maximize the use of observable inputs and minimize the use ofunobservable inputs. These inputs are prioritized as follows:

 

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

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

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

 

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

 

*Market approach* - Uses pricesand other relevant information generated by market transactions involvingidentical or comparable assets or liabilities

*Income approach* - Usesvaluation techniques to convert future amounts to a single present amount basedon current market expectations about those future amounts, including presentvalue techniques, option-pricing models and excess earnings method

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

 

Thefollowing table sets forth the Company’s financial instruments carried at fairvalue and using the lowest level of input as of March 31, 2010:

 
| ** **                                 | ** ** | **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                         |       | $                        | 53,290     |                   | $          | —           |       | $          | —     |   | $ | 53,290 |   |
| Restricted cash                            |       | 982                      |       | —                 |       | —           |       | 982        |       |
| Total cash equivalents and restricted cash |       | $                        | 54,272     |                   | $          | —           |       | $          | —     |   | $ | 54,272 |   |
|                                       |       |                     |       |                   |       |             |       |       |       |
| U.S. agency notes (2)                      |       | $                        | —     |                   | $          | 27,724           |       | $          | —     |   | $ | 27,724 |   |
| Corporate bonds (2)                        |       | —                   |       | 30,493                 |       | —           |       | 30,493     |       |
| Securities settlement agreement (1)   |       | —                   |       | —                 |       | 3,280            |       | 3,280      |       |
| Auction rate securities (1)                |       | —                   |       | —                 |       | 18,232           |       | 18,232     |       |
| Total short-term investments               |       | $                        | —     |                   | $          | 58,217           |       | $          | 21,512     |   | $ | 79,729 |   |
|                                       |       |                     |       |                   |       |             |       |       |       |
| Total Assets                               |       | $                        | 54,272     |                   | $          | 58,217           |       | $          | 21,512     |   | $ | 134,001 |   |

 

17

----

Table of Contents

 

----

(1)          The Company’s investments in ARS and the securitiessettlement agreement with UBS are classified within Level 3 because thereare currently no active markets for ARS and the Company is unable to obtainindependent valuations from market sources. Therefore, the ARS were primarilyvalued based on an income approach using an estimate of future cashflows.  For additional information regarding ARS, see Note 7.

 

(2)   Fairvalue for Level 2 assets was determined using quoted market prices for similarassets.  For the three months ended March31, 2010 the Company’s Level 2 transaction activity included $10,750 ofpurchases, $2,000 of sales, $16,875 of maturities and $8,000 of settlements.

 

Thefollowing table sets forth a summary of changes in the fair value of theCompany’s Level 3 financial assets for the three months ended March 31,2010:

 
| ** **                                                  | ** ** | **Level 3 Financial** | ** ** |
|-------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                  | ** ** | **Assets**                      | ** ** |
| Balance, beginning of period                                |       | $                               | 23,715     |   |
| Transfers in (out) of Level 3                               |       | —                          |       |
| Purchase                                                    |       | —                          |       |
| Sales                                                       |       | —                          |       |
| Issuance                                                    |       | —                          |       |
| Settlement                                                  |       | (2,250                          | )          |
| Realized gains/(losses)                                     |       | —                          |       |
| Unrealized gains/(losses) on securities held at  period end |       | 47                              |       |
| Balance, end of period                                      |       | $                               | 21,512     |   |

 

TheCompany has also adopted the provisions of FASB ASC No. 825, *Financial Instruments*, in the first quarter of 2008 whichallows companies to choose to measure eligible assets and liabilities at fairvalue with changes in value recognized in earnings. Fair value treatment may beelected either upon initial recognition of an eligible asset or liability or,for an existing asset or liability, if an event triggers a new basis ofaccounting. The Company did not elect to re-measure any of its existingfinancial assets or liabilities, and did not elect the fair value option forany financial assets and liabilities transacted in the year-ended December 31,2009.  To date, the Company has onlyelected the fair value option for the put option related to the Company’s ARS thatwas recorded in conjunction with a settlement agreement with UBS as more fullydescribed in Note 7.

 

**16.****      ****Recently Issued AccountingPronouncements**

 

On January 1,2010, the Company adopted the guidance of ASU No. 2009-13, RevenueRecognition (Topic 605): *Multiple-DeliverableRevenue Arrangements*, which was ratified by the FASB Emerging IssuesTask Force on September 23, 2009. ASU No. 2009-13addresses the accounting for multiple-deliverable arrangements to enablevendors to account for products or services (deliverables) separately ratherthan as a combined unit. This guidance establishes a selling price hierarchyfor determining the selling price of a deliverable, which is based on: (a) vendor-specificobjective evidence; (b) third-party evidence; or (c) estimates. Thisguidance also eliminates the residual method of allocation and requires thatarrangement consideration be allocated at the inception of the arrangement toall deliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements.  The impact ofthis standard was not material to the Company’s reported results of operationsfor the three months ended March 31, 2010.

 

On January 21,2010, the FASB issued ASU No. 2010-06, *FairValue Measurements and Disclosures (Topic 820)—Improving Disclosures about FairValue Measurements*. The ASU requires reporting entities to provideinformation about movements of assets among Levels 1 and 2 of the three-tierfair value hierarchy established by FASB ASC 820, *Fair Value Measurements.*  During the three months ended March 31, 2010the Company had no movements among Levels 1 and 2 of the three-tier fair valuehierarchy. Entities will also need to provide a reconciliation of purchases,sales, issuance, and settlements of anything valued with a Level 3 method,which is used to price the hardest to value instruments. The new disclosuresand clarifications of existing disclosures were adopted on January 1,2010.  Adoption of this portion of ASU No. 2010-06did not have an impact on the Company’s consolidated financial position andresults of operation. Disclosures about purchases, sales, issuances, andsettlements in the roll forward of activity in Level 3 fair value measurementsare effective for fiscal years beginning after December 15, 2010, and forinterim periods within those fiscal years. The Company elected to adopt this portion of ASU No. 2010-06 on January1, 2010.  Adoption of this portion of ASUNo. 2010-06 did not have an impact on the Company’s consolidated financialposition and results of operation.

 

18

----

Table of Contents

 

**17. ****Subsequent Event**

 

*MergerAgreement with Oracle (Non-recognized subsequent event)*

 

OnApril 15, 2010, the Company, Oracle Corporation, a Delaware corporation(“Oracle”) and Pine Acquisition Corporation, a Delaware corporation andwholly-owned subsidiary of Oracle (“Merger Sub”), entered into an Agreement andPlan of Merger (“the Merger Agreement”), pursuant to which, subject tosatisfaction or waiver of the conditions therein, Merger Sub will merge withand into the Company (the “Merger”) with the Company surviving as awholly-owned subsidiary of Oracle. A description of the Merger Agreement iscontained in the Company’s Current Report on Form 8-K filed with the SECon April 16, 2010, and a copy of the Merger Agreement is attached theretoas Exhibit 2.1.

 

*ShareholderLitigation (Non-recognized subsequent event)*

 

OnApril 20, 2010, a lawsuit, *Selma Ehrlich**et al. v. Phase Forward Incorporated, et al.,*Civ. A.No. 10-1463, was filed in the Superior Court for Middlesex County,Massachusetts against the Company, the members of the Company’s board ofdirectors, Oracle Corporation, and Pine Acquisition Corporation.  The action, brought by plaintiffs who arepurported stockholders of the Company, individually and on behalf of a putativeclass of stockholders, alleges that the board breached fiduciary duties, andthat the Company and Oracle aided and abetted the purported breaches, inconnection with the proposed Merger.  Thecomplaint seeks equitable relief, including, among other things, to enjoinconsummation of the proposed Merger, rescission of the Merger Agreement and anaward of all costs of the action, including reasonable attorneys’ fees.  The Company denies the allegations in the complaint,and intends to vigorously defend the lawsuit. However, there can be no assurance that the Company or the otherdefendants will be successful in such defense.

 

**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations*.***

** **

*The following discussion and analysis of ourfinancial condition and results of operations should be read in conjunctionwith our unaudited condensed consolidated financial statements and relatednotes thereto that appear elsewhere in this Quarterly Report on Form 10-Qand the audited financial statements and related notes thereto and Management’sDiscussion and Analysis of Financial Condition and Results of Operationsincluded in our Annual Report on Form 10-K for the year ended December 31,2009, which has been filed with the Securities and Exchange Commission (“SEC”).*

 

**Overview**

 

PhaseForward Incorporated is a provider of an Integrated Clinical Research Suite, orICRS, of enterprise-level software products, services and hosted solutions foruse in our customers’ global clinical trial and drug safety monitoringactivities. Our customers include pharmaceutical, biotechnology and medicaldevice companies, as well as academic institutions, governmental regulatoryagencies, contract research organizations, or CROs, and other entities engagedin clinical trial and drug safety monitoring activities. By automatingessential elements of the clinical trial and drug safety monitoring processes,we believe our products allow our customers to accelerate the marketintroduction of new medical therapies and corresponding revenues, reduceoverall research and development expenditures, enhance existing data qualitycontrol efforts, increase drug safety compliance and reduce clinical andeconomic risk.

 

**Subsequent Event**

 

OnApril 15, 2010, we entered into an Agreement and Plan of Merger (the“Merger Agreement”) with Oracle Corporation, a Delaware corporation (“Oracle”)and Pine Acquisition Corporation, a Delaware corporation and wholly-ownedsubsidiary of Oracle (“Merger Sub”), pursuant to which, subject to satisfactionor waiver of the conditions therein, Merger Sub will merge with us (the“Merger”) with the Company surviving as a wholly-owned subsidiary of Oracle. Adescription of the Merger Agreement is contained in our Current Report on Form 8-Kfiled with the SEC on April 16, 2010, and a copy of the Merger Agreementis attached thereto as Exhibit 2.1.

 

19

----

Table of Contents

 

On April 20, 2010, a lawsuit, *SelmaEhrlich et al. v. Phase Forward Incorporated, et al.,* Civ. A. No.10-1463, was filed in the Superior Court for Middlesex County, Massachusettsagainst us, our board of directors, Oracle, and Pine Acquisition Corporation.The action, brought by plaintiffs who are purported stockholders of ourCompany, individually and on behalf of a putative class of stockholders,alleges that the board breached fiduciary duties, and that Oracle and Phase Forwardaided and abetted the purported breaches, in connection with the proposedMerger. The complaint seeks equitable relief, including, among other things, toenjoin consummation of the proposed Merger, rescission of the Merger Agreementand an award of all costs of the action, including reasonable attorneys’ fees.We deny the allegations in the complaint, and intend to vigorously defend thelawsuit. However, there can be no assurance that we, or the other defendants,will be successful in such defense.

 

**Sources of Revenues**

 

We derive our revenues from software licenses and services of our ICRSproducts, which can be purchased on a stand-alone basis or bundled together.Our product line is comprised of four general categories that include thefollowing software products:

 

·                  *ElectronicData Capture (EDC)*

 

·*                 **InForm*, ourInternet-based electronic data capture solution for collection and transmissionof patient information in clinical trials;

 

·                  *LabPas*, our systemfor Phase I clinic automation; and

 

·                  *OutcomeLogix*, our electronicpatient reported outcomes, or ePRO, and late phase solution for data capturewhich supports data entry via web interface and/or mobile interface forhandheld devices, which we acquired as a result of the acquisition ofMaaguzi, LLC in July 2009.

 

·                  *ClinicalData Management*

 

·                  *Clintrial*, our clinicaldata management solution;

 

·                  *WebSDM,* our system forvalidating and reviewing clinical trial data represented in formats meetingindustry standards, such as those established by the Clinical Data InterchangeStandards Consortium, or CDISC; and

 

·                  *ClinicalDevelopment Center*, which includes our clinical data repositoryproduct for storing and managing clinical trials data and our statisticalcontrol environment, which we acquired as a result of the acquisition of WabanSoftware, Inc. in April 2009.

 

·                  *DrugSafety*

 

·                  *EmpiricaTrace*, our adverse event management solution for monitoring drug safety andreporting adverse events that occur during and after conclusion of the clinicaltrial process;

 

·                  *EmpiricaSignal*, our data mining and signal detection solution for post-marketingdata; and

 

·                  *EmpiricaStudy* (formerly known as *CTSD*),our signal detection solution for data from clinical trials.

 

·                  *InteractiveResponse Technology (IRT)*

 

·                  *PhaseForward IRT* (formerly known as *Clarix*),our Web-integrated interactive response technology; and

 

20

----

Table of Contents

 

·                  *CovanceIVRS/IWRS*, a legacy phone-integrated interactive responsetechnology, which we acquired from Covance, Inc. in August 2009.

 

We generally offer our software products under term enterprise licensesor as a hosted application solution delivered through a standard Web-browser.The following table details these offerings:

 
| ** **                        | ** ** | **Available As:** | ** ** |
|-----------------------------------|------------|-------------------|------------|
| **Product**                       | ** ** | **Term  License** | ** ** | **Hosted  Application** | ** ** |
| *Electronic Data Capture*         |       |              |       |   |   |
| *InForm*                          |       | Yes               |       | Yes |   |
| *LabPas*                          |       | Yes               |       | Yes |   |
| *OutcomeLogix*                    |       | No                |       | Yes |   |
| *Clinical Data Management*        |       |              |       |   |   |
| *Clintrial*                       |       | Yes               |       | No |   |
| *WebSDM*                          |       | Yes               |       | Yes |   |
| *Clinical Development Center*     |       | Yes               |       | Yes |   |
| *Drug Safety*                     |       |              |       |   |   |
| *Empirica Trace*                  |       | Yes               |       | Yes |   |
| *Empirica Signal*                 |       | Yes               |       | Yes |   |
| *Empirica Study*                  |       | Yes               |       | Yes |   |
| *Interactive Response Technology* |       |              |       |   |   |
| *Phase Forward IRT*               |       | No                |       | Yes |   |
| *Covance IVRS/IWRS* (1)           |       | No                |       | Yes |   |

 

----

(1) While we haveexisting trials running on the Covance IVRS/IWRS system, we do not intend tosell this offering or implement any new trials for use on this system.

 

In the three months ended March 31, 2009 and2010, no customer accounted for 10% or more of our total revenues for theperiod.  Our top 20 customers accountedfor approximately 64% and 58% of our total revenues, net of reimbursableout-of-pocket expenses, in the three months ended March 31, 2009 and 2010,respectively.

 

**Cost of Revenues and Operating Expenses**

 

We allocate overhead expenses such as rent andoccupancy charges and employee benefit costs to all departments based onheadcount. As such, general overhead expenses are reflected in cost of servicerevenues and in the sales and marketing, research and development, and generaland administrative expense categories.

 

*Costs of Revenues*.   Costs of license revenuesconsist primarily of the amortization of royalties paid for certain moduleswithin our *Clintrial* softwareproduct as well as our *InForm *softwareproduct. In addition, costs of revenues include expense for the amortization ofacquired technologies associated with acquisitions. The costs of licenserevenues vary based upon the mix of revenues from software licenses for ourproducts. We operate our service organization on a global basis as one distinctunit, and do not segment costs for our various service revenue elements. Theseservices include performing application hosting, consulting and customersupport 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 *software products and reimbursable out-of-pocketexpenses. Costs of services also include hosting costs that primarily consistof hosting facility fees and server depreciation and amortization of acquiredtechnologies associated with the acquisition of Clarix and Maaguzi.

 

The costs of service revenues vary based upon thenumber of employees in the service organization, the type of work performed,and royalties associated with revenues derived from providing customer support,as well as costs associated with the flexible use of outside contractors tosupport internal resources. We supplement the trial design and set up activityfor our *InForm, Phase Forward IRT*and *OutcomeLogix* applicationhosting services through the use of outside contractors. This allows us toutilize outside contractors in those periods where trial design and set upactivity is highest while reducing the use of outside contractors in thoseperiods where trial activity lessens, allowing for a more flexible deliverymodel. The percentage of the services workforce represented by outsidecontractors varies from period to period depending on the volume of specificsupport required. The costs of service revenues is 

 

21

----

Table of Contents

 

significantlyhigher as a percentage of revenues as compared to our costs of license revenuesprimarily due to the employee-related and outside contractor expensesassociated with providing services.

 

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

 

*Sales and Marketing.  *Sales and marketing expensesconsist primarily of employee-related expenses, including travel, marketingprograms which include product marketing expenses such as trade shows,workshops and seminars, corporate communications, other brand building andadvertising, allocated overhead and the amortization of commissions. Inaddition, sales and marketing include expense for the amortization ofintangible assets associated with our acquisitions. We expect that sales andmarketing expenses will continue to increase in absolute dollars as commissionexpense increases with our revenues and as we continue to expand sales coverageand to build brand awareness through what we believe are the most costeffective channels available, but may fluctuate quarter over quarter due to thetiming of marketing programs.

 

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

 

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

 

*Stock-Based Compensation Expenses*.   Our cost of servicerevenues, sales and marketing, research and development, and general andadministrative expenses include stock-based compensation expense. Stock-basedcompensation expense is the fair value of outstanding stock options andrestricted stock awards and units, which are recognized over the respectivestock option and award or unit service periods.

 

**Foreign Currency Translation**

 

With regard to our international operations, wefrequently enter into transactions in currencies other than the U.S. dollar. Asa result, our revenues, expenses and cash flows are subject to fluctuations dueto changes in foreign currency exchange rates, particularly changes in theeuro, British pound, Australian dollar, Indian rupee, Japanese yen and Romanianleu. In the three months ended March 31, 2009 and 2010, approximately 38%and 37%, respectively, of our revenues were generated in locations outside theUnited States.  The majority of theserevenues are in currencies other than the U.S. dollar, as are many of theassociated expenses. In periods when the U.S. dollar declines in value ascompared to the foreign currencies in which we conduct business, our foreigncurrency-based revenues and expenses generally increase in value whentranslated into U.S. dollars.

 

**Critical Accounting Policies and Estimates**

 

Our unaudited condensed consolidated financial statementsare prepared in accordance with accounting principles generally accepted in theUnited States. The preparation of these financial statements requires us tomake estimates and assumptions that affect the reported amounts of assets,liabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting periods. On an ongoing basis, we evaluate our estimatesand assumptions with our audit committee, including those related to revenuerecognition, deferred set up costs, commissions and royalties, accountsreceivable reserves, stock-based compensation expense, long-lived assets,intangibles assets and goodwill, income taxes, contingencies and litigation. Webase our estimates on historical experience and on various other assumptionsthat are believed to be reasonable under the circumstances, the results ofwhich form the basis for making judgments about the carrying values of assetsand liabilities that are not readily apparent from other sources. There havebeen no material changes to these estimates for the periods presented in thisQuarterly Report on Form 10-Q. Our actual results may differ from theseestimates under different assumptions or conditions.

 

22

----

Table of Contents

 

We believe that of our significant accountingpolicies, which are described in Note 1 and Note 2 of the notes to ourconsolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2009, the following condensed accountingpolicies involve a greater degree of judgment and complexity. Accordingly,these are the policies we believe are the most critical to aid in fullyunderstanding and evaluating our consolidated financial condition and resultsof operations.

 

*Revenue Recognition.*   We derive revenues from software licenses and services ofour ICRS products which can be purchased on a stand-alone basis or bundledtogether. License revenues are derived principally from the sale of termlicenses of our software products and service revenues are derived principallyfrom the delivery of the hosted solutions of our software products, consultingservices and customer support including training, for all of our products. Revenuearrangements may include one of these single elements, or may incorporate oneor more elements in a single transaction or combination of related transactions.In the first quarter of 2010, we adopted the guidance of Accounting Standards Update (“ASU”) No. 2009-13,*Revenue Recognition* (Topic 605): *Multiple-Deliverable Revenue Arrangements* which was ratifiedby the Financial Accounting Standards Board (“FASB”) Emerging Issues Task Forceon September 23, 2009. ASU No. 2009-13 affects accounting andreporting for all multiple-deliverable arrangements. The adoption of this standard did notmaterially affect the results of operations for three months ended March 31,2010.

 

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

 

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

 

We generally enter into software term licenses for our products withour customers for 1- to 5-year periods. These arrangements typically includemultiple elements: software license, consulting services and customer support.We bill our 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 license revenues are earned from the sale of off-the-shelfsoftware requiring no significant modification or customization subsequent todelivery to the customer. Consulting services, which can also be performed bythird-party consultants, are deemed to be non-essential to the functionality ofthe software and typically are for trial configuration, implementationplanning, loading of software, building simple interfaces and running test dataand documentation of procedures.

 

Customer support includes training services, telephone support andsoftware maintenance. We generally bundle customer support with the softwarelicense for the entire term of the arrangement. As a result, we generallyrecognize revenues for all elements, including consulting services, ratablyover the term of the software license and support arrangement. We allocate therevenues recognized for these arrangements to the different elements based onmanagement’s estimate of the relative fair value of each element. For ourterm-based licenses, we allocate to consulting services the anticipated serviceeffort and value throughout the term of the arrangement at an amount that wouldhave been allocated had those services been sold separately to the customer.The value of our consulting services sold within a bundled arrangement is equalto the value of consulting services sold on a stand-alone basis, as theactivities performed under both types of arrangements are similar in nature.The remaining value is allocated to license and support services, with 10% ofthis amount allocated to support services. The customer support services rateof 10% for multi-year term-based licenses reflects a significant discount fromthe rate for customer support services associated with perpetual licenses dueto the reduction in the time period during which the customer can utilize theupgrades and enhancements. We believe this rate is substantive and represents areasonable basis of allocation. We have allocated the estimated fair value toour multiple element arrangements to provide meaningful disclosures about eachof our revenue streams. The costs associated with the consulting and customersupport services are expensed as incurred. There are instances in which we sellsoftware licenses based on usage levels. These software licenses can be basedon estimated usage, in which case the license fee charged to the customer isfixed based on this estimate. When the fee is fixed, the revenues are generallyrecognized ratably over the contractual term of the arrangement. If the fee isbased on actual usage, and therefore variable, the revenues are recognized inthe period of use. Revenues from certain follow-on consulting services, whichare sold separately to customers with existing software licenses and are notconsidered part of a multiple element arrangement, are recognized as theservices are performed.

 

We continue to sell additional perpetual licenses for the *Clintrial, Empirica Trace* and *Clinical Development Center* 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. For our *Clintrial* and *Empirica Trace* products we have 

 

23

----

Table of Contents

 

establishedvendor specific 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 revenuesare recognized ratably over the term of the underlying support arrangement. Forour *Clinical Development Center*products vendor specific objective evidence of fair value for the customersupport has not been established, and therefore, revenue for the entire agreementis recognized ratably over the term of the underlying support agreement. Wecontinue to generate customer support and maintenance revenues from ourperpetual license customer base. Training revenues are recognized as earned.

 

Revenues resulting from *InForm *and*OutcomeLogix* application hostingservices consist of three stages for each clinical trial: the first stageinvolves application set up, including design of electronic case report formsand edit checks, installation and server configuration of the system; thesecond stage involves application hosting and related support services; and thethird stage involves services required to close out, or lock, the database forthe clinical trial. Revenues resulting from *PhaseForward IRT* and *Covance IVRS/IWRS*application hosting services also consist of three stages for each clinicaltrial: the first stage involves application set up, including design and set upfor the subject randomization and medication inventory management, installationand server configuration of the system; the second stage involves applicationhosting and related support services; and the third stage involves servicesrequired to close out, or lock, the database for the clinical trial. Servicesprovided for *InForm, Phase Forward IRT, OutcomeLogix*and *Covance IVRS/IWRS* for thefirst 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. We recognize revenue from allstages of the *InForm, Phase Forward IRT,OutcomeLogix* and *CovanceIVRS/IWRS* hosting service ratably over the hosting period. Workperformed outside the original scope of work is contracted for separately as anadditional fee and is generally recognized ratably over the remaining term ofthe hosting period. Fees for the first and third stages of the services arebilled based upon milestones. Fees for application hosting and related servicesin the second stage are billed quarterly in advance. Bundled into this revenueelement are the revenues attributable to the software license used by thecustomer.

 

Revenues resulting from hosting services for our *Empirica Signal*, *Empirica Study* and *WebSDM* products consist of installationand server configuration, application hosting and related support services.Services for these offerings are charged monthly as a fixed fee. Revenues arerecognized ratably over the period of the service.

 

In the event that an application hosting customercancels its related statement of work, all deferred revenues are recognized. Inaddition, certain termination related fees may be charged and if so, such feesare recognized in the period of termination.

 

We may also enter into arrangements to provideconsulting services separate from a license arrangement. In these situations,revenue is recognized on either a time-and-materials basis or using theproportional performance method. If we are not able to produce reasonablydependable estimates, revenue is recognized upon completion of the project andfinal acceptance from the customer. If significant uncertainties exist aboutproject completion or receipt of payment, the revenue is deferred until theuncertainty is resolved. Provisions for estimated losses on contracts arerecorded during the period in which they are identified.

 

Deferred revenues represent amounts billed or cashreceived in advance of revenue recognition.

 

*Accounting for Prepaid SalesCommissions, Royalties and Deferred Set Up Costs*.   For arrangements where we recognize revenueover the relevant contract period, we defer related commission payments to ourdirect sales force and software license royalties paid to third parties andamortize these amounts over the same period that the related revenues arerecognized. This is done to better match commission and royalty expenses withthe related revenues. Commission payments are nonrefundable unless amounts duefrom a customer are determined to be uncollectible or if the customersubsequently changes or terminates the level of service, in which casecommissions which were paid are recoverable by us.

 

Our royalty obligation is based upon the license andcustomer support revenues earned for certain products in an arrangement.Royalties are paid on a percentage of billings basis for certain of ourproducts, and we have the right to recover royalties in the event anarrangement is cancelled.

 

Fees charged and costs incurred for the trial systemdesign, set up and implementation are deferred as applicable, until the startof the hosting period and then amortized and recognized, as applicable, ratablyover the estimated hosting period. The deferred costs include incrementaldirect costs with third parties and certain internal direct costs related tothe trial and application set up. These costs include salary and benefitsassociated with direct labor costs incurred during trial set up, as well asthird-party subcontract fees and other contract labor costs.  In the event that an application hostingcustomer cancels its related statement of work, all deferred set up costs areexpensed.

 

*Accounts Receivable Reserve.*  We maintain allowances for doubtful accountsfor estimated losses resulting from the inability of our customers to makerequired payments. We regularly evaluate the collectability of our tradereceivables based on a combination of factors, which may include dialogue withthe customer to determine the cause of non-payment, the use of collectionagencies, and/or 

 

24

----

Table of Contents

 

theuse of litigation. In the event it is determined that the customer may not beable to meet its full obligation to us, we record a specific allowance toreduce the related receivable to the amount that we expect to recover given allinformation available to us. We continuously monitor collections from ourcustomers and maintain a provision for estimated credit losses based upon ourhistorical experience and any specific customer collection issues that we haveidentified. While such credit losses have historically been within ourexpectations and the provisions established, we cannot guarantee that we willcontinue to experience the same credit loss rates in the future. If thefinancial condition of our customers were to deteriorate, resulting in animpairment of their ability to make payments, additional allowances may berequired.

 

*Accounting for Income Taxes.*   We are subject to income taxes in both theUnited States and foreign jurisdictions, and we use estimates in determiningour provision for income taxes. We account for income taxes using the asset andliability method for accounting and reporting for income taxes. Under thismethod, deferred tax assets and liabilities are recognized based on temporarydifferences between the financial reporting and income tax bases of assets andliabilities using statutory rates. This process requires that we project ourcurrent tax liability and estimate our deferred tax assets and liabilities,including net operating loss and tax credit carryforwards. In assessing theneed for a valuation allowance, we have considered our recent operatingresults, future taxable income projections and all prudent and feasible taxplanning strategies.

 

*Accounting for Stock-BasedAwards.  *For service-based optionsand restricted stock units and awards, we recognize compensation expense on astraight-line basis over the requisite service period of the award. Forperformance based options, we recognize expense over the estimated performanceperiod. In addition the benefits of tax deductions in excess of recognizedstock-based compensation is reported as a financing activity rather than anoperating activity in the statements of cash flows. This requirement can havethe effect of reducing net operating cash flows and increasing net financingcash flows in certain periods. To date, we have not recorded these benefits asthey have not been realized.

 

We use the Black-Scholes option pricing model todetermine the weighted average fair value of options granted.

 

For the three months ending March 31, 2009 and2010, stock-based compensation expense reduced basic earnings per share by$0.04 and $0.05, respectively, and diluted earnings per share by $0.04 and$0.05, respectively.

 

*Other Significant Estimates*

 

*Goodwill and Intangible AssetsImpairment.  *We review thecarrying value of goodwill and intangible assets annually based upon theexpected future discounted operating cash flows of our business. Our cash flowestimates are based on historical results adjusted to reflect our best estimateof our operating results in future periods. Actual results may differmaterially from these estimates. The timing and size of impairment charges, ifany, involves the application of management’s judgment regarding the estimatesand could significantly affect our operating results.

 

**Overview of Results of Operations in the Three MonthsEnded March 31, 2009 and 2010**

 

Total revenues increased by 17%, or $8.4 million, in the three monthsended March 31, 2010, or 2010, compared to the three months ended March 31,2009, or 2009, primarily due to an increase in total service revenues of 21%,or $7.4 million, and to a lesser extent, an increase in license revenuesof 7%, or $1.0 million. Our revenue growth included a 20% increase inrevenues from contract research organizations, or CROs, which increased to$13.1 million from $10.9 million. The increase in services revenuesis primarily associated with revenues from application hosting services due toincreased production trials under management for our *InForm *licensecustomers as well as trials under management as a result of our recentacquisitions of Maaguzi, and Covance IVRS/IWRS. Through these recentacquisitions and the acquisition of Clarix in 2008, our objective is to providean Integrated Clinical Research Suite (ICRS) of technology solutions,which consists of multiple products that can be purchased on a stand-alonebasis, to automate and integrate the entire clinical development process fromstudy initiation and regulatory submission through post-approval trials. Ourability to provide ICRS as a single source vendor and to continue to providethe product functionality and performance that our customers require will be amajor factor in our ability to continue to increase revenues.

 

Our gross margin increased by 9%, or $2.6 million, in 2010compared to 2009, primarily due to a higher increase in revenues in relation tocost of revenues. The increase in gross margins is primarily due to theincrease in the services gross margin of $1.5 million resulting from higherservices revenues and lower services expense. With the continued shift in ourrevenues from license revenues to services revenues associated primarily withour recent acquisitions and our ICRS strategy, our ability to continue tomaintain our overall gross margins will depend on our ability to continue toincrease services efficiencies and lower our cost of delivery.

 

Operating income in 2010 of $3.1 million decreased by $2.1 million,or 41%, compared to 2009. Operating income for 2009 and 2010 included$2.6 million and $3.5 million of stock-based compensation expense,respectively, and $0.8 million and $1.5 million of amortizationexpense related to acquisitions, respectively. We expect to increase operatingincome through increased revenues from 

 

25

----

Table of Contents

 

ourrecent acquisitions and execution of our ICRS strategy and through our abilityto lower services and operating expenses as a percentage of revenues throughimproved efficiencies throughout our services organization and leveraging ouroperating expenses as revenues continue to increase.

 

The results of 2010 compared to 2009 were impacted by foreign exchangerate fluctuations, resulting in a decrease in revenue of approximately$0.6 million, or 1% of revenues, and an increase in expense ofapproximately $1.2 million, or 3% of expenses.

 

As of March 31, 2010, we had$129.7 million of unrestricted cash, cash equivalents and short-terminvestments, an increase of $20.6 million from $109.1 million at December 31,2009. In addition, as of March 31, 2010, we had $3.3 million incurrent assets associated with a securities settlement agreement with UBS AG.As of March 31, 2010, we had no outstanding debt.

 

*Revenues*

 
| ** **                                      | ** ** | **Three Months Ended  March 31,** | ** ** | ** **                   | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|----------------------------------------|------------|------------------------------|------------|------------|------------|
| ** **                                      | ** ** | **2009**                               | ** ** | **2010**                     | ** ** | **Change** | ** ** |
| **Revenues by Product Line (in thousands) (1)** | ** ** | **Amount**                             | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                            |       |                                   |       |                         |       |       |       |   |   |   |   |   |   |
| Electronic  data capture                        |       | $                                      | 36,527     |                         | 75         | %          | $          | 40,325 |   | 71 | % | $ | 3,798 |   | 10 | % |
| Clinical  data management                       |       | 5,618                                  |       | 11                           |       | 4,797      |       | 8 |   | (821 | ) | (15 | ) |
| Safety                                          |       | 5,383                                  |       | 11                           |       | 6,188      |       | 11 |   | 805 |   | 15 |   |
| Interactive  Response Technology                |       | 1,288                                  |       | 3                            |       | 5,890      |       | 10 |   | 4,602 |   | 357 |   |
| Total                                           |       | $                                      | 48,816     |                         | 100        | %          | $          | 57,200 |   | 100 | % | $ | 8,384 |   | 17 | % |

 

----

(1) Revenues byProduct 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$2.4 million as well as an increase in license revenues of$1.5 million.  These increases werepartly off-set by a decrease in consulting revenues of $0.2 million. Thedecrease in clinical data management is primarily due to a decrease in licenserevenues of $0.7 million.  The increasein safety revenues is primarily due to increases in consulting and licenserevenues of $0.3 million and $0.2 million, respectively. The increase ininteractive response technology revenues is primarily related to increasedapplication hosting revenues of $4.6 million. To a lesser extent the increase is attributable to revenues related tothe acquisition of Covance IVRS/IWRS in August 2009.

 
| ** **                          | ** ** | **Three Months Ended March 31,** | ** ** | ** **                  | ** ** | ** ** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|-----------------------------|------------|------------|------------|
| ** **                          | ** ** | **2009**                              | ** ** | **2010**                    | ** ** | **Change** | ** ** |
| **Revenues by Type (in thousands)** | ** ** | **Amount**                            | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                |       |                                  |       |                        |       |       |       |   |   |   |   |   |   |
| License                             |       | $                                     | 14,116     |                        | 29         | %          | $          | 15,141 |   | 27 | % | $ | 1,025 |   | 7 | % |
| Application hosting  services       |       | 26,626                                |       | 55                          |       | 33,782     |       | 59 |   | 7,156 |   | 27 |   |
| Consulting services                 |       | 4,861                                 |       | 10                          |       | 5,207      |       | 9 |   | 346 |   | 7 |   |
| Customer support                    |       | 3,213                                 |       | 6                           |       | 3,070      |       | 5 |   | (143 | ) | (4 | ) |
| Total                               |       | $                                     | 48,816     |                        | 100        | %          | $          | 57,200 |   | 100 | % | $ | 8,384 |   | 17 | % |

 

Total revenues increased in 2010 as compared to2009, primarily due to increases in application hosting and license revenues.The increase in 2010 revenues associated with our application hosting serviceswas partially due to a 10% increase in production trials under management fromapproximately 955 in 2009 to approximately 1,050 in 2010, which includesapplication hosting services trials and trials hosted for our *InForm *license customers. Theincrease in production trials relates to a relative increase in the number ofcustomers who purchase all trial-related services from us, customers wholicense *InForm *and buildtheir own studies. Our application hosting services also increased due to theimpact of additional trials under management for our web-integrated *Phase Forward IRT* product offering with production trials increasing 85% from 96in 2009 to 178 in 2010. The increase in license revenues was primarily theresult of additional electronic data capture revenues from both new andexisting customers, and to a lesser extent, growth in sales relating to oursafety products. The increase in consulting services was primarily attributableto additional revenue related to consulting services provided for our safetyproducts for both new and existing customers, and to a lesser extent, growth insales relating to our clinical data management products. The decrease incustomer support revenues was primarily due to decreases in

 

26

----

Table ofContents

 

clinicaldata management products. Our revenues were not significantly impacted by priceincreases or decreases. Inflation had only a nominal impact on our revenues.

 
| ** **                                               | ** ** | **Three Months Ended March 31,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                               | ** ** | **2009**                                             | ** ** | **2010**                         | ** ** | **Change** | ** ** |
| **Revenues by Geography  (in thousands)** | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                     |       |                                                 |       |                             |       |       |       |   |   |   |   |   |   |
| North America                                            |       | $                                                    | 30,339     |                             | 62         | %          | $          | 35,843 |   | 63 | % | $ | 5,504 |   | 18 | % |
|                                                     |       |                                                 |       |                             |       |       |       |   |   |   |   |   |   |
| United Kingdom                                           |       | 12,619                                               |       | 26                               |       | 14,358     |       | 25 |   | 1,739 |   | 14 |   |
| France                                                   |       | 3,651                                                |       | 7                                |       | 3,758      |       | 7 |   | 107 |   | 3 |   |
| Asia Pacific                                             |       | 2,207                                                |       | 5                                |       | 3,241      |       | 5 |   | 1,034 |   | 47 |   |
| International subtotal                                   |       | 18,477                                               |       | 38                               |       | 21,357     |       | 37 |   | 2,880 |   | 16 |   |
| Total                                                    |       | $                                                    | 48,816     |                             | 100        | %          | $          | 57,200 |   | 100 | % | $ | 8,384 |   | 17 | % |
|                                                          |            |                                                      |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Theincrease in revenues worldwide was primarily due to an increase in interactiveresponse technology revenues and electronic data capture revenues of$4.6 million and $3.8 million, respectively. The increase in NorthAmerican revenues is primarily related to an increase in interactive responsetechnology revenues and electronic data capture revenues of $3.8 million and$1.4 million, respectively. The increase in interactive response technologyrevenues is primarily a result of the acquisition of Clarix. To a lesserextent, the increase is attributable to the 2010 period including a fullquarter of application hosting services revenues relating to the acquisition ofCovance IVRS/IWRS in August 2009, while the 2009 period included norevenue. The increase in international revenues is primarily related to anincrease in electronic data capture revenues, interactive response technologyrevenues and safety revenues of $2.4 million, $0.8 million and $0.4million, respectively. These increases were slightly off-set by a decrease inclinical data management revenues of $0.8 million.

 

*Cost of Revenues*

 
| ** **                                           | ** ** | **Three Months Ended March 31,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                                           | ** ** | **2009**                                             | ** ** | **2010**                                  | ** ** | **Change** | ** ** |
| **Costs of Revenues  (in thousands)** | ** ** | **Amount**                                           | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                 |       |                                                 |       |                                      |       |       |       |   |   |   |   |   |   |
| License                                              |       | $                                                    | 566        |                                      | 4          | %          | $          | 566 |   | 4 | % | $ | — |   | — | % |
| Services                                             |       | 19,899                                               |       | 57                                        |       | 25,716     |       | 61 |   | 5,817 |   | 29 |   |
| Total                                                |       | $                                                    | 20,465     |                                      | 42         | %          | $          | 26,282 |   | 46 | % | $ | 5,817 |   | 28 | % |

 

Therewas no change in the cost of license revenues when comparing 2010 to 2009. Theincrease in cost of services in 2010 was primarily due to increases inemployee-related expenses of $2.4 million related to a headcount increaseof 66 people, and increases in depreciation expenses of $1.0 million. We alsohad expense increases for network hosting, outside contractors, customerpass-though expenses and computer related expenses of $0.7 million, $0.5million, $0.4 million and $0.3 million, respectively. Computer-related expensesinclude hardware and software support agreements as well as computeraccessories.

 

*Gross Margin*

 
| ** **                                 | ** ** | **Three Months Ended March 31,** | ** ** | ** **                                | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|------------------------------------------------------|------------|-------------------------------------------|------------|------------|------------|
| ** **                                 | ** ** | **2009**                                             | ** ** | **2010**                                  | ** ** | **Change** | ** ** |
| **Gross Margin  (in thousands)** | ** ** | **Amount**                                           | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Related  Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                       |       |                                                 |       |                                      |       |       |       |   |   |   |   |   |   |
| License                                    |       | $                                                    | 13,550     |                                      | 96         | %          | $          | 14,575 |   | 96 | % | $ | 1,025 |   | 8 | % |
| Services                                   |       | 14,801                                               |       | 43                                        |       | 16,343     |       | 39 |   | 1,542 |   | 10 |   |
| Total                                      |       | $                                                    | 28,351     |                                      | 58         | %          | $          | 30,918 |   | 54 | % | $ | 2,567 |   | 9 | % |

 

27

----

Table of Contents

 

Theoverall gross margin percentage decreased in 2010 as compared to 2009 due to alower service margin percentage. The decrease in the services gross marginpercentage was due to higher services expenses as a percentage of relatedrevenues, as well as the inclusion of our *OutcomLogix*product from the acquisition of Maaguzi in July 2009 and the acquisitionof Covance IVRS/IWRS in August 2009. The license gross margin percentageremained the same in 2010 as compared to 2009. It is likely that gross margin,as a percentage of revenues, will fluctuate quarter by quarter due to thetiming and mix of license and service revenues, and the type, amount and timingof service required in delivering certain projects.

 

*Operating Expenses*

 
| ** **                                       | ** ** | **Three Months Ended March 31,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                       | ** ** | **2009**                                             | ** ** | **2010**                         | ** ** | **Change** | ** ** |
| **Operating Expenses  (in thousands)** | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                             |       |                                                 |       |                             |       |       |       |   |   |   |   |   |   |
| Sales and marketing                              |       | $                                                    | 7,206      |                             | 15         | %          | $          | 8,986 |   | 16 | % | $ | 1,780 |   | 25 | % |
| Research and development                         |       | 8,180                                                |       | 17                               |       | 9,698      |       | 17 |   | 1,518 |   | 19 |   |
| General and administrative                       |       | 7,804                                                |       | 16                               |       | 9,184      |       | 16 |   | 1,380 |   | 18 |   |
| Total                                            |       | $                                                    | 23,190     |                             | 48         | %          | $          | 27,868 |   | 49 | % | $ | 4,678 |   | 20 | % |

 

*Sales and Marketing.*    Salesand marketing expenses increased in 2010 primarily due to employee-relatedexpense of $0.5 million related to a headcount increase of 18 people, aswell as an increase in amortization of intangible assets of $0.4 million.We also had increases in commissions expenses, outside contractor expenses andtravel expenses of $0.4 million, $0.1 million and $0.1 million,respectively. We expect that our sales and marketing expense will continue toincrease in absolute dollars as commission expense increases with our revenuesand as we continue to expand sales coverage and to build brand awarenessthrough what we believe are the most cost effective channels available. Weexpect that such increases may fluctuate, however, due to the timing ofmarketing programs.

 

*Research and Development.*    Researchand development expenses increased in 2010 primarily due to employee-relatedexpenses of $1.3 million related to a headcount increase of 74 people. Wealso had expense increases related to stock-based compensation, facilitiesexpenses and travel expenses of $0.4 million, $0.2 million and$0.1 million, respectively. Increases were partially off-set by a decreasein outside contractor expenses of $0.4 million. We expect that our research and development costs will continue toincrease in absolute dollars as we continue to add features and functionalityto our products, introduce additional integrated software solutions to ourproduct suite and expand our product and service offerings.

 

*General and Administrative.*    Generaland administrative expenses increased in 2010 primarily due to increases indepreciation, outside contractor and stock-based compensation expenses of $0.4million, $0.3 million and $0.3 million, respectively.  We also had expense increases related tofacilities and taxes and fees expenses of $0.3 million and $0.1 million,respectively. We expect that in the future our general and administrativeexpenses will increase in absolute dollars as we add personnel and incuradditional costs related to the growth of our business and operations.

 

*Other Income*

 
| ** **                            | ** ** | **Three Months Ended March 31,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|---------------------------------------|------------|------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                            | ** ** | **2009**                                             | ** ** | **2010**                         | ** ** | **Change** | ** ** |
| **Other  income (in thousands)** | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                  |       |                                                 |       |                             |       |       |       |   |   |   |   |   |   |
| Interest income                       |       | $                                                    | 640        |                             | 1          | %          | $          | 316 |   | 1 | % | $ | (324 | ) | (51 | )% |
| Other, net                            |       | 409                                                  |       | 1                                |       | (184       | )          | — |   | (593 | ) | (145 | ) |
| Total other income                    |       | $                                                    | 1,049      |                             | 2          | %          | $          | 132 |   | — | % | $ | (917 | ) | (87 | )% |

 

Thedecrease in interest income in 2010 was primarily due to the net decrease incash and cash equivalents and short and long-term investments. The decrease inother, net in 2010 was primarily due to decreases in the fair value associatedwith our securities settlement agreement.

 

*Provision for Income Taxes*

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** | ** **                       | ** ** | ** ** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------|------------|------------|------------|
| ** **                                          | ** ** | **2009**                                             | ** ** | **2010**                         | ** ** | **Change** | ** ** |
| **Provision  for income taxes (in thousands)** | ** ** | **Amount**                                           | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **Percentage  of Revenues** | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                                |       |                                                 |       |                             |       |       |       |   |   |   |   |   |   |
| Provision for income taxes                          |       | $                                                    | 2,132      |                             | 4          | %          | $          | 1,249 |   | 2 | % | $ | (883 | ) | (41 | )% |
|                                                     |            |                                                      |            |                                  |            |            |            |  |  |  |  |  |  |  |  |  |

 

28

----

Table of Contents

 

Oureffective tax rate for 2009 and 2010 was 34% and 39%, respectively.  Our effective tax rate for 2010 is higherthan the effective tax rate for 2009 principally due to the benefit derived inthe prior year from the federal research and development tax credit.  The federal research and development taxcredit expired effective December 31, 2009 and, as such, we have notforecasted a current tax benefit for this item in 2010.

 

**Non-GAAP Financial Information**

 

We provide non-GAAP revenues, income from operations, net income, andnet income per share applicable to common stockholders data as additionalinformation for our operating results. These measures are not in accordancewith, or an alternative for, generally accepted accounting principles and maybe different from non-GAAP measures used by other companies. We believe thesenon-GAAP measures are useful to investors because this supplemental informationfacilitates comparisons to prior periods. We use these non-GAAP measures to evaluateour financial results, develop budgets and manage expenditures. Investors areencouraged to review the reconciliations of these non-GAAP financial measuresto the comparable GAAP results.

 

The table below presents a reconciliation of GAAP to non-GAAP revenues,income from operations and net income and net income per share applicable tocommon stockholders for the three months ended March 31, 2009 and 2010.Non-GAAP results exclude the impact of stock-based compensation expense,amortization of intangible assets, the effects of purchase accountingadjustment to record deferred revenues and backlog assumed in acquisitions atfair value, impairment of intangible assets and restructuring expenses.

 

**Reconciliation of GAAP Revenues, GAAP Income From Operationsand GAAP Net Income (Loss) to**

**Non-GAAPRevenues, Non-GAAP Income From Operations and Non-GAAP Net Income (Loss)**

 

**(unaudited)**

 

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

 
| ** **                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                     | ** ** | **2009**                               | ** ** | **2010** | ** ** |
| **TOTAL REVENUES:**                                                            |       |                                   |       |   |   |
| GAAP total revenues                                                            |       | $                                      | 48,816     |   | $ | 57,200 |   |
| Deferred revenues and backlog adjustments related  to acquisitions(1)          |       | 628                                    |       | 296 |   |
| Non-GAAP total revenues                                                        |       | $                                      | 49,444     |   | $ | 57,496 |   |
| **INCOME FROM OPERATIONS:**                                                    |       |                                   |       |   |   |
| GAAP income from operations                                                    |       | $                                      | 5,161      |   | $ | 3,050 |   |
| Stock-based compensation expense                                               |       | 2,570                                  |       | 3,501 |   |
| Amortization of intangible assets                                              |       | 761                                    |       | 1,450 |   |
| Deferred revenues and backlog adjustments related  to acquisitions(1)          |       | 628                                    |       | 296 |   |
| Non-GAAP income from operations                                                |       | $                                      | 9,120      |   | $ | 8,297 |   |
| **NET INCOME (LOSS):**                                                         |       |                                   |       |   |   |
| GAAP net income (loss)                                                         |       | $                                      | 4,078      |   | $ | 1,933 |   |
| Stock-based compensation expense, net of tax                                   |       | 1,687                                  |       | 2,197 |   |
| Amortization of intangible assets, net of tax                                  |       | 500                                    |       | 910 |   |
| Deferred revenues and backlog adjustments related  acquisitions, net of tax(1) |       | 412                                    |       | 187 |   |
| Non-GAAP net income                                                            |       | $                                      | 6,677      |   | $ | 5,227 |   |
| GAAP net income per share applicable to common  stockholders:                  |       |                                   |       |   |   |
| Diluted                                                                        |       | $                                      | 0.09       |   | $ | 0.05 |   |
| Non-GAAP net income per share applicable to common  stockholders:              |       |                                   |       |   |   |
| Diluted                                                                        |       | $                                      | 0.15       |   | $ | 0.12 |   |

 

----

(1)                                  Fair valueadjustments to deferred revenues and backlog. Purchase accounting requires thatdeferred revenue assumed in an acquisition be recorded and subsequentlyrecognized at its fair value as of the time of the acquisition. Consequently,we do not recognize the full amount of these deferred revenues and backlog. Weadd back non-GAAP revenues associated with 

 

29

----

Table of Contents

 

deferred revenues and backlog that were excluded as a result ofpurchase accounting adjustments, as we believe that this provides informationabout the operating impact of the acquired business in a manner consistent withthe revenue recognition for our pre-existing products and services.

 

**Liquidityand Capital Resources**

 

Ourprincipal sources of liquidity were unrestricted cash, cash equivalents, shortand long-term investments totaling $135.5 million and $129.7 million at December 31,2009 and March 31, 2010, respectively, and accounts receivable of$56.0 million and $44.7 million, respectively.  For the periods ended March 31, 2009 and2010 we had no outstanding debt and, in general, we do not enter into long-termbinding purchase commitments. We currently expect to retain any future earningsfor use in the operation and expansion of our business, including our stockrepurchase program, and do not anticipate paying any cash dividends on ourcommon stock.

 

Webelieve that our existing cash, cash equivalents, short-term investments andcash provided by operating activities will be sufficient to meet our workingcapital and capital expenditure needs over at least the next 12 months.Our future capital requirements will depend on many factors, including our rateof revenue growth, the expansion of our marketing and sales activities, thetiming and extent of spending to support product development efforts, thetiming of introductions of new products and services and enhancements toexisting products and services and the continuing market acceptance of ourproducts and services. From time to time, we may also enter into agreementswith respect to potential investments in, or acquisitions of, businesses,services or technologies, which could also require us to seek additional equityor debt financing. To the extent that existing cash and securities and cashfrom operations are insufficient to fund our future activities, we may need toraise additional funds through public or private equity or debt financing.

 

Substantiallyall of our long-lived assets at December 31, 2009 and March 31, 2010are located in the United States.

 

*Net Operating Loss Carryforwards*

 

AtDecember 31, 2009, we had $19.2 million of net operating losscarryforwards that may be used to offset future U.S. federal taxable income,which may reduce our future cash tax liability. In addition, we had$20.3 million of net operating losses resulting from excess tax deductionsrelated to stock-based compensation. We will realize the benefit of theseexcess tax deductions through increases to stockholders’ equity in the periodsin which the losses are utilized to reduce tax payments. At December 31,2009, we had $3.7 million of federal research and development tax creditcarryforwards that may be utilized to offset future U.S. taxes. In addition, wehad $0.4 million of federal research and development tax credits resultingfrom excess tax deductions related to stock-based compensation, the benefits ofthese credits will be realized through increases to stockholders’ equity in theperiods in which the credits are utilized to offset future U.S. taxes. The netoperating loss and tax credit carryforward periods extend through 2029. We alsohad $4.5 million of research and development tax credit carryforwards and$1.4 million of investment tax credits that may be utilized to offsetfuture Massachusetts state taxable income. The Massachusetts research anddevelopment tax credit carryforward period extends through 2024. TheMassachusetts investment tax credits begin to expire in 2010. The federal andstate net operating loss carryforwards and research and development tax creditsare subject to review and possible adjustment by the taxing authorities. Also,the Internal Revenue Code contains provisions that may limit the net operatingloss and tax credit carryforwards available in any given year in the event ofcertain changes in the ownership interests of significant stockholders. Wecurrently expect to realize the benefit of all recorded deferred tax assets asof December 31, 2009. Our conclusion that such assets will be recovered isbased upon our expectation that our future earnings combined with tax planningstrategies available to us will provide sufficient taxable income to realizerecorded tax assets.

 

Wemay be required to make cash outlays related to our unrecognized taxbenefits.  However, due to the uncertainty of the timing of future cashflows associated with our unrecognized tax benefits, we are unable to makereasonably reliable estimates of the period of cash settlement, if any, withthe respective taxing authorities.  Accordingly, unrecognized tax benefitsof $1.6 million as of December 31, 2009 have been excluded from thecontractual obligations table below under the heading *Contractual Obligations*. For furtherinformation on unrecognized tax benefits, see Note 6 in the notes to our 2009consolidated financial statements included in our Annual Report on Form 10-Kfor the year ended December 31, 2009.

 

*Auction Rate Securities*

 

Includedwithin our investment portfolio at December 31, 2009 and March 31,2010 were $23.8 million and $21.6 million of auction rate securities, orARS, at par value, which are classified as short-term investments on ourunaudited condensed consolidated balance sheets, and recorded at fair marketvalue. These ARS are debt instruments issued by various states throughout theUnited States to finance student loans. The types of ARS that we own are backedby student loans, 95% of which are guaranteed under the Federal FamilyEducation Loan Program, and all had credit ratings of AAA (or equivalent) froma recognized rating agency. 

 

30

----

Table of Contents

 

Historically,the carrying value of ARS approximated fair value due to the frequent resettingof the interest rates. With the liquidity issues experienced in the globalcredit and capital markets, our ARS have experienced multiple failed auctions.While we continue to earn and receive interest on these investments at the maximumcontractual rate, the estimated fair value of these ARS no longer approximatespar value.

 

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

 

Weperformed a fair value calculation of our ARS as of December 31, 2009 and March 31,2010. Fair value was determined using a secondary market indications method(direct discounts) and a discounted cash flow method as recent auctions ofthese securities were not successful, resulting in our continuing to hold thesesecurities and issuers paying interest at the maximum contractual rate. Thisvaluation technique considers the following: time left to maturity, the rate ofinterest paid on the securities, the amount of principal to be repaid to theholders of the securities; the credit worthiness of the issuer and guarantors(if any) and the sufficiency of the collateral; trading characteristics of the securities;ability to borrow against the ARS; evidence from secondary market sales; andthe market-clearing yield for the securities.

 

Basedupon the valuation performed, we concluded that the fair value of these ARS at December 31,2009 was $19.4 million, a decline of $4.4 million from par value. As of March 31,2010, we concluded that the fair value of these ARS was $18.2 million, andtherefore, recorded the change in fair value of $1.1 million in theaccompanying unaudited condensed consolidated statement of income for the threemonths ended March 31, 2010. As of March 31, 2010, it remained ourintent to sell the ARS on June 30, 2010 in accordance with our rightsunder the settlement agreement. Accordingly the ARS are classified as short-term investments in theunaudited condensed consolidated balance sheets.

 

Weelected to measure the fair value of the settlement agreement (the “put option”)under the fair value option. Fair value was determined using a discounted cashflow method which considered the following factors: the term of the agreement,the availability to borrow against the ARS, the creditworthiness of UBS andcurrent market interest rates. Based on the valuation performed, we concludedthat the fair value of the put option as of December 31, 2009 and March 31,2010 was $4.3 million and $3.3 million, respectively. Accordingly, thedecrease in fair value of $1.1 million for the three months ended March 31,2010 was recorded in our accompanying unaudited condensed consolidatedstatement of income.  As of March 31,2010, it remained our intent to sell the ARS on June 30, 2010 inaccordance with our rights under the settlement agreement, and accordingly weclassify the fair value of the “securities settlement agreement” as currentassets in the unaudited condensed consolidated balance sheets.

 

**CashFlows**

 

Cashprovided by and used in operating activities has historically been affected bychanges in working capital accounts, primarily deferred revenues, accountsreceivable and accrued expenses, and add-backs of non-cash expense items suchas depreciation and amortization and stock-based compensation expense.Fluctuations within accounts receivable and deferred revenues are primarilyrelated to the timing of billings to our customers, payments from our customersand the associated revenue recognition. Movements in deferred costs are relatedto the volume and stages of hosted clinical trials and movements in accruedexpenses and accounts payable are due to the timing of certain transactions.

 

*Net Cash Provided by Operating Activities.*  Net cash provided by operating activities was$23.4 million in the three months ended March 31, 2010, which wasmore than net income of $1.9 million. The difference is primarily due tovarious changes in working capital accounts of $12.2 million which includechanges to accounts receivable and deferred revenue of $11.4 million and 12.1million, respectively, off-set by changes to accrued expenses and accountspayable of $8.8 million and $2.3 million, respectively.  Non-cash adjustments included $5.8 million ofdepreciation and amortization expense, $3.5 million of stock-based compensationexpense, and $1.1 million related to the change in fair value of the securitiessettlement agreement, partially offset by a $1.1 million change in fair valueof our investments.

 

*Net Cash Provided by Investing Activities.*  Net cash provided by investing activities was$15.3 million during the three months ended March 31, 2010, which wasprimarily due proceeds from maturities of short-term and long-term investmentsof $29.1 million.  

 

31

----

Table of Contents

 

Cashprovided by investing activities was partially offset by the purchase of shortand long-term investments of $10.8 million, and the purchase of property andequipment of $3.0 million.

 

*Net Cash Used In Financing Activities.*  Net cash used in financing activities was$26.6 million in the three months ended March 31, 2010, primarily due tothe purchase of treasury stock of $26.0 million.

 

**ContractualObligations**

 

Our principal commitments consist of obligations under non-cancelableoperating leases for office space. The following table of our materialcontractual obligations as of December 31, 2009 summarizes the aggregateeffect that these obligations are expected to have on our cash flows in theperiods indicated:

 
| ** **                                  | ** ** | **Payments Due by Period** | ** ** |
|---------------------------------------------|------------|----------------------------|------------|
| **Contractual  Obligations (in thousands)** | ** ** | **Total**                  | ** ** | **1 year or less** | ** ** | **2-3 years** | ** ** | **4-5 years** | ** ** | **More than  5 years** | ** ** |
|                                        |       |                       |       |   |   |   |   |   |   |   |   |
| Operating lease obligations                 |       | $                          | 83,440     |   | $ | 10,041 |   | $ | 19,166 |   | $ | 17,552 |   | $ | 36,681 |   |
| Total                                       |       | $                          | 83,440     |   | $ | 10,041 |   | $ | 19,166 |   | $ | 17,552 |   | $ | 36,681 |   |

 

The above table includes the lease entered into on February 13,2008 with BP Fourth Avenue, L.L.C. to secure office space for our corporateheadquarters at 77 Fourth Avenue, Waltham, Massachusetts. The commencement datefor occupancy under the lease was December 2008.

 

The lease provides for the rental of 165,129 rentable square feet ofspace and has an initial term of 10 years and three months. We can,subject to certain conditions, extend this term by exercising up to twoconsecutive five year options. We were not required to pay any rent for thefirst three months of the initial lease term. Thereafter, the annual rent onthe lease for years one through five will be $6.6 million, orapproximately $0.5 million per month. For years six through ten, theannual rent will be $7.2 million, or approximately $0.6 million permonth. The total base rent payable in the initial term is $69.1 million.

 

In addition to base rent, commencing on January 1, 2010, the leasefor our current headquarters requires us to pay our proportionate share of theamount by which defined operating expenses incurred by the landlord exceed thebase year (2009) operating expenses, as defined in the lease. The lease alsorequires us to pay our proportionate share of the amount by which real estatetaxes paid or incurred by the landlord exceed the tax base year (fiscal 2010),as defined in the lease. In addition, we are receiving lease incentives,including free rent for the first three months of occupancy, which totaledapproximately $1.6 million, and allowances for tenant improvementstotaling approximately $8.1 million. The allowances for tenantimprovements are being amortized on a straight-line basis over the lease termas a reduction of rental expense.

 

In connection with the signing of the lease for our currentheadquarters, we have deposited with the landlord an unconditional, irrevocableletter of credit in the landlord’s favor in the amount of $1.0 million.

 

The above table also includes the lease which we entered into on August 17,2009 with KBS Five Tower Bridge, L.L.C. to secure office space for our *IRT* business operations at 300 Barr HarborDrive, West Conshohocken, Pennsylvania. The commencement date for occupancyunder the lease was September 2009 with rent payments commencing in February 2010.The lease provides for the rental of 44,907 square feet of space and has aninitial term of 10 years and one month. We can, subject to certainconditions, extend this term by exercising up to two consecutive five yearoptions. The annual rent under this lease for the first year is$1.3 million, or approximately $0.1 million per month, with annualescalations in rent for each subsequent year in the amount fifty cents persquare foot. The total base rent payable in the initial term is$14.2 million.

 

In addition to base rent,commencing on January 1, 2012, the lease for our *IRT* operations requires us to pay ourproportionate share of the amount by which defined operating expenses incurredby the landlord exceed the base year operating expenses, as defined in thelease. The lease also requires us to pay our proportionate share of the amountby which real estate taxes paid or incurred by the landlord exceed the tax baseyear, as defined in the lease.

 

32

----

Table of Contents

 

**Recently Issued AccountingPronouncements**

 

On January 1,2010, we adopted the guidance of ASU No. 2009-13, Revenue Recognition(Topic 605): *Multiple-Deliverable RevenueArrangements*, which was ratified by the FASB Emerging Issues TaskForce on September 23, 2009. ASU No. 2009-13addresses the accounting for multiple-deliverable arrangements to enablevendors to account for products or services (deliverables) separately ratherthan as a combined unit. This guidance establishes a selling price hierarchyfor determining the selling price of a deliverable, which is based on: (a) vendor-specificobjective evidence; (b) third-party evidence; or (c) estimates. Thisguidance also eliminates the residual method of allocation and requires thatarrangement consideration be allocated at the inception of the arrangement toall deliverables using the relative selling price method. In addition, thisguidance significantly expands required disclosures related to a vendor’smultiple-deliverable revenue arrangements.  The impact ofthis standard was not material to our reported results of operations. Refer toour revenue recognition policies for further discussion.

 

On January 21,2010, the FASB issued ASU No. 2010-06, *FairValue Measurements and Disclosures (Topic 820)—Improving Disclosures about FairValue Measurements*. The ASU requires reporting entities to provideinformation about movements of assets among Levels 1 and 2 of the three-tierfair value hierarchy established by FASB ASC 820, *Fair Value Measurements.* During the threemonths ended March 31, 2010 we had no movements among Level 1 and 2 of thethree-tier fair value hierarchy. Entities will also need to provide areconciliation of purchases, sales, issuance, and settlements of anythingvalued with a Level 3 method, which is used to price the hardest to valueinstruments. The new disclosures and clarifications of existing disclosureswere adopted on January 1, 2010. Adoption of this portion of ASU No. 2010-06 did not have an impacton our consolidated financial position and results of operation. Disclosuresabout purchases, sales, issuances, and settlements in the roll forward ofactivity in Level 3 fair value measurements are effective for fiscal yearsbeginning after December 15, 2010, and for interim periods within thosefiscal years.  We elected to adopt thisportion of ASU No. 2010-06 on January 1, 2010. Adoption of this portion of ASU No. 2010-06 did not have an impacton our consolidated financial position and results of operation.

 

**Off-BalanceSheet Arrangements**

 

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

 

**Special Note Regarding Forward-Looking Statements**

 

Inaddition to historical consolidated financial information, this QuarterlyReport on Form 10-Q contains forward-looking statements within the meaningof Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities and Exchange Act of 1934, as amended, and are intended to becovered by the “safe harbor” created by those sections.  All statements,other than statements of historical facts, included in this Quarterly Report onForm 10-Q regarding our strategy, future operations, future financialposition, future net sales, projected costs, projected expenses, prospects andplans and objectives of management are forward-looking statements. The words “anticipates,”“believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,”“would” and similar expressions are intended to identify forward-lookingstatements, although not all forward-looking statements contain theseidentifying words.

 

We may not actually achieve the plans, intentions orexpectations disclosed in our forward-looking statements and you should notplace undue reliance on our forward-looking statements. We have based theseforward-looking statements on our current expectations and projections aboutfuture events. Although we believe that the expectations underlying any of ourforward-looking statements are reasonable, these expectations may prove to be incorrect,and all of these statements are subject to risks and uncertainties. We discussmany of the risks that we believe could cause actual results or events todiffer materially from these forward-looking statements in greater detail inthe section entitled “Risk Factors” in our Annual Report on Form 10-K forthe year ended December 31, 2009. We urge you to consider the risks and uncertainties described in Item 1Aof our Annual Report on Form 10-K for the year ended December 31,2009 in evaluating our forward-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 such statement is based.

 

**Item 3.       *Quantitative andQualitative Disclosures about Market Risk***

 

*Foreign CurrencyExchange Risk*

* *

*We*are exposed to a variety of market risks, includingchanges in interest rates and the market value of our investments.

 

33

----

Table of Contents

 

*Financial Instruments,Other Financial Instruments*

 

Financial instruments meeting fair value disclosure requirementsconsist of cash equivalents, short-term investments, securities settlementagreement, accounts receivable, accounts payable and forward foreign exchangecontracts. The fair value of these financial instruments approximates theircarrying amount.

 

*Foreign Currency Exchange Risk*

 

Our results of operations and cash flows are subject to fluctuations dueto changes in foreign currency exchange rates, particularly changes in theeuro, British pound, Australian dollar and Japanese yen. Except for revenuetransactions in Japan, we enter into transactions directly with substantiallyall of our foreign customers.

 

Percentage of revenues and expenses in foreign currency is as follows:

 
| ** **                                                      | ** ** | **Three Months Ended  March 31,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                                         | ** ** | **2010** | ** ** |
| Revenues generated in locations outside the United  States      |       | 38                                               | %          | 37 | % |
| Revenues in currencies other than the United  States dollar (1) |       | 22                                               |       | 26 |   |
| Expenses in currencies other than the United  States dollar (1) |       | 21                                               |       | 25 |   |

 

----

(1)          Percentage of revenues andexpenses denominated in foreign currency for the three months ended March 31,2010:

 
| ** **    | ** ** | **Revenues** | ** ** | **Expenses** | ** ** |
|---------------|------------|--------------|------------|--------------|------------|
| euros         |       | 15           | %          | 5            | %          |
| British pound |       | 6            |       | 12           |       |
| Japanese yen  |       | 5            |       | 5            |       |
| Other         |       | —       |       | 3            |       |
| Total         |       | 26           | %          | 25           | %          |

 

As of March 31, 2009 and 2010, we had $9.0 million and$21.1 million, respectively, of receivables denominated in currenciesother than the U.S. dollar. We also maintain cash accounts denominated incurrencies other than the local currency which exposes us to foreign exchangerate movements.

 

In addition, although our foreign subsidiaries have intercompanyaccounts that eliminate upon consolidation, such accounts expose us to foreigncurrency rate movements. Exchange rate fluctuations on short-term intercompanyaccounts are recorded in our consolidated statements of operations under “otherincome (expense), net”, while exchange rate fluctuations on long-termintercompany accounts are recorded in our consolidated balance sheets under “accumulatedother comprehensive income (loss)” in stockholders’ equity, as they areconsidered part of our net investment and hence do not give rise to gains orlosses.

 

We have implemented a risk management program under which we measureforeign currency exchange risk monthly and manage those exposures through theuse of various operating strategies and, as more fully described inNote 13 of the notes to the accompanying unaudited condensed consolidatedfinancial statements included in this Quarterly Report.  We regularly purchase short-term foreigncurrency forward contracts, designed to hedge fluctuation in non-functionalcurrencies and our subsidiaries against the U.S. dollar. This process isdesigned to minimize foreign currency translation exposures that couldotherwise affect consolidated results of operations. The terms of thesecontracts are generally for periods of one month.

 

Currently, our largest foreign currency exposures are the British poundand euro, primarily because our European operations have a higher proportion ofour local currency denominated expenses. Relative to foreign currency exposuresexisting at December 31, 2008 and 2009, a 10% unfavorable movement inforeign currency exchange rates would expose us to significant losses inearnings or cash flows or significantly diminish the fair value of our foreigncurrency financial instruments. For the year ended December 31, 2009, weestimated that a 10% unfavorable movement in foreign currency exchange rateswould have decreased revenues by $5.3 million, decreased expenses by$4.5 million and decreased operating income by $0.8 million. For thethree months ended March 31, 2010, we estimated that a 10% unfavorablemovement in foreign currency exchange rates would have decreased revenues

 

34

----

Table ofContents

 

by$1.5 million, decreased expenses by $1.3 million and decreasedoperating income by $0.1 million. The estimates used assumes that allcurrencies move in the same direction at the same time and the ratio ofnon-U.S. dollar denominated revenue and expenses to U.S. dollar denominatedrevenue and expenses does not change from current levels. Since a large portionof our revenue is deferred revenue that is recorded at different foreigncurrency exchange rates, the impact to revenue of a change in foreign currencyexchange rates is recognized over time, whereas the impact to expenses is moreimmediate, as expenses are recognized at the current foreign currency exchange ratein effect at the time the expense is incurred. All of the potential changesnoted above are based on sensitivity analyses performed on our financialresults as of December 31, 2009 and March 31, 2010.

 

Asof March 31, 2010, we entered into forward foreign exchange contracts tohedge approximately $5.2 million of receivables, intercompany accounts and cashbalances denominated in currencies other than the U.S. dollar.  We recorded foreign currency gains/(losses) of$0.1 million and $(0.2) million for the three months ended March 31,2009 and 2010, respectively.**We settleforward foreign exchange contracts in cash. As of December 31, 2009 and March 31,20109, we recorded $0.2 and less than $0.1 million, respectively, of foreignexchange gains in other income (expense) as a result of outstanding forwardforeign exchange contracts.

 

*Interest Rate Sensitivity*

 

We had unrestricted cash, cash equivalents,short-term and long-term investments totaling $129.7 million at March 31,2010. These amounts were invested primarily in money market funds, corporatebonds and government agency securities, and are held for working capitalpurposes. We do not use derivative financial instruments in our investmentportfolio. We have established investment guidelines relative to creditquality, diversification, marketability and performance measurement designed tomaintain safety and liquidity. With the exception of auction rate securities,investments in securities are invested primarily in high quality securities ofa short duration and historically have not been materially affected byfluctuations in interest rates. With the exception of auction rate securities,which are recorded at fair value, investments are reported at amortized cost.We considered the historical volatility of short-term and long-term interestrates and determined that, due to the size and duration of our investmentportfolio, a 100-basis-point increase in interest rates would not have anymaterial exposure to changes in the fair value of our portfolio at March 31,2010. A decline in interest rates, however, would reduce future investmentincome.

 

We believe that our existing cash, cash equivalents,short-term investments and cash provided by operating activities will besufficient to meet our working capital and capital expenditure needs over atleast the next 12 months.

 

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

** **

We maintain disclosure controls and procedures thatare designed to ensure that information required to be disclosed in our reportsfiled under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms, and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. In designing and evaluating thedisclosure controls and procedures, management recognized that any controls andprocedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives, as ours aredesigned to do, and management necessarily was required to apply its judgmentin evaluating the cost-benefit relationship of possible controls andprocedures.

 

As of March 31, 2010, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended. Based upon that evaluation,our Chief Executive Officer and Chief Financial Officer concluded that ourdisclosure controls and procedures are effective at that reasonable assurancelevel in (i) enabling us to record, process, summarize and reportinformation required to be included in our periodic Securities and ExchangeCommission filings within the required time period and (ii) ensuring thatinformation required to be disclosed in the reports that we file or submitunder the Securities Exchange Act is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,to allow timely decisions regarding required disclosure.

 

There have been no changes in our internal controlover financial reporting that occurred during the period covered by this reportthat have materially affected, or are reasonably likely to materially affect,our internal control over financial reporting.

 

35

----

Table of Contents

 

**Part II—Other Information**

 

**Item 1.       *Legal Proceedings***

 

From time to time and in the ordinary course ofbusiness, we are subject to various claims, charges and litigation.  The outcome of litigation cannot be predictedwith certainty and some lawsuits, claims or proceedings may be disposed ofunfavorably to us, which could materially affect our financial condition orresults of operations.

 

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

 

We operate in a rapidlychanging environment that involves a number of risks, some of which are beyondour control.  In addition to the otherinformation set forth in this report, 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 31,2009 other than as set forth below. There are no material changes to the risk factors described in the “RiskFactors” section in our Annual Report on Form 10-K for the year ended December 31,2009.  Additional risks and uncertaintiesnot presently known to us, which we currently deem immaterial or which aresimilar to those faced by other companies in our industry or business ingeneral, may also impair our business operations.  If any of the foregoing risks or uncertaintiesactually occurs, our business, financial condition and operating results wouldlikely suffer.

 

*Theannouncement and pendency of our agreement to be acquired by Oracle couldadversely affect our business.*

 

OnApril 15, 2010, we entered into a Merger Agreement with Oracle and PineAcquisition Corporation, a Delaware corporation and wholly-owned subsidiary ofOracle (“Merger Sub”), pursuant to which, subject to satisfaction or waiver ofthe conditions therein, Merger Sub will merge with us (the “Merger”) with theCompany surviving as a wholly-owned subsidiary of Oracle.  Subject to the terms of the Merger Agreement,which has been approved by our board of directors and the boards of directorsof Oracle and Merger Sub, at the effective time of the Merger (the “EffectiveTime”), each share of our common stock issued and outstanding immediately priorto the Effective Time will be converted into the right to receive $17.00 incash, without interest.  The Merger isconditioned upon, among other things, approval by our stockholders, theexpiration or early termination of the applicable premerger waiting periodunder the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and othercustomary conditions.  We will continueto operate separately from Oracle until the transaction closes.  The announcement and pendency of the Mergercould cause disruptions in our business, including affecting our relationshipwith our customers, vendors and employees, which could have an adverse effecton our business, financial results and operations.

 

*Thefailure to complete the merger could adversely affect our business.*

 

Thereis no assurance that the Merger with Oracle or any other transaction willoccur. If the proposed Merger or a similar transaction is not completed, theshare price of our common stock may change to the extent that the currentmarket price of our common stock reflects an assumption that a transaction willbe completed. In addition, under circumstances defined in the Merger Agreement,we may be required to pay a termination fee of $24.7 million and, in certaincircumstances, reimburse reasonable out-of-pocket fees and expenses of Oracleup to $4.0 million incurred with respect to the transactions contemplated bythe Merger Agreement. Further, a failed transaction may result in negativepublicity and a negative impression of us in the investment community.

 

*In certaininstances, the Merger Agreement requires us to pay a termination fee of $24.7million to Oracle. This payment could affect the decisions of a third partyconsidering making an alternative acquisition proposal to the merger.*

 

Under the terms of the merger agreement, we will berequired to pay to Oracle a termination fee of $24.7 million if the MergerAgreement is terminated under certain circumstances. This payment could affectthe structure, pricing and terms proposed by a third party seeking to acquireor merge with us and could deter such third party from making a competingacquisition proposal.

 

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

 

Under the terms of our 2004 Amended and RestatedStock Option and Incentive Plan, or the 2004 Plan, we have issued shares ofrestricted stock to our employees.  Onthe date that these restricted shares vest, we withhold, via a net exercise provisionpursuant to our applicable restricted stock agreements and the 2004 Plan, thenumber of vested shares (based on the closing price of our common stock on suchvesting date) equal to tax withholdings required by us. Up until May 2009the shares withheld from the grantees to settle their tax liability werereallocated to the number of shares available for issuance under the 2004 Plan;in May 2009 the 2004 Plan was amended and shares withheld from thegrantees to settle taxes are no longer reallocated to the number of sharesavailable for issuance. For the three month period ending March 31, 2010,we withheld an aggregate of 65,755 common shares under restricted stock unitsat a price of $11.04 per share.

 

**Purchases of Equity Securities by the Issuer andAffiliated Purchasers**

 

On November 3, 2009, our board of directors authorized therepurchase of up to $40.0 million of our common stock, par value $0.01 pershare, through a share repurchase program. On February 12, 2010, our boardof directors increased the amount available under the share repurchase programby an additional $25.0 million. As authorized by the program, shares maybe purchased in the open market or through privately negotiated transactions ina manner consistent with applicable securities laws and regulations, includingpursuant to a Rule 10b5-1 plan maintained by us.

 

This share repurchase program does not obligate us to acquire anyspecific number of shares and may be extended, suspended or discontinued at anytime. All repurchases are expected to be funded from our cash and investmentbalances. While our board of directors have approved the share purchasingguidelines, the timing of the repurchases and the exact number of shares ofcommon stock to be purchased were determined at management’s discretion, anddepended upon market conditions and other factors, including price, corporateand regulatory requirements and alternative investment opportunities. The newrepurchase program is currently scheduled to terminate on December 31,2010.

 

For the three months ended March 31, 2010, we repurchased1,934,707 shares of our common stock for an aggregate purchase price, includingapplicable brokers’ fees, of $26.0 million pursuant to this stockrepurchase program.

 

The following table sets forth our purchases of equity securities forthe three months ended March 31, 2010:

 
| **Period**                                        | ** ** | **Total number  of shares  purchased** | ** ** | **Average  Price Paid  per Share(1)** | ** ** | **Total number of  shares purchased  as part of  publicly  announced  plans or  programs** | ** ** | **Approximate dollar  value of shares  that may yet be  purchased under  the plans  or programs  (in thousands)** | ** ** |
|---------------------------------------------------|------------|----------------------------------------|------------|---------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|
| January 1, 2010—January 31, 2010   |       | 731,843                                |       | $                                     | 14.96      |                                                                                       | 731,843    |                                                                                                              | $          | 40,013 |   |
| February 1, 2010—February 28, 2010 |       | 1,202,864                              |       | 12.48                                 |       | 1,202,864                                                                                  |       | 25,000                                                                                                            |       |
| March 1, 2010—March 31, 2010       |       | —                                 |       | —                                |       | —                                                                                     |       | —                                                                                                            |       |
| Total                                             |       | 1,934,707                              |       |                                  |       | 1,934,707                                                                                  |       |                                                                                                              |       |
|                                                   |            |                                        |            |                                       |            |                                                                                            |            |                                                                                                                   |            |  |  |

 

36

----

Table ofContents

 

----

(1)                Includes applicable brokers’fees and commissions

 

**Item 4.       *(Removed and Reserved)***

 

**Item 5.       *Other Information***

 

Our policy governing transactions in our securitiesby directors, officers and employees permits our officers, directors andcertain other persons to enter into trading plans complying with Rule 10b5-1under the Securities Exchange Act of 1934, as amended. Generally, under thesetrading plans, the individual relinquishes control over the transactions oncethe 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. As of the date ofthis filing no directors or officers have trading plans in effect.

 

We anticipate that, as permitted by Rule 10b5-1and our policy governing transactions in our securities, some or all of ourofficers, directors and employees may establish trading plans in the future. Weintend to disclose the names of executive officers and directors who establisha trading plan in compliance with Rule 10b5-1 and the requirements of ourpolicy governing transactions in our securities in our future quarterly andannual reports on Form 10-Q and 10-K filed with the Securities andExchange Commission. However, we undertake no obligation to update or revisethe information provided herein, including for revision or termination of anestablished trading plan, other than in such quarterly and annual reports.

 

37

----

Table of Contents

 

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

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                         |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                               |
|  2.1   |       | Agreement and Plan of Merger by and among Phase Forward Incorporated,  Oracle Corporation and Pine Acquisition Corporation, dated as of April 15,  2010. (Incorporated by reference herein to Exhibit 2.1 of the Company’s  Current Report on Form 8-K filed with the SEC on April 16, 2010.) |
| 10.1 *+     |       | Amended and restated summary of cash compensation practices for  non-employee directors                                                                                                                                                                                                            |
| 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.                                                                                                                                                                       |

 

----

*** Filedherewith.**

**+Indicates a management contract or any compensatory plan, contract or arrangement**

 

38

----

Table of Contents

 

**Signatures**

** **

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
| ** **              | **PHASE FORWARD INCORPORATED** |
|-------------------------|--------------------------------|
|                    |                           |
|                    | By:                            | /s/ ROBERT K. WEILER |
|                    |                           | Robert K. Weiler |
|                    |                           | *Chief Executive Officer* |
|                    |                           | *(Duly authorized officer)* |
|                    |                           |   |
|                    | By:                            | /s/ CHRISTOPHER A. MENARD |
|                    |                           | Christopher A. Menard |
|                    |                           | *Chief Financial Officer* |
|                    |                           | *(Duly authorized officer and principal financial  officer)* |
| Date: May 10, 2010 |                           |   |

 

39

----

Table of Contents

 

**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                                                                                                                                                                                                                                         |
|-------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **No.**     | ** ** | **Description**                                                                                                                                                                                                                                                                                    |
|        |       |                                                                                                                                                                                                                                                                                               |
|  2.1   |       | Agreement and Plan of Merger by and among Phase Forward Incorporated,  Oracle Corporation and Pine Acquisition Corporation, dated as of April 15,  2010. (Incorporated by reference herein to Exhibit 2.1 of the Company’s  Current Report on Form 8-K filed with the SEC on April 16, 2010.) |
| 10.1 *+     |       | Amended and restated summary of cash compensation practices for  non-employee directors                                                                                                                                                                                                            |
| 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.                                                                                                                                                                       |

 

----

* Filed herewith.

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

 

40

----